Why the Federal Reserve Needs an Overhaul
An even harsher critic is Sheila Bair, former chair of the Federal Deposit Insurance Corporation, who had to liquidate hundreds of smaller banks during the crisis. “What system were we trying to save, anyway?” she asked in her under-appreciated 2012 book, Bull by the Horns: Fighting to Save Main Street From Wall Street and Wall Street From Itself. “A system in which well-connected big financial institutions get government handouts while smaller institutions and homeowners are left to fend for themselves?…
“Because we propped up mismanaged institutions, our financial sector remains bloated. The well-managed institutions have to compete with the boneheads,” Bair wrote. “A culture of greed and shortsightedness” permeates even the best-managed banks, one that “goes undetected by their executives and boards as well as their regulators.” Bair is a conservative Republican, an insider disgusted with the failure of her fellow regulators.
Part of that failure is because the Fed governors have not been isolated from political influence. Bankers, and their representatives at the twelve Reserve Banks, are very much insiders too. After the recent collapse, they were represented by some 20,000 lobbyists, who swamped federal regulators with formal comments and complaints on the Dodd-Frank reform law, weakening it considerably. But the heavy-handed influence of the banking industry is only part of the problem. Since citizens and their elected representatives have no voice in Federal Reserve decisions, the central bank excludes the issues, and downplays the economic consequences, that matter most to ordinary people. Instead, the monetary debate proceeds in the sanitized language of economic abstractions and is limited to a small group of elites. Self-interested financial-market participants constantly critique monetary policy, a debate reported in the business pages as though Wall Street traders are speaking for the broad public.
This reliance on a narrow frame of reference produces institutional blind spots and gross errors. I don’t doubt the integrity of Fed professionals; they sincerely believe their political isolation is a virtue. I say it is the source of their great failing. The telling evidence lies in what the Fed does not talk about. If you scan the public record over the last generation, you might conclude that the policy-makers were unaware of the grave disorders that were steadily accumulating. Or that they believed the economic pressures assaulting citizens were not relevant to monetary policy. Whatever the explanation, the Fed missed the big story—the steady economic deterioration stalking the middle class—just as it did not see the reckless behavior in banking that would lead to collapse.
After the fall, the extreme inequalities of income and wealth could no longer be ignored and belatedly hit the front pages. How could the Fed—staffed by professional economists who are trained to examine broad trends—have missed the importance of this? Or that industrial wages for hourly workers had been declining in real terms for three decades? Did the governors recognize that global trade and the migration of US jobs overseas destroyed the once reliable link between rising productivity and rising wages? How did the Fed explain the mountainous debt growing inexorably across the economy—not just government debt, but household and business debt too?
Perhaps the Fed did not see the threat posed by these great shifts because the central bank was centrally implicated in causing them. Intentionally or otherwise, Fed policies over many years have consistently favored capital over labor. The results are visible in the stunning statistics on income concentration at the wealthy pinnacle. These developments were sometimes justified in the name of fighting inflation, but the Fed also set out in other ways to improve the profitability of banking and finance.
Some interests, particularly organized labor, understood what was happening and complained aloud. The Fed did not respond to the cries of distress. The mystification of monetary policy is a way of avoiding nasty arguments with the losers.
During most of the past three decades, the Federal Reserve was triumphant in Washington, where politicians deferred to the wise arbiter that calmed financial anxieties and fathered good times. Recessions were infrequent and brief. Financial markets were liberated from government restraints and reached extraordinary heights. The Federal Reserve website celebrates this era as “the Great Moderation.”
An unsanctioned history would tell a less flattering story, in which the Fed contributed to the destructive forces—sometimes inadvertently, sometimes to enhance banking profitability, sometimes in pursuit of other goals. A thumbnail sketch of the action can fill in some blanks for untutored citizens who do not read The Wall Street Journal.
At the dawn of the Reagan era, while the president was cutting taxes, Fed chair Paul Volcker (a Carter appointee) was pursuing an allied goal: wage suppression. Volcker set out to break accelerating inflation (triggered mainly by increasing OPEC oil prices) by shutting down the economy with a long, harsh recession. His principal target was wages; in fact, he carried around a little card that noted the latest union contract settlements, and he told politicians the recession could not end until he had broken wages and commodity prices.
Volcker’s “wage deceleration” (his mild label) was the starting point for a seismic shift in winners and losers across the economic landscape. Labor lost the battle; but capital also won the war. During the bloodletting, when farmers were devastated, a delegation of farm-state legislators complained to Volcker. The Fed chair told them, “Look, your constituents are unhappy; mine aren’t.”