Skip to main content

Surveillance Over the Federal Reserve: On the Sanders Amendment to the Dodd Senate Financial Regulation Bill

Brad DeLong, professor of economics | May 8, 2010

President Obama came out in opposition to Vermont Senator Bernie Sanders’s amendment to the Senate financial regulation bill calling for the GAO to regularly audit the Federal Reserve’s conduct of monetary policy. My left-wing friends are not surprised but are, once again, disappointed. “Doesn’t Obama know who his friends are?” they ask, with the answer being: “No.” “Doesn’t Obama recognize that Federal Reserve governance and policymaking is badly broken?” they ask, with the answer once again being: “No.” Has Obama made any proposals to improve Federal Reserve governance and policymaking?” they ask, and the answer is: “No.” “Of the five seats on the Federal Reserve Board of seven that he has had the opportunity to fill,” they say, “Obama filled one early with Dan Tarullo, filled the chairmanship by reappointing Ben Bernanke–a dedicated public servant and excellent monetary economist and policymaker but certainly no Democrat, and has simply left the other seats empty, two of them for more than a year (although he did six days ago announce names of candidates whom he would nominate). Doesn’t this extraordinary lack of concern for the issue and lack of action on what is in the president’s power indicate an extraordinary dropping of the baton on Federal Reserve issues? Hasn’t he forfeited his authority to set out the Democratic Party’s position on these issues, and shouldn’t we be very grateful that somebody–in this case, Bernie Sanders–is picking up the baton and running with it?”

And when they put it that way, I cannot say “no” to anything they say.

And I have no doubt that Federal Reserve governance and policymaking is broken. Ben Bernanke ought to be in the center of opinion when the Federal Open Market Committee deliberates–not on its left wing. A large number of votes on the FOMC are held by people whose background and expertise is, at best, orthogonal to the skills needed to make monetary policy in the twenty-first century. The Federal Reserve suffers from problems of values and problems of analysis. The problem of values is that a great many of those making policy do not take the Federal Reserve’s dual mandate seriously–that they are tremendously upset at the thought that inflation might rise above 2% per year in some future scenarios but utterly unconcerned with the fact that unemployment is kissing 10% and projected to decline only very slowly. The biggest example of the problem of analysis is the failure of the Federal Reserve in the mid-2000s to understand just how vulnerable our economy had become to a run on the shadow banking system and just how overleveraged and overexposed to tail risk shadow banks’ portfolios had become. It’s not that I am saying I should have the job: I didn’t understand these things either. But I did not have regulatory oversight authority to dig into the workings of big banks to figure out what was going on.

Bernie Sanders wants to move Federal Reserve governance and policymaking in a positive direction by removing a 1978 restriction on the GAO’s ability to audit the Federal Reserve. At the moment a 1978 law prohibits the GAO from looking at (i) deliberations and actions on monetary policy matters by the Federal Reserve Board, (ii) communications related to monetary policy by Federal Reserve staff and policymakers, and (iii) transactions executing decisions of the FOMC. He would remove these restrictions on what the GAO can investigate, and require the Federal Reserve to publish what banks have borrowed and are borrowing from it, and on what terms.

The Federal Reserve’s opposition to the Sanders amendment appears to have three parts: (i) The Federal Reserve does not want to have its elbow joggled by the Congress or the GAO. (ii) The Federal Reserve does not want members of congress routinely hunting through transcripts searching for quotes that they can take out of context and use for destructive purposes. Currently members of congress have to do real work to accomplish this, and the Federal Reserve wants to keep it that way. (iii) The Federal Reserve is worried that if the GAO begins to routinely audit monetary policy, the quality of its own internal deliberations will suffer. People will keep quiet rather than discuss things that they think might be damaging to their reputations if taken out of context. And people will keep quiet rather than discuss things that they think might be damaging to their reputations if taken in context–things that they don’t want public but that are nevertheless shaping their thinking and decision-making. In any policymaking process, you want the considerations that are actually shaping people’s views and actions out on the table where they can be discussed, examined, evaluated, and judged, rather than kept in the back of people’s minds unchallenged because whatever they say now will show up in six months in the next GAO report. It is the executive privilege argument–only the “executive” in this case is the Federal Reserve Board and the FOMC.

