FINANCIAL REGULATION | One Year into Trump Era

Update 245 from Dana Chasin —  Financial Regulation Reshaped

A year into office, President Trump has made significant progress in reshaping the financial regulatory agencies, as many of his nominees are confirmed. Their generally ambitious deregulatory plans have risks. —————————————————- FSOC: Still Standing, with Stature At Wednesday’s Senate Banking nomination hearing, senators questioned Thomas Workman, who would serve as FSOC’s independent member with insurance expertise. Workman was president and CEO of the Life Insurance Council of New York from 1999 to 2016. Workman would join FSOC just as it reconsiders its listing of the large insurance companies critical enough within the financial system to trigger a crisis. Workman declined to answer direct questioning about what he thought about the $50 billion threshold at which FSOC declares a nonbank financial firm systemically important. He did echo the sentiment of a November Treasury report by expressing an openness to “tailoring” FSOC’s SIFI designation process by shifting regulatory analysis to focus on a firm’s activities, as opposed to its assets.  FSOC lifted its classification of AIG as a Systemically Important Financial Institution in September, while the DOJ dropped its case appealing a decision to delist MetLife. Prudential is the only remaining insurance company considered systemically important by the federal government. Expect Workman to sail through a relatively easy nomination process. CFPB Staff get a Memo from Mulvaney  Last November, the Trump administration appointed Office of Management and Budget director Mick Mulvaney as interim head to the Consumer Finance Protection Bureau. This appointment, which is the only position the administration will get to fill at this agency, drew an immediate legal challenge from outgoing Obama-era administrators.  Mulvaney remains legal acting head of the CFPB. Trump has yet to name a permanent nominee for a five-year term.   On Tuesday, Mulvaney released a memo to clarify his deregulatory stance and announce a review of “everything we do” at the CFPB. While he assured employees that he does not intend to shutdown the Bureau, he harshly criticized what he sees as his predecessors’ willingness to “push the envelope” by disproportionately target offending companies. Mulvaney might not be planning to end the CFPB, but he has certainly made clear his intentions to scale back the Bureau’s regulatory ambitions. Goodfriend’s Single-Mandate Vision for Fed Marvin Goodfriend for Fed Governor is one of the most polarizing nominations of the Trump administration yet. At Wednesday’s Senate Banking hearing, Ranking Member Brown was quick to take issue with Goodfriend’s belief that the Fed should only focus on half of its statutory mandate: stabilizing inflation.  Mr. Goodfriend has a long history of inflation hysterics. Sen. Warren called him out on his off-the-mark prediction in 2011 that further Fed interest rate cuts would push inflation past the Fed’s two percent target, without lessening the then-nine percent unemployment rate.   In 2012, he similarly stated that inflation would skyrocket if the unemployment rate fell below seven percent. Today, the unemployment rate is consistently south of 4.5 percent with inflation remaining stubbornly under the Fed’s two percent target. Goodfriend seems unmoved by this reality, and would likely push for more aggressive interest rate hikes should he be confirmed.   FDIC still a Guardian vs. Risk? Jelena McWilliams (nominated to the FDIC Board) was a longtime Republican staffer on the Senate Banking Committee. She is currently the Executive Vice President and Chief Legal Officer of Cincinnati-based Fifth Third Bank. McWilliams would replace Martin Gruenberg, a critic of the Republican Wall Street bill, S.2155.  Her confirmation would give the FDIC three Republican Board members -- its statutory maximum -- along with Mick Mulvaney (CFPB Director) and Comptroller of the Currency Joseph Otting. The Trump administration has no intention to appoint Independent and Democratic members to the Board. McWilliams emphasized her priority to reverse the consolidation and closure of community banks, which she argues should be exempt from the Dodd-Frank Act rule on proprietary trading. This would loosen their capital requirements and streamlining anti-money laundering reporting. While Williams earned unabashed praise from Republican members of the panel, Sen. Brown objected to her view that excessive leverage at the nation’s largest bank did not trigger the financial crisis. Her prospects for confirmation as FDIC Chairperson are strong, as Republicans are solidly supportive. Familiar Faces at the CFTC Chris Giancarlo — Giancarlo has been serving as CFTC chair since before Trump took office. As a Republican, Giancarlo has criticised FSOC (of which he is now a full-time member) of inadequately weighing the cost of regulation and SIFI designation on the institutions under its watch. This is in line with Trump’s deregulatory tendency and goes a long way towards explain the recent delisting of companies such as AIG. Brian Quintenz — Quintenz was nominated by Barack Obama for this role, but the session ended before the Senate voted on his appointment. Trump briefly pulled the nomination before ultimately renominating the Republican investment manager and Hill staffer. Quintenz was confirmed Aug. 3. Rostin Behnam — Benham is a former senior counselor to Debbie Stabenow and worked for the Attorney General of New Jersey. Benham joined Stabenow’s office in 2011, but has been a  supporter of DFA since its inception. Behnam assumed office last Sept. 6. MIxed Signals at the SEC Jay Clayton: Clayton was confirmed as SEC chair in May and he has exhibited conventional conservative ideology ever since. Notably, he has pushed to encourage IPO’s by reducing regulatory oversight of companies looking to go public. Sen. Cortez-Masto vocally opposed his nomination in committee. Nevertheless, with Clayton’s confirmation passing committee on a 15-8 vote, and the floor on a 61-37 vote, Clayton’s confirmation was never much in doubt. Hester Peirce: Before nomination, Ms. Peirce was a senior fellow at the very conservative Mercatus Center at George Mason University. In that role, Peirce wrote numerous articles, op-eds, and books arguing that the regulatory response to the financial crisis was overblown and that allowing the market to “pare the big banks down” would’ve been more appropriate. When she was first nominated, she refused to commit to requiring public corporations to disclose political contributions. She was confirmed by the Senate last month. Robert Jackson: Mr. Jackson has an illustrious educational background with degrees from Harvard Law and Kennedy schools, Wharton, University of Pennsylvania, and Oxford. Jackson is a staunch liberal regulator in line with Sen. Elizabeth Warren in his preference for oversight of large financial institutions. Mr. Jackson was confirmed along Ms. Pierce in December. OCC -- The Foreclosure King Goes to Washington The Senate voted to confirm Joseph Otting as comptroller of the currency on November 16. The vote was 54-43, largely on party lines. Otting was the CEO of OneWest Bank, a lender co-founded by Treasury Secretary Steve Mnuchin. During the financial crisis he was labelled the “foreclosure king” for failing to effectively oversee thousands of loans to families who would eventually lose their homes. The nomination and subsequent confirmation sparked heavy criticisms from Senate Democrats.  Ex-Im Bank Avoids Garrett Senate Banking rejected the Trump administration’s nomination of Scott Garrett to head the Export-Import Bank, with Republican Sens. Mike Rounds (S.D.) and Tim Scott (S.C.) crossing party lines to vote with Democrats, 13-10. Garrett’s nomination had been subject to intense criticism from business groups, primarily because of his strong opposition to the agency during his time representing New Jersey in the House. Other than the failed nomination of Garrett, there have been five other nominations to fill out: Claudia Slacik, Spencer Bachus III, Kimberly A. Reed, Judith Delzoppo Pryor, and Mark L. Greenblatt. These nominations are far from contentious with some of these nominees even drawing bipartisan support. If successful, these nominees would fill out the Ex-Im bank board for the first time in years.

