Friday, February 24, 2012

Transparency Issues on the US Federal Reserve

Former IMF chief Economist Simon Johnson takes the US Federal Reserve to task for their lack of transparency,

The Wall Street Journal reported on Tuesday that during the 1980s the Fed’s board held 20 to 30 public meetings a year, but these dwindled during the Greenspan years to fewer than five a year in the 2000s and “only two public meetings since July 2010.” At the same time, “the Fed has taken on a much larger regulatory role than at any time in history” — including “47 separate votes on financial regulations” since July 2010, The Journal said.

This high level of secrecy is a concern. It is particularly alarming when combined with the disproportionate access afforded to industry participants in the arguments about what constitutes sensible financial reform.

Just on the Volcker Rule — the provision in Dodd-Frank to limit proprietary trading and other high-risk activities by megabanks — Fed board members and staff members apparently met with JPMorgan Chase 16 times, Bank of America 10 times, Goldman Sachs nine times, Barclays seven times and Morgan Stanley seven times (as depicted in a chart that accompanies the Wall Street Journal article).

How many meetings does a single company need on one specific issue? How many would you get?

For example, Americans for Financial Reform, an organization that describes itself as “fighting for a banking and financial system based on accountability, fairness and security,” met with senior Federal Reserve officials only three times on the Volcker Rule. (Disclosure: I have appeared at public events organized by Americans for Financial Reform, but they have never paid me any money. I agree with many of its policy positions, but I have not been involved in any of their meetings with regulators.)

Americans for Financial Reform works hard for its cause, and it produced a strong letter on the Volcker Rule — as did others, including Better Markets and Anat Admati’s group based at Stanford University.

Based on what is in the public domain on the Fed’s Web site, my assessment is that people opposed to sensible financial reform — including but not limited to the Volcker Rule — have had much more access to top Federal Reserve officials than people who support such reforms. More generally, it looks to me as though, even by the most generous (to the Fed) account, meetings with opponents of reform outnumber meetings with supporters of reform about 10 to 1.

According to those records, for example, the Admati group has not yet managed to obtain a single meeting with top Fed officials on any issue, despite the fact that the group’s members are top experts whose input is welcomed at other leading central banks. To my definite knowledge, they have tried hard to engage with people throughout the Federal Reserve System; some regional Feds are receptive, but the board has not been – either at the governor or staff level…

I do not understand the Fed’s attitude and policies — if it is serious about pushing for financial reform. No doubt they are all busy people, but how is it possible they have time to meet with JPMorgan Chase 16 times (just on the Volcker Rule) and no time to meet Anat Admati – not even for a single substantive exchange of views?

People’s actions are driven by incentives or purpose behavior. So are the actions of those running government bureaucracies. The fundamental difference is that the incentives of bureaucrats are prompted for by political exigencies against market participants who are guided by profits and losses.

Researcher Jane Shaw expounds on the public choice theory

Their incentives explain why many regulatory agencies appear to be "captured" by special interests. (The "capture" theory was introduced by the late George Stigler, a Nobel Laureate who did not work mainly in the public choice field.) Capture occurs because bureaucrats do not have a profit goal to guide their behavior. Instead, they usually are in government because they have a goal or mission. They rely on Congress for their budgets, and often the people who will benefit from their mission can influence Congress to provide more funds. Thus interest groups—who may be as diverse as lobbyists for regulated industries or leaders of environmental groups—become important to them. Such interrelationships can lead to bureaucrats being captured by interest groups.

The political relationship between the regulator and the regulated always impels for a feedback mechanism, such as lobbying, as the regulated will always find ways to circumvent or to relax on the rules which restricts or inhibits their actions. And the typical outgrowth to such relationship has always been the lack of transparency, revolving door relationships (Wikipedia: movement of personnel between roles as legislators and regulators and the industries affected by the legislation and regulation and on within lobbying companies), logrolling and corruption. Such "conflict of interests" relationships frequently make regulatory agencies “captured” by special interest groups.

And what is the ultimate cause for this?

To quote Milton Friedman in Capitalism and Freedom

Any system which gives so much power and so much discretion to a few men that mistakes – excusable or not – can have such far-reaching effects is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic – this is the key political argument against an "independent" central bank. But it is a bad system even to those who set security higher than freedom. Mistakes, excusable or not, cannot be avoided in a system which disperses responsibility yet gives a few men great power, and which thereby makes important policy actions highly dependent on accidents of personality. This is the key technical argument against an "independent" bank. To paraphrase Clemenceau, money is much too serious a matter to be left to the Central Bankers.

In short, the kernel of the transparency issues surrounding the US Federal Reserve has been about the negative ramifications from the centralization of power. Conflicts of interests and regulatory capture signifies as issues which won’t go away for as long political power (in relation to money, but applies elsewhere) remain concentrated to a few men. The more the power assumed by central bankers, the greater the risks of political indiscretions and secrecy.

Thus, the transparency issue can be resolved by the abolishment of central banks.

This means, yes, End the Fed.

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