[Senate Hearing 114-5]
[From the U.S. Government Publishing Office]

                                                          S. Hrg. 114-5




                               before the

                              COMMITTEE ON
                          UNITED STATES SENATE


                             FIRST SESSION


                        AND THE AMERICAN PUBLIC


                             MARCH 3, 2015


  Printed for the use of the Committee on Banking, Housing, and Urban 


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                  RICHARD C. SHELBY, Alabama, Chairman

MICHAEL CRAPO, Idaho                 SHERROD BROWN, Ohio
BOB CORKER, Tennessee                JACK REED, Rhode Island
DAVID VITTER, Louisiana              CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois                  JON TESTER, Montana
DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
TIM SCOTT, South Carolina            JEFF MERKLEY, Oregon
BEN SASSE, Nebraska                  ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas                 HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota            JOE DONNELLY, Indiana

           William D. Duhnke III, Staff Director and Counsel
                 Mark Powden, Democratic Staff Director
                    Jelena McWilliams, Chief Counsel
                    Dana Wade, Deputy Staff Director
                Jack Dunn III, Professional Staff Member
            Laura Swanson, Democratic Deputy Staff Director
                Graham Steele, Democratic Chief Counsel
              Phil Rudd, Democratic Legislative Assistant
                       Dawn Ratliff, Chief Clerk
                      Troy Cornell, Hearing Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor


                            C O N T E N T S


                         TUESDAY, MARCH 3, 2015


Opening statement of Chairman Shelby.............................     1

Opening statements, comments, or prepared statements of:
    Senator Brown................................................     2


John B. Taylor, Mary and Robert Raymond Professor of Economics, 
  Stanford University............................................     4
    Prepared statement...........................................    34
Allan H. Meltzer, The Allan H. Meltzer University Professor of 
  Political Economy, Tepper School of Business, Carnegie Mellon 
  University.....................................................     6
    Prepared statement...........................................    36
    Responses to written questions of:
        Chairman Shelby..........................................    72
        Senator Vitter...........................................    74
Paul H. Kupiec, Resident Scholar, American Enterprise Institute..     7
    Prepared statement...........................................    58
    Responses to written questions of:
        Chairman Shelby..........................................    75
        Senator Vitter...........................................    79
        Senator Heller...........................................    80
Peter Conti-Brown, Academic Fellow, Stanford Law School, Rock 
  Center for Corporate Governance................................     8
    Prepared statement...........................................    66
        Chairman Shelby..........................................    83
        Senator Vitter...........................................    86

              Additional Material Supplied for the Record

Chart of the Federal Reserve Survey of Consumer Finances 
  submitted by Senator Brown.....................................    88
Testimony of Ron Paul, Chairman, Campaign for Liberty............    89




                         TUESDAY, MARCH 3, 2015

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 2:35 p.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Richard C. Shelby, Chairman of the 
Committee, presiding.


    Chairman Shelby. The Committee will come to order. We have 
had a vote. That is the reason we are not exactly on time, so 
we will get started.
    Last week, the Committee began examining potential reforms 
to the Federal Reserve System. We heard the views of Federal 
Reserve Chair Janet Yellen on this topic right here. Today we 
will further explore options to improve the oversight and 
structure of the Fed.
    Many of the Fed's actions since the financial crisis have 
emphasized the need for greater accountability. The Fed has 
undertaken three rounds of quantitative easing and grown its 
balance sheet to a staggering $4.5 trillion.
    Although the Fed has concluded new bond purchases, it has 
not yet begun to unwind its balance sheet. It has also kept its 
target interest rate close to 0 percent for more than 6 years.
    After these unprecedented actions, how will the Fed measure 
its impact on the economy? It is not entirely clear. 
Considering the extent of the monetary stimulus and the risk 
involved, the Fed should be prepared to explain this. And what 
indicators will the Fed use to determine the appropriate time 
to unwind its balance sheet? Again, it is not clear. The Fed 
should not only be able to answer these questions; it should be 
held accountable for its actions.
    Federal Reserve officials have stressed the importance of 
the Fed's independence, but such independence does not mean 
that it is immune from congressional oversight. After all, 
Congress wrote the statute that created the Fed and sets forth 
its policy objectives.
    Last week, Chair Yellen testified before this Committee 
that she believes the current structure of the Federal Reserve 
System is working well. The current structure, however, has 
allowed the Fed to expand its reach in many ways.
    The Fed's jurisdiction now covers almost every aspect of 
the financial system. Much of the expansion in its authority 
has been centralized in Washington, DC, and New York. The Fed 
now has extensive new rulemaking power which gives it the 
ability to regulate entities it did not before the crisis. 
Dodd-Frank greatly expanded the regulatory reach of the Federal 
Reserve. It did not, however, examine whether it was correctly 
structured to account for these new and expansive powers.
    Therefore, the Committee will be examining the 
appropriateness of the Fed's current structure in a post- Dodd-
Frank world. As part of this effort, we will review proposals 
aimed at providing greater clarity in Fed decision making and 
reforming the composition of the Federal Reserve System. I have 
asked for the input of the Federal Reserve Banks and welcome 
their feedback in the coming weeks.
    Today I look forward to hearing from the witnesses on 
proposals to reform or to restructure the Fed. We have a very 
distinguished panel of experts before us, and I thank them for 
being here today.
    The U.S. Congress created the Federal Reserve System to 
perform a specific set of functions. And while the Fed is an 
important institution, it is not beyond the reach of 
congressional oversight. I believe it is entirely appropriate 
that Congress periodically review the Fed's structure and its 
authorities. If we believe changes are necessary, changes 
should be made. But first we should examine all of this.
    Senator Brown.


    Senator Brown. Thank you, Mr. Chairman. Thank you for doing 
this hearing today.
    I would like to, first of all, welcome Mr. Kupiec and Mr. 
Meltzer back. They both testifies at a Subcommittee hearing 
that Senator Toomey and I did a couple of years ago. Welcome 
    The Federal Reserve System was designed, as we know, to be 
accountable to Congress and to the American people, while 
maintaining the central bank's independence, all important 
functions. The Chair of the Fed is appointed by the President 
and confirmed, as are the other six Governors, and the Chair is 
required to testify before Congress twice a year, as she did 
last week to this Committee.
    Over time, the Fed has become more accountable to the 
public. The Fed's operations are the most transparent they have 
ever been in its history. Various Government agencies and an 
outside auditing firm regularly review and audit the Fed's 
activities and financial statements, with important exceptions. 
After the crisis, as we know, the Fed began to issue regular 
reports to Congress on its lending programs. In December 2010, 
the Fed released loan details for each emergency program 
created during the crisis. It publicly releases records on its 
discount window loans and open market operations with a 2-year 
    As a result of Wall Street reform, the GAO audited the 
Fed's emergency facilities and governance. The Fed Open Market 
Committee holds press conferences four times a year--half of 
its meetings, if you will--to present its current economic 
projections and provide context for its monetary policy 
decisions. I continue to have concerns about the slow pace of 
the recovery for most Americans. FOMC's monetary policy, I 
would argue, has allowed--factually has allowed for sustained 
economic growth.
    Some pundits and politicians have been critical of these 
steps, predicting runaway inflation for years. They have been 
decidedly wrong. But our economy continues to gain jobs, and 
prices have remained stable.
    Under the guise of additional transparency and 
accountability, some are proposing to second-guess the 
decisions of an independent central bank. The Fed certainly 
looms larger in the economy than it has in the past, but the 
Fed's extraordinary measures were the result of extraordinary 
excesses in our economy. And changing course to pursue only one 
part of the Fed's mandate harms workers.
    As a result of the crisis, the Fed gained new authority 
over the Nation's largest banks in nonbank firms designated as 
``systemically important.'' If we learned anything from the 
financial crisis, it is that we all have a responsibility to 
remain vigilant in our oversight of Wall Street risk taking.
    Governor Tarullo has called for capping on the nondeposit 
liabilities of the largest financial institutions as a way to 
end too big to fail, a proposal similar to the one that 
introduced in 2010 that Dr. Meltzer commented on and that I 
offered as an amendment to the Dodd-Frank Act that both 
Democrats and Republicans, including some on this Committee, 
    We should hold a hearing on that proposal, Mr. Chair. We 
should give the Federal Reserve the authority to implement 
that. And rather than attempting to interfere in or, more 
problematically, dictate monetary policy, Congress should focus 
on whether the Fed is protecting consumers, as is its charge; 
ensuring safety and soundness, perhaps its most important 
function; and strengthening the financial stability of our 
financial system.
    The Committee should consider if the current governance of 
the Fed appropriately holds the regulators accountable and 
encourages diverse perspectives. For example, the Reserve Bank 
Presidents are not Presidentially appointed. We know the seven 
Washington Governors are. We know the Presidents of the 12 
districts are not. The Class A and Class B Directors of each of 
the Federal Reserve Bank Boards are either member banks or 
chosen by the member banks. The Class C Directors are selected 
somehow, some way, but not all that specifically prescribed, by 
the Board of Governors in Washington, the Class C Directors in 
the 12 district.
    With independent and accountable leaders, diverse 
perspectives, and strong regulation, the Federal Reserve System 
can be responsive, should be more responsive to the American 
public. That is where we should focus our discussion of 
reforms. Some changes would require legislation, some would 
not. We should be thoughtful, we should be careful before we 
choose to proceed.
    Thank you, Mr. Chairman.
    Chairman Shelby. Thank you.
    I would like to introduce our distinguished panel to the 
Committee. Their written testimony, all of it, will be made 
part of the record in its entirety.
    First we will hear the testimony of Dr. John B. Taylor, who 
is no stranger to this Committee. Dr. Taylor is the Mary and 
Robert Raymond Professor of Economics at Stanford University. 
He is a well-known expert on monetary policy, and I welcome him 
again here today.
    Second we will hear from Dr. Allan Meltzer, who is the 
Allan H. Meltzer University Professor of Political Economy at 
the Tepper School of Business at Carnegie Mellon University. 
Dr. Meltzer wrote the definitive history of the Fed and is well 
regarded for his knowledge on this subject. We welcome you 
again to the Committee.
    Next we will hear testimony from Dr. Paul Kupiec, a 
Resident Scholar at the American Enterprise Institute, who has 
held positions at the FDIC and the Federal Reserve Board, among 
    Finally, we will hear from Mr. Peter Conti-Brown, an 
Academic Fellow at Stanford Law School, Rock Center for 
Corporate Governance, who has also written on these matters.
    I thank all of you for appearing here today. Dr. Taylor, we 
will start with you. You need to turn on the mic.


    Mr. Taylor. Thank you, Mr. Chairman, Ranking Member Brown, 
and other Members of the Committee, for inviting me to testify. 
I would like to focus on a particular reform that I think would 
improve the accountability and transparency of monetary policy 
and lead to better economic performance. The reform would 
simply require the Fed to describe its strategy for monetary 
policy. It is a reform about which you, Mr. Chairman, and 
Congressman Jeb Hensarling asked Fed Chair Janet Yellen quite a 
bit about at her hearings last week.
    The prime example of such a reform is a bill which passed 
the House Financial Services Committee last year. The bill 
would require that the Fed, and I quote, ``describe the 
strategy or rule of the Federal Open Market Committee for the 
systematic quantitative adjustment'' of its policy instruments. 
It would be the Fed's job to choose the strategy and to 
describe it. The Fed could change the strategy or deviate from 
it if circumstances called for it, but the Fed would have to 
explain why.
    In considering the merits of such a reform, I think it is 
important to emphasize the word ``strategy'' in the bill. 
Though economists frequently use the word ``rule'' rather than 
``strategy,'' the term ``rule'' can sometimes be intimidating 
if one imagines, incorrectly, that a rules-based strategy must 
be purely mechanical.
    The Congress, through the Banking Committee and the 
Financial Services Committee, is in a good position--in fact, 
it is a unique position in our Government--to oversee monetary 
policy in a strategic sense, not in a tactical sense.
    Experienced policymakers know the importance of having a 
strategy and the close connection between a strategy and rules-
based processes. George Shultz put it this way, and I quote: 
``I think it is important, based on my own experience, to have 
a rules-based monetary policy. If you have policy rule, you 
have a strategy. A strategy is a key element in getting 
    Fed Chair Janet Yellen made similar observations when she 
served on the Federal Reserve Board in the 1990s. She 
explained, and I will quote, ``The existence of policy 
tradeoffs requires a strategy for managing them.'' And then she 
went on to describe a policy rule pointing out ``several 
desirable features'' it has ``as a general strategy for 
conducting monetary policy.'' She also stated a rule would 
``help the Federal Reserve communicate to the public the 
rationale behind policy moves, and how those moves are 
consistent with its objectives.''
    Experience and research by many people over many years has 
shown that a rules-based monetary strategy leads to good 
economic performance. During periods when policy is more rules-
based, as in much of the 1980s and the 1990s, the economy 
performed well. During periods such as the 1970s and the past 
decade when policy has been more discretionary, economic 
performance has been poor.
    But as economists Michael Belongia and Peter Ireland put it 
recently, ``For all the talk about `transparency,' . . . the 
process--or rule--by which the FOMC intends to defend its 2-
percent inflation target remains unknown.''
    In answering questions last week, the Fed Chair said, and I 
quote, ``I do not believe that the Fed should chain itself to 
any mechanical rule.'' But the reforms in question would not 
chain the Fed. The Fed would choose its own strategy, which 
presumably would not be mechanical. And it could change or 
deviation from the strategy if it gave the reasons why.
    Another concern is that by publicly describing its 
strategy, the Fed would lose independence. But based on my own 
experience in Government, the opposite is more likely. A clear 
public strategy helps prevent policymakers from bending to 
    Some have expressed concern that a rules-based strategy 
would be too rigid. But this reform provides flexibility. It 
would allow the Fed to serve as lender of last resort and take 
appropriate actions in the event of a crisis.
    Another concern is expressed by those who claim the reform 
would require the Fed to follow the so-called Taylor rule, but 
that is not the case. The bill from the House does require the 
Fed to describe how its strategy or rule might differ from a 
``reference rule,'' which happens to be the Taylor rule. 
However, that is a natural and routine task for people who work 
on rules, and the Fed does it all the time.
    There is precedent for this type of congressional 
oversight. I think it is important to emphasize that, in this 
Committee in particular. Previous legislation, which was put in 
the Federal Reserve Act in 1977 and removed in the year 2000, 
required the Fed to report on the ranges of its money and 
credit aggregates. In many ways, the reform I am referring to 
today is simply needed to fill the void left by the removal of 
that requirement in the year 2000.
    The Congress and this Committee in particular have an 
opportunity to move forward on such a reform, I believe in a 
nonpartisan way, with constructive input from the Fed. The 
result would be a more effective monetary policy based on an 
accountable strategy.
    Thank you. I am happy to answer any questions.
    Chairman Shelby. Dr. Meltzer.


    Mr. Meltzer. Mr. Chairman, Senator Brown, other Members, I 
welcome the opportunity to discuss this issue with you.
    Let me step back and ask, What do you think James Madison, 
the founder, the writer, the author of our Constitution, would 
say if he were told that an agency of the Federal Government 
has increased its balance sheet by a factor of four, four times 
what it had before, without any substantial oversight on the 
part of this Committee or the House Committee? I think he would 
be appalled. And I am appalled, and you should be appalled. 
That is a sign that we need change. We need change to improve 
the oversight that this Committee and the House Committee 
exercises over the Fed. You have the responsibility. Article I, 
Section 8 gives that to you.
    But you do not have the ability to exercise authority. You 
are busy people. You are involved in many issues. The 
Chairperson of the Fed is a person who has devoted his life to 
monetary policy. There is not any series of questions that you 
can ask on the fly that they are not going to be able to brush 
aside. That is why you need a rule. I agree with John Taylor 
about some of the reasons for the rule, but I believe one of 
the most important is that Congress has to fulfill its 
obligation to monitor the Fed, and it cannot do that now 
because the Chairman of the Fed can come in here, as Alan 
Greenspan has said on occasion, Paul Volcker has said on 
occasion, and they can tell you whatever it is they wish, and 
it is very hard for you to contradict them.
    So you need a rule which says, look, you said you were 
going to do this, and you have not done it. That requires an 
answer, and that I think is one of the most important reasons 
why we need some kind of a rule.
    Now, the idea of a rule is not some newfangled idea. The 
Federal Reserve in 1913 started under two substantial rules. 
Rules. One was the gold standard. The other was a rule which, 
listen, you are not allowed to buy any Government bonds for any 
purpose. That rule was relaxed, and then it was circumvented, 
because while they cannot lend money directly to the Treasury, 
they can buy it in the market, buy the Treasury's debt in the 
market the moment after it comes out. So those rules were, by 
the 1920s and the 1930s, completely circumvented. The gold 
standard had gone. The other rule, which bound the Fed to be 
responsible and not to finance the Treasury's debt the way it 
has been doing, those rules were gone.
    So there is a need for improved oversight, and there is a 
need for Congress to impose a burden on the Fed.
    Is the Fed now an independent agency? In part, but only in 
part. The New York Bank is the agent primarily these days of 
the New York banks. The Fed Board from the very beginning, back 
in Woodrow Wilson's time, was always referred to as ``the 
political branch of the Fed,'' the regional banks being the 
academic or reliable public policy agencies. And as crises have 
occurred, the power of the Board has increased, and the power 
of the banks has been reduced. So the Fed is a more political 
institution than it has been in the past.
    Senator Brown and Senator Vitter introduced a bipartisan 
bill dealing with the question of oversight of financial 
fragility. The essence of that bill is a simple but most 
important point. It asks you to think about this question: Who 
is going to be a better watchdog of responsible, prudent 
policies--the equity owners of a bank or the regulators? Well, 
we know the answer. The regulators totally failed in 2006 and 
2007 to do things. They allowed agencies, banks, to set up off-
balance-sheet facilities that bought these bad mortgages, had 
no capital in them. They did not regulate at all in advance of 
the crisis. In fact, they denied that there was such a thing as 
a need for regulation in advance of the crisis.
    The Brown-Vitter bill says the responsibility will be 
exercised most effectively if you put the capital requirement 
high enough so that if the management is lax, the principal 
stockholders will say, ``What in God's name are you doing to 
our money?'' That is what you want.
    Chairman Shelby. Dr. Kupiec.

                      ENTERPRISE INSTITUTE

    Mr. Kupiec. Chairman Shelby, Ranking Member Brown, and 
distinguished Members of the Committee, thank you for convening 
today's hearing. I have submitted detailed written testimony 
which I will summarize in my oral remarks.
    Congress retains the responsibility for Federal Reserve 
oversight, and it may exercise this oversight in many ways--
through laws requiring transparency and public disclosure, 
through regular reports to Congress, or through special 
hearings like today's.
    Congress may also use the Government Accountability Office, 
or GAO, to investigate or audit Fed performance. GAO audits are 
a flexible tool. They produce useful reports overall, but these 
reports can sometimes be superficial and detect only obvious 
weaknesses in Government agency practices and performance. For 
monetary policy oversight, legislation will be required because 
existing laws prohibit the GAO from evaluating the Federal 
Reserve's activities on monetary policy.
    The GAO, however, may examine other Federal Reserve 
activities, including the Fed's expanded regulatory powers 
under the Dodd-Frank Act. In my opinion, many Federal Reserve 
Board regulatory activities merit closer congressional 
oversight. Because time is limited, I will focus on three areas 
that are especially important.
    First, Congress should examine the Fed's involvement with 
international standard-setting bodies, like the Financial 
Stability Board, or FSB. The Fed has enormous influence over 
FSB policy development because the Fed contributes a very large 
and highly credentialed staff to these FSB activities. FSB 
working groups formulate the FSB's financial stability 
policies, its G-SIFI designations, and its international 
agreements on heightened supervision and capital regulation.
    The FSB's goal is to promote and impose uniform 
international financial stability policies on its members, and 
its members include the Federal Reserve Board. It is not a 
coincidence that the FSB regulatory policies are subsequently 
introduced as U.S. regulatory policy. But the Federal Reserve 
does not consult the Congress before negotiating or reaching 
agreement on FSB policy directives, even though these 
directives look a lot like international treaties.
    This worrisome pattern has appeared in FSOC designation 
decisions on insurance companies. The FSB published a list of 
insurance G-SIFIs, and only later were these G-SIFIs designated 
by the FSOC, despite protests from multiple U.S. insurance 
regulators on the designation. There are danger signs that this 
pattern will be repeated. On shadow banking, the FSB is in the 
process of making G-SIFI designations and formulating 
heightened supervision and capital regulations. For insurance, 
FSB work is underway on capital requirements and heightened 
    My second suggestion is that Congress critically examine 
the recurring Board of Governors' stress tests mandated by 
Section 165 of the Dodd-Frank Act. These stress tests are very 
expensive for both banks and bank regulators. Yet there is no 
evidence that these tests are a cost-effective method for 
supervising individual financial institutions or for even 
identifying hidden risks in the financial sector. The 
quantitative test outcomes are arbitrary and completely under 
the control of the Federal Reserve Board because they are 
driven by the Fed's subjective modeling judgments. The 
uncertainty associated with these tests make it difficult for 
banks to anticipate their capital needs when they consider 
future business plans.
    My final recommendation is for Congress to investigate the 
conflict that has been created by the Fed's expanded insurance 
powers under Dodd-Frank. Using new powers, the Fed is now 
examining insurers that have long been examined by State 
insurance supervisors. The old system has worked perfectly 
    About one-third of the insurance industry is now facing Fed 
supervision. For this industry segment, the Fed is also 
imposing bank holding company capital standards on top of the 
capital standards set by State insurance regulators. This Fed 
entry into domestic insurance supervision and the Fed's 
participation in the FSB insurance work streams developing 
international capital standards for insurance companies has 
created concerns that the Fed will seek to impose bank-style 
capital regulation on all U.S. insurance companies. Dodd-Frank 
framers were careful not to create a national insurance 
regulator, and yet the Fed is taking steps that could in the 
near future make it de facto the national insurance regulator.
    Thank you.
    Chairman Shelby. Mr. Conti-Brown.