Feedback (anonymous or not): https://goo.gl/forms/7NoJ2CmPTzuSzzVZ2  Archive of past updates:  https://dc-policyupdate.com/

VIEWS | 370K. Ten Most-Viewed Posts in October

This blog has had 370,000 page views.

Thank you for reading.

The following posts are the ten most read on this blog in the last month.

Post

FSOC | Delisting AIG Oct 5, 2017

THE FED | Who Will Follow Yellen? Sep 20, 2017

HOSPITALS | Outlook Is Worrisome Oct 10, 2017

TAX REFORM | Hatching a Bipartisan Plan? Sep 14, 2017 2 comments

TAXES | Using the Budget to Reform Oct 5, 2017

TAX REFORM | Business Taxes Sep 19, 2017

UNIONS | Oct. 18–First American Trade Unions, 1648... Oct 18, 2013 10 comments

R.I.P. | Sep. 3–Andrew Kay, Kaypro-IBM (Comment) Sep 7, 2014

PORT AUTHORITY | Chris Ward Speaks Out Sep 12, 2008

MALONEY | Dem Electeds in Sag Harbor Jul 8, 2015

THE FED | Who Will Follow Yellen?

Janet Yellen, Fed Chair

The following is Update 206 (September 20, 2017) from Dana Chasin, reposted by permission:

Today's Fed Statement

Yellen today confirmed that the federal funds rate target range from 1-1.25 percent will remain unchanged once again, and that further reduction of the balance sheet will occur in October.

Under its asset sales plan, the Fed will be receiving monthly payments of up to $30 billion for its maturing Treasury securities, and $20 billion per month for its mortgage-backed securities, 12 months into the plan. A full transcript of Yellen's statement is here.

Yellen called this process of normalization necessary for the Fed, and timely. Inflation has been well below two percent this year. It is 1.6 percent now and is expected to rise to 1.9 percent next year. This increase should be accompanied by higher interest rates and a more stable economy.  It does not impel the Fed to accelerate its planned series of rate hikes.  

Labor Market

Labor market statistics of late offer reasons for optimism. Unemployment remains historically low and household incomes are rising. Additionally, labor force participation (employed/population) has clearly stabilized. Over the last three years, the range has been within 62.4 and 63.0 percent. The Obama years saw the labor market size stabilize, despite large and increasing numbers of Baby Boomers retiring. However, wages are barely moving.  

Yellen admitted that analysts were unsure how to explain the sluggish core inflation rate, but pointed out that temporary inflation dampeners might be source of some of the lag. She defended the Fed’s rate-hike plan, arguing that, with little remaining slack in the labor market and the typical wage-price inflation lag, inflation is likely to increase next year.

Macroeconomic Policy Chops:  Fed v. Congress

The GOP on the Hill has been unwilling for years to approve fiscal policy measures to combat the recession and stimulate the recovery. Recovery came to depend on the Fed to use its monetary policy authority creatively and aggressively – which it did to enormously beneficial effect. But when the economy was desperate for stimulus, the GOP leadership in Congress used debt brinksmanship to push through the rather contractionary 2011 Budget Control Act. 

As yesterday’s reports of deficit-negative budget bills in the Senate might suggest, Republicans' austerity fever may have broken now, or for now, with visions of major tax cuts in the offing. But gone is the day when the Fed will take guidance from Congress or the President or compensate for policies badly designed for current economic conditions. 

Succession Speculation

The President's views on monetary policy, the Fed, and his upcoming appointments to it will become much better known fairly soon. NEC Director Gary Cohn’s chance of being appointed Fed Chair after Yellen's term is up in four months has diminished. A new contender has emerged. Banker Kevin Warsh appears the most likely alternative to Yellen at present. Warsh was one of the youngest Federal Reserve Board Governors from 2006 to 2011. His views favoring broad  financial deregulation clash with those of the Yellen Fed majority. 

But Warsh has criticized low interest rates. The President, King of Debt, probably doesn't want it made too expensive. It is not beyond the pale that Janet Yellen may be reappointed Chair.  

