There has always been something controversial about the Federal Reserve System and it has been a target for conspiracy theorists thanks to its complex structure and mix of private and public underpinnings. For an institution that is not technically part of government it wields a huge amount of power over our economy and has the authority to picks winners and losers as demonstrated by its recent intervention in the blow-up of investment bank Bear Stearns.
Tuesday Fed Chairman Ben Bernanke politely asked for additional powers. He noted in a speech to the Federal Deposit Insurance Corporation that, “Another possible step to reduce the incidence and severity of financial crises, recently proposed in the Treasury blueprint for regulatory reform, would be to task the Federal Reserve with promoting the overall stability of financial markets.”
The kicker to that was this, “That said, holding the Fed more formally accountable for promoting financial stability makes sense only if the institution's powers are consistent with its responsibilities.”
He then added, “If the Congress chooses to go in this direction, attention should be paid to the risk that market participants might incorrectly view the Fed as a source of unconditional support for financial institutions and markets, which could lead to an unacceptable reduction in market discipline.”
Here is where there is a disconnect. What has the entire subprime crisis been, if not the result of an unacceptable reduction in market discipline. Bernanke and others Fed officials pointed out during Congressional hearings on the Bear Stearns bailout that no financial institution would knowingly take unacceptable risks if they knew this would be the result. We saw that statement at the time as disingenuous, naïve or both. The Fed bailout insured that millions paid out in bonuses to executives were safe despite the collapse of the bank. A multi-million dollar payout was the worst case scenario for those who created the mess. Would you take unnecessary risk if that was your worst case scenario?
In his speech Bernanke points out how the Fed opened their lending window to investment banks and broker dealers as a result of the credit crisis and suggested extending that window. Acceptance of such relief should have required wholesale changes at board levels and the forfeiture of bonuses. The Fed has bailed out these institutions and continues to do so without making any demands on them, then pays lip service to avoiding a reduction in market discipline.