    Mr. Conti-Brown. Chairman Shelby, Ranking Member Brown, 
distinguished Members of the Committee, thank you for the 
opportunity you have given me to testify today. I am a legal 
scholar and a financial historian who focuses on the 
institutional evolution of the Federal Reserve System. Much of 
my written testimony and oral testimony I will be presenting 
today come from my book, ``The Power and Independence of the 
Federal Reserve,'' which is forthcoming from Princeton 
University Press, and a paper I presented at the Brookings 
Institution yesterday. I note that I am here on my own behalf 
and do not speak for any organization.
    Since before its founding in 1913, the Fed has engendered 
enormous controversy. People recognize that the Fed wields 
extraordinary power over the economy, but they do not always 
see how that power operates or who exactly is pulling the 
levers. This opacity has prompted reform proposals from the 
left and the right throughout the Fed's history.
    The solution to this opacity seems plain enough: Turn on 
the lights, increase transparency, define the Fed's limits, and 
let the work of democratic politics drive the agenda for 
monetary policy in a clear and transparent way, as it does in 
so many other areas of our Government.
    I am very sympathetic to this impulse. The Fed is the 
people's central bank and must, in appearance and in fact, make 
its policies on behalf of the entire people. But there is a 
unique tension in central banking that does not exist in other 
policy contexts.
    In terms of democratic control over monetary policy, there 
can be too much of a good thing. The innovation of central bank 
independence or the separation of monetary policy from the day-
to-day of electoral politics helps us as a democracy to take 
the long view when it comes to the value of our currency and 
the management of financial and economic crises and economic 
growth. Short-term political considerations are useful in many 
contexts, but managing the value of the currency has not 
historically been one of them.
    The legislative task then is to balance this tension 
between the need, even the constitutional demand, to make the 
Fed democratically accountable without turning it into a 
political football that erases this institutional innovation of 
central bank independence. We must maintain that buffer between 
the day-to-day operation of monetary policy and the day-to-day 
of electoral politics.
    The legislative proposals to reform the Fed currently 
pending before the Congress, as with literally hundreds of 
others that have preceded them, deal with the need to strike 
this balance with varying degrees of success. In general, these 
proposals come in two forms: they either deal with the 
functions of the Federal Reserve or with its structure. In 
other words, they seek to dictate macroeconomic policies or 
seek to influence the Fed's personnel.
    I am generally more sympathetic to structural changes to 
the Fed than to functional ones. To illustrate, let me discuss 
very briefly two pending proposals: the Audit the Fed bill and 
Senator Reed's bill changing the governance structure of the 
Federal Reserve Bank of New York.
    First, Audit the Fed. This is, as the saying goes, 
something of a solution looking for a problem. The Fed is, as 
Senator Brown already noted, already audited, its balance sheet 
increasingly transparent, its communications with the public 
increasingly frequent and clear. Indeed, the entire language of 
balance sheets and profits and leverage and equity are at best 
metaphors, at worst fictions, when applied to the Fed. And this 
bill would insert Congress into the day-to-day of monetary 
policymaking, a place that Congress has historically, rightly, 
decided to avoid.
    Ironically, although most of the proponents of the public 
audit focus on combating inflation, the proposal risks 
institutionalizing pressure to pursue the inflationary policies 
that usually command the strongest support in a democracy. 
Indeed, the first adopters of a public audit were not inflation 
hawks but employment doves.
    Second, Senator Reed has proposed to subject the President 
of the New York Fed to Presidential appointment and Senate 
confirmation. I like this proposal much more. The New York Fed 
occupies a unique place in our financial system. It has a 
permanent vote on the Federal Open Market Committee, the only 
one without a Presidential appointment. And given its location, 
it supervises some of the largest banks in the country. That 
its President is selected in part by the banks it must regulate 
is, frankly, astonishing from a governance perspective. This 
governance structure feeds the popular impulse that the banking 
regulators do not work for the people. This view cannot be 
dismissed as a crank conspiracy theory. It finds support in the 
structure of the Federal Reserve Act itself.
    Allowing the regulated banks to have this kind of direct, 
proximate control over their Federal regulators should be 
addressed. It makes the Reserve Banks something of the gall 
bladder of the financial system: they perform a useful but not 
essential function on behalf of the regulated banks in good 
times, but can allow the banks to introduce extraordinary risk 
into the system in bad. A public appointment at the New York 
Fed would balance the need to ensure that the Fed serves the 
public interest without eliminating the valuable buffer between 
the Fed and the daily press of electoral politics.
    An alternative to this proposal would be to remove the 
bankers and their representatives from the Fed's governance 
structure completely and render the Reserve Banks fully 
subordinate to the publicly accountable Board of Governors. 
Regardless, the Reserve Banks' governance represents in 
appearance and in fact the kind of private influence over 
public goods that our political institutions are designed to 
    Thank you again for this opportunity. I look forward to 
your questions.
    Chairman Shelby. Thank you, sir.
    Currently, the New York Fed President permanently holds 
Vice Chairmanship on the Federal Open Market Committee that you 
alluded to, with four remaining votes allocated to the other 11 
regional banks on a rotating basis. Dallas Fed President 
Richard Fisher recently addressed the concern, and I will 
quote, and he says, ``Too much power is concentrated in the New 
York Fed.'' He put forward a proposal that would, among other 
things, rotate the Vice Chairmanship and give the Federal 
Reserve Bank Presidents the same number of votes as the 
Washington-based Governors, save the Federal Reserve Chair.
    To all of you, and, Dr. Taylor, I will start with you, do 
you support any of Mr. Fisher's proposals?
    Mr. Taylor. I think that is a good start. He points to a 
problem about the New York Fed and proposes a solution which 
kind of equalizes across the other members.
    Chairman Shelby. Dr. Meltzer.
    Mr. Meltzer. I agree with Mr. Fisher. My own proposal was 
that the Presidents of the Reserve Banks should be given the 
voting power because they are much more--the Boards have been 
changed over the years. They now have labor union 
representatives, women representatives. They are no longer 
banker boards, and they represent something much closer to the 
public interest than we get from the New York Fed, which 
represents the New York banks.
    Chairman Shelby. Dr. Kupiec.
    Mr. Kupiec. The New York Fed has enormous power within the 
Federal Reserve System. They have the closest contacts with the 
markets. They typically feed a lot of the market intelligence 
to the Board of Governors and control the information flow. So 
I think methods to level the playing field and make other parts 
of the country equally important. Some have discussed not just 
rotating the Vice Chairman of the FOMC, but actually moving the 
markets desk across different banks. This would give each bank 
access for a certain period of time and give access to the 
markets and have backup facilities available if something were 
ever to happen, God forbid, in New York or somewhere else 
    So I think it makes a lot of sense to diversify the New 
York power base across the system. Thank you.
    Chairman Shelby. Mr. Conti-Brown.
    Mr. Conti-Brown. I also agree that this is a very good 
first step in the right direction. I would make two points, one 
of law and one of history.
    Legally, the Federal Reserve Act does not dictate who will 
be the Vice Chair of the FOMC. That is determined by the FOMC's 
internal regulations. So it is only by convention and tradition 
that the New York Fed President is the Vice Chair. So President 
Fisher's recommendation could be instituted tomorrow by the 
    Second, historically it is inaccurate, too, to say that the 
New York Fed has always had a permanent vote on the FOMC. 
Between the years of 1935 and 1942, it rotated along with the 
over Reserve Bank Presidents. So this is also something that 
has a precedent in history and something that I think--anything 
that would deemphasize the influence in perception and in fact 
of representatives of the financial industry in New York I 
think would be a step in the right direction.
    Chairman Shelby. Rules-based monetary policy. Dr. Taylor, 
you are well known for your work in developing a monetary 
policy rule known as the Taylor rule. We talk about it here a 
lot. You indicated in your opening statement that such a rule, 
whether it be the Taylor rule or another rule, would more 
effectively highlight the Fed's strategy, as you talked about. 
As you stated, Chair Yellen said that she would not be a 
proponent of chaining the Federal Open Market Committee in its 
decision making to any rule whatsoever. You mentioned several 
reasons why this should not be the real case.
    Would you discuss in a little more detail how Congress 
could structure a monetary policy rule to allow flexibility and 
predictability, not to make monetary policy but to do proper 
    Mr. Taylor. I think the key is to require that the Fed 
describe, choose, its own policy rule, its own strategy. I 
think it also should be permitted to change it if circumstances 
change. The world is not a constant place. And if there is a 
crisis, there is going to be a deviation from time to time.
    Designing the rule, implementing the rule is the 
responsibility of the Fed. But the Congress has, I think, the 
role of requiring that the Fed have the strategy and describe 
it to you. I think that is the key to not micromanaging, not 
threatening the independence, but having the accountability and 
exercising the accountability that the Congress should have 
with respect to this agency.
    Chairman Shelby. Currently the Federal Open Market 
Committee transcripts are supposed to be released 5 years after 
meetings take place. Even with this 5-year lag, the most recent 
transcripts on the Federal Reserve Web site date to 2008.
    This is a question for all of you. What timeframe do you 
think is appropriate, if you do, for the release of these 
transcripts in order to strike an appropriate balance between 
transparency and not compromising market-sensitive information? 
We should never want to do that. Dr. Taylor, we will start with 
    Mr. Taylor. I think a lot of studies show that the 
transcripts themselves and the releases have affected the 
nature of the discussion at the FOMC, and I think you have to 
recognize that transparency can go too far. You do not want to 
have C-SPAN broadcasting the meetings. So there has to be a 
decision. I do not think the 5 years has been shown to be any 
more problems than 3 years would. I think it could be closer in 
time. It would enable people to study important events like the 
financial crisis. We had to wait for quite a while until that 
    I think that it is also important to try to make sure there 
is a consistency between more current things, like the minutes 
and the transcripts--the minutes and the transcripts are 
supposed to coincide with the same events. One is released 
before the other. But over time you can check the consistency 
between those. The minutes do give you a chance to see a little 
earlier; the transcripts are later. I think that would also go 
a way to improving the transparency without interfering with 
the decision making.
    Chairman Shelby. Dr. Meltzer, do you have an opinion?
    Mr. Meltzer. The problem with many of these proposals is 
they do not look at what will be the circumvention. If you said 
you have to release your minutes at the end of a year, they 
would not have much information in them. That is, they just 
would not say it in a place where you could see it.
    What I think the Congress needs to do, it needs to face up 
to its responsibility. Its responsibility is to be able to say 
to the Fed, ``You told us you were going to do this, and you 
did not do it. Why?'' And that is where the rule gives you 
leverage to do it, and that is more important--I mean, I know, 
Senator, a bill that wants to make more transparent the minutes 
of the Fed. Ask yourselves, suppose you had them, how would you 
be better able to monitor what the Fed does because you have 
them? My opinion is you would not. You have to get a discipline 
in the Fed to tell you what it is going to do and do it. That 
is, I believe----
    Chairman Shelby. That is more important, isn't it?
    Mr. Meltzer. More important than any other single thing 
that you can do. You do not have the ability now to monitor 
    Chairman Shelby. You have a comment, Dr. Kupiec?
    Mr. Kupiec. Sure. I think the longer the lag in releasing 
the detailed minutes of the meetings, the easier it is to 
forget if the Fed sort of, you know, did the right thing or not 
the right thing. Five years is a long time. It is hard to 
remember what happened back then. Shortening the lag would 
increase accountability, I think, in some ways, but I think you 
have the information and the problems that you have heard Dr. 
    Chairman Shelby. We just have to reach a medium which makes 
sense, would we not?
    Mr. Kupiec. It has got to be short enough that there is a 
memory for what was going on and whether they were discussing 
the right things and doing the right things. I mean, if you go 
back to what we find out before the crisis, you find out they 
were woefully uninformed, even through the summer of 2007 when 
subprime mortgages were blowing up and----
    Chairman Shelby. We found it out right here.
    Mr. Kupiec. Yes, and that is kind of scary. So, yes, there 
is a tradeoff there.
    Chairman Shelby. Mr. Conti-Brown.
    Mr. Conti-Brown. The only thing I would add to echo these 
sentiments is the nature by which this information has been 
disclosed over time, so not only does the Fed disclose its 
transcripts on a 5-year lag, but its minutes after several 
weeks, and the decision itself after several hours, all of 
which are innovations in the practice of central banking within 
the last several decades. I think it illustrates a central 
point that I think is worth emphasizing, that central bank 
transparency under Chairman Bernanke, Chair Yellen, and Chair 
Greenspan has been expanding over time. So none of this is 
written in the Federal Reserve Act itself but is an innovation 
of the Fed.
    Chairman Shelby. Dr. Meltzer, I have a couple of questions 
I want to direct to you, if you would. You have written 
extensively--and you have testified here about this before--
about the topic of Federal independence. One rough measure of 
independence you have cited is the portion of a budget deficit 
financed by issuing base money.
    Could you elaborate on how this measure has changed in 
recent years? Does the Fed take actions today that threaten its 
    Mr. Meltzer. Yes. I am glad you asked. When the Fed 
started, as I said in my testimony, they were not allowed to 
buy Government bonds at all under any circumstances. That was 
relaxed. Then they circumvented it so they could buy mostly 
Treasury bills, and until even through World War II, up to 
World War II, they bought mostly Treasury bills. And after 
World War II, one of the great Chairmen of the Fed, William 
McChesney Martin, wanted to institute, and did, bills only; the 
Fed would only buy bills. That is because he wanted a sound, 
secure, competitive bond market, and he thought the way to get 
that was to keep the Fed out of that market, because if they 
were in the market, they would dominate the market. And that 
had the great advantage that the central bank--the reason we 
had the original rule was the people back in 1913 understood 
that the great danger to a central bank is that it finances--it 
is used to finance the Government budget. That is what they 
have been doing. They keep the interest rate low, and then they 
pay 90 percent of the interest that they collect back to the 
Treasury. So it does not cost the Treasury anything to finance 
these huge deficits, and it takes away any of the incentives we 
would have to begin to think about how over the long term are 
we going to solve the fiscal policy problem of the United 
States, with not just the budget deficit but something on the 
order of $100 trillion worth of unfunded liabilities. I mean, 
that is a lot of money, even for a country like ours. And we 
are not going to be able to pay $100 trillion for the unfunded 
    So we need to find a human way to change the health care 
laws so that we take care of the indigent and we do not wreck 
the economy. And we are not doing that, and that is a problem. 
And if we wait until it becomes a crisis, then we will--as sure 
as God makes green apples, we will do something which will be 
draconian and harmful and difficult for the public.
    Chairman Shelby. A lot of us are very interested in greater 
accountability and oversight of the Fed, like any institution, 
but also we would like to strengthen the independence of the 
Fed. How do we do this?
    Mr. Meltzer. I think a rule--think back to the period, not 
the very end but the years from 1985-86, when Alan Greenspan 
became Chairman, to about 2002. We had the longest period in 
our history, in the Federal Reserve history, of stable growth, 
short, mild recessions, low inflation. There were no complaints 
about the Fed. It was very responsible. It worked well. It 
operated more or less, not slavishly but more or less in 
response to the Taylor rule. That is what Greenspan did.
    Why did it work better? Because one of the great mistakes 
that the Fed is pressured to make is it pays too much attention 
to the latest news and what is happening now; whereas, all of 
its abilities are to resolve longer-term, medium-term problems. 
And when he adopted the Taylor rule, he essentially adopted a 
medium-term strategy, and that worked exceedingly well, the 
best in the whole 100-year history of the Fed.
    Chairman Shelby. Dr. Taylor, do you want to add anything to 
    Mr. Taylor. Well, I agree, it is a period which economists 
focus on a lot. We call it the ``Great Moderation'' in the 
sense it has been smooth and had a long boom. And there has 
been debate about what it is, but I think Allan is--monetary 
policy is a big part of that, and they had followed a steady-
as-you-go strategy, simple, people understood it, and it worked 
very well.
    In fact, I could add something to this, Mr. Chairman. It is 
pretty clear to me when they started moving away from that is 
when things started being problematic in the economy. I have 
written a lot about that; especially around 2003, 2004, and 
2005, that rate was held remarkably low compared to history, 
compared to the period Allan is referring to. There was 
excessive risk taking, a search for yield; the regulatory 
apparatus became a problem as well, and I think that was a big 
factor in the mess that we got into. And since then, it has 
been pretty much off again as well.
    Chairman Shelby. Senator Brown, you have been very patient. 
Thank you.
    Senator Brown. Thank you, Mr. Chairman. Always. Thank you.
    Income inequality by some measures has reached its highest 
levels in perhaps nine decades. In 1983, the Fed began the 
survey of consumer finances. Thanks to this data, we can see 
that the wealth gap has widened for white families compared to 
nonwhite families over the past 30 years. I apologize to 
Senator Warren and Senator Donnelly for not being able to see 
this, but you already know this stuff because you are so 
prescient, both of you.
    It seems to me the Fed has cared about these issues for 
some time. I think it is entirely appropriate, as the strength 
of our economy should not and I think cannot be divorced from 
how families are faring.
    I would like to hear your views, each of you, starting with 
Dr. Taylor, if you would. Do you think the Fed should care 
about wealth and income inequality? Is that something in the 
purview of the Fed to care about?
    Mr. Taylor. Yes, I think individuals on the Fed, like 
anybody else, are concerned about it. I am concerned about it. 
I think as an institution it is very important, especially 
independent institutions, to have limited purposes. It cannot 
solve every problem in America. And what has happened in some 
sense is an independent, limited-purpose organization has begun 
to expand it scope. Allan Meltzer mentioned a number of those 
things. The goals of the Fed--price stability, as suggested by 
the Congress, employment, low interest rates, all those 
things--those are the macro responsibilities that they 
currently have at this point in time.
    I believe that as an important part of our overall economic 
policy, if we get that right, if we get that macroeconomic part 
right, monetary policy right, then there are a lot of things 
that public policy can do to address the problem that you are 
referring to here.
    I have written about it. We probably all have written about 
it. There is tax policy. There is regulatory policy. Growth 
itself is so important. Our growth rate in this expansion has 
been 2.2 percent. I think a lot of that is because of policy. 
We would help this income distribution tremendously if we had 
better opportunity for people at the lower 30 percent to grow 
and thrive with more jobs and better jobs. It seems to me that 
should be the focus. The Fed should focus on what its 
responsibilities are. We have other instruments of Government. 
It is an allocation of responsibility. It is a governance 
issue. It is what has worked well in the past, and I think we 
should continue with that overall approach.
    Senator Brown. Thank you. Before Dr. Meltzer, just to be 
clear, employment--you said employment, suggested by the 
Congress. It is actually mandated, as you know, the dual 
mandate. It is not just suggested by Congress.
    Dr. Meltzer, your thoughts? And I am not sure from Dr. 
Taylor's comments if he thinks that income inequality should be 
a purpose of the Fed to address that. I understand that--or one 
of the purposes. I was not entirely clear. If you could be as 
specific as possible.
    Mr. Meltzer. The Fed, like any organization, does its best 
work if it has a single motive to go to. If we give it many 
different motives or objectives, we spoil its path.
    I am glad you asked the question because I think this is a 
subject on which I am currently working, which I am very 
interested in, and think is really a major issue for our 
country. Redistribution has not helped to spread the 
distribution of income. As a matter of fact, it worsens it.
    Just ask yourself, if redistribution was the way to 
equalize incomes, France would be the richest and most equal 
country in the world. Instead, it is lagging behind many of its 
    Ask yourself this question: How did your relatives, my 
relatives, get to be from immigrant status to middle-class and 
wealthier status in many cases? They came here ignorant, 
lacking in skills. They took jobs. When they took those jobs, 
output went up. But the distribution of income widened because 
they were getting low pay. My first job in a major company was 
25 cents an hour. I do better than that these days.
    How did they get to the middle class? They got there by 
learning on the job. Companies trained them, so they learned 
more. And as they learned more, output expanded, but 
productivity went up. And as their productivity went up, their 
wages went up. That is the way----
    Senator Brown. Well, let me interrupt----
    Mr. Meltzer. ----we get a middle class.
    Senator Brown. We do have limited time. Correct, except 
look at the charts, which we do not have here, since 1973----
    Mr. Meltzer. Because we are not investing--this is the 
lowest rate of investment of any postwar business cycle. It is 
the lowest rate of productivity growth. That is why the middle 
    Senator Brown. But there has been such a disconnect between 
productivity growth and income growth, and you can blame that 
on Fed action, inaction, or other things, but it is clearly 
more complicated than that.
    Mr. Meltzer. One of the things that the welfare State does, 
which is counterproductive, is it does not get them to make 
those steps which are important, that is, to go from the first 
job, learn on the job----
    Senator Brown. I am sorry, Dr. Meltzer. It is hard for me 
to blame--it sounds like you are blaming the worker who is 
increasingly productive for not being smart enough to share in 
the wealth he creates for his employer. But that is far afield. 
Let me go on in this question. I apologize.
    Dr. Kupiec, your thought on the Fed's role in dealing with 
income inequality?
    Mr. Kupiec. Yes, I think income inequality is an important 
problem for everybody. I am not sure how you exactly work an 
income inequality mandate into a monetary policy decision 
making role. Here you have income inequality by race. I do not 
know how you tell the Fed to do monetary policy according to 
race. That makes no sense to me. But I would say that Federal 
Reserve monetary policy largely works by redistributing income. 
Right now retirees and savers make nothing for 6 years now; 
whereas, borrowers are encouraged--borrowing is very cheap. So 
the Federal Reserve and monetary policy plays a role in the 
distribution of income, but it is not always the one that 
encourages the distribution you may like to see in the end.
    Senator Brown. Mr. Conti-Brown.
    Mr. Conti-Brown. So, in a word, yes. The Fed should and 
does and has focused on income inequality. There is the Jackson 
Hole Symposium hosted by the Kansas City Fed each year. In 
1998, its theme was income inequality, and then-Chairman 
Greenspan gave a very good speech talking about how income 
inequality as a topic of conversation among economists should 
be brought out from the cold, and I agree with that. And I 
think that Chairman Greenspan and since then Bernanke and 
Yellen have done well by focusing on this issue. I do not think 
that anyone is saying that interest rates should be dropped for 
the redistributional consequences among debtors and creditors 
in order to adjust the chasms between different sections of our 
economy. I think instead it is to understand what are the 
consequences of this kind of income inequality to the mandates 
that the Congress has given the Fed. I think to ignore that, to 
say that income inequality is outside of our bailiwick, is to 
ignore the very clear connections that income inequality can 
have on price stability, financial stability, and maximum 
    Senator Brown. Thank you, Mr. Conti-Brown.
    Let me go to the Audit the Fed issue more directly. You 
described the proposals in your opening testimony as solutions 
in search of problems. On the other hand, it is hard to argue 
against more transparency and accountability. Why not ask the 
GAO to audit their monetary policy? How do you argue against 
more transparency that you have all talked about?
    Mr. Conti-Brown. Right, I mean, you do not argue with the 
importance of transparency. The question that is important here 
is: Do we want to throw organizational complexity at one of the 
most organizationally complex agencies of Government? So 
putting the GAO into the business of both evaluating and, 
frankly--as there is not much difference between evaluation and 
implementation--and implementing monetary policy strikes me as 
a very dangerous idea. It adds, frankly, and ironically, 
opacity to this organization rather than taking it away.
    I think that is why focusing on governance structures so 
that we have a clear line between the people, their 
representatives in the Senate and the House, and then through 
the Congress to the Fed is better so that we know when as 
citizens there is something that we like about the Fed or do 
not like about the Fed, we have a clear mechanism of conveying 
that. When we separate those powers among different 
organizations within Government, it can muddy those waters and 
make it less clear whom we should hold accountable.
    Senator Brown. Dr. Meltzer, be specific, if you would, 
about your thoughts about the Audit the Fed proposals.
    Mr. Meltzer. I think you do not get what you want. Suppose 
you knew everything. Suppose you found out that the Fed chooses 
its policy using a Ouija board. What would you be able to do 
with that?
    What you want to do is get something which permits you to 
see that the policies that are carried out are carried for the 
benefit of the public. Knowing how they make those decisions--
let me give you an example. There is a rule now--it may be a 
law--that says if three members of the Fed meet together, they 
have to consider it a meeting. So three members of the Fed do 
not meet together. They circumvent the law. That is not going 
to get you the information you want. The information you want 
has to come from having something very deliberate that you know 
they are going to do and that they tell you they are going to 
do, and you are able to say, ``You did not do it,'' or, ``You 
    Senator Brown. Thank you. One last real quick question, Mr. 
    Last week, during congressional testimony after Chair 
Yellen was here, she testified at the House Financial Services 
Committee, and she was criticized, in part, by, I believe, the 
Chairman and a number of other House members for meeting with 
Secretary Lew, although Chairman Bernanke met apparently weekly 
with Secretary Geithner during his tenure. Just a yes or no 
question, starting with you, Dr. Taylor: Do you believe the 
Chair of the Federal Reserve should meet with the Secretary of 
the Treasury?
    Mr. Taylor. Yes.
    Senator Brown. Dr. Meltzer.
    Mr. Meltzer. Sure.
    Senator Brown. Dr. Kupiec----
    Mr. Meltzer. Let me say that President Wilson at the start 
of the Fed would not invite Fed Governors to social events at 
the White House because he did not want to influence them. But 
I believe that they should meet because they have common 
    Senator Brown. OK. Dr. Kupiec.
    Mr. Kupiec. Yes, but there should be a balance of 
interaction between the executive branch and the Congress, I 
think. And I think it is probably overweighted to Treasury.
    Senator Brown. Mr. Conti-Brown.
    Mr. Conti-Brown. Yes.
    Senator Brown. OK. Thank you, Mr. Chairman.
    Chairman Shelby. Senator Rounds.
    Senator Rounds. Thank you, Mr. Chairman.
    I am not sure if this is anecdotal or exactly how accurate 
it is, but I recall the statement that between 2009 and the end 
of 2013, there was an increase in the employment rate among 
financial institutions in this country by over 300,000 
individuals being employed. You would normally think of an 
increase in the employment rate as an increase in productivity, 
but that has not happened, specifically because the vast 
majority of that 300,000 was in the area of compliance. The 
Federal Reserve has, among other things, a responsibility for 
the regulatory aspects within the banking industry--not alone 
but, nonetheless, a part of it.
    I was going to ask Dr. Kupiec--and I hope I am saying that 
correctly--in your testimony you make the point that the 
Federal Reserve does a lot more than set monetary policy. It is 
also a major financial regulator. This means that the Federal 
Reserve essentially has two sides: setting monetary policy and 
financial regulation. Giving the Federal Reserve the freedom to 
set monetary policy is important, but how can we preserve that 
freedom while making sure that their regulatory decisions are 
just as accountable as any other Federal agency?
    Mr. Kupiec. Well, some people think the Fed should be 
stripped of its regulatory authority and those regulatory 
authorities should be given to other agencies. That is probably 
the most extreme view.
    The Congress has the complete ability to audit the Federal 
Reserve on its supervision activities. They are not restricted 
in any way by any law, by the GAO or otherwise, on hearings or 
other things, to audit the Federal Reserve's regulatory 
activities, at least to any degree I can find in the law.
    Senator Rounds. Would you suggest that it is simply a 
failure on the part of the Congress to exercise that authority?
    Mr. Kupiec. I think since the Dodd-Frank Act has come into 
being, the Federal Reserve has extensive powers that it did not 
use to have, and I think the case for much more congressional 
oversight now is far stronger than it was in the past.
    Senator Rounds. Thank you.
    Dr. Meltzer, if I could, I find your comments refreshing, 
and as I have watched, I think your message suggesting that 
there are some limitations that the Fed has with regard to 
being able to fix issues within our society is something that 
you point out, and I think you did a very nice job, sir. And I 
thank my colleague Senator Brown for that question.
    I noticed that the table that they provided showed only up 
through the year 2010. It would be interesting to have observed 
what the changes might have been between 2010 and 2014 as well.
    But for you, sir, if you could, in the year 2012 you wrote 
that for 60 years, from the mid-1920s through 1986, the Federal 
Reserve's minutes showed almost no discussion of policy issues. 
You then contrasted this with the Fed's recent actions on 
quantitative easing. Are you concerned that the Fed is becoming 
more reactive to short-term changes?
    Mr. Meltzer. Yes, much too reactive to short-term changes. 
I have been a practicing economist for 57 years. The one thing 
that I have certainly learned is economics is not the science 
that tells you good--gives you good quarterly forecasts. There 
is no such science. There is just too much randomness in the 
world to be able to predict accurately what happens from 
quarter to quarter. So to improve what we do, we should look 
over longer terms. We can do a lot of good for the public if we 
get them on a stable path. We do not do that.
    I will give you an example, which you are all familiar 
with, I believe. The Fed for many years in recent times--it has 
given it up now--concentrated its attention on the growth in 
the employment rate that came out every month. The report would 
come out; it would go up, the market would boom. People would 
be very happy. The same number would be revised the next month, 
and it would be lowered.
    Now, what was the point of concentrating on changing the 
policies on the basis of a number which was largely a random 
number that got it right. Instead of saying, look, our 
objective is to get back to full employment with low inflation, 
and this is the way--we know how to do that. But we do not do 
it. We concentrate too much on the short term.
    Senator Rounds. Thank you.
    For Dr. Taylor, in your testimony you talk about the 
importance of having a transparent and predictable rule to 
guide the Federal Reserve policy. Sometimes it can be easy to 
forget that the Federal Reserve decisions impact Main Street as 
much as if not more than Wall Street. I know that several of 
Members of the Committee have also suggested the need for a 
rule, and I would invite you if you would begin. How can you 
discuss--or can you discuss how the Taylor rule would help to 
create economic stability and what it would do for Main Street 
businesses and consumers? And then I would open it up at that 
point for other Members if they would also like to comment on 
it. Dr. Taylor?
    Mr. Taylor. One thing is the predictability itself. It is 
important because so much of policy becomes unpredictable and 
hard to interpret. There is uncertainty, business decisions and 
life decisions that are based on some sense of certainty, so a 
more rules-based policy would deliver that.
    I think the best thing, though, for communicating about 
this is history and the fact that, as Allan Meltzer mentioned, 
we have had so much experience in the U.S. and other countries 
when policy is more predictable, monetary policy in particular, 
when it is rules-based, the economy works better. People know 
what is happening. It is more reliable. In a sense, the 
decisions are easier. We can see that in the United States. You 
can see it in other countries. You can see it in emerging 
markets. There is just a tremendous amount of evidence for 
that. And I think from people who do not follow the Fed every 
day, it just kind of makes sense. Here is what they do.
    One of the things I found years ago in making proposals, 
central bankers, who were just maybe appointed to be president 
of their bank, and somebody from out of the country would come 
and they said, ``Well, this is terrific. Now I kind of know 
what to do. I did not know that.'' You know, here is a 
description which is fairly easy, and then they talk about it 
to people in their country. It is amazing. All over the world 
this is happening.
    So we have a lot of experience with this. In a way it makes 
common sense. I tried to quote people like George Shultz, Janet 
Yellen herself has found this, this kind of experience. So 
there is just tremendous evidence for this. And I can refer to 
academic studies, compare different periods of time when things 
worked better. But ultimately it comes down to common sense. An 
independent agency should have limited purposes, it should be 
accountable. You can see it better. Allan Meltzer says just 
having an audit, just having earlier release of transcripts or 
minutes is not enough if there is not a description of what 
their strategy or their rule is. And I would say I cannot see 
why someone would object to an independent agency describing 
its strategy. What is the problem with that? You are not 
telling it what the strategy would be. You are saying just tell 
us your rule, tell us your strategy. I think it would work a 
lot better.
    Chairman Shelby. Dr. Meltzer, do you want to comment on 
    Mr. Meltzer. Yes, I want to make a very simple point. Last 
week, Stanley Fischer, whom I admire greatly and who is a good 
friend, gave a talk at the Chicago Federal Reserve Bank. In it 
he cited what was accomplished by $4 trillion worth of QE. He 
said, ``We lowered the unemployment rate by 1\1/4\ percentage 
points.'' The rest of the drop in the unemployment rate is 
something about which we should be very concerned. We for a 
long time have had people, men over 60, dropping out of the 
labor force. We now have men 18 to 34--and women, too, 
presumably--dropping out of the labor force. They do not get 
training. They do not learn on the job. They do not have 
productivity growth. They are a problem for our future. That is 
what the Fed accomplished with $4 trillion?
    Senator Rounds. Mr. Chairman, I believe my time has 
expired. Thank you.
    Chairman Shelby. Thank you.
    Senator Warren.
    Senator Warren. Thank you, Mr. Chairman, and thank all for 
being here.
    During the financial crisis, Congress bailed out the big 
banks with hundreds of billions of dollars in taxpayer money, 
and that is a lot of money. But the biggest money for the 
biggest banks was never voted on by Congress. Instead, between 
2007 and 2009, the Fed provided over $13 trillion in emergency 
lending to just a handful of large financial institutions. That 
is nearly 20 times the amount authorized in the TARP bailout.
    Now, let us be clear. Those Fed loans were a bailout, too. 
Nearly all the money went to too-big-to-fail institutions. For 
example, in one emergency lending program, the Fed put out $9 
trillion, and over two-thirds of the money went to just three 
institutions: Citigroup, Morgan Stanley, and Merrill Lynch. 
Those loans were made available at rock-bottom interest rates, 
in many cases under 1 percent, and the loans could be 
continuously rolled over so they were effectively available for 
an average of about 2 years.
    Now, in Section 1101 of Dodd-Frank, Congress said no more 
back-door bailouts. It recognized that the Fed should still 
serve as the lender of last resort, but that there should be 
strict limitations on its emergency lending authority so that 
big financial institutions could not count on the Fed to bail 
them out if they made a bunch of wild bets and then lost.
    Now, recently, the Fed released a proposed rule 
implementing Section 1101. Dr. Meltzer, do you think that the 
Fed's proposed rule on emergency lending prevents back-door 
bailouts as Congress intended?
    Mr. Meltzer. No. I congratulate you, Senator Warren, for 
keeping this issue alive. It is a disgrace that we have got so 
much money thrown at such low interest rates at so few banks. 
And the Dodd-Frank Act in its heart may talk about getting rid 
of too big to fail, but at the heart of the Dodd-Frank Act, the 
Secretary of the Treasury is authorized to do exactly what 
Secretaries of the Treasury have been doing for years.
    The way to get out of that is to get the Fed out of the 
too-big-to-fail business, pass the Brown-Vitter bill, which 
says the bank is responsible for its errors, make it have 
    Now, why did we move away from that? See, we started with 
the idea that the Government's responsibility was a legitimate 
responsibility to protect the payment system. We have shifted 
that to where it protects the banks. We want to go back to 
protecting the payment system, and we want to get them out of 
the too-big-to-fail business.
    Senator Warren. Thank you, Dr. Meltzer. And what I want to 
do for just a second is stay focused on Rule 1101. You have got 
the larger picture, but I want to stay on this part, because 
there is a rule pending right now from the Federal Reserve 
    Last August, I joined with Republicans and Democrats to 
send a letter to the Fed urging it to strengthen its emergency 
lending rule. Three others on that letter are on this 
Committee: Ranking Member Brown, Senator Vitter over there, and 
Senator Cotton. And the letter included some specific ideas for 
strengthening the rule, trying to prevent this form of back-
door bailout. It will not stop them all. We have got a lot of 
things we need to work on, but this one.
    So, Dr. Meltzer, I just want to run through some of the 
ideas that were in our joint letter and ask you if you could 
just briefly give your thoughts on them.
    One suggestion, establish in advance that any emergency 
lending will be offered at a penalty rate, not a rate well 
below market rates.
    Mr. Meltzer. Yes, because that leaves, for example, the 
example of banks taking the money that was pushed on them, 
insisted upon, and use it to buy up other banks.
    Senator Warren. All right. The second one, establish in 
advance that emergency lending would not be available to any 
institution at or near insolvency.
    Mr. Meltzer. Yes.
    Senator Warren. Good. Third, establish in advance that an 
emergency lending program is for a systemwide problem and used 
by a number of institutions large and small, not just to bail 
out one or two giant institutions.
    Mr. Meltzer. Yes, that is a way of protecting the payment 
system, which is essential for the maintenance of the economy. 
But it is not important. There is--if we have the right set of 
rules, we do not have to worry about bank failures any more 
than we have to worry about corporate failures.
    Senator Warren. Thank you, and let me just try a fourth one 
here. I am a little over time, but if I can do a fourth one, 
establish in advance that any lending facilities would be made 
available only for a short, defined period of time so that 
banks could not excessively roll over the loans.
    Mr. Meltzer. Good.
    Senator Warren. Good. Thank you. Thank you very much, Dr. 
Meltzer. This is a critically important aspect of Dodd-Frank 
that the Fed has just glossed over. If big financial 
institutions know that they can rely on the Fed to save them if 
they start to falter, then they have every incentive to take on 
more risk and to threaten the entire system. These rules are 
not yet final, so the Fed still has an opportunity to place 
real limitations on its emergency lending. But if the Fed fails 
to do that, I believe Congress should act.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Vitter.
    Senator Vitter. Thank you, Mr. Chairman. And I want to 
continue this same line of discussion because I strongly agree 
with it.
    My biggest concern in this whole space since the crisis, 
including Dodd-Frank, including Fed action or inaction, is what 
I think is clearly the continuation of too big to fail. Just by 
the numbers, concentration in our banking system has grown 
significantly. The four largest U.S. banks are 25 percent 
larger by assets today than they were in 2007.
    According to FDIC, the top four control 43 percent of all 
the assets. The top six U.S. banks have assets equal to about 
63 percent of the U.S. economy. So just by the numbers, the 
threat is greater. Let me first----
    Mr. Meltzer. We are creating monopolies.
    Senator Vitter. Yes. Let me first ask all four of you, do 
any of you consider that trend either positive or neutral, not 
necessarily negative?
    Mr. Meltzer. Negative.
    Senator Vitter. Anybody else disagree with that?
    Mr. Taylor. No.
    Senator Vitter. OK. Do any of you think if one of those 
mega-institutions were threatened today, they would not 
essentially be bailed out, that they would not have emergency 
lending authority or some other means to continue without 
serious repercussions? Anybody want to offer an opinion?
    Mr. Meltzer. They would be bailed out.
    Senator Vitter. Anybody disagree with that?
    Mr. Taylor. Yes, with the current situation, they would. I 
think there are some things that can be done, but in the 
current situation it is, unfortunately, very likely.
    Mr. Kupiec. I would say it would depend on circumstances. I 
think if one very large institutional loan would get into 
trouble, people might use Dodd-Frank powers and put that 
through a liquidation, one in isolation. But the probability of 
that happening is nil. It is probably a crisis situation and 
all of them are weak. So I take your point.
    Mr. Meltzer. Senator Vitter, let me just take a minute to 
explain to you why I am sure that would happen. The Secretary 
of the Treasury would be confronted--would meet with his staff. 
They would tell him all the things that could happen, 
disastrous things. They do not know they are going to happen, 
but if you were the Secretary of the Treasury, if I were the 
Secretary of the Treasury, and someone came in and said take a 
risk, what would you do? We have to set up arrangements under 
which that will not happen. We cannot just depend upon the will 
of the Secretary of the Treasury, because he will be under 
pressure and he will know or be told that terrible things will 
happen if he does not do the bailout.
    Senator Vitter. Right. Mr. Conti-Brown.
    Mr. Conti-Brown. The only thing I would add--and I agree. I 
mean, the scenario you are describing is exactly what Dodd-
Frank is designed to address. This would be not the trial run, 
the actual performance of Dodd-Frank liquidation authority. And 
I agree with my copanelists and with you, Senator Vitter, and 
Senators Brown and Warren, that I think the capital levels of 
banks today are so low that I can hardly imagine even if it 
were a one-off situation with one of these multitrillion-dollar 
banks, that we would see a seamless operation of the orderly 
liquidation authority. And so this is also a great concern for 
    Senator Vitter. Thank you. That is a perfect segue to my 
next question. As you know, in broad terms, I think the best 
response to avoid that is higher capital requirements for the 
    How do each of you feel about the current--now, that 
requirement has improved, moved in the right direction. I do 
not think it has moved enough. How do each of you feel about 
the current capital requirements for very large banks?
    Mr. Taylor. I think higher capital requirements are a way 
to get at this problem, and it may be the easiest way. But 
there are other ways, too, which I would just make a short 
pitch for. There is something in our Bankruptcy Code that could 
be amended and reformed to actually allow one of these 
institutions to go through bankruptcy and not cause a mess. 
There is a proposal called Chapter 14. One version came out of 
the House. Senator Toomey has been involved with another one 
here. I think it is really a good reform. It needs to be done 
anyway, and that would enable the Secretary of the Treasury, or 
whoever has to make this tough decision, to say, No, you know, 
staff, there is a chance this is going to happen, but we have 
got this other approach. We have got this bankruptcy thing that 
even a large institution can go through. That, I think, coupled 
with these capital requirement changes, could improve the 
situation a lot.
    Senator Vitter. And I am very open to that, and you 
certainly agree those are not mutually exclusive. They can work 
together. Dr. Meltzer.
    Mr. Meltzer. You certainly know my position on this, 
Senator Vitter. You know, it is really, as I see it, a 
fundamental economic question, and that is, who will have the 
incentive to do the right thing at the right time--the people 
whose money is at risk or the people who regulate them? The 
answer is the people whose money is at risk.
    Senator Vitter. Thank you.
    Dr. Kupiec.
    Mr. Kupiec. The current system of capital regulation we 
have got ourselves into is incredibly complex. It is hard to 
even know what the requirements are for firms. In fact, most of 
the large firms' capital requirement is being set by the 
Federal Reserve CCAR stress test, which is about to happen next 
week when the Fed--but we do not even really know objectively 
what the capital rules are. So while I am for higher capital, I 
am for much more simple, straightforward, objective measures of 
capital that regular people can understand, that you do not 
need a----
    Senator Vitter. Also, I agree with that, too.
    Mr. Kupiec. You do not need 100 Ph.D.s to read through the 
    Senator Vitter. I agree with that, too.
    Mr. Conti-Brown.
    Mr. Conti-Brown. I am not even sure a Ph.D. helps you read 
through some of the capital rules that we have. And so I think 
it is true that Basel III does make significant improvements, 
but tripling very little just still leaves you with little. And 
here I think substantial, dramatic increases to capital would 
go a very long way, and the reason, of course, is very simple. 
Debt is the contagion in a financial crisis. When there is 
uncertainty about the value of assets and questions about who 
owes whom what money and what are the consequences to the 
financial health of the firms interlocked together, that is the 
financial crisis. When equity plays a much greater role, well, 
that is the very nature of the contract that shareholders have 
entered into. And so I think this is a simple and clear 
solution that is not mutually exclusive with the Bankruptcy 
Code, and I would flag one other issue on the Bankruptcy Code. 
I think there are other exceptions besides even a Chapter 14 
where assets and transactions have been written out of the 
Bankruptcy Code in derivatives and other kinds of financial 
markets that should be written back in so that we have a much 