The President praised Yellen earlier this year for being “a low interest rate person.” It stands to reason that President Trump would favor her slow and measured approach to raising interest rates. That's one reason it's hard to predict his stance. 

Fed Board – Trump Majority Forecast

With four central bank Governor vacancies out of seven seats to fill after Vice Chair Stanley Fischer’s announced retirement next month, Trump has the opportunity to shape monetary policy for years to come. A majority of Trump-appointed Federal Reserve Board is likely by early next year. Trump’s presumed preference is for accommodative policy. A howl from the bond vigilantes is likely if his nominees seem bent on economic growth. 

We will find out in short order. Trump’s first nominee cleared the Senate Banking Committee two weeks ago and is headed for a floor vote. We await the appointment of three more nominees, along with Trump’s determination on the Chair and Vice-Chair positions. However, curiously, Yellen did mention during the press conference that the Board could function with only three Governors – three incumbents, that is.

See also Chasin Update 205 (Business Taxes) and 204 (Income Taxes)

LEHMAN | Did It Have to Fail?

Paulson, Bernanke, Geithner.

James B. Stewart in The NY Times today reports on a new study of the dark days of Lehman Brothers in September 2008.

Could Lehman have been saved from bankruptcy? Should it have been? Would the world thereby have been saved from the Great Recession and its globally destabilizing consequences?

The study's author is Laurence M. Ball, Chairman of the Economics Department at Johns Hopkins University. He presented his 214-page paper, "The Fed and Lehman Brothers", which took him four years to write, to a conference of economists in Cambridge, Mass.

The study makes, as I read the story, two main points. Despite what Treasury and Fed officials (i.e., Henry M. "Hank" Paulson Jr., Treasury Secretary; Fed Chairman Ben S. Bernanke; and NY Fed President Timothy F. Geithner) have said,

• Lehman Brothers could have been saved. Bernanke told the Financial Crisis Inquiry Commission in 2010 that Lehman's collateral was weak and saving it would have required breaking the law. Ball argues that is not true, and that Lehman's financial condition was never properly analyzed. The whole point of the creation of the Federal Reserve in 1913 was to "lean against the wind" and when panic hits, its job is to save the system. The officials of the time underestimated the consequences of not saving the system and we live with these consequences today. 
• Paulson called the shots. Bernanke at the Fed followed the lead of Treasury Secretary Paulson, who took charge of the situation and was the prime mover in promoting the decision to let Lehman fail, because he didn't want to be known as "Mr. Bailout". Paulson says that the decision was that of the Fed to make.

Ball's paper was supported in its general conclusions by Prof. David Romer at Berkeley and another professor at M.I.T. Other academics interviewed by The NY Times withheld their judgment.

BLOG READS | 230K Views–Thank You–Most Read

Jan. 28, 2016–Today the CityEconomist blog site just passed 230,000 page views.

All blogs together have passed the 945,000 mark.

Thank you for reading. Here are the Top 10 posts for the past month. 

FIX THE MIX | Missing Glass-Steagall! Jan 21, 2016

MIAMI | Gun Problem? (Carl Hiaasen, March 1988)
Jan 10, 2016

COST OF 9/11 | Gulf War II–a Non Sequitur?
Jan 26, 2016

JOBS | U.S. Boom Amidst Global Gloom
Jan 8, 2016

OBIT | John E. Zuccotti (1937-2015)
Nov 28, 2015,

WW2 | SUPERLINK–Boissevains in the Dutch Resistanc...
Jan 26, 2015,

DEPRESSION | Cause–the Fed? Or Real-Estate Specula...
Feb 23, 2009,

ART BIZ | Did Van Gogh Sell Just One Painting? (Up...
Mar 16, 2015,

WW2 | 5. Armed Resistance: Jan Canada and Sons (Up...
Jan 29, 2015,

JOBS | NYC Tech Firms Top Growth List–"Inc. 5000"
Sep 1, 2014

FOMC | St. Louis Fed Chief Asks Hawks to Think Harder

James Bullard, President of the St.
Louis Fed, predisposed to raise rates
but wondering if this will actually
increase, not lower, inflation.

The President of the St. Louis Fed, James Bullard, is in line to join Jeffrey Lacker of the Richmond Fed in calling for an increase in the fed funds rate.

The St. Louis Fed has historically been the champion of the monetarist school, which keeps reminding Keynesians and New Keynesians who want to keep stimulating the economy that increasing the money supply will cause inflation.

At one time, zero-lower-bound interest rates were viewed as dangerously inflationary. The fact that inflation has remained low hasn't changed the tune of a hawk like Jeffrey Lacker of the Federal Reserve Bank of Richmond. Six years ago he predicted that the zero-lower-bound approach taken in 2008 would make inflation soar. Now he's been voting for a rate increase at the most recent meetings of the FOMC, warning that inflation will get out of control if the FOMC doesn't raise rates.

However, yesterday Bullard gave some support to the idea that the long period of low interest rates – the "Permazero" – might require a rethinking of monetary policy.  At a Cato conference he said that after seven years, expectations for permanently low interest rates might be baked into the cake.

Bullard says we should pay attention to the ideas of John Cochrane of Chicago's Booth School of Business, who suggests that raising the interest rate target off the zero-lower-bound floor may raise, not lower, inflation. The 94-page paper in which Cochrane lays out his theory and data poses the theory as a question – Do Higher Interest Rates Raise or Lower Inflation? 

Cochrane provides charts showing what happens to inflation under different assumptions. If you disagree with his story, I can hear him say, show me your model.

I note that Cochrane relies on the simple version of the Irving Fisher's equation, using an expected inflation rate added to "real" rate.

Most theories contain the Fisher relation that the nominal interest rate equals the real rate plus expected inflation, it = rt +Etπt+1, so they contain a steady state in which higher interest rates correspond to higher inflation. 

