Sense on Cents

An independent Federal Reserve Bank has been one of the cornerstones of free market capitalism. In my opinion, those days are over. Politicians, central bankers, and financial titans would certainly dispute this statement; the simple fact of the matter is the Fed has not been an independent entity for a long time. That lack of independence is now further exposed. President Obama’s plan to designate the Fed as the uber-regulator for our financial system solidifies it.

The need for an independent central bank has always been viewed as critical to the workings of our markets. The Federal Reserve itself promotes this independence:

Who owns the Federal Reserve?

The Federal Reserve System is not “owned” by anyone and is not a private, profit-making institution. Instead, it is an independent entity within the government, having both public purposes and private aspects.

As the nation’s central bank, the Federal Reserve derives its authority from the U.S. Congress. It is considered an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive or legislative branch of government, it does not receive funding appropriated by Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms. However, the Federal Reserve is subject to oversight by Congress, which periodically reviews its activities and can alter its responsibilities by statute. Also, the Federal Reserve must work within the framework of the overall objectives of economic and financial policy established by the government. Therefore, the Federal Reserve can be more accurately described as “independent within the government.”

The market has traditionally viewed the workings of the Fed as being above the fray. In years past, that independence was critiqued as being almost secretive. The Fed heard those criticisms and has tried to be more transparent while still independent.

In my opinion, the Fed can no longer lay claim to being an independent entity. In fact, the more I see and hear of the Fed recently, it has not been an independent entity for a protracted period. When did the Fed begin to lose its independence? Under Alan Greenspan during the late ’90s, if not before.

While Greenspan was the chair of the Fed, he was enormously well respected. In hindsight, he was not near the star we thought and history will not treat him kindly.

Greenspan politicized the Fed more than we ever knew. He curried favor with the Clinton administration and was heavily involved in keeping the derivatives market unregulated. Until now.

Paul McCulley of Pimco along with Jonathan Fuerbringer wrote Your Financial Edge. In their book they highlight how Greenspan intentionally kept interest rates low to support and promote housing in the United States after the Nasdaq imploded at the turn of the century.

Greenspan has shown himself to be as much a social engineer as he was a central banker. The Fed lost its moral compass in the process and has never fully regained it.

An independent Fed should only have to play defense twice a year–that is when the Fed chair presents to Congress. Beyond that, an independent Fed should remain above the fray while providing a necessary measure of transparency. Otherwise, the Fed can and will become beholden to market forces and short term volatility.

I see that just today Bloomberg reports, Fed Weighs Using Statement to Damp Rate Speculation:

Federal Reserve officials are considering whether to use next week’s policy statement to suppress any speculation they’re prepared to raise interest rates as soon as this year.

A Fed that is transparent as necessary is one thing; a Fed that is deemed as reactionary is something far different. Market participants will prey upon a central bank that has shown it can be influenced by market prices. In doing so, the market participants will attempt to create leverage over that bank, be it the Fed or any other central bank.

The Fed can not allow itself to be held “hostage” by the ebb and flow of market prices and volatility. As Bloomberg reports:

“How do you get people to believe what you have been saying?” Feroli said.

In my opinion, you can call the Fed a lot of things . . . but please don’t call it independent any longer.

LD

This entry was posted on Wednesday, June 17th, 2009 at 3:04 PM and is filed under Federal Reserve, General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.