Ben Bernanke’s “Report to Congress” on July 17, brought home again how intensely we regard pronouncements from the Federal Reserve System. As “The Fed” speaks, markets rise or fall, affecting us all whether we realize it or not. I want to take a look at the Fed, to perhaps demystify it a bit, to provide a snapshot so the whole business won’t seem entirely cabal-like.
The Federal Reserve System, created by an Act of Congress in 1913, consists of a seven member Board of Governors headquartered in Washington, D.C., and twelve Reserve Banks located in major cities throughout the United States. The board is appointed by the president and confirmed by the Senate to serve 14-year terms of office. Members may serve only one full term, but a member who has been appointed to complete an unexpired term may be reappointed to a full term. In making appointments, the president is directed by law to select a "fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country."
The primary responsibility of the board is the formulation of monetary policy. It has regulatory and supervisory responsibilities over Reserve banks, bank holding companies, Edge Act and agreement corporations, and the U.S. activities of foreign-owned banks. The board sets margin requirements which limit the use of credit for purchasing or carrying securities. Another area of responsibility is the development and administration of regulations that implement federal laws governing consumer credit.
The Fed is an independent entity within the government, accountable to the public and Congress and not a private, profit-making institution. Its policy decisions do not have to be approved by the president or anyone else, and it does not receive funding appropriated by Congress. Authority is derived from Congress, and Congress can alter its responsibilities by statute. Board financial statements are audited annually by an independent audit firm retained by its Office of Inspector General in addition to its own internal auditing procedures.
The Fed is structured to remove the influence of politics from monetary policy. That being the official “party line,” it would appear that appointments to the board are politically motivated with each president nominating according to his party. However, President Obama took the unusual step of nominating a Republican, Jerome H. Powell, along with a Democrat, Jeremy C. Stein, as a pragmatic attempt to satisfy Senate Republicans.
Congress sets the salaries of the board members. For 2012, the chairman's annual salary is $199,700. The annual salary of the other board members, including the vice chairman, is $179,700. Board rules do not allow employees, their spouses, and minor children, to own debt or equity interests in banks, thrifts, or other depository institutions or their affiliates.
Now for a short study of the board members. Detailed career and education background is given on the Fed website (http://www.federalreserve.gov/aboutthefed/default.htm).
Jerome H. Powell, a member since May 2012, has described himself as “by any fair reckoning a fiscal conservative” but he is known for taking independent positions on policy issues. He has argued publicly that the debt ceiling should be raised, warning Republicans against failing to do so.
Jeremy C. Stein, also a member since May 2012, has advocated for stricter regulation of financial companies, including higher capital requirements for large financial institutions. He has argued for strengthened regulation of “shadow banks” such as private equity funds and mutual funds that function like banks but are not subject to the same rules or oversight.
Both Powell and Stein are experts in the workings of financial markets; at the time of their appointments, the other five board members were primarily experts in other areas.
Daniel K. Tarullo, a member since January 2009, recently stated that much remains to be done in implementing banking reforms, and that policies underlying regulation should embody an affirmative set of goals. He said that to return to, and maintain, a healthy housing market a healthy system of mortgage finance is needed, and that the debate about what we don’t want intermediaries and financial markets doing must be informed by a better articulated view of what we do want them doing.
Elizabeth A. Duke, a member since August 2008, has said that it would be unlikely that anyone would fully agree with the final decisions eventually made with regard to policies that will affect the future of the mortgage market, but until those decisions are made, uncertainties will continue to hinder access to credit, the evolution of the mortgage finance system, and the ultimate recovery in the housing market.
Sarah Bloom Raskin, a member since October 2010, has said that the financial inequality resulting from stagnating incomes for most Americans, and rapid growth in the richest 1%, is hindering the economic recovery, and that regulators must work to help consumers gain access to financial services and to ban products inherently unfair or deceptive.
Janet L. Yellen in October 2010 took positions simultaneously as vice chair of the board and as a board member. She has said that the lackluster trajectory of the economic recovery might require the Fed to continue its efforts to bolster growth even beyond the end of 2014, and that the Fed remains committed to the efforts to suppress interest rates and reduce the cost of borrowing. She stated that a highly accommodative monetary policy will remain appropriate for some time to come.
Ben S. Bernanke, originally took office simultaneously as chairman and board member in February 2006. He began a second term as chairman in February 2010. Bernanke is a vocal advocate for an even more transparent Federal Reserve. His study of the Great Depression instilled a life-long interest in the effects of deflation and its impact on people’s lives. While stemming deflationary pressure by increasing the supply of money can have an inflationary result, he does not take inflation lightly. He has stated that while the banking system has improved significantly in the past few years, banks have more to do to restore their health and adapt to the post-crisis regulatory and economic environment.
On July 17, 2012, Bernanke reported that while our economy has continued to recover, economic activity decelerated during the first half of this year. While there have been modest signs of improvement in housing, a number of factors continue to impede progress (tighter lending standards, prospective buyers worrying about their own finances, etc.). Rise in business spending has decelerated from that pace seen the second half of 2011. Financial strains associated with the crisis in Europe have increased since earlier in the year. Recovery continues to be held back by still-tight borrowing conditions and the restraining effects of fiscal policy and fiscal uncertainty. The development of a credible medium-term plan for controlling deficits should be a high priority. Recovery could be endangered by the confluence of tax increases and spending reductions that will take effect early next year if no legislative action is taken. The most effective way that Congress could help would be to address the nation’s fiscal challenges in a way that takes into account by the need for long-run sustainability and the fragility of recovery. He assured that the Fed is prepared to take further action as appropriate to promote a stronger economic recovery. (However, as Bloomberg summed, while Bernanke says the Fed is prepared to act, he declines to specify steps.)
You can read Bernanke’s complete report at http://www.federalreserve.gov/newsevents/testimony/bernanke20120717a.htm
Board member terms can't be cut short. The chairman, also nominated by the president, is limited to four-year terms, but after he's confirmed the president has no authority to remove him unilaterally. He can only be removed “for cause.” Furthermore, the chairman is also a member of the board, so even if a president were to replace Bernanke as chair when his chair term expires in 2014, Bernanke could choose to complete the remainder of his 14-year term as a board member. Removal, however, would involve proving wrongdoing of some kind, and the process would ultimately be decided by employment lawyers and the legal system, not by a president alone. The Fed has declined to specify which causes might prove grounds for removal.
That it's not easy to get rid of a Fed chairman is evidenced by the fact that two different presidents tried, or at least considered, removing one and failed. Presidents John F. Kennedy and Richard M. Nixon both wanted to remove William McChesney Martin. Martin refused to step down and filled out his term. It looks like Bernanke has as close to supreme job security as you can get.
So let’s see here, we have an organization with top management that can’t be fired and with a board that is pretty much guaranteed a job for a finite period of time. As they speak, markets fluctuate, affecting the world. Talk about job security combined with an ultimate power of economic rule!
Can’t help but remember that famous quote by Lord Acton: Power tends to corrupt, and absolute power corrupts absolutely.
Until next time, LLAP!
References
http://www.federalreserve.gov/aboutthefed/default.htm
http://www.federalreserve.gov/newsevents/testimony/bernanke20120717a.htm
http://www.federalreserve.gov/newsevents/testimony/bernanke20120717a.htm
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