This is a simplification of the actual equation, which is multiplicative (rt * Etπt+1). The distinction doesn't doesn't matter for low levels of expected inflation (the "Fisher premium"), but it certainly does for higher ones – far as that may be from our recent inflation numbers.

Bullard does not take the step of opposing a rate increase based on Cochrane's theories. That would put him in the same boat as Paul Krugman, who opposes a rate increase on Keynesian grounds that we still need more demand and higher rates could choke off demand.

After seven years of Zero Interest Rate Policy, the FOMC is getting cabin fever. They are generals who look like they are avoiding a battle. Bullard made clear that his predisposition in December is to vote to raise rates. The FOMC may in December want to give the benefit of any doubt to a rise in rates.

Cochrane has therefore done everyone a favor by providing a reason for inflation hawks to think a little harder... because raising rates just might be inflationary.

FOMC | Committee Stands Pat

Jeffery Lacker, FRB Richmond
inflation hawk, voted again for
a rate increase, losing 9 to 1.

Today the Federal Open Market Committee voted to continue interest-rate policy at the zero-bound level, where it has been since 2008.

The sole vote against the decision was that of Jeffrey M. Lacker, President of the Federal Reserve Bank of Richmond, who would have preferred that the FOMC raise the target range for the federal funds rate by 25 basis points at this meeting. He had voted for a rate increase at the previous FOMC meeting.

The case for raising rates is that zero-bound interest policy makes it difficult for the Fed to encourage the economy should it take a turn for the worse, and unemployment rates are low by historical standards.

The majority view is that the FOMC has been charged since 1946 with steering between the twin dangers of inflation and unemployment. The inflation rate is below the Fed target of 2 percent and economic growth has been moderate by historical standards.

Meanwhile, the news from the Bureau of Labor Statistics this morning was that the September improvement in jobs was broadly based among metro areas.

The next meeting of the FOMC is in mid-December. The meeting will be informed by two more months' worth of new data on labor markets and other economic indicators.

BANKS | Comptroller Curry Is Scary

Thomas J. Curry, Comptroller of the
Currency

Thomas J. Curry, Comptroller of the Currency, gave mild speeches on March 2 and April 2 focused on risks from terrorist attacks on cybersecurity, a threat to bank operations. Worrisome, but with an enemy on some distant shore and technical fixes waiting in the wings.

Yesterday at the Exchequer Club in Washington, it was different. He allowed himself to step out and make a few spicier comments. He acknowledges that at this stage of the credit cycle, credit quality is and can be expected to deteriorate, and "credit risks are coming to the forefront," ahead of threats from jihadist hackers.

Curry doesn't go much further than that in his remarks. But he plants the seeds of worry. Wall Street on Parade spells out what Curry might have said. Reforms have failed and we may see in this credit cycle a repeat of what led up to the disaster of 2008. One solution is more unified oversight of the financial sector at the Federal level, i.e., encompassing the securities industry.

When I was working for the Federal Reserve and FDIC in the 1960s, the Bureau of the Budget was looking at unifying financial regulation just as a matter of efficiency as well as effectiveness. But if you are an institution being regulated, the last thing you want is efficiency and effectiveness. You want the maximum number of regulators, so you can shop among them.

And if you are the regulator, you don't want your agency eliminated. We can't expect the Comptroller of the Currency, speaking for a 150-year-old office that has had to fight to remain independent from the Federal Reserve System, to advocate for consolidation of Federal oversight agencies.

The issues are surfacing now because of the good work of Pam and Russ Martens of Wall Street on Parade, who are keeping up a steady Pecora-like stream of revelations of what Senator Wright Patman used to call malfeasance, misfeasance and nonfeasance. The candidacy of Bernie Sanders has kept the Glass-Steagall issue in the public eye during the first Democratic debate.

Here is a snippet from today's post from the Martenses outlining the problem:

What Curry didn’t mention are the real elephants in the room – the casino room on Wall Street: the $180.29 trillion of derivatives held at the insured banking units of just four banks: JPMorgan Chase, Bank of America, Citibank (part of Citigroup) and Goldman Sachs. Just those four banks hold 91.1 percent of all derivatives held at the thousands of banks in the U.S. If that’s not concentrated risk, we don’t know what is. Curry also didn’t mention the frightening reality that some of the biggest banks are up to their old dirty tricks of dodging capital requirements through trades with dubious counterparties.
In June, the U.S. Treasury’s Office of Financial Research (OFR) released a report that set off alarm bells. The report, written by Jill Cetina, John McDonough, and Sriram Rajan, revealed that the big Wall Street banks are ginning up their capital measures by engaging in non-transparent “capital relief trades.”
The report indicated that JPMorgan’s London Whale trades, exposed in 2012 and the subject of multiple Congressional hearings and an in-depth report by the Senate’s Permanent Subcommittee on Investigations, was, in fact, a capital relief trade. JPMorgan Chase has owned up to losing at least $6.2 billion of bank depositors’ money on those trades.

Back in 1933, the Pecora Committee - a Senate Committee that was, unusually, named after the aggressive staff counsel, a New Yorker named Ferdinand Pecora - held hearings that led to the Glass-Steagall Act of 1933 and the Securities and Exchange Act of 1933 (while, alas, also skewering a few people who should not have been so impaled).

The Glass-Steagall Act was well-conceived and lasted 70 years. Banks traded deposit insurance for ring-fencing around the commercial banks to keep out the investment bankers. The flaw in the Act was there from the beginning, namely that the securities business was regulated separately and inadequately. The financial lobby has exploited that loophole in stages, notably in 1999 and 2002. The Economist Magazine in 1999 wisely opined that if the Congress was going to take away some Glass-Steagall controls, they would have to extend controls on the securities business; the reverse happened.