If I can summarize the Federal Reserve’s position, it is that detailed scrutiny of its internal processes and thoughts is something that should be left to rare after-the-fact investigations that attempt to understand crucial moments and decisions, and that having the Federal Reserve have to all the time live naked inside a glass house would have a chilling effect on the quality of its work.

Bernie Sanders’s position, on the other hand, is that the Federal Reserve clearly missed some big things in the mid-2000s, and more eyes on the issues might have helped. If the GAO had been asking why Chairman Alan Greenspan was so unconcerned with issues of housing finance that were clearly distressing and perplexing Governor Ned Gramlich and if the Federal Reserve had been forced to answer more pointed questions more directly, perhaps mistakes could have been avoided.

If I thought the Federal Reserve were working reasonably well–that what we have here is a problem of analysis, a failure to take one of many potential sources of risk seriously enough–it would be easy. I find myself flashing back to the last time I saw Tim Geithner in the flesh, in… I think it was… the summer of 2005. Two now-senior members of the Obama administration and I were peppering him with questions about the stability of the U.S. financial system: What would happen if foreign central banks suddenly stopped buying dollar assets? Did JPMorganChase have control of its derivatives book? Would Lehman Brothers survive a sudden 25% fall in the value of the dollar, or had underlings written enough out-of-the-money puts and other derivatives on foreign exchange that a five-sigma move in the dollar would bankrupt it? And Geithner convinced me, at least, that he and the Federal Reserve Bank of New York were on the case: properly conducting their mission of surveillance over banks’ positions in the foreign exchange derivatives market and ready with contingency plans to deal with a dollar-centered global foreign exchange crisis should one occur.

Only that was not the crisis we had…

I really wish that we had been peppering him with questions about the rating agencies and mortgage-backed CDOs and about whether firms that claimed to be following the originate-and-distribute model really were distributing. I know that I said often in 2005 and 2006 that subprime and the housing bubble were not a big threat to cause a financial crisis and a deep recession because “the banks are not holding onto these loans but are instead selling them off–it’s not as though leveraged financial institutions are holding these things; a real-estate crash would probably have small macroeconomic effects just as the dot-com crash did.” It would have been nice if somebody inside the Fed had back then been doing the legwork to establish that I was wrong…

If I thought the Federal Reserve were working reasonably well then the appropriate response is not an expanded regular GAO audit but instead an expanded Humphrey-Hawkins process: to throw more resources both from Congress and from the Federal Reserve into a greatly expanded “risks and contingency plans” section of the Federal Reserve’s Humphrey-Hawkins documents

But my problem is that I do not think that the Federal Reserve is working reasonably well. I do not think that the dominant views of monetary policy in the FOMC right now are informed by American values and a reality-based assessment of the state of the economy. That a good many of the people speaking and voting in the FOMC are the wrong people to do so did not matter (much) when the Federal Reserve was dominated by the incredibly charismatic (yes, I mean that) philosopher-central banker-princes of William McChesney Martin, Arthur Burns, Paul Volcker, and Alan Greenspan, but it matters now.

So I am willing to defer to President Obama’s judgment that the Federal Reserve’s desire for a modicum of central banker privilege is worth respecting, and that the Sanders amendment is the wrong treatment for the disease. I am willing to do so, in large part, because I think the problems are not those that detailed routine investigations of staff communications would solve: the staff of the Federal Reserve do, it seems to me, overwhelmingly have a reality-based vision of the economy, conduct thorough and appropriate analyses of risks and scenarios, and understand the Federal Reserve’s dual mandate.

But I ask President Obama: What is your alternative? What is your alternate plan for improving the quality of Federal Reserve decisions–for getting policymakers who properly understand the state of the economy and who believe in the Federal Reserve’s dual mandate? It’s very hard to beat something–even a bad something–with nothing.

Comments to “Surveillance Over the Federal Reserve: On the Sanders Amendment to the Dodd Senate Financial Regulation Bill

  1. Millions of people on main street saw the market meltdown coming but didn’t profit as much as Wall Street because they didn’t have access to obscure financial instruments.

