Daily Archives: July 10, 2009

The Fed As Super Duper Regulator? Will We be Duped Again?

By L. Randall Wray

Treasury Secretary Geithner is floating a plan that would consolidate more power in the hands of the Fed. The idea is that because it failed so miserably over the past decade to recognize a series of asset bubbles and growing systemic risk, it should be placed in charge of assessing and controlling systemic risk. You’ve got to love the logic. Could it have anything to do with the fact that Geithner came from the NY Fed where he used to cozy-up to Wall Street banks?

Three economists with widely different perspectives trashed the idea in hearings before the Subcommittee on Domestic Monetary Policy and Technology, Committee on Financial Services, U.S. House of Representatives, July 9, 2009.

“I do not know of any single clear example in which the Federal Reserve acted in advance to head off a crisis or a series of banking or financial failures,” said Allan H. Meltzer, professor of political economy at Carnegie Mellon University and the author of a history of the Fed.

John Taylor went on: “The administration proposal would grant to the Fed significant new powers, more powers than it has ever had before,” he told lawmakers. “My experience in government and elsewhere is that institutions work best when they focus on a limited set of understandable goals.”

James Galbraith, a long time Fed critic weighed in:

“Chairman Greenspan actively encouraged consumers to sign up for the innovative adjustable-rate mortgage products that would, eventually, destroy the system. Right up to July, 2007 in public statements and testimony before Congress, Chairman Bernanke continued to say that problems in the housing sector were manageable, and that the “predominant risk” was inflation. No doubt this emphasis reflected the macroeconomic priorities of the Federal Reserve at the time. Perhaps there was, also, a calculated desire to maintain public confidence. But that is precisely the problem. An effective systemic-risk regulator would not have those conflicting considerations.”

Those who followed the 1980s Savings and Loan fiasco will recall how that crisis was created by Chairman Volcker’s decision to raise interest rates to historic levels no matter how much that devastated the nation’s thrifts plus a hands-off treatment by regulators—who actually encouraged them to take on big risks to try to grow their way back to profitability. Indeed, top regulators saw their role as something akin to “cheerleading”, best represented by FDIC Chairman William Seidman’s enthusiastic statement that “bankers are our friends”, so encouraged his agency to operate like a “trade association” for the industry. Needless to say, cheerleaders do not make good regulators. (See my article here)

To be sure, the FDIC has done a much better job in recent years (and Chairwoman Sheila Blair has been a thorn in the side of both Geithner and previous Treasury Secretary Paulson). In his testimony Galbraith makes a good case for putting the FDIC—not the Fed–in charge of regulating systemic risk. The reason is that bankers more easily capture the Fed for the simple reason that most decision-making takes place in Washington at the FOMC meetings, where the regional Fed presidents take turns voting on monetary policy. Many of these come directly out of the banking sector (of course Chairman Bernanke does not), and all represent the interests of their member banks. Don’t forget, the private banks own the Fed, although the Fed is legally a creature of Congress. Imagine the outcry if we sold the Treasury to the highest bidder to create a similar Frankenstein creature. (A cynic might argue that “Government Sachs” already bought the Treasury—but let’s not go there.)

Whether the Super Duper Regulator is placed under the auspices of the FDIC, the Fed, or elsewhere, however, I am skeptical that it will do much good in the absence of thorough-going reform of the financial system. The fact is that the biggest financial institutions are too big to supervise, too powerful to regulate, and too big to fail. Practically by definition, anything that hurts the profitability of one of these behemoths will increase systemic fragility. Further, as students of the S&L crisis know, powerful financial institutions are able to buy lots of friendship in Congress (think Charles Keating and Senator John McCain).

Thus, it appears that the proposal for a Super Duper Regulator is an attempt to make a run around any real reform, which would have to start with the recognition that any institution that is too big to fail and too big to manage and too big to supervise and too big to regulate is also too big to save, thus, too big to retain.

Sovereign State of California (An Update)

by L. Randall Wray

Finally, there is some good news out of California:

SACRAMENTO — State vendors and contractors could use their government-issued IOUs to pay state taxes, fees and liens under a bill approved by an Assembly committee. The Business and Professions Committee unanimously passed the bill by Assemblyman Joel Anderson during its first legislative hearing Tuesday. The bill requires the state to accept its own IOUs as payment for money owed to the government.

As a stopgap measure, this will ensure a demand for the state’s IOUs. Each individual vendor, contractor, or even state employee will accept the state’s new warrants up to the individual’s expected tax liability. Eventually the warrants will also be accepted by retail establishments and others who also have liabilities to the state of California—meaning that the state could (eventually) issue a number of warrants equal to the total of all such obligations owed to the state, on an annual basis.

The next step is to issue these IOUs at zero interest. The taxes, fees, and liens will be sufficient to generate a demand without promising interest. Currency is simply an IOU that does not pay interest—it is “current”. As I suggested before, the state can also accept its own “currency” in payment of fees and tuition paid to state institutions of higher learning—further increasing demand.

Unlike other local currencies around the country—such as the BerkShare in Massachusetts, the new California currency will be “tax driven”, thus sustainable. In other words, it is a sovereign currency backed by the state’s ability to impose taxes. As California is reportedly the eighth largest economy in the world, a new Bear Flag Dollar ought to do fairly well internationally (meaning in the United States and abroad).

It is amazing that the Obama Administration is ignoring the fiscal crisis in that state (and in all states). Since Arnold cannot run against Obama in the next election, he can at least threaten to secede and run for President of the new Great Nation of California. Mike Norman has outlined a nice game of chicken he could play:

“Here’s what Arnold can do, and I’ve said this before: Declare himself President of California and secede from the Union. Then he can issue his own currency (which is what these I.O.U’s are, effectively). After that, there’d be a short war and California would be brought back into the U.S. and war reparations would be paid to the state. (Possibly far more than what the state was asking for anyway.)”

Perhaps it is a bit far-fetched, but better than going bankrupt quietly—think Orange County in 1994 or New York City and State in 1975-76. See also John Avalon’s thoughts on the possible bankruptcy of both NY and CA.

Hey, here’s an idea. Why don’t all 50 states secede, form a Second United States, issue a New Dollar, and ramp up spending to the required level to get the national economy as well as the economies of the 50 states on a path to full employment?