clearer sense in the event of bankruptcy of who owes whom what 
and how they can participate in a more organized way without 
circumventing that and getting first in line just because your 
lobbyists before Congress were more effective than the other 
    Senator Vitter. Thank you all very much.
    Thank you, Mr. Chairman.
    Chairman Shelby. Senator Donnelly.
    Senator Donnelly. Thank you, Mr. Chairman, and I want to 
thank you all for being here.
    I just want, Mr. Kupiec, to talk about another subject for 
a second. The International Association of Insurance 
Supervisors is attempting to develop capital standards for 
internationally active insurance groups. There is a concern 
that these proposed global capital standards could be adopted 
by Treasury and the Federal Reserve. And in my State, Indiana, 
we have lots of insurance companies governed by State 
regulation, and there is a concern.
    So what I am wondering is, as you look at this, do you 
believe that the process that is going on could endanger the 
State-regulated insurance system we have had for over a hundred 
years here?
    Mr. Kupiec. Yes, I think this is a big issue, and it really 
needs to be looked into. The entire insurance regulatory system 
in the U.S. is based on State insurance regulation, and it has 
served us well for many, many years. The problems that arose in 
the crisis with the one insurer, AIG, were not in an insurance 
subsidiary. It happened in London in a special financial 
products group that was not considered insurance, and, in fact, 
that products group was actually subject to regulation by a 
bank regulator, the Office of Thrift Supervision.
    So the insurance system that exists is--now actually many 
in the industry feel threatened by the developments. The 
Federal Reserve now has powers over the insurance companies 
that are affiliated with depository institutions. They got this 
power under Dodd-Frank when they inherited insurance holding 
company and savings and loan holding company supervision from 
the Office of Thrift Supervision. And the Federal Reserve has 
testified that they have a very large examination program going 
into State insurance firms and examining them. And prior to 
this, these firms were under the examination authorities of the 
State supervisors.
    More than that, the Federal Reserve has been applying bank 
holding company capital rules to these groups, and so if they 
look at an insurer and they think of it through a bank capital 
prism, they say that insurer's capital is low. Well, in fact, 
the insurer meets State capital regulations which are defined 
for an entirely different purpose than bank capital 
regulations, and it is completely well capitalized. But the Fed 
will look at the group and say the capital is too low, apply 
the bank capital standards and require the group to raise 
capital. So insurers that have depositories as affiliates are 
finding real problems here. They are finding their capital 
constrained by the Federal Reserve, who was never intended to 
be their primary supervisor.
    Senator Donnelly. Well, obviously, I am proud of our 
companies in our State, and we have found that our State 
regulation system has worked pretty well over the years.
    Dr. Meltzer, I want to ask you something. I am just 
curious. Let me paint a little picture for you. In 2009, 
Elkhart County, Indiana, 20-percent-plus unemployment; Howard 
County, Indiana, 20-percent-plus unemployment. We build 
Chrysler transmissions in Howard County. We build recreational 
vehicles in Elkhart County. Today unemployment, 5.5 percent in 
both places. Do you think that was done in a bad way?
    Mr. Meltzer. No, I do not think that is--that is only good. 
I mean, I certainly think----
    Senator Donnelly. I have sat with the families when they 
did not have jobs and when they did have jobs.
    Mr. Meltzer. Yes.
    Senator Donnelly. And when I look up today from where we 
were at the time we had the collapse, it is a completely 
different world for these families.
    Mr. Meltzer. I agree that reducing the unemployment rate is 
a desirable thing in itself. What we are perhaps differing 
about is how much of that is due to the Fed's QE policy and how 
much of it is due to other things that were going on, like a 
drop in oil prices.
    Senator Donnelly. The oil prices did not get the 
transmission workers back to work. That was the assistance of 
the Federal Government.
    Mr. Meltzer. Good. But the Fed or the Federal Government--
    Senator Donnelly. Oh, I did not say the Fed. I am just 
saying, overall do you see that as something that actually 
benefited the country?
    Mr. Meltzer. Of course it is good. I mean, there is no 
question that low unemployment is desirable, and it should be 
and is an objective that we should try to meet all the time.
    Senator Donnelly. OK. Let me ask you one other question, 
and this goes against the rule I learned as an attorney to 
never ask a question you do not know the answer to, and that 
would be: How do you define redistribution? I was curious when 
you were talking about that, and you said this redistribution 
is a problem. How do you define redistribution?
    Mr. Meltzer. When you tax high incomes in order to pay 
benefits to low incomes.
    Senator Donnelly. What was the tax rate under Eisenhower?
    Mr. Meltzer. Oh, it was around 70 percent----
    Senator Donnelly. What is it today?
    Mr. Meltzer. ----coming out of the war. But ask yourself 
the next question: How many people actually paid that tax?
    Senator Donnelly. Enough to build the roads at the time.
    Mr. Meltzer. Not so much.
    Senator Donnelly. They did pretty good, as far as I could 
    Mr. Meltzer. I do not believe that taxation is the major 
problem. I believe regulation is the major problem. Regulation 
is what is hurting our economy. Regulation is what is deterring 
business investment. You want to worry about--both for the near 
term and the longer term, you want to worry about the fact that 
we are not getting much investment, and much of the investment 
that we have been getting was in the oil and gas industry, 
which is now going temporarily to be reduced. Investment leads 
to productivity growth. Productivity growth leads to middle 
income going up. The best way that we can get the income 
distribution to collapse is to increase Part D growth by 
getting corporations to invest more.
    Senator Donnelly. OK. I am out of time, so thank you, Mr. 
    Chairman Shelby. Thank you.
    Dr. Meltzer, with respect to Dodd-Frank, you have written, 
and I will quote, ``The Federal Reserve made the mistake of 
accepting responsibility for writing rules to increase 
financial stability. Some among them should know that the 
Federal Reserve had failed to require prudential policy in the 
years preceding the 2008 crisis.''
    Are you concerned that such failures could happen again?
    Mr. Meltzer. Absolutely.
    Chairman Shelby. Should we reconsider some of the 
authorities granted regulators under Dodd-Frank that were 
intended to enhance or preserve financial stability?
    Mr. Meltzer. Yes. The key to the Brown-Vitter bill, which I 
have tried to work on with Senator Vitter, talked to Senator 
Brown, the key to that is to give the incentives to do the 
right thing, to be prudent in your choice of policies and 
actions, to do that on the people who have the most at stake, 
and that is the bankers and their principal stockholders.
    One of the things--I was glad that Senator Vitter brought 
up the problem of the concentration in banking because it is a 
problem. Here is a fact that was told to me by a banker friend. 
To meet one of the regulations, they hired temporarily 1,000 
attorneys to do the thing. Now, what does a community bank do 
under those circumstances? What does a small or medium-sized 
bank do under those circumstances? It sells out to the big 
banks, or it goes out of business. It cannot afford to pay 
those costs. That is why we are getting concentration in the 
banking system that he talked about.
    The best way to get rid of that is to go and put the 
responsibility on the bankers. Take off the Dodd-Frank emphasis 
on having the Fed regulate them. Put the responsibility on them 
to regulate themselves.
    Chairman Shelby. The effect of financial regulation on 
liquidity, financial regulatory reforms put in place, as you 
all know, have added thousands of pages of rules and 
regulations that have vastly increased compliance costs and 
liability for banks.
    On the one hand, the Fed's easy money policies over the 
last few years were supposed to stimulate the economy. On the 
other, we now have draconian rules, for example, on when and 
how banks can lend.
    I will point this question to you, Dr. Meltzer and Dr. 
Kupiec. Do you agree that the regulatory burden on financial 
institutions has limited the effectiveness of the Fed's 
monetary policy actions?
    Mr. Meltzer. I am not sure.
    Chairman Shelby. Dr. Kupiec.
    Mr. Kupiec. I think it has. There is an interesting 
phenomenon going on now where you find the Fed has created all 
this liquidity and deposits, and the largest institutions now 
are about to be charged negative interest rates to get the 
banks to hold their deposits, and this is a consequence 
actually of the new liquidity regulations that are going into 
place. The liquidity regulations require banks to treat large 
deposits as if they will run in a 30-day period under the 
liquidity coverage ratio, and the bank has to have investments 
to offset that run. Currently the investments pay almost 
nothing because of the zero interest rate policy, so you have 
the large banks basically posting these programs where they are 
telling people to take deposits out of the banking system. So 
we have this very strange new world where regulation that is 
meant to cause banks to be liquid is actually encouraging the 
banks to get deposits out of the banking system.
    Chairman Shelby. Dr. Kupiec, what are your views on the way 
the Federal Reserve is currently conducting stress tests? Do 
you have any recommendations to make the tests more efficient, 
transparent, and perhaps effective?
    Mr. Kupiec. I think auditing the Federal Reserve stress 
test process would be a very good first step to understanding--
for the Congress to understand whether they think it is a cost-
effective means for regulation.
    In my own opinion, doing stress tests for a number of years 
and the head of the FDIC group that contributed to stress 
tests, both at the FDIC and the Federal Reserve System, and 
getting economists to their CCAR process, I can tell you these 
tests are very subjective. There is no right answer. It is 
really a game where you go in and you try to guess what the 
Federal Reserve thinks the losses are going to be under these 
scenarios, and you never know what the right answer is. It is 
almost impossible to plan long-run business planning in a 
situation where you have no idea what the rules of the game 
really are, and the regulator can change the rules of the game 
at the last minute.
    So I think these rules are very unproductive, and I think 
they give us a false sense of confidence, and they give a lot 
of discretion to the Federal Reserve Board and take it away 
from the banks.
    Chairman Shelby. Dr. Taylor, we have been using--or it has 
been used, Let us audit the Fed. A lot of people associate 
audit with just running the numbers and so forth. But what I 
took from some of your statements and others' in this way, 
basically we ought to do great oversight of the Fed and their 
policies, not be a member of the Board of Governors, not to 
make that policy, but to do the proper oversight that Congress 
should have always done. Is that what we are saying here?
    Mr. Taylor. Very much so, Mr. Chairman. It is require that 
the Fed specify its own strategy in a way that you can hold 
them to, and in hearings, in written statements, and, again, 
give them the flexibility they would need to implement that.
    Chairman Shelby. Do you agree with that, Dr. Meltzer?
    Mr. Meltzer. Absolutely. I mean, there should be a law 
which says choose your strategy--very much like the House bill, 
choose your strategy, compare it to the Taylor rule or some 
other rule----
    Chairman Shelby. Sure.
    Mr. Meltzer. ----and we will monitor you.
    Mr. Kupiec. I very much agree, and I think part of the 
transparency issue is understanding whether the decisions the 
Federal Reserve Board makes at the time it makes the decisions, 
do they actually perform the way the Board thinks they perform, 
or have some accountability, some measure of whether their 
judgments at the time are really working or not. If you find 
out over time they are not working, then you have to change 
something about the system to improve that, and I think that is 
the Congress' job.
    Chairman Shelby. So when we talk about audit, we are really 
talking about responsible oversight, aren't we?
    Mr. Kupiec. That is very much what we are talking about, 
not an audit but oversight.
    Chairman Shelby. Thank you.
    Senator Brown.
    Senator Brown. Thank you, Mr. Chairman. I very much 
appreciate your distinction between auditing--and I remember 
what Chair Yellen held up, the book of the audits of the 
Federal Reserve--and oversight, and I think you are dead on.
    A couple of comments and a couple of last questions, Mr. 
Conti-Brown. We talk about not just reforming the Fed. I think 
it is important to remember what Senator Vitter said, what Dr. 
Meltzer echoed, what Senator Warren said about the increasing 
economic power, if you will, of the regulated, the six largest 
banks, the eight largest banks, wherever you want to start the 
cutoff there, do the cutoff, and not just the economic power 
that six banks having 65 percent--their assets being 65 percent 
of GDP, but the political power that they hold with agencies, 
with regulators, with Congress, all up and down.
    The second thing I thought of during this hearing--and it 
has really sparked interest in my office and among my staff and 
among the Banking Committee staff, Graham and Laura 
particularly, is sort of the structure of the Fed and the 12 
regional Presidents and the 12 districts, how each of the Class 
A--each of the three Class A Directors are drawn from the 
banks, each of the Class B Directors are chosen by the banks, 
and each of the Class C Directors are chosen we do not really 
quite know how, ultimately by the Fed, but we do not know where 
names are submitted, and the statute does not seem to speak to 
this at all clearly, and it raises a lot of questions about 
sort of the most--the potential of regulatory capture and the 
fact--and I think the question that I asked all of you that you 
all answered fairly well about, you know, should the Fed be 
interested in income inequality, and when the nine--typically, 
the nine Class A, B, and C Directors in each of the Fed 
regions, in each of the Fed districts, who have hired--six of 
whom have hired the Fed Presidents in those district, how they 
are not exactly a cross-section of America in their income and 
their backgrounds and their education levels, perhaps in their 
interests also.
    But let me talk for a moment about the Taylor rule and ask 
you, Mr. Conti-Brown, some thoughts. Dr. Simon Johnson at a 
hearing in the House some months ago made clear there is a 
significant difference between central banks being transparent 
about their objectives and actions for monetary policy and 
Congress specifying in detail a default rule for determining 
monetary policy for a central bank. Dr. Taylor 20 years 
authored an article that we know about titled, ``Discretion 
Versus Policy Rules and Practice''. He wrote, ``A policy rule 
can be implemented and operated more informally by policymakers 
who recognize the general instrument responses that underlie a 
policy rule, but who also recognize that operating the rule 
requires judgment and can be done by computer. A policy rule 
need not necessarily mean either a fixed setting for the policy 
instruments or a mechanical formula.''
    Mr. Conti-Brown, is the Fed transparent about its 
objectives and actions for monetary policy? And should they, in 
fact, follow a fixed monetary policy rule?
    Mr. Conti-Brown. So recognizing that I am a legal scholar 
and a historian, not an economist, let me answer that question, 
and that is actually not so much a qualifier, but gives insight 
into why I am not in favor of the House bill that is sometimes 
called ``the Taylor rule bill'' or the ``policy rule bill,'' 
and the reason is that law can be very sticky. So Professor 
Taylor has been talking about how we just need--you know, 
define your rule, and if it deviates from the Taylor rule or 
whatever rule is specified by the House, then explain it. And 
in a perfect world where people come to these questions 
rationally, are looking at the same data and information, this 
becomes a very technocratic or technical evaluation. You can 
imagine that there would be built in a great deal of consensus 
about why a rule that was written in statute should be deviated 
    Now, as an expert in the Federal Reserve Act, I can tell 
you there are so many provisions that were written subject to 
political compromises of decades long past but still exert a 
great deal of pressure over the organization of our central 
bank. So the thing that I fear about a statutory policy rule is 
that it would just get stuck in statutory inertia and make it 
very difficult to deviate, even if there is broad consensus 
ideologically among economists and others that there should be 
that deviation. And, indeed, the periods historically that 
Professors Taylor and Meltzer have pointed to as being eras 
when there have been really successful outcomes, those were 
policy rules adopted internally by the Fed. The Fed today has 
also adopted policy rules and is very clear about what their 
outcomes and targets are at a time--more clear than they were, 
in fact, during that period that is pointed to as really the 
bastion of policy rules.
    So that is what gives me great pause about putting policy 
rules into the Federal Reserve Act, is the unintended 
consequences that future generations will be dealing with a 
political moment that we are confronting today, where, frankly, 
there is not even consensus among economists as to the virtues 
of this action for today's problems, let alone tomorrow's.
    Senator Brown. Thank you. Let me for a moment ask you to 
discuss sort of the difference between transparency and 
clarity. No one has accused the Fed, at least in my lifetime, 
of always being clear in its public statements. President 
Fisher of the Dallas Fed delivered a speech and said, ``In this 
era of social media and uber transparency, we all at the Fed 
need to learn to speak English rather than Fed-speak.'' It 
seems to me it would not take legislation. It would be more 
effective than Audit the Fed.
    Give us briefly your thoughts on how the Feds could do more 
to change how they speak to the American public.
    Mr. Conti-Brown. Absolutely, I think that that emphasis on 
clarity is extremely important. Chairman Greenspan very 
famously said in 1987, since he became Fed Chairman, he learned 
to ``mumble with great incoherence,'' and that was seen as a 
bastion of an old guard rule that central bankers never defend, 
never explain.
    That is changing, and it is continuing to change. The Fed 
can do more, by speaking in English, issuing FOMC statements 
that have clarity around them, having a Web site that is easy 
to navigate, which the Fed has done and markedly improved, 
having a more liberal FOIA policy where they let go of some of 
their documents. As a scholar, I have had some run-ins with the 
Fed where they have held onto things that they should not have 
held onto, other things they released that they should, and it 
is very healthy. So I think the Fed is paying a great deal of 
attention to its public-facing interactions. It is doing more, 
and Members of Congress should encourage it through hearings 
and through our mechanisms to say that they should stop 
speaking in too technical language.
    The last point I would make on this, here is why the 
diversity on the FOMC and Board of Governors is so essential, 
and diversity here I mean in an intellectual and methodological 
approach. Academic economists have now dominated the FOMC, the 
Reserve Bank Presidents on the Board of Governors, and I think 
economists, of course, have a natural interest in the functions 
of the macro economy and the functions of central banks. But 
when they all gather together, they start to speak a language 
that is not necessarily accessible to the American people 
because the American people do not all have Ph.D.s in 
    Having more people who are coming from legal backgrounds, 
banking backgrounds, consumer backgrounds, labor backgrounds, 
historians, others, to participate in not only the formulation 
of policy but also its explanation to others would go a very 
long way at reaching the clarity that you are talking about, 
Senator Brown.
    Senator Brown. Thank you. And the last question--and Dr. 
Meltzer told us, I thought very aptly, gave his description of 
regulatory capture with some thoughts on what to do. Give me 
    Mr. Conti-Brown. So regulatory capture is sometimes defined 
as when the regulated get to dictate the terms to the 
regulators it is a problem all throughout our economy, not just 
in the financial sector. But it is hardwired into the Federal 
Reserve Act. The mechanisms that you described where it is not 
just Class B and C Directors who choose the Presidents. Class A 
Directors are still, just as you said, in the selection of the 
Directors, are they participating in those conversations? Are 
they putting forward names, even if they do not formally vote? 
We do not know. But the very idea that bankers are selecting 
their regulators, not through Congress but directly, by the 
exercise of a vote, should give us all pause and ask questions 
about how could the Reserve Bank Presidents do anything but 
dance with the one that ``brung'' them. This is the problem 
that I see, and I think addressing those governance problems at 
the Reserve Banks would go a very long way at increasing public 
accountability, congressional oversight of the appointment 
personnel level in a very healthy way, and indeed could help 
facilitate rules-based monetary policy. If we want to see a 
Taylor rule at the Fed, then we should appoint Professor Taylor 
to be at the Fed, and having that kind of focus on appointment 
    Chairman Shelby. That would probably be a great idea.
    Chairman Shelby. He has been mentioned. Maybe he will be.
    Mr. Conti-Brown. I think that that would be vastly superior 
to writing the Taylor rule into the Federal Reserve Act, is 
focusing on the appointment and governance structure of the Fed 
instead of dictating policies.
    Senator Brown. Thank you, Mr. Chairman.
    Chairman Shelby. Dr. Taylor, your name has been mentioned 
here several times by me and others and by Mr. Conti-Brown, and 
the Taylor rule. Do you want to respond to any of that?
    Mr. Taylor. Just briefly. There is nothing in the House 
bill where a rule would be written into statute, as I hear Mr. 
Conti-Brown saying. This is the Fed's decision to choose its 
strategy and its rule. And as Allan Meltzer indicated, during 
certain periods it has done that quite well. In other periods 
it has not.
    I think part of the accountability would be that they would 
say what they are doing and when they are off and when they are 
on, and there could be a good discussion of that. It seems to 
me it is so integral to public policy.
    I think the idea that the Fed could just do it on its own--
in other words, the Chair could come up and just describe the 
strategy and without any legal change--it is conceivable. But I 
think the partnership, if you like, the accountability, would 
benefit if it was actually part of the law. Many people have 
taken this suggestion, many people at the Fed said, well, we 
can do that anyway. But I think they are not. And so this would 
be, I think, an encouragement for them.
    It is hard for me to understand why people object to this. 
Most of the objections--and, admittedly, I might not be hearing 
them properly. But most of the objections seem to be 
misinterpreting what the law, what the proposal, what the bill 
is all about. And just if I go back to Senator Brown's question 
of Mr. Conti-Brown, there is a distinction between setting a 
goal, like 2-percent inflation, and setting your strategy to 
get to the goal. There is a difference. That is in some sense 
why I quoted from Janet Yellen. This is simply just meant to be 
someone who has thought about this for many years, and 
carefully. She said a rule could help the Federal Reserve 
communicate to the public the rationale behind its moves--that 
is, instrument moves--and how those moves are consistent with 
the objectives, like 2-percent inflation.
    So there is a great deal of value to having a dialog like 
that. It is more than we have now. And I think going back to 
the experience, we have had periods where, as Allan Meltzer 
indicated, the policy has been more strategic, rule-like, less 
reacting to individual things, more understandable, more 
predictable, and the economy has worked better. And then there 
are these other periods, unfortunately--and I wish I could have 
been part of the answer to that 20-percent unemployment in 
Indiana. That just did not magically happen. That 20 percent 
was also due to public policy, going down to 5. But do not 
forget that we are trying to avoid those 20-percent phenomena. 
It is terrible.
    And so, sincerely, from looking at the experience, the way 
Government works, my own experience in Government, it seems to 
me that there is a lot of ration off this. It does not need to 
be partisan. There is a lot of people who understood this and 
study it. So I urge you to continue talking about it, Mr. 
    Chairman Shelby. I thank the panel. We will continue our 
hearings regarding the Fed and other regulatory agencies. Thank 
you very much.
    [Whereupon, at 4:25 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
  Mary and Robert Raymond Professor of Economics, Stanford University
                             March 3, 2015
    Chairman Shelby, Ranking Member Brown, and other Members of the 
Committee, thank you for the opportunity to testify at this hearing on 
``Federal Reserve Accountability and Reform''.
    John Brian Taylor is the Mary and Robert Raymond Professor of 
Economics at Stanford University, and the George P. Shultz Senior 
Fellow in Economics at Stanford University's Hoover Institution.
    In my opening remarks I would like to focus on a particular reform 
that would improve the accountability and transparency of monetary 
policy and lead to better economic performance. The reform would simply 
require the Fed to describe its strategy for monetary policy. It is a 
reform about which both Chairman Shelby and Chairman Jeb Hensarling of 
the House Financial Services Committee asked Fed Chair Janet Yellen in 
their opening questions at the Congressional hearings last week. It has 
attracted a lot of attention and has led to discussion and debate in 
the media, in the markets, and among economists.
    The prime example of such a reform is a bill which passed out of 
the House Financial Services Committee as Section 2 of HR 5018 last 
year. \1\ This bill would require that the Fed ``describe the strategy 
or rule of the Federal Open Market Committee for the systematic 
quantitative adjustment'' of its policy instruments. It would be the 
Fed's job to choose the strategy and how to describe it. The Fed could 
change its strategy or deviate from it if circumstances called for a 
change, but the Fed would have to explain why.
     \1\ For additional background on this general type of reform see 
John B. Taylor, ``Legislating a Rule for Monetary Policy'', The Cato 
Journal, 31 (3), Fall, 407-415, 2011.
    In considering the merits of such a reform, I think it is important 
to emphasize the word ``strategy'' in the bill. Though monetary 
economists often use the word ``rule'' rather than strategy, the term 
rule can sometimes be intimidating if one imagines that a rules-based 
strategy must be purely mechanical, contrary to what I and others have 
argued for many years. The United States Congress through the Senate 
Banking Committee and the House Financial Services Committee is in a 
good position--and in a unique position in our Government--to oversee 
monetary policy in a strategic rather than a tactical sense. The most 
effective way to exercise this oversight is to require that the Federal 
Reserve describe its strategy publicly as the House bill does.
    Experienced public officials know the importance of having a 
strategy and the close connection between a strategy and a rules-based 
process. One of the most experienced, George Shultz, put it this way, 
and I quote \2\ ``Let me explain why I think it is important, based on 
my own experience, to have a rules-based monetary policy. First of all, 
if you have policy rule, like a Taylor Rule, you have a strategy, which 
is sort of what it amounts to . . . And at least as I have observed 
from policy decisions over the years in various fields, if you have a 
strategy, you get somewhere. If you don't have a strategy, you are just 
a tactician at large and it doesn't add up. So a strategy is a key 
element in getting somewhere.''
     \2\ ``The Importance of Rules-Based Policy in Practice'', in 
Frameworks for Central Banking in the Next Century, Michael D. Bordo, 
William Dupor, and John B. Taylor (Eds.), A Special Issue on the 
Occasion of the Centennial of the Founding of the Federal Reserve, 
Journal of Economic Dynamics and Control, Volume 49, December 2014.
    Fed Chair Janet Yellen made similar observations when she served on 
the Federal Reserve Board in the 1990s. In ``Monetary Policy: Goals and 
Strategy'' she explained that \3\ ``The existence of policy tradeoffs 
requires a strategy for managing them,'' and she described a policy 
rule (the Taylor rule) pointing out ``several desirable features'' it 
has ``as a general strategy for conducting monetary policy.'' She also 
stated that ``the framework of a Taylor-type rule could help the 
Federal Reserve communicate to the public the rationale behind policy 
moves, and how those moves are consistent with its objectives.''
     \3\ Janet L. Yellen, ``Monetary Policy: Goals and Strategy'', 
Remarks to the National Association of Business Economics, Washington, 
DC, March 13, 1996.
    In testimony before the House Financial Services Committee last 
summer I described how experience and research by many people over many 
years has shown that a rules-based monetary strategy leads to good 
economic performance. \4\ This view is based on historical and 
statistical evidence. During periods when policy is more rules-based as 
in much of the 1980s, 1990s, the economy has performed well. During 
periods such as the 1970s and the past decade when policy has been more 
discretionary, economic performance has been poor. The shifts in policy 
preceded the shifts in economic performance, which indicates that 
policy shifts cause the changes in performance.
     \4\ For a summary of the research see John B. Taylor and John C. 
Williams ``Simple and Robust Rules for Monetary Policy'', in Benjamin 
Friedman and Michael Woodford (Eds.), Handbook of Monetary Economics, 
Elsevier, 2011, 829-859.
    In a compendium published just last December to mark the Centennial 
of the Federal Reserve, Michael Bordo, Richard Clarida, John Cochrane, 
Marvin Goodfriend, Jeffrey Lacker, Allan Meltzer, Lee Ohanian, David 
Papell, Charles Plosser, and William Poole joined George Shultz in 
writing about the advantages of such a policy strategy. \5\ Most also 
agreed that during the past decade the Fed has either moved away from a 
rules-based strategy or has not been clear about what the strategy is. 
As stated last week by monetary economists Michael Belongia and Peter 
Ireland \6\ ``For all the talk about `transparency,' . . . the 
process--or rule--by which the FOMC intends to defend its 2-percent 
inflation target remains unknown.''
     \5\ Frameworks for Central Banking in the Next Century, Michael D. 
Bordo, William Dupor, and John B. Taylor (Eds.), A Special Issue on the 
Occasion of the Centennial of the Founding of the Federal Reserve, 
Journal of Economics Dynamics and Control, Volume 49, December 2014.
     \6\ Michael Belongia and Peter Ireland, ``Don't Audit the Fed, 
Restructure It'', e21 February 19, 2015.
    Hearings specifically about this reform and other hearings such as 
those with Chair Yellen last week have been useful for getting input 
and finding the best way forward. But concerns and misunderstandings 
persist. For example, in answering questions from Chairman Shelby last 
week, Fed Chair Yellen stated that ``I am not a proponent of chaining 
the Federal Open Market Committee in its decision making to any rule 
whatsoever.'' And the next day she repeated that view to Chairman 
Hensarling, saying ``I don't believe that the Fed should chain itself 
to any mechanical rule.'' And in both hearings she quoted me saying 
that the Fed should not follow a mechanical rule. But the House 
monetary strategy bill, or similar proposals, would not chain the Fed 
to any rule. First, the Fed would choose and describe its own strategy, 
and it need not be a mechanical rule. Second, the Fed could change the 
strategy if the world changed, or it could deviate from the strategy in 
a crisis; so it would not be ``chained.'' The Fed would have to report 
the reasons for the changes or departures, but, as in the example of 
departing from the policy rule during the stock market break in 1987, 
which Chair Yellen referred to, it would not be difficult to explain 
such adjustments.
    Another concern has been raised by those who warn that by publicly 
describing its policy strategy, the Fed would lose independence. In my 
view, based on my own experience in Government, the opposite is more 
likely. A clear public strategy helps prevent policymakers from bending 
to pressure. Moreover, de jure central bank independence alone has not 
prevented departures from a rules-based strategy. De jure central bank 
independence has been virtually unchanged in the past 50 years, yet 
policymakers have varied their adherence to rules-based policy. These 
variations demonstrate the need for legislation requiring the Fed to 
set and clarify its strategy for its policy instruments.
    Some have expressed concern that a rules-based strategy would be 
too rigid. But the reform provides flexibility. It would allow the Fed 
to serve as lender of last resort or take appropriate actions in the 
event of a crisis. A policy strategy or rule does not require that any 
instrument of policy be fixed, but rather that it flexibly adjusts in a 
systematic and predictable way to economic developments. Moreover, as I 
indicated, the reform allows the Fed to change its rule or deviate from 
    Another concern is expressed by those who claim that the House 
monetary strategy bill would require the Fed to follow the Taylor Rule; 
but this is not the case. The bill does require the Fed to describe how 
its strategy or rule might differ from a ``reference rule,'' which 
happens to be the Taylor rule. However, describing the difference 
between a particular policy rule and this reference rule is a natural 
and routine task for the Fed. In fact, many at the Fed already make 
such comparisons including Fed Chair Yellen; \7\ another recent example 
is the Fed staff paper that makes extensive use of the rule to measure 
the impact of the Fed's unconventional policies. \8\
     \7\ Janet Yellen, ``The Economic Outlook and Monetary Policy'', 
Money Marketeers, New York, New York, April 11, 2012.
     \8\ Eric Engen, Thomas Laubach, and David Reifschneider, ``The 
Macroeconomic Effects of the Federal Reserve's Unconventional Monetary 
Policies'', January 14, 2015.
    It is important to point out that there is precedent for this type 
of Congressional oversight. Previous legislation, which appeared in the 
Federal Reserve Act from 1977 to 2000, required reporting of the ranges 
of the monetary aggregates. The legislation did not specify exactly 
what the numerical settings of these ranges should be, but the greater 
focus on the money and credit ranges were helpful in the disinflation 
efforts of the 1980s. When the requirement for reporting ranges for the 
monetary aggregates were removed from the law in 2000, nothing was put 
in its place. A legislative void was thus created concerning reporting 
requirements and accountability. In many ways reform is needed simply 
to fill that void.
    In my view the Congress and this Committee now have an opportunity 
to move forward on such a reform in a nonpartisan way with constructive 
input from the Fed. The result would be a more effective monetary 
policy based on a strategy to achieve the goals of a better performing 
economy which we all share. I would be happy to answer any questions 
you may have about this reform or others.
The Allan H. Meltzer University Professor of Political Economy, Tepper 
             School of Business, Carnegie Mellon University
                             March 3, 2015
    What does ``independent'' mean when the Federal Reserve is called 
an independent agency? The question is not one that the Federal Reserve 
or others try to answer, so we must look at what it does to supplement 
its few efforts to define independence.
    The answer is mixed. Any agency that can quadruple the size of its 
balance sheet without oversight over 4 or 5 years, as the Fed has just 
done, has considerable freedom or independence. Yet, many of the 
increased services, more than 40 percent, went to finance the outsized 
budget deficits during the period. Independent central banks do not 
finance budget deficits.
    In fact, the original Federal Reserve Act in 1913, did not permit 
any Federal Reserve support of the Treasury. For the founders, an 
independent central bank followed a gold standard rule and also a rule 
that prohibited financing the Treasury and the budget. Those two rules 
supported an independent Federal Reserve during the 1920s. After 
surrendering independence to finance World War I and accepting control 
by the Treasury and administration in the early postwar, the Federal 
Reserve restored its independence by restoring the gold exchange 
standard. That standard was a weaker type of gold standard that became 
an operating rule. The Fed worked to expand the gold exchange standard 
internationally. The U.S. did not leave the standard until 1934, but it 
did not monetize gold inflows in 1930-32, a mistake but made 
    The prohibition against financing the Treasury did not last long. 
By 1923, the Reserve Banks, subject to Board approval, bought and sold 
Treasury issues to change bank reserves. Once open market operations 
became the principal means of implementing monetary policy, the Federal 
Reserve could buy new Treasury issues, not directly from Treasury, but 
in the market.
    Legally the Federal Reserve remained an independent agency. Once 
the two rules were no longer binding, independence lost much of its 
meaning. As Milton Friedman claimed (Friedman, 1959), and Thomas 
Cargill recently documented (Cargill, 2014), it is a rule that 
restricts Federal Reserve actions. And it is the decision to follow a 
rule that maintains central bank independence.
    In the 1930s, once the two original rules no longer affected 
Federal Reserve decisions, the Treasury demanded monetary actions. 
Secretary Morgenthau wanted low interest rates to finance budget 
deficits. He threatened to use the profit from revaluing the gold stock 
to purchase debt, if the Federal Reserve allowed interest rates to 
rise. Legal independence gave no protection. \1\
     \1\ More detail on this period and other examples of lack of 
independence that I cite, and some that I don't cite, come from my 
Federal Reserve history.
    As is well-known, the Federal Reserve agreed to hold interest rates 
fixed to finance World War II debt. The Federal Reserve sacrificed its 
independence. The Korean War is the only war in which the Federal 
Government ran a budget surplus in the war years 1951-52.
    The Federal Reserve used concern about Korean wartime inflation to 
end its policy of pegging rates inherited from World War II. From the 
end of the war in 1945 to March 1951, the prevailing Federal Reserve 
position was that it could not regain independence because it lacked 
political strength. The Federal Reserve acted only after several U.S. 
senators led by Senator Paul Douglas insisted on an end to the wartime 
pegging policy. The Fed's independence remained restricted by its 
agreement to maintain an ``even keel'' when the Treasury issued debt, 
so independence of Treasury was not complete. Even keel required the 
Federal Reserve to support Treasury issues by purchasing treasuries if 
a treasury issue was mispriced. The Fed continued even keel 
interventions until the 1970s when the Treasury finally decided to 
auction its bonds and notes.
    A much greater restriction on independence after 1951 was Chairman 
Martin's definition of independence, borrowed from an earlier statement 
by Alan Sproul of the New York bank. This is the only explicit 
definition offered by officials. Martin said that the Fed was 
independent within the Government, not independent of the Government.
    Martin explained the distinction on several occasions. Independence 
within Government turned out to have little true independence. Martin 
explained that if Congress passes and the president signs a budget that 
requires substantial deficit finance, the Federal Reserve has the 
obligation to help finance the budget. A consequence of this policy was 
that inflation remained lower than the 1.4 percent average of consumer 
price inflation in the 1950s, when President Eisenhower maintained 
small deficits or surpluses except in the recession year, 1958. In the 
years of President Johnson's larger Federal budget deficits, 1965-69, 
the average inflation (CPI) rate rose to 3.5 percent and was rising at 
a 5.5 percent rate when Martin retired.
    Arthur Burns replaced Martin. Burns was a frequent visitor at the 
White House and considered himself a friend and confident of President 
Nixon. During his term as chairman, cpi inflation averaged 6.6 percent 
and reached as high as 11 percent in 1974. Burns was present with 
Administration officials when President Nixon adopted price and wage 
controls in 1971. As part of the controls program, Burns chaired the 
Committee on Interest and Dividends. He cannot be regarded as 
independent during President Nixon's terms.
    The Carter administration did not reappoint Burns to a third 4-year 
term as chairman because he did not share information with them. This 
was a more independent Burns. His replacement was a businessman who had 
worked in the Carter presidential campaign and served on a regional 
Federal Reserve Bank board. The choice shows no evidence of a desire 
for an independent monetary policy.
    When President Carter moved William Miller to Treasury Secretary, 
he appointed Paul Volcker as Federal Reserve chairman. Volcker was a 
relatively independent chairman committed to a policy of reducing 
inflation. President Carter shared his aim. He did not share Volcker's 
belief that the Federal Reserve had to reduce money growth to lower 
inflation. President Carter under pressure from Congressional members 
of his own party, chose to have the Federal Reserve impose credit 
controls. Volcker participated in the Administration discussions and 
agreed to implement the control program. This is a breach in his 
    The Federal Reserve credit control program was rather benign. The 
public's reaction much less so. A widespread surge of popular support 
for lower inflation brought a large decline in spending and quarterly 
GNP. Although use of credit cards was not restricted, thousands mailed 
their credit cards to the White House and the Fed.
    The response to credit controls was so strong that the open market 
committee shifted to expansive policy in the summer of 1980. Credit 
controls ended.
    In the fall of 1980, the Federal Reserve raised interest rates and 
renewed anti-inflation policy. President Carter accepted the Fed's 
actions. He declined to act despite the urgings of his advisers who 
warned that high unemployment and high interest rates would hurt his 
campaign for reelection. Volcker was not pressed to lower interest 
    Ronald Reagan won the 1980 election. His campaign promised to 
reduce inflation. Despite urgings from the so-called supply-side 
economists at the Treasury, President Reagan did not pressure the 
Federal Reserve. The president accepted the highest unemployment rate 
of the postwar years, 10.8 percent, and with it the loss of many 
Republican seats in the fall 1982 election.
    Volcker called himself a ``practical monetarist.'' He explained 
repeatedly what I call the anti-Phillips curve foundation of his 
strategy. He often told Congress and the public that the way to reduce 
the unemployment rate was to lower expected inflation. Despite long 
term interest rates of 5 to 7 percent, the economy recovered strongly 
in 1983 and 1984. Inflation remained low most years after 1984.
    Alan Greenspan replaced Volcker in 1986. Greenspan further lowered 
the inflation rate. He was also a relatively independent chairman who 
resisted open criticism from the Administration of his anti-inflation 
policy during the 1992 election year.
    Greenspan made a radical departure from the discretionary policy 
followed by many of his predecessors. From 1986 to about 2002, he let 
the Fed more or less follow a Taylor rule. This produced a long period 
of growth, short and mild recessions, accompanied by low inflation. 
After the fact, the period was called ``the great moderation'' because 
of the combination of relatively stable growth, low inflation, and 
short, mild recessions.
    By following a rule, the Greenspan Fed produced the longest period 
of stable growth and low inflation in Federal Reserve history. 
Greenspan was able to maintain Federal Reserve independence because his 
policy maintained popular support. Following a rule sustained a rule 
sustained independence.
    There are many explanations of the so-called great moderation. I 
believe the main reason is reliance on the Taylor rule to guide policy. 
Following that rule induces policymakers to avoid responding to noisy 
monthly and quarterly data. By following a Phillips Curve, FOMC actions 
increase variability. The Fed responds to the unemployment rate and 
ignores inflation until inflation rises. Then it ignores unemployment 
until unemployment rises. By approximately following a Taylor rule, the 
Federal Reserve responded to both unemployment and inflation. That gave 
more of a medium-term focus to their actions and avoided shifting from 
one goal in the dual mandate to the other.
    Unfortunately, the Greenspan Federal Reserve reverted to earlier 
procedures after 2003. And when Ben Bernanke became chairman in 2006, 
the Fed restored its policy of responding to noisy, frequently revised 
monthly reports on unemployment.
    The Bernanke Fed made the mistake of bailing out a failed Bear 
Stearns early in 2008. This contributed to the belief that the Fed 
would support failing financial firms. By encouraging this belief and 
doing little to force banks to strengthen their balance sheets and 
increase equity reserves, the Fed encouraged the financial system to be 
unprepared for the crisis that followed failure of Lehman Brothers in 
October 2008. Bankers interpreted Federal Reserve policy statements as 
an indication that it would bail out large banks. Lehman's failure came 
when the financial system was undercapitalized. Fear of additional 
failures--widespread collapse of the payments system--was met by 
massive Federal Reserve action including a bailout of a major insurance 
    The Treasury and the Federal Reserve worked together to restore 
confidence and solvency. There was no thought of independence. In a 
major crisis independence vanishes. This was true of the Bank of 
England under the traditional gold standard, and it remains true.
    Preventing systemic collapse avoided the mistakes of 1929-32. 
Although some at the Fed claimed to follow Bagehot's (1873) rule, that 
is only partly true. The Fed lent freely to all legitimate borrowers, 
but it did not charge a penalty rate to limit lending to those at risk. 
Most importantly, in its 100 year history it never announced a rule for 
the lender of last resort. Bagehot understood that announcing the 
crisis rule encouraged banks to hold short-term paper eligible for 
discount. \2\
     \2\ Bagehot criticized the Bank of England for not publicly 
announcing its lender-of-last-resort policy. In its entire history, the 
Federal Reserve has never announced a crisis policy. By announcing its 
policy, the Federal Reserve would encourage some banks to act 
prudently. For more detail on Federal Reserve lender-of-last-resort 
policy see Goodfriend (2012, 2013) where he relates the Federal Reserve 
failure to the incentives induced by its governance structure. See also 
Bordo (2014) at this conference.
    Following its successful policy of preventing financial collapse, 
the Federal Reserve pursued the most expansive policy in its history. 
Idle excess reserves of banks rose from less than $800 billion to more 
than $2.5 trillion. Currently, on its projected path, idle reserves 
will reach $3 trillion in 2014.
    This policy finances massive Government budget deficits at very low 
interest rates. This is the very opposite of what an independent 
central bank does. I do not know of any example, anywhere, in which 
base money creation to finance large budget deficits avoided higher 
inflation. The Federal Reserve has not revealed a credible policy that 
will prevent future inflation.
    Market participants credit the Federal Reserve with ability to 
prevent inflation. That seems to neglect much previous history. Perhaps 
market expectations are encouraged by the low inflation to date. That 
ignores the possible tsunami of idle reserves that spill over the 
domestic and international economy.
What We Should Learn
    In its first 100 years, the cpi inflation rate rose from 1 percent 
in 1914 to 18 percent during World War I, then fell to -10.5 percent in 
1926. Under the gold exchange rule from 1923 to 1929 inflation remained 
relatively low and stable, never exceeding 2.3 percent in 1925.
    During the 1930s, inflation fell to -9.9 percent in 1932 and rose 
to 3.6 percent during the inflation scare of the mid-1930s. Price and 
wage controls held down reported inflation rates during World War II. 
Nevertheless, cpi inflation reached 10.9 percent in 1942 and 14.1 
percent in 1947 after the Congress removed controls.
    By the late 1960s and the 1970s, inflation rose as the Federal 
Reserve helped to finance Federal budget deficits. That ended with the 
Volcker disinflation and the Greenspan policy.
    Table 1 shows a rough measure of recent Federal Reserve 
independence, the portion of a relatively large budget deficit financed 
by issuing base money. This measure is not useful for periods like the 
1950s, when the budget deficit was small in most years and budget 
surpluses were frequent.
    The chart shows the large difference between the Volcker years and 
the Bernanke years. President Obama's deficits increased massively, and 
the Federal Reserve financed a much larger share. The inflation 
consequences are currently postponed because banks hold most of the 
reserves idle. Independent central banks behave like the Volcker Fed, 
not like the Bernanke Fed.


