[Senate Hearing 114-5]
[From the U.S. Government Publishing Office]
S. Hrg. 114-5
FEDERAL RESERVE ACCOUNTABILITY AND REFORM
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE ACCOUNTABILITY OF THE FEDERAL RESERVE SYSTEM TO CONGRESS
AND THE AMERICAN PUBLIC
__________
MARCH 3, 2015
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Available at: http: //www.fdsys.gov /
______
U.S. GOVERNMENT PUBLISHING OFFICE
93-893 PDF WASHINGTON : 2015
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Publishing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
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
JERRY MORAN, Kansas
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
(ii)
C O N T E N T S
----------
TUESDAY, MARCH 3, 2015
Page
Opening statement of Chairman Shelby............................. 1
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
WITNESSES
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
(iii)
FEDERAL RESERVE ACCOUNTABILITY AND REFORM
----------
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.
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
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.
STATEMENT OF SENATOR SHERROD 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
back.
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
lag.
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,
supported.
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
others.
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.
STATEMENT OF JOHN B. TAYLOR, MARY AND ROBERT RAYMOND PROFESSOR
OF ECONOMICS, STANFORD UNIVERSITY
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
somewhere.''
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
pressure.
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.
STATEMENT OF ALLAN H. MELTZER, THE ALLAN H. MELTZER UNIVERSITY
PROFESSOR OF POLITICAL ECONOMY, TEPPER SCHOOL OF BUSINESS,
CARNEGIE MELLON UNIVERSITY
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.
STATEMENT OF PAUL H. KUPIEC, RESIDENT SCHOLAR, AMERICAN
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
regulations.
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
well.
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.
STATEMENT OF PETER CONTI-BROWN, ACADEMIC FELLOW, STANFORD LAW
SCHOOL, ROCK CENTER FOR CORPORATE GOVERNANCE
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
prevent.
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
again.
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
FOMC.
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
oversight?
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
you.
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
happened.
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
them.
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.
Meltzer----
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
independence?
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
liabilities.
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
that?
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
neighbors.
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
class----
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
employment.
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
did.''
Senator Brown. Thank you. One last real quick question, Mr.
Chairman.
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
problems.
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
that?
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
capital.
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
Bank.
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
me.
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
megabanks.
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
rules.
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
guys.
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
tell.
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.
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
from.
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
economics.
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
yours.
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
personnel----
Chairman Shelby. That would probably be a great idea.
[Laughter.]
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.
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:]
PREPARED STATEMENT OF JOHN B. TAYLOR
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
it.
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.
______
PREPARED STATEMENT OF ALLAN H. MELTZER
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
independently.
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
independence.
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
rates.
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
company.
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.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
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.
Bibliography
Bagehot, Walter, (1873/1962). Lombard Street. Homewood, IL: Richard D.
Irwin.
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.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF PAUL H. KUPIEC
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
functions.
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
responsibilities.
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
lag.
---------------------------------------------------------------------------
\1\ http://www.federalreserve.gov/newsevents/
reform_transaction.htm
\2\ http://www.federalreserve.gov/newsevents/
reform_discount_window.htm
\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
---------------------------------------------------------------------------
organizations
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
areas.
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
Bodies
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-
Chair-letter-to-G20-February-2015.pdf
---------------------------------------------------------------------------
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
economists.
\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/
Documents/Dissenting%20and%20Minority%20Views.pdf
---------------------------------------------------------------------------
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
jurisdictions.
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/
r_130829c.pdf
---------------------------------------------------------------------------
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/
r_140108.pdf?page_moved=1
---------------------------------------------------------------------------
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
Tests
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\
---------------------------------------------------------------------------
\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-
1442/R-1442_101712_109102_441597364672_1.pdf.
\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
institutions.
---------------------------------------------------------------------------
\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
II.
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.
______
PREPARED STATEMENT OF PETER CONTI-BROWN
Academic Fellow, Stanford Law School, Rock Center for Corporate
Governance
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-
fed-banks-21st-century/fed_banks_21st_century.pdf?la=en.
---------------------------------------------------------------------------
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
accountability.
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
appointment.
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
institution.
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
problem.
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.
Conclusion
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
balance.
RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN SHELBY FROM ALLAN H. MELTZER
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
rule.
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
past.
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
5.
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
history.
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
authority.
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
banks.
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
individuals.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
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
function?
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.
------
RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN SHELBY FROM PAUL H. KUPIEC
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
level.
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
sector.
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
underfunding.
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
growth.
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
standards.
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
5;
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
rescinded.
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.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
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.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER
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
growth.
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
standards?
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
markups?
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.
------
RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN SHELBY FROM PETER CONTI-BROWN
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
5.
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
policy.
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
Governors.
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
cycle.
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.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
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
CHART OF THE FEDERAL RESERVE SURVEY OF CONSUMER FINANCES, SUBMITTED BY
SENATOR BROWN
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
TESTIMONY OF RON PAUL, CHAIRMAN, CAMPAIGN FOR LIBERTY
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]