A predecessor of Curry as Comptroller of the Currency, John D. Hawke, Jr., in a speech to the NY State Bankers Association in 2000 said:

Regulatory competition has stimulated innovation and efficiency. Competition keeps all of us on our toes, and provides incentives to add real value to our supervision. While the system unquestionably provides opportunities for regulatory arbitrage, there is little evidence that it has stimulated the competition in laxity that former Federal Reserve Chairman Arthur Burns discussed 30 years ago.

Competition in laxity is exactly the term I would choose to describe what happened to the mortgage sector during the next seven years. New York State has now recognized that financial services has  become one industry, and has consolidated banking and securities oversight into one regulatory oversight body that talks openly about financial risk and the risk-taking enemies closer to home. It's time we consolidate financial regulation in Washington.

THE FED | Moral Hazard

Paul Volcker

Wall Street on Parade in recent years has been playing the role that the Pecora Committee played in 1933.

Ferdinand Pecora was hired as general counsel to the Senate Banking Committee to investigate the causes of the 1929 Crash. His hearings in 1933 revealed many practices that tilted the financial marketplace against small investors. He laid the groundwork of public opinion to ensure passage of the Securities Acts of 1933 and 1934.

In the process, the testimony that Pecora extracted injured the reputations of many Wall Street leaders and their friends. Some practices were illegal. Others were attacked with the benefit of hindsight, in the new light of the Crash of 1929. What seemed normal in 1929 had become unethical or unfair... and with the new laws would become illegal.

Today's installment of Wall Street on Parade by Pam Martens and Russ Martens looks at the Latin American financial crisis of the early 1980s and cites from the transcript of the FOMC meeting of June 30, 1982 to examine why the Fed approved a loan to Mexico of $700 million. Mexico owed U.S. banks $21.5 billion. The Fed bailed out Mexico to bail out the banks that had loaned money to Mexico.

In an interview published in the fall of 2013, Harvard Professor Martin Feldstein asked former Fed Chairman Paul Volcker whether the high interest rates of the early 1980s caused debt problems in emerging economies. Volcker responded that U.S. bank loans were of great concern to his predecessor as Fed Chairman in the 1970s:

Arthur Burns, to his credit, was the Paul Revere on this thing. He'd go around and make speeches: "This can't continue. ... We've got to do something about it." The borrowing continued until the winter [1981-82] when a couple of banks stopped lending. Mexico ran out of money. What do you do? [my emphasis]... The big US banks and some of the big foreign banks had more exposure to Latin America than they had capital. It wasn't something you could just say: "Okay, knock off the loans by 50 percent or something and everybody will be happy." They all would have been bust. You look for other approaches, and it took nearly a decade until Mr. Brady [Nicholas Brady, Treasury Secretary, 1988-1993] came along and settled them [Brady bonds replaced Latin American debt, paying lower rates or reducing the face value, but with greater certainty of repayment].  (Martin Feldstein, "An Interview with Paul Volcker, Journal of Economic Perspectives, 27:4, Fall 2013, pp. 112-113.)

Wall Street on Parade argues that the too-big-to-fail attitude, on view in 1982, was behind the Fed and Treasury response to the financial crisis of 2007-2009.

These issues go back to the earliest years of the Fed. Founded in 1913, the Fed published a statement of its policy intentions in 1924, in its Tenth Annual Report in 1924. It announced that it would seek to encourage "productive" loans and discourage "speculative" ones. As loans to purchase securities rose the following year, the Fed tightened money. Benjamin Strong in 1927 complained about the tightening. Concerns about productive lending were shelved that year in favor of expansionary monetary policy - the Fed purchased government securities to add to liquidity.

When the Fed tightened again in 1928, it created the disastrous crisis of 1929-30, and the expansion of 1927 was viewed as the root cause. When banks started to fail, the Fed often refused to lend to them. Not until April 1932 did it expand the money supply, and this ended by August. Julio Rotemberg, "Shifts in US Federal Reserve Goals and Tactics for Monetary Policy: A Role for Penitence?", Journal of Economic Perspectives, 27:4, Fall 2013, 67-69.

Thus a "too-big-to-fail" attitude emerged from the panics caused by a tough line on the banks in 1929-32, which was motivated by a reaction to the expansion of 1927. The "too-big-to-fail" idea creates moral hazard, as Wall Street on Parade notes. As long as that is not addressed, speculative lending will grow and the global financial structure remains shaky.

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JOBS | On Good News, Fears of Sooner Rate Hike

The 295,000 payroll-jobs increase is well above expectations for jobs. Job numbers for January were revised down by 18,000, lowering the base, but even so, the increase suggests a breakout for the economy. This increases concern about the impact of the Fed moving earlier to higher interest rates. Some Fed officials think the February 5.5 percent unemployment rate is full employment.

Sectors showing strong job growth include:

• Eating (food services) and drinking places - reflecting the American appetite for better food and ability to pay for it. This sector accounts for one-fifth of the job growth,
• Professional and business services accounting for one-fifth of the growth. This sector has added 660,000 jobs during the past year. Key growth areas are management and technical consulting services, computer systems design and related services, and architectural and engineering services.
• Construction, adding 29,000 jobs in February, despite worse-than-normal weather in parts of the country. (The BLS in a note says that unusually bad weather affects earnings more than employment.) Employment in specialty trade contractors rose by 27,000, mostly in the residential component.
• Health care services, continuing to rise by 24,000 jobs, with gains mostly in ambulatory care services, with fewer gains in hospital jobs. The increase is lower than the average over the past 12 months. This number is an indicator of the net impact of Obamacare.