    The Bernanke Federal Reserve never claimed to hold interest rates 
low to help the Treasury and it did not repeat Chairman Martin's 
definition of independence. It defended its policy as an effort to 
lower the unemployment rate. With trillions of idle reserves on bank 
balance sheets and additional trillions of money and short-term 
securities on corporate balance sheets, it did not explain what it 
thought additional reserves could achieve that could not be achieved by 
the banks and corporations. This seems an elementary error, but an 
error nonetheless. I believe it is a political decision made by a 
politicized and therefore nonindependent Federal Reserve.
    A main lesson of this trip through history is that following a rule 
or quasi-rule in 1923-28 and 1986-2002 produced two of the best periods 
in Federal Reserve history. The lesson I draw, as Friedman (1959) 
taught us, following a rule contributes to independence by producing 
better outcomes, but claiming independence does not.
    No rule will work perfectly in all circumstances. The classical 
gold standard rule required suspensions during crises. Following a 
Taylor rule produced better than average results. Congress, under 
Article I, Section 8 of the Constitution, should require the Federal 
Reserve to follow a specific Taylor rule with opportunity to deviate 
based on an announced objective.
    The Federal Reserve is an agent of Congress. Congress holds a 
hearing twice a year to fulfill its oversight requirement. Federal 
Reserve chairmen are able to avoid serious oversight because they are 
able to talk around their mistakes. A rule would increase control by 
Congressional oversight committees.
    A Taylor rule can improve monetary policy and economic performance. 
It achieves greater policy independence also. It should be supplemented 
by a pre-announced rule for its service as lender of last resort.
Bagehot, Walter, (1873/1962). Lombard Street. Homewood, IL: Richard D. 
Bordo, Michael, (2014). ``Rules for a Lender of Last Resort: An 
    Historical Perspective''. Xeroxed, Rutgers University, April.
Friedman, Milton, (1959). A Program for Monetary Stability. New York: 
    Fordham University Press.
Cargill, Thomas, (2014). ``Independence No Substitute for Rules Board 
    Policy'', Central Banking, 24 (February), 3, 9-46.
Goodfriend, Marvin, (2012). ``The Elusive Promise of Independent 
    Central Banking''. Money and Economic Studies, Bank of Japan, 
    November, 39-53.
Goodfriend, Marvin, (2013). ``Lessons Learned From a Century of Federal 
    Reserve Lending''. Testimony Subcommittee on Monetary Policy and 
    Trade, House Committee on Financial Services, September 28.
            Resident Scholar, American Enterprise Institute
                             March 3, 2015
    Chairman Shelby, Ranking Member Brown, and distinguished Members of 
the Committee, thank you for convening today's hearing on Federal 
Reserve Accountability and for inviting me to testify. I am a resident 
scholar at the American Enterprise Institute, but this testimony 
represents my personal views. My research is focused on banking, 
regulation, and financial stability. I have prior experience working on 
banking and financial policy issues at the Federal Reserve Board, the 
IMF and, in the most recent past, for 10 years as Director of the FDIC 
Center of Financial Research where I served a 3-year term as chairman 
of the Research Task Force of the Basel Committee on Banking 
Supervision. It is an honor for me to be able to testify before the 
Committee today.
    I will begin with a high-level summary of my testimony:

