The Federal Reserve System
Nobody owns the Federal Reserve System (FRS), which is an independent central bank that can take decisions without ratification by the President, Congress or anyone else. Members of the Board of Governors of the FRS are appointed to terms that extend over presidential and congressional terms. The FRS is subject to oversight and changes of statutes by Congress and must function within the general framework of government policy. The first major function of the FRS is monetary policy to ensure financial stability. According to 12 USC 225a, “The Board of Governors of the Federal Reserve System and the Federal Open Market Committee (FOMC) shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” The role of “independence within government,” appointment of prominent members to the Board, the technical nature of monetary policy and decentralized appointment of the 12 presidents of the regional Federal Reserve Banks (FRB) resulted in an institution that is freer from political influence and characterized by elite staff. The FOMC reaches decisions on the basis of information obtained from the research and supervisory functions of the FRS and the state of the art on the conduct of monetary policy (Pelaez and Pelaez, Regulation of Banks and Finance, 99-116, Financial Regulation after the Global Recession, 84-90). Errors have abounded in the decisions of the FOMC and central banks worldwide because of the ambiguous analysis of current and future economic conditions, which is a deficiency of a nonexperimental science such as economics. In addition, policy simulation models suffer from the Lucas Critique, by which expectations of economic agents may reverse policies, resulting in effects different than those intended. The errors and deficiencies in the credit/dollar crisis and global recession were by nearly all central banks in the world and not only by the FOMC because of insufficient knowledge of how the economy functions (Pelaez and Pelaez, The Global Recession Risk, 221-5, Financial Regulation after the Global Recession, 155-71, Regulation of Banks and Finance, 217-33). A proposed financial stability agency or systemic risk council would not be able to attain the technical excellence of the FOMC and the traditional political independence of the FRS. Monetary policy could be captured for political purposes during cycles of presidential elections and midterm elections for Congress, causing future instability. Independence of the chief monetary authority is highly desirable if sound policy management is the main objective. The second function of the FRS is provided by the Federal Reserve Act 12 USC 248 (a-r) that empowers the FRS with supervisory and regulatory functions. The Federal Reserve has created over the years competent staff to implement these powers. The United States has four federal supervisors and regulators of financial institutions, FRS, OCC, FDIC and OTS, with multiple state bank supervisors and regulators (Pelaez and Pelaez, Financial Regulation after the Global Recession, 69-77). Each of these agencies has developed own staff and procedures. The elimination of the supervisory and regulatory powers of the agencies for concentration in a sole federal regulator may prove unfeasible and undesirable in the United States, which has thousands of financial institutions of different sizes that are focused on diverse segments of the financial markets. The logistics of consolidation of these agencies could create a chaotic and difficult transition period during high unemployment. The FOMC would lose key information on supervised banks. An ambitious agenda of single regulatory agency, centralized systemic risk council, reduction of size of banks, consumer protection agency and other proposals (Pelaez and Pelaez, Financial Regulation after the Global Recession, 171-5, Regulation of Banks and Finance, 229-36) conflicts with the immediate objective of promoting tranquil, growing financial markets required for recovering full employment. The regulatory shock could increase the premium of bank capital, reducing lending capacity. None of these proposals addresses the true causes of the credit/dollar crisis and global recession, which were errors of central banks in lowering policy rates to nearly zero in 2003-4 and the purchase or guarantee of $1.6 trillion of nonprime mortgages by Fannie and Freddie. Congressional oversight failed in detecting policy errors and proposed regulation can cause more harm. The regulatory proposals can jeopardize the work of the FOMC and existing regulatory agencies, preventing the recovery of credit required for faster economic growth and employment creation. There are much higher returns in terms of employment creation in devising an exit strategy for the Fed balance sheet and the fiscal deficit than in proposing complex new controls.