Earnings growth was slow. (The recent announcement of raises for workers at Wal-Mart and other large employers has yet to show up as significant changes in earnings data.) The full BLS report is here.

Comment 

Table A-6 shows the labor force participation rate rising year-over-year in February for men (to 81.8 percent from 81.4 percent for adult men without a disability) and declining for women (to 69.9 percent from 70.5 percent for adult women without a disability). It also rose for disabled people of both genders, to 19.8 percent from 19.1 percent.

The overall good news is that the U.S. economy is continuing its momentum. This is a relief for the rest of the world, which depends heavily on the U.S. recovery.

The downside is that the Fed will be poised to raise interest rates - from its existing near-zero level - sooner rather than later (June rather than September). In the zero-bound range the Fed has little room for positively affecting the economy - its foot is all the way down on the pedal. Letting the pedal up gives it room later to be helpful in a downturn.

FOMC | More Choices–Rip van Winkle Awakes

Oct. 29, 2014–What's the FOMC going to do today? A quick sampling of forecasts is that it will move away from QE3, its makeshift easy-money policy during the period of zero-bound interest rates.

I've been following the Fed since I worked there and at the FDIC five decades ago as a financial economist.

The latest week's Initial Unemployment Claims, which FRED (the wonderful database of the St. Louis Fed–thank you, James Bullard) graphs for us, has fallen to 283,000.

That's about to where it was briefly in 2000 before the dot-com bubble burst. Not since the early 1970s have initial claims been lower. This suggests inflation should be waiting to ambush us.

It's certainly taken a long time to get to this point. In January 2009, former Fed Governor and inflation hawk Laurence Meyer of Macroeconomic Advisers told a packed luncheon group sponsored by the New York Association for Business Economics that recovery was "at least 18 months away". He wasn't kidding.

Now, nearly six years later, we seem there. Unemployment is below the 6 percent threshold where the Fed historically (using the NAIRU) has started to worry about inflation.

However, wages have not kept pace, which shows slack in the labor market. And, as Paul Krugman reminds us, there are still no signs of overall inflation. (See graph - the Personal Consumption Expenditures chart shows the same pattern.)

So the Fed doves - Chair Janet Yellen, Gov. Daniel Tarullo, and Fed Bank Presidents William Dudley (NY), Charles Evans (Chicago) and Eric Rosengren (Boston) don't want to raise interest rates yet.

They point to the big mistake of FDR's economic policymaking in 1937, when interest rates were raised too soon. Wall Street has an adage: "When the Fed starts to crunch, it's time to go to lunch."

Fed hawks, however - Bank Presidents Richard Fisher (Dallas), Jeffrey Lacker (Richmond) and Charles Plosser (Philadelphia) - are concerned to stay ahead of the curve. They have their eyes on the 1970s when it seemed the Fed had lost control over prices because of the oil crisis... although former Fed Chair Paul Volcker proved in the early 1980s that if you closed your eyes to the temporary pain, the Fed can always dampen inflationary expectations.

At least in the coming months the FOMC will start getting back to the job it is familiar with, controlling T-bill interest rates through open market operations. A zero-bound interest context doesn't leave much latitude for policy options. Larry Meyer in 2009 even suggested, tongue in cheek, that  the FOMC take a long vacation. If they had followed his advice, they would just now be getting back to work. Like Washington Irving's Rip van Winkle, they may find it hard to settle back in to their traditional role after all these years.

BANKS | Fed Showed Risk-Blindness

On March 22, 2008, I expressed concern about the cumulative impact of financial deregulation:

http://cityeconomist.blogspot.com/2008/03/us-financial-regulation-2008.html

The post, which was widely read and a version of which also appeared on Huffington Post, refers back to the 1999 Financial Modernization Act, in which the US Congress took another step toward deregulation of the banks, removing more bricks from the wall between government-insured banks and the non-bank institutions.

I said the Economist magazine was correct in 1999 when it said that the implication of weakening the Glass-Steagall wall should be to extend the net covered by U.S. financial regulation.

The implication of a story in today's New York Times by Gretchen Morgenstern is that my thinking in March 2008 was on target. Financial regulators in New York and Washington at that time were dissing the "pessimists" who were concerned that banks were under-capitalized. The pessimists were worrying about the risky behavior of the unregulated sector of the economy and the porous nature of what was left of Sen. Carter Glass's wall in the Banking ("Glass-Steagall") Act of 1933.

(Rep. Steagall's part of Glass-Steagall is of course still with us–i.e., the FDIC. But the original idea was that government insurance of bank deposits was a trade for stronger regulation and a wall between banks and other, unregulated financial actors. Deposit insurance coverage has expanded in many ways but the regulation has evaporated.)

Here is Morgenstern's story, based on reviewing 2,000 pages of transcripts just released by the Fed.

http://www.nytimes.com/2014/02/23/business/a-new-light-on-regulators-in-the-dark.html?ref=fairgame

Comment on CityEconomist Readership: The CityEconomist blog just passed 70,000 pageviews. The previous marker was 60,000 in October 2013, so that's 10,000 pageviews in four months, or 2,500 per month, roughly 100 per day. The blog was started in the first half of 2007. I did not post during a two-year break while I was working in Washington for the Joint Economic Committee, but the blog was open and the pageviews kept coming, so it is fair to pin the average pageviews per year at about 10,000. So the recent rate of viewership is three times the average over the life of the blog. Thank you for reading.

YELLEN | Perfect Choice for Fed

Janet Yellen, President Obama's

nominee for Fed Chair

The appointment of Janet Yellen is perfect because she is pragmatic, eyes on the data, and concerned about unemployment as well as inflation. She is not one of those central bankers who consider the unemployment problem to be a secondary concern.

Also, because she is a woman, we won't be hearing so many complaints about "100 years of patriarchy at the Fed".