    The Federal Reserve was created by and enjoys duties and 
        powers delimited by laws passed by Congress. Congress retains 
        the legal right and social responsibility to amend the Federal 
        Reserve Act and related legislation when such amendments are 
        judged to be in the national interest. To exercise this duty, 
        the Congress must have the right to assess the performance of 
        existing Federal Reserve powers and responsibilities.

    New legislation is required should Congress decide to 
        assess the Federal Reserve's monetary policy performance using 
        the Government Accountability Office (GAO). The Federal Banking 
        Agency Audit Act of 1978 restricts the GAO from evaluating 
        Federal Reserve activities related to the Fed's monetary policy 

    No new legislation is required to use the GAO to assess 
        many other Federal Reserve activities and process including the 
        expanded regulatory powers granted to the Federal Reserve and 
        the Board of Governors by the Dodd-Frank Act.

    Many Federal Reserve regulatory initiatives related to 
        their Dodd-Frank expanded powers merit closer Congressional 
        oversight. In this testimony, I will limit my discussion to 
        three areas that have especially important ramifications for 
        the safety and vitality of the entire U.S. financial system:

      The Congress should exercise closer oversight over the 
        Federal Reserve's ongoing interactions with international 
        standard-setting bodies like the Financial Stability Board, the 
        International Association of Insurance Supervisors, and the 
        Basel Committee on Banking Supervision.

      Congresses should instruct the GAO to assess the costs, 
        benefits, and processes associated with the recurring Board of 
        Governors stress tests mandated by Section 165 of the Dodd-
        Frank Act. These stress tests are very resource-intensive, both 
        for banks and for the banking regulators, and there is little 
        evidence that they are a cost-effective and objective means for 
        regulating individual financial institutions.

      Congress should assess potential conflicts that may be 
        developing between the Federal Reserve's Dodd-Frank expanded 
        powers over the domestic insurance industry and State insurance 
        regulations. There are indications that new Federal Reserve 
        examination and capital policies for insurers affiliated with a 
        depository institution may be generating serious conflicts with 
        existing State insurance supervision and regulation, contrary 
        to the intent of the Dodd-Frank Act.
Federal Reserve Independence and Calls To ``Audit the Fed''
    The Federal Reserve was created by and enjoys duties and powers 
delimited by laws passed by Congress. Congress retains the legal right 
and social responsibility to amend the Federal Reserve Act and related 
legislation when such amendments are judged to be in the national 
interest. To exercise this duty, the Congress must have the right to 
assess the performance of existing Federal Reserve powers and 
    The Federal Reserve (Fed) was created by Congress in 1913 with 
limited responsibilities. These included: the establishment of regional 
Federal Reserve Banks; the provision of an elastic currency; the 
rediscounting of commercial paper; and, the supervision of Federal 
Reserve member banks. Over the years Congress amended the Federal 
Reserve Act to liberalize constraints on Fed operations, establish a 
Federal Reserve Open Market Committee, change the Fed's governance 
structure, require periodic reports by the Fed Chairman to Congress, 
and assign the Fed specific monetary policy goals.
    For most of the Fed's history, its battle for independence has been 
a struggle to formulate monetary policy without interference from the 
executive branch. Before the Fed won its independence from the U.S. 
Treasury in the early 1950s, many Administrations had run the Federal 
Reserve as if it were a captive finance arm of the U.S. Treasury.
    Today the battle for Federal Reserve independence is a struggle to 
maintain minimal Congressional oversight over some of its operational 
areas, and a fight to maintain the legal luxury to carefully manage the 
Fed's operational transparency. The current struggle is probably less 
about safeguarding monetary policy from being high-jacked by parochial 
Congressional interests, but more about safeguarding unique Federal 
Reserve privacy privileges derived from its monetary policy functions.
    Critics of ``audit the Fed'' proposals argue that the modern 
Federal Reserve is already transparent regarding its monetary policy 
deliberations and operations. True, the Fed now releases minutes and 
transcripts from its FOMC meetings with modest delays, and it has Web 
sites that document the details of its balance sheet and securities 
holdings. The Dodd-Frank Act pushed the Fed to disclose details about 
borrowers using the Feds emergency credit facilities \1\ and, beginning 
in 2012, the Fed was required to release detailed data on discount 
window borrowing \2\ and open market transactions \3\ with a 2 year 
     \1\ http://www.federalreserve.gov/newsevents/
     \2\ http://www.federalreserve.gov/newsevents/
     \3\ http://www.newyorkfed.org/markets/OMO_transaction_data.html
    While the Fed has responded to public and Congressional pressures 
and become much more transparent in its disclosures in recent years, 
disclosure is not the same thing as oversight. Oversight involves 
independent evaluation of process and performance. \4\ The Federal 
Banking Agency Audit Act of 1978 gives the GAO audit authority over the 
Federal Reserve, but prohibited it from auditing: \5\
     \4\ This discussion borrows from Marc Labonte, ``Federal Reserve: 
Oversight and Disclosure'', Congressional Research Service, September 
19, 2014.
     \5\ 31 U.S. Code Sec. 714. The GAO normally has a number of 
separate Federal Reserve audits underway in any single year. The 
Federal Reserve System also has an Office of Inspector General (OIG) 
that is responsible for detecting and preventing fraud, waste, and 
abuse. The Fed's OIG also issues semiannual reports to Congress.

    Transactions with or for foreign central banks, 
        Governments, or nonprivate international financing 

    Deliberations or actions concerning monetary policy

    Federal Open Market Committee transactions

    Discussions and communications between Federal Reserve 
        members, officers, or employees associated with the prior three 

    Given the uncertainties associated with the long-run economic 
impacts of the Fed's postcrisis monetary policy, some in Congress favor 
an expanded role for the GAO that includes the power to make an 
independent assessment of the Fed's monetary policy. For example, among 
other legislative features, S. 264 (the Federal Reserve Transparency 
Act of 2015) would remove all restrictions on the GAO's ability to 
audit the Federal Reserve. An alternative proposal, H.R. 5018 (the 
Federal Reserve Accountability and Transparency Act of 2014) would 
remove all GAO audit restrictions but also require the Fed to provide 
the Congress with detailed information regarding its monetary policy 
decision rule.
    Congress created the Federal Reserve and Congress retains the power 
to evaluate Federal Reserve performance and amend the Federal Reserve 
Act. In this context, the ``audit the Fed'' debate is about whether 
Congress should deputize the GAO to evaluate Fed performance, not 
whether the Congress has the power to do so. Whatever the outcome of 
the ``audit the Fed'' debate, ideally Federal Reserve oversight should 
be designed to allow Congress to ask and receive answers to its 
questions and criticisms, including about the Fed's monetary policy, 
but still shield the Fed from undue pressure to alter monetary policy 
to satisfy short-run political interests.
    The modern Federal Reserve does far more than monetary policy, and 
the Fed's nonmonetary policy duties also raise important accountability 
concerns. The Dodd-Frank Act (the Act) granted the Federal Reserve 
extensive new powers to formulate supervision, regulation, and 
bankruptcy reorganization standards for large financial institutions, 
and yet the Act itself includes no explicit congressional control over 
these expanded Federal Reserve powers. Indeed recent speeches by 
Federal Reserve officials argue that these new Fed ``macroprudential 
powers'' are an essential complement to monetary policy, especially in 
the current zero interest rate environment.
    Using its expanded regulatory powers, the Federal Reserve has the 
ability to shape the growth and development of the entire U.S. 
financial system. Unless the Congress exercises heightened oversight 
and control over the Federal Reserve's use of these expanded regulatory 
powers, Congress will delegate decisions that determine the future 
vitality of U.S. financial markets to unelected Federal Reserve 
officials who are at best only weakly accountable to the public. \6\
     \6\ The Federal Reserve chairman and vice-chairman face Senate 
confirmation every 4 years. Federal Reserve governors are confirmed by 
the Senate, but limited to a 14-year term unless they are initially 
filling a partial term of departing governor. Regional Federal Reserve 
Bank presidents are not confirmed by the Senate.
    In the remainder of my testimony, I will focus on the need for 
expanded congressional oversight over the Fed's Dodd-Frank regulatory 
powers and related operations. Current legal authorities appear 
adequate and do not appear to restrict the GAO's ability to audit the 
Federal Reserve's regulatory activities, including audits on the 
Federal Reserve's use of its expanded regulatory powers. \7\ In the 
remainder of my testimony I will highlight three areas where I think 
Congress should step up its oversight of the Federal Reserve's enhanced 
supervision and regulation operations.
     \7\ If however, there are legal impediments for GAO audits, simple 
amendments to the Dodd-Frank Act, like extending Section 122 powers to 
other sections of the Act, could explicitly provide the needed powers.
The Federal Reserve's Relationship to International Standard Setting 
    The Congress should exercise closer oversight over the Federal 
Reserve's ongoing interactions with international standard-setting 
bodies like the Financial Stability Board, the International 
Association of Insurance Supervisors, and the Basel Committee on 
Banking Supervision.
    A recent GAO report \8\ examined the relationship between Financial 
Stability Oversight Council (FSOC) designations of nonbank financial 
firms for enhanced supervision and regulation by the Federal Reserve 
Board and prior designations of the same firms (as global systemically 
important institutions) by the Financial Stability Board (FSB). Since 
the Treasury and Federal Reserve are both members of the FSB 
designation group, this coincidence raised concern that the FSOC 
designation decisions were actually made during FSB deliberations, well 
before the FSOC completed its designation analysis.
     \8\ Report to the Ranking Member, Committee on Banking, Housing, 
and Urban Affairs, U.S. Senate, ``Financial Stability Oversight 
Council: Further Actions Could Improve the Nonbank Designation 
Process'', GAO, November 2014.
    The GAO reported that Treasury and Federal Reserve officials it 
interviewed argued that FSB designations imposed no constraint on the 
FSOC's subsequent designations, but were just ``another factor'' taken 
into account in the FSOC deliberations. The GAO report also includes 
commentary and footnotes that suggest that GAO investigators had a 
difficult time believing these claims. The GAO noted that FSB documents 
report that national authorities are consulted before the FSB 
designates individual institutions.
    A recent letter to G20 Ministers and Central Bank Governors dated 
February 4, 2015, \9\ raises new issues regarding the Federal Reserve's 
participation in FSB work streams including work streams that make FSB 
designations. In the letter, FSB chairman (and governor of the Bank of 
England) Mark Carney, makes clear to FSB members that the decisions of 
the FSB are directives, which all FSB members are expected to carry 
out. In this letter, Carney states specifically that FSB members--
including the Federal Reserve--have agreed to ``Full, consistent and 
prompt implementation of agreed reforms.''
     \9\ http://www.financialstabilityboard.org/wp-content/uploads/FSB-
    FSB chairman Carney's letter notes that ``FSB peer reviews'' will 
cover ``implementation of the G20 policy framework.'' Carney reinforces 
the point mentioning that the FSB's will use its oversight as a means 
for achieving its objectives: ``The FSB will support the determined 
efforts of its members through enhanced monitoring of implementation 
and its effects across all jurisdictions. We will regularly report our 
key findings to the G20.''
    The Federal Reserve apparently has agreed that its financial 
regulatory policies and institution designations will be guided by FSB 
directives that it has agreed to implement. Moreover, the Fed appears 
to have agreed to have its policy implementation overseen by a body 
dominated by European bureaucrats and chaired by the governor of the 
Bank of England. While the U.S. Treasury was clearly aware of these 
developments by virtue of their own FSB membership and participation, 
it does not appear that the U.S. Congress received prior consultation 
before the Federal Reserve made these commitments.
    Recent experience raises legitimate concerns that the Federal 
Reserve and the Treasury have been deciding on FSOC designations well 
before the FSOC finalizes its analysis. Given the unbalanced nature of 
FSOC member resources, pressure from the Treasury and the Federal 
Reserve Board on other FSOC members would likely be more than adequate 
to ensure a specific institution's designation. The November 14 GAO 
report documents that Federal Reserve has by far the largest staff 
allocated to the FSOC designations process and it is unlikely that few 
if any of the other FSOC members without a direct regulatory interest 
would challenge the Federal Reserve Board staff on its designation 
conclusions. \10\ Indeed Federal Reserve influence on FSOC designations 
goes beyond the Board of Governors as there are reports that Federal 
Reserve Bank of New York staff has also been heavily involved and 
influential in the FSOC designation process. \11\
     \10\ No other agency has a staff as large, technically 
sophisticated, or as academically credentialed as the Federal Reserve. 
For example, the Federal Reserve Board has more than 350 economists on 
its home Web page, http://www.federalreserve.gov/econresdata/
theeconomists.htm and virtually all of them have Ph.D.s. This does not 
include Federal Reserve economists at the Reserve Banks. For example, 
the New York Fed alone lists 71 Ph.D. economists on its Web site. In 
contrast, on their respective Web sites, the CFTC lists 10 economists, 
the FDIC lists 19 economists, FHFA lists 15 Ph.D. equivalent 
economists, and the newly ``economist fortified'' SEC lists roughly 70 
     \11\ See the letter dated July 9, 2014, from Representative 
Garrett to William Dudley expressing concerns and additional 
information about the New York Fed's extensive involvement on the FSOC 
designation process.
    The recent FSOC decision regarding Metlife's designation for 
heightened prudential standards and supervision by the Federal Reserve 
Board highlights the overwhelming influence that the Federal Reserve 
Board and Treasury can have on the FSOC designation process, especially 
when the FSOC's members have no direct interest in the nonbank industry 
under consideration. Dissenting from the FSOC's Metlife designation was 
the council's independent member having insurance expertise and the 
Council's State insurance commissioner representative. \12\ Moreover, 
the State insurance commissioners from five States--California, 
Connecticut, Delaware, New York, and North Carolina--independently 
wrote to FSOC Chairman Lew to protest the Metlife designation.
     \12\ http://www.treasury.gov/initiatives/fsoc/designations/
    The Metlife dissent opinion written by the FSOC's independent 
member with insurance expertise was particularly informative about the 
relationship between FSB designation and subsequent FSOC decisions. It 
is worth quoting at length:

        On July 18, 2013, the Financial Stability Board (FSB), an 
        international organization within the umbrella of the Group of 
        Twenty (G20), primarily comprising the world's finance 
        ministers and central bankers, including the U.S. Department of 
        the Treasury (Treasury) and the Board of Governors, announced 
        that it had identified MetLife as a global systemically 
        important financial institution (G-SIFI). G-SIFIs are declared 
        by the FSB to be ``institutions of such size, market 
        importance, and global interconnectedness that their distress 
        or failure would cause significant dislocation in the global 
        financial system and adverse economic consequences across a 
        range of countries.'' Thus, MetLife was declared by the FSB as 
        a threat not to just the U.S. financial system, but to the 
        entire global financial system.

        The FSB's announcement of the identification of MetLife and 
        eight other insurers as G-SIFIs stated that its action had been 
        taken ``in collaboration with the standard-setters and national 
        authorities;'' and, that as G-SIFIs, these organizations would 
        be subject to policy measures including immediate enhanced 
        groupwide supervision, as well as to recovery and resolution 
        planning requirements. It is clear to me that the consent and 
        agreement by some of the Council's members at the FSB to 
        identify MetLife a G-SIFI, along with their commitment to use 
        their best efforts to regulate said companies accordingly, sent 
        a strong signal early-on of a predisposition as to the status 
        of MetLife in the U.S--ahead of the Council's own decision by 
        all of its members.