    The idea that the fed, other government agencies, and above all banks didn’t see it coming is absurd. Anyone who has read books on the history of fiat currencies, market bubbles and crashes, Lefevre’s “Reminiscences of a Stock Operator” — or subscribed to one of hundres of web and financial newsletters knew the “day of reckoning” was coming – is still coming despite the trillions that have temporarily halted the crash ahead.

    Anyone who was flipping homes — and at one point there were several TV shows and numerous books on how to do this, knew there was a housing bubble and was counting on not being the last sucker.

    What’s outrageous is how much money a few on wall street made at the expense of
    millions on main street.

    Of course, there were people on Main street who made some money, such as those who flipped homes and got out in time. Financial newsletters / websites advised Main Street to short REIT’s, not buy a home until after the housing bubble and instead invest in precious metals and commodities, not to use their home as an ATM machine, and to sell their home ASAP and rent until after the bubble had popped.

    It’s impossible to know how many millions knew about the housing meltdown, and when they knew it, but I bet if you added up the number of people who subscribed or read the Websites/newsletters below, or have read books on past bubbles and financial history, or could still remember the bubble, or had a friend or relative who emailed / put on facebook links to information about the housing bubble / debt / derivatives, etc., the number of people who could see this coming numbered in the millions.

    It’s been well known since at least 1994 that the ratings agencies, Standard & Poor’s, Moody’s, and Fitch, who take money from the companies they’re rating, can’t be trusted.

    Back in 2002 they also failed to warn about Enron.
    Feb 8, 2002. ENRON’S MANY STRANDS: WARNING SIGNS; Credit Agencies Waited Months To Voice Doubt About Enron. By EDWARD WYATT. New York Times.

    And in the latest meltdown, according to Martin Weiss, former president of Weiss Ratings (which consistently did see these problems because they didn’t take any money from the companies they rated):
    Conflict #1. As with nearly all other ratings you issue, your mortgage security ratings were paid for by the issuers, empowering them to achieve undue influence over the ratings process.
    Conflict #2. You earned substantial additional consulting fees to help structure the very securities you rated.
    Conflict #3. You revealed your ratings formulas to issuers, helping them manipulate their data to game the system and more easily get high grades for their junk securities.

    Millions on Main Street understand that the housing bubble (which isn’t over yet), is just a small part of a much larger financial meltdown still to come. Here’s what millions knew May 22, 2004 and earlier:

    In summary:
    1) there’s no meaningful regulation of Wall Street in sight (and if you read financial history, it won’t matter if there is, they’ll find a way to get around regulations)
    2) debt exists at all levels of society from personal and business to city, state to national
    3) 44+ trillion in unfunded liabilities: medicare, and SSN
    4) 600 trillion in derivatives to unwind chasing 8 trillion in real goods
    5) 20 years for employment to recover even if the economy grew at 3% per year, because there are so many unemployed (much larger than not-to-be-trusted government stats) and millions of new job seekers every year: high school and college grads every year, legal and illegal immigrants.
    6) economy can’t continue to grow: depletion of natural resources: topsoil, aquifers, forests, fisheries, phosphorous, and the master resource that make all other resource exploitation possible — energy: oil, natural gas, coal, etc
    7) 39 million Americans on food stamps, with that number growing every day
    8) Our infrastructure is falling apart. The American Society of Civil Engineers gives us a grade of D. Where’s the money and raw materials to fix our nations Bridges, Dams, Drinking Water, Energy, Hazardous Waste, Inland Waterways, Levees, Rail, Roads, Schools, Solid Waste, Transit, Wastewater going to come from?
    10) FDIC in the red, pensions, distribution of wealth, sovereign debt, etc

    Just a few of the Websites/newsletters warning of the financial meltdown since 1999-2005:
    dozens more

    books on the history of bubbles, wall street fraud and greed, etc
    Lila Rajiva Mobs,Messiahs,and Markets Surviving the Public Spectacle in Finance and Politics

    booklist: “Fraud & Greed: Wall Street, Banks, & How to Invest booklist”


