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Sunday, March 15, 2009

Rethinking the Federal Reserve

A couple days ago, I began reading a piece from the Nation and was totally startled. I was startled because I appeared to be in total agreement with the piece. (given my conservative leanings and the far left leanings of the magazine, that's why I was startled) The piece correctly identified that the Fed has become a serious problem to financial stability. It even correctly pointed out that the Fed's pschzonphrenic interest rate policy has lead directly to economic instability. (over the last ten years no less than four times did the Fed raise or lower rates only to have to reverse course because its action boomeranged and created a new problem) Then, the article got to solutions and all order was restored.

This analysis is drawn from the work of Jane D'Arista, a reform-minded economist and retired professor with a deep conceptual understanding of money and credit. (Read her recent essay, "Setting an Agenda for Monetary Reform.") D'Arista proposes operating reforms at the central bank that would be powerfully stimulative for the economy and would also restore the Fed's role as the moderating governor of the credit system. The Fed, she argues, must create a system of control that will cover not only the commercial banks it already regulates but also the unregulated nonbank financial firms and funds that dispense credit in the "shadow banking system," like hedge funds and private equity firms. These and other important pools of capital displaced traditional bank lending with market securities and collaborated with major banks in evading prudential rules and regulatory limits. "Shadow banking" is, likewise, frozen by crisis.

In my opinion, the biggest problem with the Fed is that we consolidate an enormous amount of power into the hands of one person, the Federal Reserve Chairman. I would argue with anyone that it is the Fed Chairman that is the most powerful person in the world. That's because they control our nation's money supply and the one that controls the money controls everything.

A colleague of mine once told me that the creation of the Fed made it much easier to make war. That's because the Fed can very easily print money through a variety of sources. By doing so, waging war no longer requires raising taxes like it used to.

What this piece proposes to do is to make the regulatory umbrella of the Federal Reserve even large and include all financial institutions rather than just banks. The problem, in my opinion, is that the Fed Chairman has too much power.

As such, here is my proposal. I would remove the Fed Chairman. Instead, I would continue the current Federal Reserve Board Districts of which there are twelve. There will need to be a head of each district. Each head will be chosen by a Congressional Committee made up of each Congress Person and Senator that serves the district. Most importantly, a super majority of seven would be required for any action worth more than a billion Dollars. Currently, each governor must agree with the Fed chairman however that is almost always a rubber stamp. By creating a decentralized system rather than a rubber stamp, we will have a democratic form of decision making. Furthermore, for any action, the Fed will be required to also publish the dissenting opinion (if there is one) much like the Supreme Court does.

The danger here is that it would make monetary policy less nimble and rather rigid. In my opinion, that current Fed policy is so nimble is part of the problem. The Fed is so nimble that it is at the mercy of its Chairman. If the Chairman is right then all is well, but if they are misguided then disaster strikes. It was the nimble nature in which then Charman Greenspan lowered rates and kept them there that lead to us being here. It's true that often Fed policy must be nimble, however if that policy is clear there would always be agreement. Much more often, the future policy is less clear and rather than being at the mercy of the Chairman, we would have a vigorous debate among its regional Chairmen. Rather than someone taking on a leadership role because they were chosen, leaders would emerge from their efforts in crafting policy.

Furthermore, by localizing their selection, it also makes the Fed more answerable to the citizens. The selection of future Fed District Charimen would become a campaign issue. What this would do is educate the public on the nature and role of the Fed. Rather than being a nebulous organization that is understood by almost no one but those that run it, it will become an organization that will be an issue that voters will consider.

Doing this will also allow the Fed to take on more responsibility without giving one person too much power. As such, we could have the Fed take on the responsibility of oversight and regulation of all financial services, as the article suggests, without consolidating too much power in the hands of one person. By doing this, it solves the two biggest problems of the Fed, too much power and an organization that is misunderstood.

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