        Despite subsequent assertions by some of the Council's members 
        that the FSB and Council processes are separate and distinct, 
        they are in my mind very much interconnected and not 
        dissimilar. It would seem to follow that FSB members who 
        consent to the FSB's identification of G-SIFIs also commit to 
        impose consolidated supervision, yet-to-be agreed-to capital 
        standards, resolution planning, and other heightened prudential 
        measures on those G-SIFIs that are domiciled in their 

    These pointed remarks from FSOC members make it apparent that the 
Congress must exercise closer oversight over the Federal Reserve's 
participation in FSB work streams. The Congress could exercise 
additional oversight using GAO audits, hearings, or through other 
legislation. For example, H.R. 5018 would require the Fed to notify 
congressional committees with jurisdiction and the general public 90 
days prior to its intention to enter into or complete negotiations with 
international committees or standard setting bodies.
    Regardless of the method the Congress selects, it needs to improve 
oversight of Federal Reserve's involvement in FSB initiatives, 
especially those regarding the capital regulation of insurance firms 
including any work streams on capital surcharges for insurance firms 
designated as global systemically important institutions as well as 
Federal Reserve involvement in FSB work streams focused on the 
designation of systemically important nonbank noninsurance (a.k.a. 
shadow bank) institutions and the enhanced regulation of ``shadow 
banking'' activities. \13\
     \13\ http://www.financialstabilityboard.org/wp-content/uploads/
    When Federal Reserve officials refer to shadow banking, they are 
referring to activities that primarily associated with the asset 
management industry. In January 2014, the FSB issued a consultative 
document discussing a designation process for nonbank noninsurer 
systemically important firms. \14\ Firms fitting the FSB's consultative 
document profile are large asset management institutions. In November 
2014, the FSB committed to issue policy recommendations that will 
establish regulatory minimum ``haircuts'' for securities financing 
transactions (securities lending and repurchase agreements) among 
shadow banks. Mirroring these developments, senior Federal Reserve 
officials used recent speeches to telegraph the Federal Reserve's 
intention to impose marketwide minimum haircuts on securities lending 
and repurchase transactions. Federal Reserve officials have also 
identified high-yield short-maturity by mutual fund investments as a 
shadow banking activity that should be discouraged as a potential 
source systemic risk.
     \14\ http://www.financialstabilityboard.org/wp-content/uploads/
    The FSB is also in the process of recommending changes in insurance 
regulation. In October 2013, the FSB directed the International 
Association of Insurance Supervisors to develop a comprehensive 
supervisory and regulatory framework, including a risk-based global 
insurance capital standard for internationally active insurers as well 
as basic capital requirements (BCR) and higher loss absorbency (HLA) 
requirements for global systemically important insurance institutions. 
The Federal Reserve is an important member of this FSB insurance work 
stream and many observers believe that the Federal Reserve will 
eventually try to impose the FSB's insurance regulatory capital 
standards on State-regulated domestic U.S. insurers. The potential 
conflict with FSB insurance capital initiatives and U.S. insurance 
company capital requirements will be discussed in a subsequent section 
of my testimony.
    If recent history is a guide, the policies the Federal Reserve 
develops in these and any other FSB work streams will form the basis of 
the policies the Federal Reserve subsequently attempts to impose as 
domestic regulations. It is important for Congress to step up its 
oversight of the Federal Reserve's involvement in FSB activities so it 
can make a timely evaluation of regulatory developments. Once FSB work 
streams conclude, it becomes more difficult for Congress to intervene 
and alter policies.
Congress Should Assess the Merits of Dodd-Frank Section 165 Stress 
    Congresses should instruct the GAO to assess the costs, benefits, 
and processes associated with the recurring Board of Governors stress 
tests mandated by Section 165 of the Dodd-Frank Act. These stress tests 
are very resource-intensive, both for banks and for the banking 
regulators, and there is little evidence that they are a cost-effective 
and objective means for regulating individual financial institutions.
    Section 165 of the Dodd-Frank Act directs the Board of Governors to 
establish heighted prudential standards that apply to bank holding 
companies with consolidated assets in excess of $50 billion and nonbank 
financial firms designated by the FSOC. Included in Section 165 is the 
requirement that these institutions participate in an annual stress 
test exercise supervised by the Federal Reserve Board. The Federal 
Reserve is required to publish the results of these annual stress 
tests. In addition, financial institutions with $10 billion in 
consolidated assets and a primary Federal regulator must conduct annual 
stress tests similar to the Board of Governors stress test and report 
the results to their primary Federal regulator.
    Congress should consider an extensive audit of the Dodd-Frank 
mandate for recurring Federal Reserve Board stress tests. The audit 
should include an independent assessment of the Federal Reserve Board's 
stress test models and methodology including an assessment of the 
predictive accuracy (i.e., assess the confidence bounds) of the Federal 
Reserve's methodology. Assessments should evaluate the consistency with 
which the Federal Reserve Board applies its quantitative and 
qualitative stress test assessments both across institutions within a 
year and Fed's consistency across time. Independent assessors should 
identify weaknesses in the methodology and evaluate the Federal Reserve 
Board's internal approach for identifying and managing stress test 
methodology weaknesses. The examination should include the remediation 
process that occurs when a bank disputes the Fed's findings. Assessors 
should have confidential discussions with the financial institutions 
that have participated in these stress test exercises and report on 
these institution's concerns with the Fed's processes. The audit should 
evaluate the costs and benefits of using this methodology as a primary 
input in supervision and regulation of individual institutions.
    The Board of Governors stress tests mandated by Dodd-Frank Act are 
expensive both for the banks and bank regulatory agency resources that 
could be deployed in other productive supervisory activities. These 
stress tests have dubious predictive power for identifying hidden 
financial system imbalances or for identifying risks in specific 
institutions financial institutions that would otherwise remain 
undetected. The quantitative outcome of these stress tests is arbitrary 
and completely under the control of the Federal Reserve Board because 
the stress tests estimates involve an overwhelming amount of judgment 
on the part of the stress tester. Consequently stress test results 
cannot be replicated by different independent stress testers. Since 
banks cannot accurately anticipate the Fed's stress test results even 
when they know the macroeconomic stress scenarios, this mandatory 
process interjects a huge and unproductive source of uncertainty in the 
bank planning process.
    Board of Governor stress tests are a particularly problematic form 
of enhanced prudential supervision because there is no objectively 
correct answer in a Board of Governor's stress test. Participants are 
required to produce specific numerical answers questions that have no 
single correct answer knowing that the Board of Governors has wide 
discretion to decide the ``correct'' at will by changing modeling 
assumptions. Moreover, institutions have no mechanism to challenge the 
Board of Governors on the accuracy of Board's preferred correct answer. 
     \15\ I am adapting Kevin Dowd's analogy in, ``Math Gone Mad: 
Regulatory Risk Modeling by the Federal Reserve'', CATO Policy Analysis 
No. 754, September 3, 2014.
    Many have questioned the value of macroeconomic scenario stress 
tests for identifying and mitigating financial sector excesses, \16\ 
and yet the Federal Reserve System spends an enormous amount of 
resources and requires covered institutions to spend significant sums 
on the activity. Already, Fed stress tests have missed the ``London 
Whale'' at JPM Chase and a multibillion-dollar hole in Bank of 
America's balance sheet. Fannie Mae and Freddie Mac both passed 
Government-designed macroeconomic stress right up to the time they 
failed in September 2008. Before the financial crisis, many countries 
produced financial stability reports that included bank stress tests 
and none anticipated the crisis. And there are many additional examples 
where similar tests failed to identify subsequent problems.
     \16\ For some examples, see: C. Borio, M. Drehmann, and K. 
Tsatsaronis, ``Stress-Testing Macro Stress Testing: Does It Live up to 
Expectaions?'' Bank for International Settlements, November 2011; or, 
Til Schuermann, ``The Fed's Stress Tests Add Risk to the Financial 
System'', The Wall Street Journal, March 19, 2013; or, L. Guerrieri and 
M. Welch, ``Can Macro Variables Used in Stress Testing Forecast the 
Performance of Banks?'' Federal Reserve Board Finance and Economics 
Discussion Series 2012-49.
    A stress-test based approach for setting bank capital has two 
gigantic measurement problems. First, the macroeconomic scenario must 
actually anticipate the next financial crisis. And secondly, regulators 
must be able to translate the macroeconomic crisis scenario into 
accurate predictions about actual bank profits and losses.
    Few regulators possess the prescience necessary to accomplish this 
first step. In 2006, the subprime crisis was less than 2 years away, 
but the Federal Reserve did not see it coming. The New York Fed's staff 
was publishing papers that dismissed the idea of a housing bubble and 
the Federal Reserve Chairman's speeches argued--worst case--there may 
be some ``froth'' in local housing markets. Even as the subprime bubble 
burst, the new Fed Chairman publicly opined that the economy would 
suffer only minor fallout.
    Even if a stress scenario correctly anticipates a coming crisis, 
the crisis must be translated into individual bank profits and losses. 
However, bank profits and losses are not very tightly linked with 
changes in macroeconomic indicators. Quarter-to-quarter bank profits do 
not closely follow quarterly changes in GDP, inflation, unemployment, 
or any other macroeconomic indication. The best macroeconomic stress 
test models explain maybe 25 percent of the quarterly variation in 
individual bank profits and losses, meaning that more than 75 percent 
of the variation in bank profit and losses cannot be predicted using 
GDP, unemployment, or other business cycle indicators.
    Because of these measurement issues, bank loss predictions from 
macroeconomic stress tests have very little objective accuracy. Even 
using the best models, there remains a great deal of uncertainty 
surrounding how each bank may actually perform in the next crisis, 
presuming the stress scenario anticipates the crisis.
    These issues make macroeconomic stress testing more of an art than 
a science and a tool that is inappropriate for the supervision on an 
individual institution. There are just too many places to make 
mistakes. There is no formula or procedure that will lead to a single 
set of stress test bank loss estimates that can be independently 
calculated by different stress test modelers. Thus, it is not 
surprising that the Board of Governors and the U.S. banks rarely agree 
on stress test results.
    Less widely appreciated is that these coordinated macroeconomic 
stress tests encourage a ``group think'' approach to risk management 
that may actually increase the probability of a financial crisis. \17\ 
Stress test crisis scenarios have to be specific so that banks and 
regulators can model the same event. Moreover, the Board of Governors 
imposes some uniformity in loss rates across all designated banks by 
using its own stress test estimates. The Board of Governors is very 
much like a coach or a central planner that tries to ensure some 
coherence in each designated firms estimates and capital plans. Perhaps 
unintentionally, by requiring all firms to approach the stress test 
problem in the same way as the Board of Governors, the process 
encourages all large institutions to think and operate the same way.
     \17\ Til Schuermann, op. cit. makes this argument.
    A final weakness concern is that the stress test process requires 
the Board of Governors to be intimately involved in modeling the 
operations and exposures of each large banking institution. The process 
requires the Federal Reserve Board to use its own judgment to set each 
large bank holding company's ``stress tested'' capital plan. These 
regulations have become so intrusive that the regulator virtually runs 
the bank. In such a situation, it becomes difficult for the regulator 
to admit a mistake and allow an institution to fail.
Congress Should Examine Conflicts Between Federal Reserve and State 
        Insurance Regulation
    Congress should assess potential conflicts that may be developing 
between the Federal Reserve's Dodd-Frank expanded powers over the 
domestic insurance industry and State insurance regulations. There are 
indications that new Federal Reserve examination and capital policies 
for insurers affiliated with a depository institution may be generating 
serious conflicts with existing State insurance supervision and 
regulation, contrary to the intent of the Dodd-Frank Act.
    The new regulatory powers granted by the Dodd-Frank Act to the 
Federal Reserve could lead to substantial changes in insurance 
regulation. Since the McCarran-Ferguson Act of 1945, insurance 
regulation has been conducted by the States and their insurance 
commissions. The Dodd-Frank Act created a new Federal Insurance Office 
within the U.S. Treasury, but the Act purposely limited the new 
office's responsibilities to monitoring and advisory duties; it does 
not have national supervisory responsibility.
    Notwithstanding the fact that the Dodd-Frank Act intentionally 
avoided the creation of a national insurance regulator, many in the 
insurance industry believe that the Federal Reserve is using its new 
Dodd-Frank powers to become the de facto national insurance supervisor. 
Moreover, the industry is concerned that these developments could lead 
to wholesale revisions in the supervision and capital regulations that 
apply to State insurers and result in the imposition of bank-style 
capital regulation on the insurance industry.
    Section 312 of the Dodd-Frank Act transferred regulatory authority 
and rulemaking over thrift holding companies and insurance holding 
companies that owned depository institutions from the Office of Thrift 
Supervision to the Federal Reserve. Section 604 of the Act authorizes 
the Federal Reserve to conduct examinations of the nonbank subsidiaries 
and affiliates of these holding companies even if these institutions 
have a functional regulator.
    Section 312 empowers the Federal Reserve to examine insurance 
companies whereas, prior to the Dodd-Frank Act, bank regulators were 
prohibited from examining these State regulated entities. Since 
acquiring its new powers, the Federal Reserve has launched an extensive 
examinations program for insurance companies owned by thrift and 
insurance holding companies. These examination often are conducted 
using newly hired Federal Reserve examiners with little or no insurance 
experience, even though these insurers being examined are already fully 
regulated and supervised by State insurance commissioners.\18\ \19\
     \18\ Testimony of Thomas Sullivan of the Board of Governors before 
the House Subcommittee on Housing and Insurance, November 18, 2014.
     \19\ For official Federal Reserve guidance on these examinations, 
see http://www.federalreserve.gov/bankinforeg/srletters/sr1111a2.pdf.
    These Federal Reserve insurance examinations are causing 
considerable concern for insurers. Industry sources suggest that the 
Federal Reserve examiners are less than fully conversant with State 
insurance regulations and they frequently find that insurer 
subsidiaries or affiliates are undercapitalized if their capital levels 
do not agree with bank capital standards, even when these insurers are 
well-capitalized according to long-standing State insurance 
regulations. Representatives of the insurance industry are worried 
that, unless Congress intervenes, these Federal Reserve insurance 
examinations and associated holding company regulatory capital 
restrictions will eventually lead to the imposition of bank regulatory 
capital standards on the entire insurance industry.
    Section 606 of the Dodd Frank Act allows the Federal Reserve to 
apply its bank holding company ``source of strength doctrine'' to the 
insurance and thrift holding companies it now regulates. Industry 
sources suggest that the Fed's erroneous examiner opinions alleging 
weak capital positions at insurance subsidiaries and affiliates have 
lead the Fed to conclude that the consolidated capital positons of some 
holding companies must increase. Again, in the opinion of the insurance 
industry experts familiar with the specific details of these cases, 
these mandated capital increases are not addressing true holding 
company capital weaknesses. Instead they are the result of long-
standing and appropriate differences between the capital regulations 
for insurers (set by the States), and consolidated capital standards 
for banks (set by the U.S. bank regulatory agencies in consultation 
with the Basel Committee on Bank Supervision).
    Industry representatives suggest that the Federal Reserve's 
approach for assessing the capital position of thrift and insurance 
holding companies could lead to new insurance industry constraints on 
dividend payments or other transactions that return capital to 
shareholders. The Fed can apply its holding company capital rules even 
in cases where the holding company is comprised predominately of 
insurance related activities and includes a subsidiary depository 
institution that holds only a tiny fraction of the holding companies' 
assets. \20\ Recent congressional testimony by Federal Reserve Board 
Senior Advisor Thomas Sullivan did not allay industry concerns when he 
reported, ``Our principal supervisory objectives for insurance holding 
companies are protecting the safety and soundness of the consolidated 
firms and their subsidiary depository institutions . . . '' \21\
     \20\ For a detailed discussion of the issues that concern the 
industry see, Letter to Regulatory Agencies on Behalf of Nationwide 
Mutual Company regarding ``Regulatory Capital Rules: Regulatory 
Capital, Implementation of Basel III, Minimum Regulatory Capital 
Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective 
Action'', http://www.federalreserve.gov/SECRS/2012/December/20121206/R-
     \21\ See Thomas Sullivan's testimony.
    With the Fed's acquisition of thrift and insurance holding company 
supervision and the three large FSOC-designated insurance companies now 
subject to enhanced supervision and regulation by the Federal Reserve 
Board, the Federal Reserve is now the consolidated supervisor of 
companies that hold about one-third of the asset in U.S. insurance 
industry. \22\
     \22\ Ibid.
    Reflecting these new insurance powers, in 2013 the Federal Reserve 
has joined the International Association of Insurance Supervisors--the 
international standard setting body for insurance regulation. The 
Federal Reserve is now a member of the IAIS work stream that is 
developing global standards for the supervision and regulation 
internationally active insurers, including regulatory capital standards 
for insurance groups. \23\ This work is part of the overall G20 
financial stability initiative coordinated by the FSB. The Federal 
Reserve is also a member of the IAIS group that is responsible for 
identifying global systemically important insurers and designing the 
enhanced regulatory and supervisory framework that will apply to these 
     \23\ Ibid.
    The Federal Reserve is a member of the IAIS work stream charged 
with developing groupwide capital standards for insurance groups. These 
consolidated capital requirements are similar to the consolidated 
capital requirements for bank holding companies. For some years, Europe 
has been developing new insurance capital standards called Solvency II. 
Solvency II standards are in many respects similar to the Basel capital 
standards for banks and bank holding companies. In fact, Solvency II 
and is often called ``Basel for insurers.'' The similarity between bank 
and insurance capital requirements in Europe is no accident because 
European insurance activities are often conducted as part of a 
universal banking organization. Because the IAIS membership is 
dominated by European insurance supervisors, many believe that, in the 
end, any new IAIS groupwide standard will strongly resemble Solvency 
    In contrast to Europe, the U.S. does not have a consolidated 
capital standard for insurers. Historically, the U.S. approach to 
insurer capitalization has served the industry well. It has not 
resulted in any systemic weaknesses and it likely works to contain 
contagion risk because it limits interdependencies among insurance 
companies. U.S. capital standards are set for individual State 
insurance entities that are incorporated and fully capitalized within a 
single State. They are licensed, regulated and if need be, liquidated 
at by the State insurance regulator. Consolidated group capital has not 
been an important issue in the U.S. because each State chartered 
insurance entity must be fully capitalized and cannot rely on capital 
support from a larger insurance group.
    The extent of Federal Reserve involvement in insurance regulation 
and the potential for the Fed to impose significant changes on 
insurance supervision and regulation was unlikely to have been 
anticipated by Congress. The Federal Reserve is now poised to become 
the de facto national insurance regulator that Congress declined to 
create in the Dodd-Frank Act. The Fed is empowered to exam firms that 
hold one-third of insurance industry assets even though these firms are 
examined by State insurance regulators. The Fed is now also the most 
influential U.S. regulatory member charged with designing new capital 
and supervisory processes in the IAIS/FSB work stream. The Fed is 
already showing a preference to impose bank capital regulations on 
insurance holding companies and there is industry concern that the Fed 
may agree to Solvency II bank-like capital regulations in its IAIS 
insurance capital work stream.
    This concludes my written remarks. Thank you for the opportunity to 
testify on these issues.
    Academic Fellow, Stanford Law School, Rock Center for Corporate 
                             March 3, 2015
    Mr. Chairman, Ranking Member Brown, Members of the Committee, my 
name is Peter Conti-Brown and I am an Academic Fellow at Stanford Law 
School's Rock Center for Corporate Governance. In July, 2015, I will be 
an assistant professor of legal studies and business ethics at the 
Wharton School of the University of Pennsylvania. I am here today as a 
legal scholar and a financial historian who studies the institutional 
evolution of central banking, especially in the United States. Much of 
what follows comes from a paper I presented on March 2, 2015, at the 
Hutchins Center on Fiscal and Monetary Policy at the Brookings 
Institution. As noted above, I reiterate that I speak only on my own 
behalf. \1\
     \1\ Much of the detail, the citations, and other supporting 
evidence is contained in that paper: ``The Twelve Federal Reserve 
Banks: Governance and Accountability in the 21st Century'', available 
at http://www.brookings.edu//media/Research/Files/Papers/2015/03/02-
    It's been an exhausting 7 years to be a central banker. It began in 
the summer of 2007 and extended through the shotgun marriage between 
JPMorgan Chase and Bear Stearns, the concomitant resurrection of 
unusual lending authority, the ongoing implementation of unconventional 
monetary policy, and so much else in between. To paraphrase Thomas 
Paine, these have been the times that try central bankers' souls, that 
test the resolve of the summer hawk or the sunshine dove.
    But these central banking times have been trying not only, perhaps 
not even especially, for central bankers, but also for the public they 
serve. This heterogeneous public--including long-standing Fed watchers 
and those who have only recently realized that the United States has a 
central bank, those who love the Fed, and those who hate it--has not 
always, or indeed not even very often, been fully comfortable with 
these decisions. The emergency lending--the ``bailouts,'' in the 
popular if misleading parlance--that began with Bear Stearns and 
accelerated through the alphabet soup of Fed and Treasury programs gave 
birth to the populist-libertarian revival of 2010. And the monetary 
policy response, especially in unconventional monetary policy, has only 
exacerbated these tensions. The views of once and future presidential 
hopeful Rick Perry are emblematic of the feelings of many in the 
American polity: quantitative easing was ``printing more money to play 
politics,'' and was, by Perry's lights, ``almost treacherous, or 
treasonous.'' \2\ In the United States, the Fed and its chair were 
among the most admired of agencies and officials in Government at the 
time of, for example, Alan Greenspan's retirement in 2006; just a few 
years later, they were among the lowest (Conti-Brown, 2015b).
     \2\ Zeleny, Jeff, and Jackie Calmes, 2011. ``Perry Links Federal 
Reserve Policies and Treason''. The New York Times, U.S. Politics, 
August 16.
    As a consequence, there has been no shortage of discussions--during 
the crisis and unceasingly since--about how to reform the Fed. Most of 
these discussions, though, have been on reforming the Fed's functions. 
That is, changing the way it lends money in an emergency, how it 
determines which financial institutions are systemically important, how 
it accounts for its spending and decisions, how it determines its 
models of the economy, and how it makes monetary policy. The answer to 
the question: ``What does the Fed do, and what should it do?'' is no 
doubt essential to our understanding of what lessons for central 
banking we are to take from the recent crisis.
    Less discussed, however, is the Fed's structure, raising the 
question, ``Who is the Fed?'' Public and scholarly attention on the Fed 
usually focuses on a monolithic it, or on the personal she or he. In 
fact, the standard grammatical practice--followed in this paper--is to 
refer to the Federal Reserve (or just ``the Fed'') as a proper noun. 
The Fed raised interest rates; the Fed bailed out AIG; the Fed issued 
new banking regulations; the Fed fired a bank examiner for challenging 
Goldman Sachs. But this linguistic practice is an institutional, and 
even grammatical, error. The term ``Federal Reserve'' is not a noun, 
but a compound adjective. There are Federal Reserve Banks, Federal 
Reserve Notes, a Federal Reserve Board, and, taken together, a Federal 
Reserve System, all created by the Federal Reserve Act of 1913. But 
there is no ``Federal Reserve'' by itself. \3\ This vocabulary failure 
belies a harder problem for thinking about the Federal Reserve System--
even though we rarely refer to it as such, to paraphrase Kenneth 
Shepsle, the Fed is a ``they,'' not an ``it.'' \4\
     \3\ To highlight this point, in the original debates during, and 
for many years following, the passage of the Federal Reserve Act of 
1913, the only word capitalized was frequently ``Federal'': it was the 
``Federal reserve board'' and the ``Federal reserve banks.''
     \4\ Shepsle (1992).
    This is not a pedantic grammatical point. Understanding the Fed's 
complex ecosystem and the institutional actors within the Federal 
Reserve System is essential to understanding the space within which the 
Fed makes policy. It also speaks to the very independence that some 
distrust and others hold very dear. This complexity also illustrates a 
problem not just of public understanding--though it is certainly that--
but also one of governance. When the public is faced with a monolith, 
all debates about Fed actions--no matter where they occur within the 
system, and no matter what those actions may be--easily spiral into 
debates. Such debates involve the first principles about the gold 
standard, the Coinage Clause of the U.S. Constitution, and the pure 
democratic virtues of Thomas Jefferson over the venal tyrannies of 
Alexander Hamilton.
    My book, The Power and Independence of the Federal Reserve takes up 
the largely descriptive task of laying out the governance, 
independence, and structure of the Federal Reserve System, especially 
as that structure has evolved over time. \5\ It relates it to the 
conception of central bank independence that grew out of a historical 
moment in the 1980s and 1990s. But this paper examines one aspect of 
the largely normative issue of central bank design: not what the Fed 
is, but what it should be. In particular, this is a question of the 
federal in the Federal Reserve, looking at the curious decisions of 
institutional design to place some authority in a Government agency in 
Washington, DC, and other authority dispersed unevenly in mostly 
private regional Federal Reserve Banks. It is a question of whether or 
not this failed experiment in quasi-federalism and central banks (and 
without question, it was a failure) should inform our discussions of 
structural reform today.
     \5\ Conti-Brown (forthcoming, 2015).
    My policy prescriptions vary from those offered by Sen. Paul, who 
recommends an audit of the Federal Reserve, and different too from the 
bill pending before the House Financial Services Committee, that would 
mandate that the Fed follow a monetary policy rule or explain its 
deviations to congressional hearings and the Government Accountability 
Office. These bills focus on the policies of the Fed. Given the massive 
uncertainty about the future and the real potential for mischief that 
subjecting the Federal Reserve to the day-to-day of political pressure 
could produce, I favor instead focusing on the Fed's governance 
structure and the proposal that we should have more presidential and 
congressional control at the highest level of policymaking at the 
Federal Reserve.
The Reserve Banks
    Once we accept that there is a role to play for Government in 
implementing policies that redound to the social good--a sometimes 
contested proposition, but one that enjoys relatively widespread 
support--we must answer two additional questions: (1) How will those 
governmental agents be selected? and (2) Will their policies reflect 
that ``social good,'' or some other set of values?
    This is the fundamental question for the Reserve Banks' continued 
participation in the formulation of the Nation's banking and monetary 
policies. As I explain in more detail elsewhere, the Reserve Banks--
especially the Federal Reserve Bank of New York--have the potential to 
make policy and constitutional trouble. Reforming the Reserve Banks by 
revisiting the question of the appointment of their leaders should be 
the top priority of any politician who wants the system to conform to 
constitutional requirements and to allow meaningful democratic 
    The problems with the Reserve Banks are in the nature of their 
appointment and restrictions on their removal. There are three 
alternatives for resolving this problem: (1) make the U.S. President 
responsible for appointing the Reserve Bank presidents; (2) make only 
the president of the Federal Reserve Bank of New York a Presidential 
appointment, or most convincing, (3) make the Board of Governors 
responsible for both appointing and removing the Reserve Bank 
presidents. I will address each in turn.
    The first alternative is the perennial proposal to vest the 
appointment of the Reserve Bank presidents in the U.S. President, with 
the Senate confirming those appointments. This would resolve absolutely 
the constitutional issues of appointment and removal, which I address 
in more detail elsewhere. \6\ And the statute could be clarified to 
demonstrate a hierarchy in nonmonetary policy, placing the Reserve 
Banks under the supervision of the board. But this would also allow the 
Reserve Banks to remain on the FOMC as equals to the governors. Given 
the diversity of their views, this seems a promising reform.
     \6\ See Conti-Brown, ``The Institutions of Federal Reserve 
Independence'', Yale Journal on Regulation, forthcoming 2015.
    Of course, the recent trend toward failing to fill the appointments 
on the Board of Governors may suggest that the fate would be the same 
for the newly installed Presidential appointments at the Reserve Banks, 
as discussed above. This possibility also points toward rendering the 
Reserve Banks fully accountable to the Board of Governors. At the same 
time, it is not likely that we would see the same vacancy rates at the 
Reserve Banks as we have at the Board of Governors, for two reasons. 
First, filibuster reform made it much harder for the minority party to 
block presidential nominees. And second, the vastly expanded Senate 
franchise at the Federal Reserve might make Reserve Bank presidents 
look more like ambassadors or U.S. attorneys, positions that don't 
usually attract the same kinds of partisan political attention we 
associate with Senate gridlock. Even so, this concern is enough to 
weigh against a policy proposal in favor of rendering the Reserve Banks 
presidential appointments.
    There's another reason why making the heads of the 12 Reserve Bank 
Presidential appointments seems a misplaced policy. It would almost be 
sentimental. If all members of the FOMC become Presidential 
appointments, the value of a 19-person committee must come from 
something other than the process of their appointment (the strongest 
justification under the current arrangement). If the problems that 
inhere to the other proposed alternatives are enough to defeat those 
proposals--that is, to subject the Reserve Bank presidents to board 
removal, or board appointment and removal--it may be appropriate to 
entertain the idea that motivated Marriner Eccles back in 1935: 
removing the Reserve Banks entirely from the world of making policy. 
The Reserve Banks could continue to exist as branch offices of the 
Federal Reserve in the 12 cities where they are located, but they would 
not participate on the FOMC. And, consistent with Carter Glass's 
original conception, the Fed could then expand its presence even more 
evenly to other cities, even removing regional banks from places where 
they no longer serve a useful purpose. That way, we could revisit some 
of the decisions about the design of the system that were curious even 
in 1914 when they were decided: Do we really need two Fed branches in 
Missouri, and only one west of Dallas?
    Third, Senator Jack Reed (D-RI) has proposed making only the 
president of the Federal Reserve Bank of New York subject to 
Presidential appointment and Senate confirmation. The Federal Reserve 
Bank of New York and its president are by far the most important 
players in the system from both banking and monetary policy 
perspectives. Giving more presidential and congressional accountability 
to this key figure in the financial system would go a very long way to 
ensuring that the public can participate, appropriately, in the 
governance of its central bank.
    I would prefer a third proposal: Vest the appointment and removal 
of the Reserve Bank presidents in the Board of Governors. \7\ There 
would no longer be multiple layers of removal protection, nor a 
complicated asymmetry in the appointment and removal dynamic. In that 
sense, the change would complete the revolution in central banking 
design that Marriner Eccles began 80 years ago.
     \7\ The Federal Reserve Act does give the Board of Governors 
approval over the appointment of the Reserve Banks. While there are 
anecdotal reports about the frequency with which the board exercises 
this veto, this still needs to be confirmed systematically. ``The 
president shall be the chief executive officer of the bank and shall be 
appointed by the Class B and Class C directors of the bank, with the 
approval of the Board of Governors of the Federal Reserve System, for a 
term of 5 years'' (12 U.S.C. 341).
    This solution does present something of a quandary. If the Board of 
Governors fully appointed, and could remove at will, the Reserve Bank 
presidents, what would be the point of the 19-person FOMC at all? 
Wouldn't this just make the Federal Reserve Bank president a member of 
the Fed's senior staff? And why give them votes on the Nation's 
monetary policy?
    The answer to these questions seems obvious. Making the Reserve 
Bank presidents fully subject to board appointment and removal would 
also mean the abolition of the FOMC and the consolidation of all the 
Fed's legal authority at that board. As mentioned earlier, even for 
those who favor the mixed committee system as a check on inflation, 
there are sharper ways to accomplish this task. It's unclear what we 
gain by having such an unwieldy committee.
    One argument in favor of retaining the current committee size is 
that each Reserve Bank president comes equipped to FOMC meetings, at 
least in part, with research conducted independent of the board's own 
staff assessments. But this feature of the Fed's dispersed research 
function is preservable, if it is indeed desirable. That is, governors 
can gain better access to staff assessments, rather than consume only 
the options the chair has shaped with the staff ahead of FOMC meetings. 
In other words, getting diversity of research views presented at the 
FOMC is not tied to the existence of a 19-person committee.
Federal Reserve Staff
    There are currently 15 divisions at the Fed's Board of Governors, 
each appointed by the Board, none vetted publicly. For some of them, 
and perhaps just for one of them, I would propose that the Senate 
consider revising that appointment process.
    For example, the Director of International Affairs exercises 
extraordinary policy authority on behalf of the United States. True, 
there is much in the position that is very technical. But there is 
much, too, that is highly diplomatic. If the Director of International 
Affairs is seen in the latter role--as essentially the Fed's chief 
diplomat--presidential appointment is very desirable. The Fed's role in 
the international economy has increased substantially in the last 30 
years. The argument for presidential appointment for this key position 
is very strong.
    The strongest argument for presidential appointment among Fed staff 
is in the position of General Counsel. The Fed's chief lawyer, as 
discussed in chapter four, exercises extraordinary authority. As this 
book has argued at great length, the laws of Fed independence and 
authority are difficult to parse. The idea that the exercise of legal 
expertise as a purely technocratic function has been dead for eighty 
years. These positions require value judgments informed by technical 
expertise. While I don't argue that these functions should be subject 
to constant debate on the floor of the House, the case for allowing the 
public to vet the appointment of these lawyers is essentially ironclad.
    Two points of comparison are useful here. First, unlike the case 
with the other ``barons'' of the Fed staff, the Fed Board is not in a 
position to exercise significant oversight over the Fed's chief lawyer. 
As discussed above, the Fed has become increasingly dominated by 
economists, a transition away from a tradition of bankers and lawyers. 
There are good reasons for this transition, but one consequence is that 
the Fed is not in the position to push back against or even, perhaps, 
understand the issues of value judgments that a lawyer must make when 
making a recommendation as monumental as what kind of collateral counts 
when extending emergency loans or whether an enforcement decision 
matches the degree of noncompliance with which it is associated. This 
is not the fault of the Board, but a reflection that theirs is largely 
a different kind of expertise. As of this writing, there are two 
lawyers on the Fed's Board, but only one who has spent a significant 
portion of his career dealing with the legal issues relevant to the 
Fed's regulatory work.
    Second, while other general counsels at administrative agencies are 
not subject to presidential appointment, the Fed's chief lawyer makes 
judgments of extraordinary importance that are unlikely to ever be 
subject to judicial review. Courts have made clear for 80 years that 
they will not review the Fed's decision about monetary policy, 
including when those decisions require novel interpretations of law. 
And in the crisis, emergency decisions were made that have been 
effectively removed from judicial review, including violations of State 
corporate law and issues raised by the Constitution. While judicial 
review still occurs in many of the Fed's regulatory determinations, in 
places where value judgments are of the most consequence, the Fed's 
lawyer is the first and last word on what the law allows or forbids. 
For this reason, the Fed's chief lawyer should be a presidential 
Other Policy Proposals
    There are two proposals for reform that have circulated 
historically, perennially, and are pending before this Committee or the 
House Financial Services Committee. The three proposals are (1) to 
audit the Fed annually through the Government Accountability Office; 
and (2) to legislative a monetary policy rule and require the Fed to 
follow it or explain its deviation to congressional committees with, 
again, support from the GAO.
    The first proposal has been around for decades and continues as a 
perennial favorite for those who seek to understand and reform the Fed. 
That proposal is to subject the Fed to an annual, transparent audit 
performed by the Government Accountability Office. Many within the Fed 
view the ``Audit the Fed'' bills and their proponents with fear and 
loathing and equate the practice with an end of Fed independence. I 
don't share those convictions, at least not completely. That is, the 
public audit part of the proposal strikes me as a scholar and as a 
citizen as an essential part of the way we can understand what the Fed, 
what the Fed does, and who on the outside tries to influence Fed 
behavior. And, historically, Congress has mandated at least two partial 
public audits--in 1978 and 2010--that the Fed vociferously opposed. 
What we learn about Fed practices, especially from its lending behavior 
during the crisis, is essential to our comprehension of this opaque 
    What troubles me about the Audit the Fed bills is the regularity of 
those audits. The potential for one-off audits is a sufficient 
deterrent for the truly scandalous behavior. As noted, it is frankly 
astonishing that the Fed, given its robust financial independence, has 
never had a scandal such as those that have plagued other agencies 
including, ironically, the GAO itself. The problem with the regularity 
of the audits is that they will inject politics deep into the everyday 
operations of the Fed. At present, the Fed and its officials testify 
regularly before Congress, but more in a question and answer format. 
These hearings are public and allow for members of both the House and 
the Senate committees to explore any question of interest. And the 
committees can summon the Fed at their own prompting.
    What an audit would do is force the Fed to structure all of its 
activities toward that kind of transparency. While not as much of an 
intrusion as the hostage holding that would occur through the 
appropriations process, it would significantly decrease the distance 
between the Congress and the Fed that currently exists. Because of the 
deterrent benefits of potential audits and the opportunities that 
members of Congress already have for public accountability through 
congressional hearings, I see annual audits as part of the same 
    The second proposal is the newest, although it too has antecedents 
in history. That proposal would require the Fed to follow a version of 
the ``Taylor Rule'', a model of the monetary policy for the years 1987-
1992 written by Stanford economist John B. Taylor in 1992 and causing a 
large outpouring of research from Taylor and others following in his 
wake. The rule would require the Fed to conform its monetary policies 
to a basic formula that relates a number of variables, including the 
level of current inflation, unemployment, and targets for economic 
growth and inflation. The Fed would input a standard set of 
coefficients to its empirical determination of the economic indicators 
(inflation, unemployment, the output gap, and so forth); the interest 
rate is the output of the equation. Within 48 hours of each FOMC 
meeting, the FOMC would submit to the GAO its determination of the 
Taylor Rule and be audited thereafter by the GAO. If the Fed deviated 
from the Taylor Rule, it would have to appear before a congressional 
committee to explain itself.
    This is a very controversial bill, I think for good reason. I am 
not an economist and have no particular insight into whether the Taylor 
Rule reflects the best version of monetary policy. But economists do 
not agree either. Some of the concerns are not about the need for 
Rules--the Fed has been following a modified version of the Taylor Rule 
for years. It is on the value of those coefficients, and whether the 
determinations made in the Taylor paper, based on data from 1987-1992 
are in fact portable to all times and all places.
    While my research tells us little about whether monetary rules are 
superior, it does tell us something about the nature of law and 
personnel. Intricate rules like the one proposed in the Taylor Bill are 
subject to legal entropy. By inserting the GAO into the monetary policy 
equation, we cannot predict the institutional consequences. It is not 
far-fetched to predict, depending on the personnel choices made under 
the Taylor Bill regime, monetary policy drift from the central bank to 
the GAO. This result isn't guaranteed by the bill, of course, but the 
point of this book is to argue that the legal institutions established 
at one time period cannot be trusted to stay in place. For this reason, 
the legal modifications proposed here are entirely about public 
scrutiny of personnel decisions, not policy rules.
    To put the point differently, the Taylor Rule may well be exactly 
the right approach to monetary policy. If that's the case, we should 
appoint John Taylor to the Fed, not insert the GAO and congressional 
committees into the micromanagement of monetary policy.
    The impulse behind Fed reform on the left and the right comes from 
the recognition that the Fed wields extraordinary authority that the 
public does not always understand. At the same time, one of the central 
innovations of institutional design in the 20th century was to create 
central banks that could exist apart from the day-to-day of electoral 
politics. The task for the Congress is to continue to maintain that 
buffer from politics without eliminating the Fed's public 
accountability. I believe focusing on the Fed's governance as opposed 
to micromanaging the Fed's policies is the best way to achieve that 

