Lost in the debate over the failing of financial behemoths and the meltdown of Wall Street is an accounting about how this mess came about. The housing bubble that created bad mortgage loans did not just materialize out of thin air. Toxic derivatives that threaten financial institutions and the overall economy were not cooked up in someone’s garage like some high tech internet startup. The fact is that much of what threatens the world economy can be placed squarely on the shoulders of the Federal Reserve. Instead of throwing good money at bad we need to fix the problem and reform the Fed.
We are not just talking about bad policy choices by the Fed. We all make poor decisions, and as a former global money manager I am all too familiar with how the best analysis can at times lead to the worst of results. I am talking about something more insidious. The Fed, particularly under Greenspan, not only made poor policy choices, but pursued a radical free markets agenda and an experiment in financial alchemy from which we now suffer.
Who gave Greenspan the authority to push his agenda and have average Americans serve as guinea pigs for his experiments in free markets and financial sorcery? No one!
Greenspan was able to pursue his whims because the Federal Reserve exists as an independent entity unencumbered by rules that govern other government agencies.
The Fed is free from the checks and balances that are the backbone of the US constitution. The Fed is free from GAO reporting and Freedom of Information Act scrutiny. Its meetings are kept secrecy until long after the fact. It was mandated to report to Congress by the Humphrey Hawkins Full Employment Act until it expired in 2000. Although no longer required to report to Congress the Fed chairman still does. Arguably it is only beholding to its board of directors made up of primarily the largest financial institutions in America ; a classic example of the industry supervising the regulator.
The Fed is responsible for conducting monetary policy, overseeing financial institutions and financial markets. In other words the Fed not only sets policy but oversees itself, a clear conflict of interest. Because the Fed can print its own money it is free from Congressional oversight. No need to worry about a budget, just turn on the presses; and don’t worry no one can audit you.
It is difficult for people outside the world of finance to understand the scope and power of the Fed since we are so used to thinking of line authority that gives certain powers to individuals. The Fed’s power rests in a mix of monetary policy tools and confidence in the institution; but in a world ruled by money, the one that controls money is the king. Bob Woodward’s book on Greenspan, Maestro: Greenspan’s Fed and the American Boom expressed the perspective of many that Greenspan was the most powerful person in the world when he said, “On January 20, 2001, a new president takes the oath of office. He assumes the presidency in a Greenspan era.”
Amity Shlaes of the Financial Times similarly commented on the enormity of Greenspan’s power and the inherent failure of the design of the Federal Reserve system:
How can it be, at a time of unprecedented faith in free markets, that we even think a government authority might have such strength? And how can it be that the world’s monetary order rests on the shoulders of an individual, much admired but still fallible economist?
The answer is America ’s uniquely flawed and outdated monetary law, which gives the nation’s monetary chief the sort of discretion of which his peers in other developed countries can only dream. Mr. Greenspan is so powerful that today he is perceived as a loving dictator. This is only natural. For as we know from history, wherever the law is weak-in any area of politics-public credibility tends to vest itself in an individual.
A Radical Agenda
Greenspan is an ardent devotee of the most radical element of capitalism and free markets. As William Greider notes, “His thinking is still anchored by Ayn Rand’s brittle social philosophy: Let the strong prevail, let the weak pay for their weakness.”
Throughout his career beginning with the 1987 stock market crash Greenspan has bailed out the rich while ignoring the plight of average Americans. During the Fed engineered bailout of the speculative hedge fund, Long Term Capital Management, the Wall Street Journal’s op-ed page would lament (“Decade of Moral Hazard,” 2/25/98):
“As moral hazard grows you get a market so skewed by the expectation of bailouts that vital signals about genuine risk no longer get through. Eventually, the danger turns into one of systemic collapse…”
The bailouts have only increased in frequency and size of money needed for rescue that today we face the “systemic collapse” the Wall Street Journal forecast.
