1. He does not understand that “unwinding” the Fed’s balance sheet is nothing to be concerned about. As I have written previously, this will occur naturally as banks pay-off their loans that the Fed extended in the crisis, and as banks repurchase the assets they sold to the Fed to obtain reserves. However, Bernanke still seems to believe in the discredited “deposit multiplier” and believes the Fed will have to take action to drain reserves (“reverse the quantitative easing”) to prevent excess reserves from fueling inflation. This is nonsense. Banks do not lend reserves and existence of excess reserves does not make them more willing to lend. The Fed does not need to do anything more than to accommodate banks—no concerted action is required. Still, even in the worst case, the Fed will not be able to create a huge mess. Since it operates with an overnight interest rate target, if it tries to remove reserves that the banks want to hold, it will drive rates above the target—so will have to add back the reserves. This could create some uncertainty but it is not likely to generate any crisis.
2. Bernanke might appear to be a “born again” regulator, but that is highly doubtful. The Fed will never take regulation seriously because it is captured by Wall Street. So the important thing is to ensure that the Fed does not become the “super duper systemic regulator” that many are now proposing. This job needs to go to the FDIC, which has in the past actually done some regulating.
3. A win for Bernanke might energize the forces that want to keep Timmy Geithner and Larry Summers in their jobs. In truth, it is far more important to remove Timmy and Larry (and to remove Robert Rubin from his position as advisor to the administration). I have not seen any evidence that Bernanke has been corrupted by Wall Street. Unfortunately, the same cannot be said of Geithner and Summers—where apparent conflicts of interest abound, and questionable decisions have been taken that favor Wall Street institutions. And the Treasury is far more important than the Fed. If we are going to reregulate financial institutions (as Obama now seems inclined to do), we have got to have real regulators at the Treasury. Neither Timmy nor Larry has ever indicated any interest in “interfering” with Wall Street. Indeed, Geithner seems to have been leaking to the press his dissatisfaction with Obama’s recent proposals. Perhaps he is already angling for his Wall Street rewards—seeking a well-compensated position in a financial institution should he be fired.
To be clear, I would prefer to replace Bernanke with someone who actually understands monetary policy and who advocates regulation and supervision of financial institutions. Unfortunately, that looks unlikely. We need to turn our attention to Rubin, Geithner and Summers. Obama does not need any action by Congress to rid himself of these anchors that are dragging down his administration, as well as the Democratic party.
I'd say it does matter politically though. The Democrats are in trouble because of the public outrage of favoring Wall Street over Main Street, which looks like crony capitalism. If the Dems are savvy, the president will replace Geithner and Summers, and the Senate will not reconfirm Bernanke.
Well, by paying interest on reserves (has the Fed ever done that before?), Bernanke did open Pandora's Box if a (future) president with a non-idiot Treasury Sec. ever wished to fund government by Fed account overdrafts instead of increasing the debt limit by open-market borrowing. I'm curious though, if Treasury overdrafts its Fed account, does the Fed or Treasury pay the interest costs?I know that borrowing and overdrafts have basically the same economic effect, but as missionaries to aboriginal tribes have found, its easier to adapt the message to what the audience already believes (the debt taboo!) than to beat the Gospel into someone.Speaking of Treasury overdrafts, I quoted your debt limit article in response to an Ellen Brown piece advocating a single payer healthcare system funded by low-interest loans by the Fed.http://webofdebt.wordpress.com/2010/01/23/funding-public-health-care-with-a-publicly-owned-bank-how-canada-did-it/#comments
You'd object if all three of them went? 🙂
Re: Point 1 ~ Why don’t any of these guys understand this? It really doesn’t seem all that hard, and yet it seems to be a very wide-spread misperception. Is it a new idea, or is it simply not taught?Re: Point 2 ~ I’m also having trouble with this idea of a “systemic risk regulator”. Isn’t systemic risk primarily the accumulation across financial institutions of risks they keep hidden (e.g., in unregulated CDSs) from each other and the world? What then would a systemic risk regulator even look at? And wouldn’t forcing derivatives onto exchanges pretty much clear this up?
Thanks for comments.Briefly:1. No the Fed had not previously paid interest; in fact many within the Fed had long wanted to do this. Their reason was to reduce the "tax" on banks. They probably did not understand the advantage with regard to interest rate setting. Canada moved to this system a decade ago.2. Once you have done this, there is no reason to issue Treasuries. That is why I wrote the piece arguing that we should not raise the debt limit. Just pay interest on reserves, instead. Operationally that is the same thing.3. If Treasury pays interest to Fed, it adds to Fed profits; and Fed turns over all profits above 6% return to the Treasury. So effectively the treasury pays the interest to itself.4. Yes politically it would be far better to dump Bernanke, too. Forget all the arguments about how difficult it would be to replace him. A robot or a chimp could do this job.5. The rallying by financial mkts around Bernanke is more evidence that he should go. 6. Even if all assets/liabilities are on books, there still is systemic risk. Balance sheets are interconnected–if one fails, it brings down another. Add to that "bigness", failure of one brings down pension funds (who own financial stocks). So it is more complex than simply bringing everything onto books. But of course that is a good idea. LRWray
That's very interesting stuff. Does the Fed subtract the sum of IOR paid from its lending profits and/or Trsy's account? I take your point that IOR can replace Treasuries sales, could the Fed manipulate the IOR and/or discount window rate to drain reserves without requiring federal tax collection?(sorry if this doubleposted)