    Dear Mr. Chairman, I would like to offer a brief statement 
before answering your questions. My statement tells you why I 
believe Federal Reserve reform is important and necessary.
    In the past few years--2008-14, the Federal Reserve 
quadrupled the size of its balance sheet by buying up large 
parts of the Government debt and Government guaranteed 
mortgages. By these actions, the Federal Reserve added several 
trillion dollars to available bank reserves.
    The end result of these actions is highly uncertain. One 
can be skeptical that it will work out to the benefit of the 
Nation, but the outcome is uncertain.
    Even if the outcome is reached without serious problem, the 
Congress must ask if it can permit an agency of Government to 
have the unrestrained power to quadruple its balance sheet 
without any formal oversight by the Congress.
    My answer is a firm NO. That is not the Government of 
limited powers that safeguards our liberty. Congress must 
legislate to restrict future actions of this kind by passing a 

Q.1. The Wall Street Journal recently reported that much of the 
authority previously delegated to the New York Fed to oversee 
the many of the Nation's largest banks has been, in effect, 
revoked and given to a secret committee run by Governor 
Tarullo. One of Dallas Fed President Fisher's proposals calls 
for moving supervision of a ``systemically important'' bank to 
a district outside where that bank is based in order to address 
the potential for regulatory capture. Is it better to 
centralize control of systemic regulation at the Board of 
Governors of the Federal Reserve System or rotate it among 
Federal Reserve Banks?

A.1. I agree with President Fisher. Removing supervision and 
regulation of gigantic banks outside their home district 
reduces the special privileges that the largest banks get from 
their Federal Reserve Banks. I do not believe that Governor 
Tarullo or the Federal Reserve Board is the proper place to 
house regulatory oversight. From the start of the Federal 
Reserve System in 1913, the board has been regarded as the most 
political part of the system. That is more true now than in the 
    Regulation and supervision come closest to the public 
interest if the regulators are disinterested technicians 
applying known, pre-announced standards.

Q.2. Recent proposals have called for certain reforms of the 
Federal Reserve System. Do you support individual proposals 
listed below, and if so, what is the best way to implement such 
changes? If you do not support an individual proposal listed 
below, please explain why and provide any feedback you may have 
on how better to implement the intent of such proposal. Please 
note that some of the proposal listed below are mutually 
exclusive and provide your opinion on each proposal 
individually, and not in the aggregate. If you believe that 
certain proposals work better in combination with another 
proposal or proposals, please explain how and why.
    Reduce the number of Federal Reserve districts from 12 to 

A.2. No. I Oppose. There is rarely clarity about the condition 
of the economy at or near turning points. The district banks 
bring information to the FOMC meeting that they gather from 
business, labor, and other interested parties. Such information 
is very useful. Fewer Federal Reserve districts would deprive 
decision makers of accurate regional information.

Q.3. Remove the requirement that the Federal Reserve Bank of 
New York president have a permanent seat on the FOMC.

A.3. The banking act of 1935 specified that the NY bank was not 
a permanent member of FOMC. Its vote alternated with Boston. In 
practice, however, Boston allowed NY to have the vote at every 
meeting. In 1942 the rules were changed to make NY the 
permanent member.
    The NY bank stays very close to developments in the money 
and securities markets. The FOMC values that information.
    If the Banking Committees adopted and congress legislated a 
rule, there would be less attention to the money market. A 
major benefit would be reduced attention to current events and 
more attention to medium-term changes in the economy. That is 
what happened when Alan Greenspan more or less followed the 
Taylor Rule. It gave us the longest period of low inflation, 
stable growth, and short, mild recessions in Federal Reserve 
    If a rule is adopted, the NY bank would be less ``special'' 
and more like other reserve banks.

Q.4. Rotate the Vice Chairmanship of the FOMC position among 
all Federal Reserve Banks on the FOMC every 2 years.

A.4. I do not think it matters. The vice-chair has no special 

Q.5. Make the Presidents of all Federal Reserve Banks voting 
members on the FOMC.

A.5. I favor that and have proposed it in the past. It gives 
more weight to developments affecting the general public and 
less to the financial markets. That was the initial practice. 
The board of governors did not even participate in the decions 
until the 1930s. In the 1920s, the board could only veto 
decisions about open market operations made by the reserve 

Q.6. Remove the trading desk from the Federal Reserve Bank of 
New York to a lower cost district.

A.6. Not useful. The principal market is in NY and is likely to 
remain there. The regional bank would be forced to cooperate 
with NY.

Q.7. Make the New York Fed President a Presidentially nominated 
and Senate-confirmed position.

A.7. No. That would increase political influence and reduce 
independence, I prefer steps to make the Federal Reserve (1) 
more independent and (2) more accountable to the Congress for 
its actions, good or bad.

Q.8. Require press conferences following each FOMC meeting.

A.8. Useful requirement to provide regular information.

Q.9. Shorten lag time for the release of the FOMC transcripts, 
and if so, please explain what an appropriate timeframe is.

A.9. The timing of releases has been shortened considerably in 
the recent past. The current schedule seems fine to me.

Q.10. Codify and clarify the application of FOMC blackout 
period (i.e., prohibiting Federal Reserve Governors and 
officials from speaking in public on any matter during the week 
prior to a FOMC meeting and immediately following an FOMC 
meeting, which is known as the FOMC blackout period).

A.10. This is a way to prevent leaks and tips to the market or 

                     FROM ALLAN H. MELTZER

Q.1. Dr. Meltzer, in 2009 at a Banking Committee hearing titled 
``Establishing a Framework for Systemic Risk Regulation'', 
[July 23, 2009] former Senator, Chris Dodd, asked you based on 
your study of the Federal Reserve's history do you see the bank 
supervisory role as critical to its monetary policy and 
    You replied, ``No sir and the staff has told them many 
times it is really unrelated. I mean. They can get the 
information from the other agencies. The reason I believe. The 
reason the Fed wants supervisory authority is it wants a 
coalition of people to protect itself against pressures that 
comes from the Administration and Congress. It wants people 
that know about the Fed and wants to protect its monetary 
policy responsibilities and they've used it in that way, and in 
one time in the history the Committee your Committee got very 
angry at Chairman Burns because of the extent in which he used 
that mechanism to protect himself against something that the 
Congress wanted to do.''
    Do you think that statement is any less true today, that 
the Fed wants supervisory authority to protect itself from 
pressures that come from the Administration and Congress?

A.1. Probably truer because there is more concern and 
difference of opinion in the Congress and the Administration. 
The Federal Reserve has acted as an agent of the Administration 
especially with respect to the debt.

Q.2. If bank supervisory authority is removed from the Federal 
Reserve, do you think that would negatively impact its ability 
to conduct monetary policy? If so, how could that be remedied?

A.2. No. Almost surely it would make this claim. In practice it 
would set up regular meetings to get information from the FDIC 
and other agencies.
    A useful rule of thumb says that agencies like the Federal 
Reserve should have a single mandate, at times, monetary policy 
and financial regulation can be in conflict. A single mandate 
reduces conflict and excuses for making errors.


Q.1. This past December, both the House and the Senate 
unanimously passed S. 2270, the Insurance Capital Standards 
Clarification Act to give the Federal Reserve flexibility to 
not impose bank-centric capital standards on insurers. The 
Federal Reserve recently announced that it will undertake a 
Quantitative Impact Study to determine an appropriate capital 
regime for insurers. What other studies or additional steps 
should the Federal Reserve take before issuing capital rules 
for insurers?

A.1. In the language of the Federal Reserve (Fed) (and the 
Basel Bank Supervisors Committee), a Quantitative Impact Study 
(or QIS) means a survey in which a sample of institutions 
impacted by newly proposed regulation are asked to specifically 
estimate how the new regulation will affect their business. The 
survey questions usually take the form of a request for an 
estimate of how much additional capital (or liquid assets or 
some other balance sheet factor) will be impacted by the 
proposed regulation. Such surveys have been done in the past 
for changes in bank capital regulations proposed by the Basel 
Committee and subsequently implemented as a regulation in the 
U.S., often at a more restrictive level than the international 
Basel agreement specifies and without regard to any QIS 
assessment of the potential competitive impacts of the stricter 
U.S. regulation.
    In order to undertake a QIS, the Fed must first propose a 
capital regime for insurers it regulates. Without a capital 
regime outlined in sufficient detail, there can be no 
meaningful QIS assessment.
    No regulatory capital regime is without shortcomings. Past 
experience highlights significant flaws in both bank and 
insurance capital regulations. Still, in any proposed capital 
regime for insurers, the Fed should be required to clearly 
document the shortcomings in the existing insurer capital 
regime and explain how the Fed's proposed capital regime 
mitigates the weakness in the exiting capital rules.
    Insurer capital requirements are set to insure that policy 
holder claims can be paid in full in a timely manner. The 
timeframe for meeting policy holder claims differs 
substantially according to the type of insurance sold, and in 
all cases the payout of insurance claims is much slower process 
than a sudden ``run'' withdrawal of bank deposits. The Fed 
should be required to explicitly state the policy goals 
associated with its proposed insurance capital regime and 
explain why the regulatory goal needs to be expanded beyond 
ensuring that policy holder interests are protected.
    Unlike for banks, there is no explicit Federal Government 
safety net for insurers and no body of empirical evidence that 
finds that large insurers receive a ``safety net funding 
subsidy.'' The AIG bailout--multiple Government bailouts 
actually--were initiated by the Federal Reserve and later 
joined by the U.S. Treasury. These bailouts provide the sole 
historical example to support the argument that large FSOC-
designated insurers require heighten capital regulation because 
they enjoy an implicit Government safety net guarantee because 
of their ``too-big-to-fail'' status.
    Dodd-Frank Act supporters simultaneously argue that because 
the Act removes the Fed's Section 13 powers for firm-specific 
bailouts and simultaneously creates a new Title II Orderly 
Liquidation Authority, the Act has ended too-big-to-fail by 
making government-assisted liquidation a possibility for any 
large financial firm. If the later claim is true, too-big-to-
fail insurers no longer exist and it is unclear why the Federal 
Reserve needs any supervisory authority over large insurers, or 
what goals supplemental insurer capital regulation is intended 
to accomplish.
    The Fed should also be required to explain how the proposed 
changes in the capital regime will reduce the possibility that 
the failure of a large FSOC-designated insurer will cause wider 
financial instability. It should be required to provide solid 
empirical evidence that the benefits of the proposed capital 
regime changes outweigh costs on consumers.
    The Fed should release for public comment its proposed 
capital regime for insurers and revise the plan based on 
public, industry, State insurance commissioners, and 
Congressional reactions before undertaking a QIS study.

Q.2. The Federal Reserve is a key voice at the International 
Association of Insurance Supervisors (IAIS). The IAIS is 
currently developing global capital standards for international 
insurance companies, which would apply to U.S. insurers 
designated as SIFIs. What specific steps should the Federal 
Reserve take to ensure U.S. interests are properly represented 
internationally and that any such international agreements 
appropriately address the needs of U.S. insurance companies?

A.2. In the U.S., insurance is underwritten and capitalized at 
the State level according to State regulations, most of which 
are in conformity with NAIC standards. Insurance company 
solvency problems, should they occur, are handled at the State 
    From time to time, this State-centric approach to insurance 
regulation has come under attack by legislators who prefer 
centralized insurance regulation and the establishment of a 
Federal insurance regulatory authority. To date, all efforts to 
establish a centralized insurance regulatory agency have been 
defeated, including most recently in the Dodd-Frank Act. This 
State-centric approach to capital, industry conduct and 
insurance rate regulation has proven to be resilient. It has 
not been a source of systemic risk for the U.S. financial 
    The U.S. Congress has never explicitly designated the 
Federal Reserve as the national insurance regulator or 
empowered the Fed to negotiate international regulatory capital 
agreements on behalf of State insurance regulators. The Federal 
Reserve has unilaterally taken on this authority. Unless the 
Congress asserts its power to either: (1) specifically empower 
the Fed to represent the U.S. in these negotiations, imposing 
appropriate guidelines and restrictions; or, (2) prohibit the 
Fed from negotiating an international capital agreement on 
insurance; and, (3) appoint an alternative U.S. representative 
for these international insurance negotiations with explicit 
Congressional authorization, guidelines, and restrictions, the 
Congress will de facto be recognizing the Fed as the national 
insurance regulator.

Q.3. Estimates suggest the Fed is the consolidated supervisor 
for a third of the insurance industry's assets vis-a-vis its 
supervision of insurance companies that have insurance savings 
and loan holding companies, as well as companies designated by 
FSOC. What are the benefits and shortcomings, if any, of having 
the Federal Reserve supervise and regulate insurance companies 
compared to State insurance commissioners?