    October 14, 2002 Money & Investing. Home Sick by A. Gary Shilling

    December 26, 2002 Pop Goes the Bubble – Part II. Sell Your House Now! by M.A. Nystrom

    2004 Stephen Roach of Morgan Stanley

    Jan 20, 2004 Debt Bomb in Barrons by R. Laing
    Only housing is keeping the fuse on America’s borrowing habit from burning down

    June 7, 2004 Daily Reckoning by The Mogambo Guru

    March 16, 2005 Beat the bubblicious real estate market
    Tips to get through the sizzling market unscathed. By Amey Stone. Business Week

    May 29, 2005 Hear a Pop? Watch Out N Y TIMES
    NOW that even Alan Greenspan is talking about “froth” in real estate markets, how concerned should people be – not just about the value of their own homes, but about the entire country?

    June 21, 2006 Who Gets Hammered in the 2007 Housing Bust: the Lower Middle Class

    June 13, 2006 What Happens When Housing Employment Plummets?

    2004 Nothing Down for the 2000s: Dynamic New Wealth Strategies in Real Estate
    2006 Flipping Properties: Generate Instant Cash Profits in Real Estate
    2006 Find It, Fix It, Flip It!: Make Millions in Real Estate–One House at a Time
    2006 Fast Real Estate Profits in Any Market: The Art of Flipping
    Properties–Insider Secrets from the Experts Who Do It Every Day
    2006 FLIP: How to Find, Fix, and Sell Houses for Profit
    2007 Nothing Down for Women: The Smart Woman’s Quick-Start Guide to Real Estate Investing
    2007 Flipping Houses For Dummies
    2007 Flipping Confidential
    2007 Getting Started in Property Flipping
    2007 The Unofficial Guide to Flipping Properties
    2008 Flip and Grow Rich
    2008 The Complete Guide to Flipping Properties
    2008 The House Flipping Answer Book

    Flip this house A&E Channel
    Flip that house TLC/Discovery Channel
    The Property Ladder TLC/Discovery channel
    Flipping Out Bravo Channel
    House Hunters HTV Channel
    Home to Flip HGTV (canada)

    July 11, 2003
    “…I’m afraid he’s right.” – Jack Bogle, Vanguard Funds
    Freight Trains and Steep Curves The U.S. financial system’s big gamble on perpetually low short-term interest rates

    NOV 21, 2004 Credit Card Debt Trap & Rising Interest Rates
    THE PLASTIC TRAP Soaring Interest Compounds Credit Card Pain for Millions

    Spending our way to disaster
    October 3, 2003 The consumer debt bubble in the United States could make the stock bubble seem like nothing. By Justin Lahart, CNN/Money Senior Writer


    Aug 27, 2005 Experts Warn Debt May Threaten Economy NY Times

    September 7, 2001 The JPM Derivatives Monster by Adam Hamilton

    Avoiding a ‘Mega-Catastrophe’
    Derivatives are financial weapons of mass destruction. The dangers are now
    latent–but they could be lethal.
    FORTUNE Monday, March 3, 2003 By Warren Buffett,15114,427751,00.html
    Testimony of Frank Partnoy The Unregulated Status of Derivatives & Enron
    Professor of Law, University of San Diego School of Law
    Hearings before the United States Senate
    Committee on Governmental Affairs, January 24, 2002

    about half way down
    George Soros’ April 13, 1994 testimony before the US House Banking Committee:

    Global Capitalism
    Open Society: Reforming Global Capitalism
    George Soros Little, Brown & Company, London, 2000 review of the book

    May 22, 2004 Financial Sense NewsHour Radio & Net Talk Show Presenting Catherine Austin

    Fitts w/ Jim Puplava Webcast
    Catherine Austin Fitts is a former Assistant Secretary of Housing-Federal Housing

    Commissioner in the first Bush Administration.
    America’s Black Budget & the Manipulation of Mortgage & Financial Markets

    der spiegel nov 21, 2008 The Next Crisis: FHA-backed loans

    ecological bubbles
    Lester R. Brown

  2. President Obama made many changes in the financial area to enhance the financial area to survive from the crisis.

Comments are closed.