While the Phillips Curve has given way in academic circles to the concept of a non-accelerating-inflation rate of unemployment (the NAIRU), the two desirables of low inflation and low unemployment remain the twin objectives of the Fed, with low inflation being the traditional central bank goal and a low-unemployment goal having been added by the Employment Act of 1946.

Inflation appears to be under control, so the "doves" on the Federal Open Market Committee believe that it is not yet time to "taper" the Quantitative Easing program that has been designed to encourage economic growth. The idea is to keep long-term interest rates low by providing a ready secondary market for long-term Treasuries, thereby lowering yields on all long-term instruments and providing inexpensive capital for job-creation.

In a fine interview a few hours ago on Charlie Rose, Professor Yellen emphasized that the Federal Reserve is working on behalf of all Americans. The implication of that is that containing inflation satisfies the concerns of those who hold debt, i.e., wealthier Americans. Unemployment, however, is more prevalent among poorer people and it creates poverty.

That, in a word, is why the doves tend to be liberal Democrats and the "inflation hawks" tend to be more banker-oriented. Yellen is close to Bernanke on this spectrum, but more dovish than Bernanke has appeared to be recently in his effort to preserve consensus.

The target rate for interest rates continues to be near the zero bound because inflation is coming in below the 2 percent target that Chairman Bernanke announced at the beginning of 2012. Right now 6.5 percent still appears to be the target unemployment rate, and we are not there yet, although we lack the September number because of the government shutdown. By the standards of the targets, based on the data, Janet Yellen is in the right place on the dove-hawk perch.

A few critics from the left note that she did not oppose the 1999 takedown of the Glass-Steagall Act, but then neither did Senator Schumer and other key Democrats. No one fully foresaw how things would play out through 2008. It was the London Economist that in 1999 observed correctly that if the investment banking (and other non-bank financial) foxes were allowed to mingle with the banks, the investment banks – or preferably the entire financial system including the investment banks – should be regulated. For more on this period, see this post from 2008.

Krugman vs. Taylor on the Zero-Bound Fed

Here's how I see the Great Debate about monetary policy, with John Taylor opening with an op-ed in the Wall Street Journal (http://on.wsj.com/VY0Iet) on the Fed being a drag on the economy through its continued zero-interest rate FOMC directive and Paul Krugman lambasting him via his NY Times perch for arguing that the low interest rates are inhibiting lending. (http://nyti.ms/VwkXU7):

Taylor is a "hard money" man (consistent with the dour mien of John Calvin, although Krugman says he has Calvin of Calvin & Hobbes in mind), unhappy at low interest rates that don't sufficiently reward prudent savers/debt-holders, so that banks withhold loans. Krugman has maintained consistently that the economy has not been stimulated enough on the fiscal side after the meltdown in 2008 and therefore staying at the zero-interest-rate bound at the short end of the market is a consequence; he is a continued-easy-money man.

Krugman's answer to Taylor's argument is that his theoretical framework is one of a ceiling, which is inappropriate. In fact the FOMC directs open market operations (buying short-term Treasury bills to put cash into the economy), and the equivalent in the longer end of the bond market, Quantitative Easing (buying longer-term Treasurys to bring down longer-term rates) also operates in the open market for debt.

The Fed does not regulate interest rates. It just buys and sells Treasurys.

For those who don't have time to pore through this exchange and its 60+ comments, I excerpt three comments that were posted around 9 am this morning to exemplify the struggle that the commentators have to be fair and to try to figure out who is right.

Justin - Brooklyn, NY: Can anyone kindly explain what this sentence is purporting to say? (I know that Krugman is refuting it, but this went over my head.): "low rates engineered by the Fed are just like a price ceiling that reduces the supply of loans, and therefore reduces overall lending."

AndyfromTucson - Tucson AZ: The reasoning is that the interest rate is the price paid for borrowing money, and so if the government caps the price at an artificially low level then it will reduce the supply of loans. Like if the government put a $5000 cap on the price of new automobiles all the car manufacturers would cut production. What Krugman is saying is that interest rates are not a legal cap, so this analysis doesn't work. Jan. 30, 2013 at 9:41 a.m.
save10percent - Denver, CO: My understanding of it is that as the price goes down (talking about the cost of taking out a loan, which is the interest paid), the quantity demanded goes up, but the quantity supplied goes down (econ 101). Taylor is saying that the fed sets the price ceiling too low and therefore banks aren't lending (less supply). Krugman says that the fed does not set a price ceiling for the interest on loans that banks make, so Taylor's argument doesn't make sense.

I have no doubt that Taylor will be back with an involved explanation why he was misunderstood. Meanwhile the winner of the debate pro tem is Paul Krugman and as one commentator observes, we can be glad that Gov. Mitt Romney did not win the presidential election, because if he had, Prof. Taylor was in line to become his Treasury Secretary.

Creating U.S. Jobs - Six Avenues

What are the real choices before Washington this fall?

The number one issue before the nation is economic recovery. Unemployment rates have been too high for too long. Here are a few ideas about what we can expect and hope for during the next few months:

1. Don't Depend on an Out-of-Ammo Fed. Federal Reserve Chairman Bernanke wants to appear to be doing everything he can. However, there is little more the Fed/FOMC can do to help the economy since December 16, 2008 when the Federal Funds rate was lowered to the Zero Bound. Quantitative Easing hasn't made much difference. How much can the Fed spend buying long-term Treasury bonds to lower long-term interest rates, even if it sells short-term Treasurys at the same time? How much difference does it make for the Fed to buy up long-term bonds if the Treasury is selling new ones at the next window?