A.3. The issue of Federal regulation of the insurance industry 
periodically surfaces. Arguments in favor of Federal regulation 
suggest that State insurance regulation tends to be 
underfunded, understaffed, and easily captured by the insurance 
industry. There is probably some truth to these claims, but 
investigations into consumer complaints about industry conduct, 
and not issues of insurer financial solvency, tend to be the 
supervision areas most restricted by State regulatory 
    In contrast, the Federal Reserve is fabulously well-funded 
and overstaffed. The Fed has proven to be difficult to control, 
even by the U.S. Congress, and so it is a good bet that it 
would be difficult for the Fed to be easily ``captured'' by the 
insurance industry.
    Technically, the Fed has little experience in insurance 
regulation, but since it pays its employees far better than any 
U.S. Government or State regulatory agency, with time, it could 
buy the insurance staff necessary to discharge any insurance 
supervision function. Fed examinations are also likely to 
become more standardized over time than the State insurance 
examinations conducted by the separate State regulators. Given 
the Federal Reserve pay scale and resource deployed, Federal 
Reserve examinations are likely to be much more expensive. 
However, since the Fed does not charge for examinations, the 
cost will be borne by U.S. taxpayers through high Federal 
Reserve operating expenses and smaller surpluses returned to 
the U.S. Treasury.
    While there is little doubt in my mind that the Fed would 
spend far more on the supervision and regulation of the 
insurance firms within its jurisdiction compared to State 
insurance regulators, there is little evidence that a 
significant increase in resources devoted to insurer 
supervision is justified. The increase in taxpayer expense 
would not facilitate a measureable improvements in financial 
system stability, increase the certainty of payment on insurer 
claims, reduce contingent taxpayer liability for future insurer 
bailouts, or otherwise improve the prospects for economic 
    Recent developments suggest that the Fed views insurance 
regulation as a special subset of bank regulation. Reports 
suggest that the Fed has decided that the depository 
institution must always be the recipient of any and all 
assistance from parent holding companies even when the holding 
company is dominated by insurance subsidiaries. When insurance 
subsidiaries appear weakly capitalized by bank regulatory 
measures, holding companies can thus be required to raise 
capital so that they can be in a position to support the 
depository subsidiary if needed, even when the insurance 
subsidiaries satisfy State regulatory insurance capital 
requirements. The mixture of insurance and bank capital 
regulatory approaches is proving problematic as insurance 
companies end up being subjected to bank minimum capital 
    If the insurance industry faces two different sets of 
capital standards--one imposed by State insurance regulation, 
and the other imposed by the Fed using bank regulatory capital 
standards as an overlay on State insurance regulation--then one 
group of insurers will be at a competitive disadvantage 
regarding the costs of its policies or the return it offers to 
its shareholders.

Q.4. The Federal Reserve was granted some oversight authority 
by Congress over insurance holding companies with depository 
institution subsidiaries. Because of the added regulatory 
burden, many relatively small regional insurers with small 
community banks or thrifts have been divesting their thrifts 
over the last few years, depriving consumers of the benefits 
provided by insurers affiliated with banks. What steps has the 
Federal Reserve taken to ensure that its regulations are 
properly tailored to fit these unique insurers and do not 
undermine their business models?

A.4. I am not aware of any adjustments that the Federal Reserve 
has made in an attempt to tailor its supervision processes or 
regulations to reduce regulatory burden so that regulation 
expenses are commensurate with the financial system risks posed 
by small insurers affiliated with depository institutions.

Q.5. The Wall Street Journal recently reported that much of the 
authority previously delegated to the New York Fed to oversee 
the many of the Nation's largest banks has been, in effect, 
revoked and given to a secret committee run by Governor 
Tarullo. One of Dallas Fed President Fisher's proposals calls 
for moving supervision of a ``systemically important'' bank to 
a district outside where that bank is based in order to address 
the potential for regulatory capture. Is it better to 
centralize control of systemic regulation at the Board of 
Governors of the Federal Reserve System or rotate it among 
Federal Reserve Banks?

A.5. The Dodd-Frank Act places the responsibility for enhanced 
supervision of large bank holding companies and FSOC-designated 
nonbank financial institutions on the Federal Reserve Board.
    Unless the Reserve Banks were given explicit new autonomy 
from the Federal Reserve Board, moving responsibility for 
enhance supervision of SIFIs to a Reserve Bank would probably 
not accomplish very much. The Federal Reserve Board would still 
try to control the process given that it is the part of the 
Federal Reserve that most accountable to Congress. Moreover, 
giving unelected Reserve Bank presidents who are not directly 
accountable to Congress this much new authority seems unwise 
and inconsistent with our system of Government.

Q.6. Recent proposals have called for certain reforms of the 
Federal Reserve System. Do you support individual proposals 
listed below, and if so, what is the best way to implement such 
changes? If you do not support an individual proposal listed 
below, please explain why and provide any feedback you may have 
on how better to implement the intent of such proposal. Please 
note that some of the proposals listed below are mutually 
exclusive and provide your opinion on each proposal 
individually, and not in the aggregate. If you believe that 
certain proposals work better in combination with another 
proposal or proposals, please explain how and why.
    Reduce the number of Federal Reserve districts from 12 to 

A.6. There is no economic or political justification for 12 
Federal Reserve districts. Five would suffice.

Q.7. Remove the requirement that the Federal Reserve Bank of 
New York President have a permanent seat on the FOMC;

A.7. Yes.

Q.8. Rotate the Vice Chairmanship of the FOMC position among 
all Federal Reserve Banks on the FOMC every 2 years;

A.8. Yes.

Q.9. Make the Presidents of all Federal Reserve Banks voting 
members on the FOMC;

A.9. Yes, especially if there the number of FR districts are 
reduced to 5.

Q.10. Remove the trading desk from the Federal Reserve Bank of 
New York to a lower cost district;

A.10. The trading desk does not need to be in New York given 
modern communications technology.

Q.11. Make the New York Fed President a Presidentially 
nominated and Senate-confirmed position;

A.11. No, so long as the special status of NY Fed president are 

Q.12. Require press conferences following each FOMC meeting;

A.12. No opinion.

Q.13. Shorten lag time for the release of the FOMC transcripts, 
and if so, please explain what an appropriate timeframe is;

A.13. No opinion.

Q.14. Codify and clarify the application of FOMC blackout 
period (i.e., prohibiting Federal Reserve Governors and 
officials from speaking in public on any matter during the week 
prior to a FOMC meeting and immediately following an FOMC 
meeting, which is known as the FOMC blackout period).

A.14. No opinion.

                      FROM PAUL H. KUPIEC

Q.1. At a Senate Banking Committee hearing in 2009 on 
``Establishing a Framework for Systemic Risk Regulation'', 
former Chairman Chris Dodd asked Dr. Meltzer based on his study 
of the Federal Reserve's history if he saw the bank supervisory 
role as critical to its monetary policy and function.
    Dr. Meltzer responded, ``No sir and the staff has told them 
many times it is really unrelated. I mean. They can get the 
information from the other agencies. The reason I believe. The 
reason the Fed wants supervisory authority is it wants a 
coalition of people to protect itself against pressures that 
comes from the Administration and Congress. It wants people 
that know about the Fed and wants to protect its monetary 
policy responsibilities and they've used it in that way, and in 
one time in the history the committee your committee got very 
angry at Chairman Burns because of the extent in which he used 
that mechanism to protect himself against something that the 
Congress wanted to do.''
    Do you agree or disagree with Dr. Meltzer, and why?
    If bank supervisory authority is removed from the Federal 
Reserve, do you think that would negatively impact its ability 
to conduct monetary policy? If so, how could that be remedied?

A.1. I agree with Dr. Meltzer. There are no compelling economic 
reasons why the Federal Reserve needs bank supervisory 
authority to carry out monetary policy. The Federal Reserve 
would be able to learn anything it needed to know about the 
condition of the banking system by merely asking a separate 
bank supervisory agency.
    In the past, the Fed has maintained that it required 
supervisory powers over bank holding companies in large part so 
it could have supervisory jurisdiction over large national 
banks. There is really no need for multiple bank regulators, 
and Fed's post Dodd-Frank regulatory activities are a major 
threat to its ``independence.'' The Congress must clearly 
exercise more intrusive oversight over an institution that now 
routinely makes operating decisions for the largest banks. 
Decisions that used to be routinely made by banks' directors 
must garner Fed approval on all banking institutions larger 
than $50 billion.
    Increasingly, the Fed is supporting its sustained 0-
interest rate policy by using its new Dodd-Frank enhanced 
supervisory powers. The Fed is worried that 0 rates have 
sparked financial bubbles and so the Fed now tells banks which 
type of investments are ``sound'' and which are ``too risky.'' 
The Fed calls this ``macroprudential policy,'' but it comes 
very close to central planning.
    Using the justification of macroprudential policy, the Fed 
is essentially arguing that it can keep the monetary 
accelerator to the floor if only it is allowed to control the 
investments banks make. Moreover, senior Fed officials are 
publically claiming that they need to extend this control to 
``shadow banks'' which is really code for the rest of the 
financial sector. In fact, the Fed has already agreed to this 
strategy which is being planned by the Financial Stability 
Board. The Fed is now exerting pressure to discourage certain 
types of lending--in essence, approving which investments banks 
should make and which they must avoid, and it wants to extend 
this power to nonbank financial institutions.
    This macroprudential policy experiment can only end badly, 
since history has demonstrated time and again, that the Fed's 
crystal ball has a bad case of myopia. Fed control over bank 
and other financial firm investments will either produce 
prolonged sluggish growth as banks and ``shadow banks'' are 
required to avoid sound high return investments because the Fed 
sees them as too risky, or it will end with large financial 
sector losses because the Fed will fail to identify and stop a 
financial bubble before the economic damage is done. The 
probability the Fed will have the foresight and judgement to 
engineer a ``goldilocks path'' is about 0.

                      FROM PAUL H. KUPIEC

Q.1. The Federal Reserve is increasingly more involved in 
international negotiations on financial regulations. In the 
United States we have a very unique banking and insurance 
structure compared to Europe. Yet, more and more we are hearing 
about the Financial Stability Board and the International 
Association of Insurance Supervisors. A prevalence of 
groupthink is starting to develop among the world's financial 
regulators with the Federal Reserve often being a participant 
in these negotiations.
    How can we have greater oversight over international 
negotiations and should there be more public disclosures and 
reports before and after Federal Reserve officials engage in 
international negotiations?

A.1. Groupthink is an especially important problem that has 
been created by international regulatory agreements. For 
example, the Basel Market Risk Amendment and Basel II credit 
risk requirements substantially lowered bank capital 
requirements intentionally, as a reward, to get banks to adopt 
a new system of economic model-based capital requirements. 
International regulators--including (and indeed especially) the 
Federal Reserve--were very clear when they were finalizing the 
Basel II. Their claim was that the safety and soundness of 
large banks would be improved by allowing banks to use internal 
model based capital requirements to replace the prior Basel 
Accord regime of fixed risk weights. International regulators 
claimed that, because these new model-based capital 
requirements better aligned bank risk with minimum capital 
requirements, the large banks that adopted the new capital 
scheme could operate with lower capital levels because the 
appropriate capital was calculated more accurately.
    All the international bank regulators bought into the 
talking point that lower bank capital was appropriate given the 
new risk-sensitive capital rules. And shortly after Basel II 
was finalized in 2006, the folly of this regulatory groupthink 
was revealed as many large internationally active banks that 
adopted the Basel II model-based capital requirements required 
capital injections from their Governments. The regulators' 
talking points after the crisis claimed that the Basel II 
capital requirement approach really was solution to the 
problems of the crisis--and not the cause--and what the world 
needed was of this type of regulation to ensure a crisis never 
happened again.
    The real truth behind the crisis was that Basel II and the 
Market Risk Amendments were riddled with errors and mistakes 
that allowed banks to hold very little capital for extremely 
risky positions. Regulators never owned up to their mistakes, 
but instead modified the rules to produce a newer even more 
complex Basel III capital agreement, and in the process fixed 
the mistakes that the crisis revealed in the earlier Basel II 
and Market Risk Amendment rules without ever admitting as much 
in public.
    The capacity for regulators to agree to flawed 
international regulatory and supervisory policies and succumb 
to groupthink errors has not diminished since the crisis. For 
example, the new Basel III international agreement requires 
large banks to meet a so-called Liquidity Coverage Ratio (or 
LCR). The LCR has had the unintended consequence of making it 
unprofitable for banks to accept large deposits from nonbank 
financial institutions while interest rates are near zero 
(actually negative in some countries). Indeed many banks in 
Europe, and now increasingly banks in the U.S. are charging 
very large negative interest rates on financial institution 
deposits to encourage these deposits to leave the bank. What is 
the point of a banking system if it cannot afford to accept 
deposits? And yet this is the situation today, and it is the 
new international bank regulations that are forcing liquidity 
out of the banking system into nonbank financial institutions.
    Already the Federal Reserve is arguing publically that they 
need extended regulatory jurisdiction over ``shadow banks'' so 
they can try to chase the liquidity leaving the banking system 
and regulate it elsewhere.
    Financial regulations have become increasingly complex. 
Consequently these regulations are difficult to assess and 
monitor. This complexity hinders Congressional oversight and 
works to further empower the Federal Reserve. However 
difficult, without strong Congressional oversight, the Fed 
becomes an unaccountable while it is increasingly acting like 
central planner as it develops new regulations that allocate 
credit and investment in the economy.
    Financial regulations have important impacts on the savings 
and investment decisions of millions of Americans consumers and 
business with ramifications that ultimately negatively impact 
the growth rate of the American economy. I unaware of any 
historical instance when the introduction of new complex and 
extensive financial regulations caused an increase in economic 
    Effective oversight will require the Congress to be 
vigilant in asking for information and holding regular hearings 
on the Fed's international regulatory activities. Following the 
idea of a Bill introduced in the House last summer, the 
Congress might require the Fed to make prior notification to 
Congress before attending international meetings and include a 
briefing on the materials and issues to be covered. The Bill 
would also require the Fed to provide Congressional Committees 
with a summary of agreements and discussions following the 
international meeting.
    Additionally, Congress might consider passing legislation 
to limit the Fed's involvement in these negotiations by, for 
example, restricting the Fed's authority to banking issues and 
prohibit it from representing the U.S. in international 
insurance regulatory negotiations.
    The current situation leaves the Fed with tremendous power 
over international financial regulatory developments--powers 
that should reside in the U.S. Congress. Such a concentration 
of power in an independent agency that is only weakly 
accountable to Congress is not a recipe for good Government. 
The Congress should empower a different agent to represent the 
U.S. in international insurance regulatory negotiations and 
step up monitoring of the Feds international participation in 
other Financial Stability Board and Basel Banking Supervision 
Committee negotiations.

Q.2. The Federal Reserve is a member of the International 
Association of Insurance Supervisors (IAIS) and is actively 
participating in the creation of insurance capital standards 
for internationally active insurance companies.
    Do you believe the Federal Reserve should advocate for the 
U.S. State insurance system, which performed well in the 
financial crisis, to be recognized by other jurisdictions as 
one way to comply with the IAIS insurance capital standard or 
do you believe that State insurance solvency standards should 
be preempted by Federal application of some version of the IAIS 

A.2. Unless the Congress wishes to empower the Federal Reserve 
as the de facto U.S. national insurance regulator, the Congress 
should explicitly empower an agent other than the Federal 
Reserve as the recognized U.S. representative in IAIS capital 
negotiations. If Congress does nothing, the Fed will fill the 
role of national insurance regulator.
    If Congress decides to empower the Fed as the recognized 
U.S. IAIS representative, then it should move quickly to put 
restrictions on this power and create a system for oversight 
and monitoring the Fed's exercise of this power.
    My own opinion is that this insurance regulation power 
should not be concentrated in the Federal Reserve.

Q.3. Shortly after the Federal Reserve joined the International 
Association of Insurance Supervisors (IAIS), the IAIS voted 
behind closed doors to shut out public observers, including 
consumer groups, from most of their meetings.
    Do you believe that the Federal Reserve should be committed 
to being transparent in its operations, and support allowing 
the public to observe the IAIS meetings in the same way 
Congress--and this Committee--does with its hearings and 

A.3. Transparency is important and could be achieved by either 
opening up the IAIS meetings themselves, or by requiring the 
Federal Reserve or other congressionally appointed U.S. 
representative to the IAIS, to provide a full and timely 
accounting of each meeting, including a summary of all 
discussions and agreements, to the appropriate Congressional 
subcommittee and on a publically accessible Web site.


Q.1. Recent proposals have called for certain reforms of the 
Federal Reserve System. Do you support individual proposals 
listed below, and if so, what is the best way to implement such 
changes? If you do not support an individual proposal listed 
below, please explain why and provide any feedback you may have 
on how better to implement the intent of such proposal. Please 
note that some of the proposal listed below are mutually 
exclusive and provide your opinion on each proposal 
individually, and not in the aggregate. If you believe that 
certain proposals work better in combination with another 
proposal or proposals, please explain how and why.
    Reduce the number of Federal Reserve districts from 12 to 

A.1. I'm not exactly sure what this proposal would accomplish. 
I support making the governance of the Federal Reserve System--
especially at the Federal Reserve Banks--more transparent to 
the public. By ``governance,'' I mean the selection of the 
directors and officers of the Reserve Banks. By 
``transparent,'' I mean making the process by which the 
directors and officers are selected subject to greater public 
participation. I favor making the directors of the Reserve 
Banks purely advisory, and the presidents of the Reserve Banks 
appointed and removable by the Fed's Board of Governors.
    Reducing the number of Federal Reserve districts eliminates 
some of the influence of the Reserve Banks, but simply 
concentrates that influence in the other five districts. The 
governance problems in the remaining five districts would 
remain unchanged.

Q.2. Remove the requirement that the Federal Reserve Bank of 
New York President have a permanent seat on the FOMC.

A.2. I favor this proposal. Doing so would require a change to 
12 U.S.C. 263(a) and would add the New York Fed into one of 
the rotations followed by the other Reserve Banks.

Q.3. Rotate the Vice Chairmanship of the FOMC position among 
all Federal Reserve Banks on the FOMC every 2 years.

A.3. In our digital age, when the physical transfer of cash, 
gold, and securities plays a much smaller role in the 
supervision of the financial and payment system, the 
justification for the New York Fed's Vice Chairmanship no 
longer exists. In the previous era, given the concentration of 
financial services in the second district (where the New York 
Fed sits), this prominence made more sense.
    But I'm not sure rotating the Vice Chairmanship among 
Reserve Banks actually makes sense, for much the same reason. 
The Reserve Banks themselves don't serve the vital physical 
delivery process that they once served in the operation of our 
financial system. All respect to these great cities, but it's 
unclear to me why Richmond or Cleveland or Kansas City should 
have enhanced representation in the formulation of our monetary 
    A better solution would be toward simplifying, rather than 
complicating, the governance structure of the Fed by making the 
Vice Chair of the FOMC and the Vice Chair of the Board of 
Governors one in the same. The current Vice Chair of the Board 
of Governors is an eminent economist and central banker, 
Stanley Fischer. But his most important qualification is this: 
the U.S. President nominated him, and the U.S. Senate confirmed 
him. The public had a chance to participate in his vetting and 
confirmation process. The same cannot be said for any of the 
Reserve Bank presidents.

Q.4. Make the Presidents of all Federal Reserve Banks voting 
members on the FOMC.

A.4. I oppose this proposal. Given the problematic governance 
structure of the Reserve Banks, their enhanced participation on 
the FOMC would only dilute appropriate congressional control 
over the staffing of our monetary policy. While I do not 
support efforts to impose more congressional control on the 
day-to-day of monetary policy, I do support efforts to impose 
more congressional control on who gets to wield this authority 
in the first place. Extending the Reserve Banks' participation 
on the FOMC is a move in the wrong direction.

Q.5. Remove the trading desk from the Federal Reserve Bank of 
New York to a lower cost district.

A.5. This is a very practical proposal. Again, the costs of 
market interventions are not what they were in the era when the 
FRBNY was given its pride of place.
    That said, there will be transition costs in moving the 
trading desk, in terms of institutional knowledge lost in the 
transfer (I assume not all FRBNY personnel would be willing to 
relocate). Even so, these costs would not be permanent. Before 
endorsing this proposal definitively, I would want to quantify 
the costs associated with this transition and measure them 
against the savings of the relocation. I imagine the costs 
would be relatively minor in comparison to the savings.

Q.6. Make the New York Fed President a Presidentially nominated 
and Senate-confirmed position.

A.6. This proposal focuses on exactly the right issue: making 
the Reserve Bank presidents more accountable to the democratic 
process, without erasing the benefits of a central bank 
insulated from the political process. The current selection, 
appointment, and removal procedures for the Reserve Bank 
presidents raise policy and even constitutional concerns that 
the Congress should address.
    Even so, I don't support this proposal, for two reasons. 
First, it does nothing to the other 11 Reserve Banks. Their 
governance problems are just as significant, even if the New 
York Fed's district is home to the some of the Nation's largest 
financial institutions. Leaving the Reserve Banks' governance 
untouched beyond New York would be problematic.
    Second, and ironically, giving the New York Fed a 
presidential appointment may make the New York Fed more 
independent of the rest of the System, and potentially more 
dependent on the financial industry in New York. If the New 
York Fed president is a presidential appointment, she will 
become the focus of extraordinary lobbying efforts. If the 
industry succeeds in placing a friendly regulator in its 
backyard, efforts from elsewhere in the System--principally 
from the Board of Governors--to be a more critical regulator 
could be thwarted. A presidential appointment might give the 
FRBNY an independent power base that could lead to great 
confusion within the System.
    In its place, I recommend placing all Reserve Bank 
appointments (and their removal) in the hands of the Board of 

Q.7. Require press conferences following each FOMC meeting.

A.7. I like this proposal very much. We learned a lot from the 
March 18, 2015, press conference. It provides a mechanism for 
the Fed Chair to communicate through the press in a way that is 
less scripted than press releases and less overtly political 
than congressional hearings. The Fed has been moving toward 
press conferences in the last decade; I would like to see this 
become a matter of practice.

Q.8. Shorten lag time for the release of the FOMC transcripts, 
and if so, please explain what an appropriate timeframe is.

A.8. I favor the 5-year lag. It gives enough time to insulate, 
at least to some extent, the day-to-day monetary policy the Fed 
from becoming too intensely connected to a quadrennial election 

Q.9. Codify and clarify the application of FOMC blackout period 
(i.e., prohibiting Federal Reserve Governors and officials from 
speaking in public on any matter during the week prior to a 
FOMC meeting and immediately following an FOMC meeting, which 
is known as the FOMC blackout period).

A.9. The blackout period is, at present, clearly stated: ``The 
blackout period will begin at midnight Eastern Time seven days 
before the beginning of the meeting . . . and will end at 
midnight Eastern Time on the next day after the meeting.'' With 
many others, I anxiously await the Fed's Inspector General 
report on FOMC leaks to understand better how that leak 
occurred and what measures, if any, should be taken to prevent 
them in the future.

                     FROM PETER CONTI-BROWN

Q.1. At a Senate Banking Committee hearing in 2009 on 
``Establishing a Framework for Systemic Risk Regulation'', 
former Chairman Chris Dodd asked Dr. Meltzer based on his study 
of the Federal Reserve's history if he saw the bank supervisory 
role as critical to its monetary policy and function.
    Dr. Meltzer responded, ``No sir and the staff has told them 
many times it is really unrelated. I mean. They can get the 
information from the other agencies. The reason I believe. The 
reason the Fed wants supervisory authority is it wants a 
coalition of people to protect itself against pressures that 
comes from the Administration and Congress. It wants people 
that know about the Fed and wants to protect its monetary 
policy responsibilities and they've used it in that way, and in 
one time in the history the Committee your Committee got very 
angry at Chairman Burns because of the extent in which he used 
that mechanism to protect himself against something that the 
Congress wanted to do.''
    Do you agree or disagree with Dr. Meltzer, and why?

A.1. I agree with Dr. Meltzer that, historically, much of the 
banking supervisory apparatus has come to the Fed in ways 
completely disconnected from its role in monetary policy. As I 
document in my forthcoming book, the Fed was agnostic regarding 
its selection as the regulator for Bank Holding Companies in 
1956, and hostile to the role it was given in regulating the 
Truth in Lending Act (now the purview of the Consumer Financial 
Protection Bureau). These functions were not seen by the Fed--
rightly, I think--as essential to its monetary missions.
    And several Administrations, from both parties, have sought 
to consolidate banking regulation in the hands of a single, 
non-Fed regulator. For example, Presidents Lyndon Johnson, Bill 
Clinton, and George W. Bush all proposed this kind of 
supervisory consolidation of functions that are currently 
spread across the executive and independent agencies.
    I am less certain than Dr. Meltzer that the Fed can 
appropriately formulate and implement traditional central 
banking functions without retaining regulatory and supervisory 
authority over systemically important financial institutions. 
The problem is in the appropriate deployment of emergency 
lending authority, sometimes broadly called the ``lender of 
last resort function.'' There is a central tension in the use 
of the central bank (or Government, or any other authority) as 
a lender of last resort. On the one hand, the central bank must 
be available when all other lending avenues have failed to 
secure and support the financial system. On the other, if banks 
know that the central bank will provide whatever liquidity is 
necessary to save them in the event of crisis, the banks will 
not take appropriate measures to avoid the crisis in the first 
place. This is the ``moral hazard'' problem that was so central 
to discussions of the recent financial crisis and the Fed's 
response to it.
    If the Fed retains its emergency lending authority, but 
loses the regulatory authority over those who would use that 
emergency lending authority, the risk of moral hazard is 
extraordinary. It is not simply an information-sharing problem, 
as Dr. Meltzer described. The Fed must be in a position to 
regulate and supervise financial institutions with an eye 
toward preventing financial crises before they start, followed 
by appropriately stringent regulatory controls over the use of 
emergency lending funds in the event of crisis, and postcrisis 
repayment in ways that do not exacerbate moral hazard. For 
these reasons, I fear that stripping the Fed of all its 
regulatory authority would make financial crises more likely, 
not less likely.
    That said, this conception of the Fed's regulatory 
authority applies to its supervision of the largest financial 
institutions. It does not apply to others. I am in favor of a 
consolidation of financial regulatory authority for other 
institutions into a single agency, similar to the Clinton and 
George W. Bush proposals.

Q.2. If bank supervisory authority is removed from the Federal 
Reserve, do you think that would negatively impact its ability 
to conduct monetary policy? If so, how could that be remedied?

A.2. See above for the discussion of emergency lending.

              Additional Material Supplied for the Record
                             SENATOR BROWN