Instead of balancing the needs of the well to do (inflation) with the interest of working Americans (jobs) as mandated by the Humphrey Hawkins Full Employment Act, Greenspan consistently championed the rich. The Fed has almost exclusively focused on keeping the rate inflation low and ignored the needs of working Americans’ for a strong economy to create jobs. Generally speaking low inflation benefits financial assets and modest, or higher inflation stimulates the economy. The decision to focus almost exclusively on keeping inflation low sent the value of financial assets rocketing higher. Since the advent of Reaganomics and the Greenspan Fed, the PE ratio of the stock market tripled from its historical range of 10 to 15 to 30 to 45. The PE ratio (Price Earning Ratio) is the price of stock divided by its earnings per share. The higher the PE the greater the value.
This explosion in the value of financial assets was a boon to the wealthy that own the bulk of the stock market. Having the value of their investments triple in value by having the Fed simply wave a wand and put the onus on average Americans meant that they had more money to spend on funding conservative think tanks and lobbyists, both of which have dramatically increased. The Fed’s decision to hoist the value of stocks at the expense of average Americans underscores what James Livingston argued in Origins of the Federal Reserve System: Money, Class, and Corporate Capitalism, 1890-1913, that the creation of the Federal Reserve was part of an effort to create a new ruling class of ‘corporate-industrial business elite.’
The Financial Experiment Gone Bad
One of the incipient factors behind our current financial maelstrom is financial derivatives. Derivatives are financial assets whose value is based upon the price performance of some underlying asset. They usually entail leverage.
Greenspan has consistently championed and protected government oversight of derivatives. On 9/11/00 the NY Times, in “Greenspan Urges Congress To Fuel Growth of Derivatives,” reported that:
“The Federal Reserve chairman, Alan Greenspan, urged Congress today to encourage the growth of complex financial contracts known as derivatives before the United States share of that market and associated benefits are lost to other countries.”
One must wonder if we would be suffering today if Congress had not been railroaded?
One of the other financial innovations in derivative products creating havoc is subprime mortgages. The subprime market developed as a response to Reagan’s deregulation of the banking system. Banks were allowed to depart our inner cities where the most vulnerable in our country live. Greenspan stood by while this void was filled by loan sharks and shysters who found creative means to circumvent state usury laws and created the fringe banking market. New and innovative financial products were created to prey on the less well to do such as sub prime mortgages, payday loans, auto title loans, check cashing stores, tax refund anticipations loans and others all of which charged exorbitant interest rates.
Many community groups correctly pointed out that fringe banking preyed on the poor, the elderly and people of color. The Fed turned a blind eye to this abuse and did nothing to prevent or even regulate this industry!
Reform the Fed
New Humphrey Hawkins Act — A new Humphrey Hawkins Full Employment Act needs to be passed that has the Fed focusing primarily on creating jobs, the real economy and the interests of average Americans. The Fed’s mandate must be to focus on all Americans.
New Board of Directors — The Fed needs a new board of directors who is primarily made up of individuals and organizations that serve the common good. They need to have the power to rein in the chairman.
Supervision needs to be separated from oversight — The policy arm and oversight functions of the Fed need to be separated.
Fed Head Should be Elected — The head of the Federal Reserve needs to be an elected official.
Congressional Oversight — The head of the Fed has to report to Congress on a regular basis. Congress should receive a detailed plan as to Fed’s policy objectives.
No More PKO’s for the stock market — Since the 1987 stock market crash it is widely rumored that the Federal Reserve, like the Bank of Japan before the precipitous decline of the Japanese market, has been pursuing an active “Price Keeping Operation” (PKO) to buy stocks during dramatic price declines. This must stop! Congress needs to investigate the books of the Fed to determine whether it holds any stocks in its portfolio.
Member Services — Financial institutions that are members of the Federal Reserve system have to offer basic checking, savings and cash checking at minimal cost to our most vulnerable communities.
No more bailouts.
For more information on the Fed go to:
Federal Reserve Links: www.jubileeinitiative.org/FedInfo.htm
William Greider’s Secrets of the Temple: How the Federal Reserve Runs the Country after two decades since publication remains the authoritative text on the Fed. Greider has written a plethora of excellent articles on the Fed that can be accessed here.
The Financial Markets Center focuses on the Fed and has a rich archive of informative articles.