2.  Implement Dodd-Frank to Help Address the Liquidity Trap. The economy would turn around if the Fed's easy-money policies led to more bank lending. But bankers are still worried about their balance sheets. Lax oversight by bank regulators has been replaced by close questioning. Bad loans are still not all recognized and new categories of potentially bad loans have opened up, e.g., the sovereign debt of the PIIGS countries, whose debts are freezing bank liquidity despite  of banks EU rescue programs. Speeding up implementation of Dodd-Frank financial reforms would improve confidence in and among U.S. banks.

3. Pass the President's Second Jobs Program. Another $450 billion for job creation may not be sufficient. However, it is necessary and a CNN poll and others show, by wide margin, that the U.S. public wants this program implemented.

4. Encourage Entrepreneurship. Creating jobs is not just about getting existing firms to hire more workers. It's about encouraging people to start up new businesses. Incubators help. Entrepreneurship can be taught - it's like a language. Governments at all levels can do big and small things to make it easier for people to create businesses.

5. Modify Fuel Prices to Encourage Green Jobs. Federal subsidies of alternative energy and energy efficiency didn't work as well as hoped because prices for fossil fuels don't reflect their full costs (and also because many states and localities did not have staff ready in 2009 to respond to stimulus programs offering money for green jobs). Subsidies for fossil fuels need to be ended and a tax on gasoline or carbon should be imposed. Tom Friedman had a good op-ed on this topic today ("Is It Weird Enough Yet?"). The last Congress rejected cap-and-trade and a carbon tax, but the pressure to find money to pay for Medicare and Social Security, as well as more evidence on global warming, might bring these proposals back to debate and action.

6. Most of All, Reform the Tax Code to Encourage Job Creation. If U.S. payroll tax rates are lowered significantly, as President Obama has suggested, this will have a dual benefit, encouraging employers to hire and putting money in the hands of middle-class consumers, who will spend it. This could be paid for by raising the top tax for those earning, say, $500,000 or more, and gradually raising the cap on the payroll tax (as Sen. Bernie Sanders, I-VT, has proposed). This would return the income tax to a semblance of progressivity and would tax those best able to bear the burden and least likely to spend new money.

George Magnus in the Financial Times describes the world's predicament as a "once-in-a-generation crisis of capitalism", bequeathed by the excesses of the 1980s-2008 period. The stakes couldn't be higher.

Regulating Banks and Non-Banks: One Year Later

A year ago today I wrote about financial regulation . As the G20 meeting on April 2 approaches, the topic is more relevant than ever.

I argued last year that when the Glass-Steagall wall between banking and non-bank financial institutions was torn down in 1999, the law should have extended U.S. regulatory authority beyond banking to all the other institutions.

My views were shaped by research I did at the FDIC. I developed a state credit-quality indicator, based on bank examiners' classification of loan quality at insured banks. The indicator deducted 20 percent of the loan value classified as substandard, 50 percent of loans classified as doubtful, and 100 percent of loans classified as loss. The results were included in an article I wrote with Professor George Benston published in the Journal of Money, Credit and Banking, "Bank Examiners' Evaluation of Credit".

Whatever use a state credit-quality indicator might have had as an early warning system (e.g., of mortgage-quality problems in Arizona, California, Florida and Nevada) disappeared when mortgage loans were wrapped up into securitized packages that were beyond easy classification by bank examiners and were camouflaged by AAA ratings by rating agencies and insurance companies.

The Chairman of the UK Financial Service Authority (FSA), Lord Turner, on March 18 has highlighted for the G20 socially undesirable financial innovation as a key source of the global crisis. He recommends regulation of near-bank activities such as hedge funds and credit-rating agencies, with a Europe-wide financial body to set standards and supervise. The UK seems to have joined the hawkish German and French authorities.

While the United States has been considered a dove on financial regulatory issues, the Obama administration may surprise the G20. Stephen Labaton in the NY Times on Saturday says a plan is being prepared that would

regulate the shadow banking system, with heightened standards put in place after the economy began to rebound. A broad consensus has emerged that hedge funds must be registered and more closely monitored, probably by the Securities and Exchange Commission.

The U.S. plan will probably give the government greater authority over large troubled companies not now regulated by Washington. The Treasury secretary would have authority to seize a struggling institution after consulting with the president and upon the recommendation of two-thirds of the Federal Reserve board. The government now can seize only the banking unit that controls federally insured deposits of large troubled institutions.

The Great Recession

In his NY Times column today, "Bad News, and More Bad News," Clark Hoyt responds to mail that complains of the NY Times writing too much about bad news. He says: "A newspaper's responsibility is not to be an economic cheerleader, but to maintain a level head and help put the world in perspective for readers.

The theme of Mr. Hoyt's column can't be repeated too often, but I have a problem with the sentence that the Public Editor attributes to Times business columnist David Leonhardt:

"[A]s bad as things are, they are still not as bad as the recession of 1982, let alone the Great Depression."

Does Mr. Leonhardt still say that? If so, I would respond that his comparison between today and 1982, which he based on job-market data, is a case of apples and oranges. The reason for the recession that produced high unemployment in 1982 was Fed Chairman Paul Volcker's brave determination to break the back of inflation. In the process he allowed interest rates to soar.

The 1980-82 recession was painful, but recovery was entirely within the control of the Fed, which simply had to ease credit.

Continuing credit problems today are not the deliberate creation of the Fed, which has--on the contrary--eased the target fed funds interest rate down to the "zero bound". To say that 1982 was worse is like someone suffering an angina attack saying that his heart was worse off right after his triple-bypass operation. Not so, because the surgeons then had the situation under control.

A consensus is growing that this recession is the worst downturn since the Great Depression. It's global. it looks only at U.S. data and misses the full extent of the devastation from the credit freeze. The IMF’s Dominique Strauss-Kahn, said on March 10: "I think that we can now say that we've entered a Great Recession."

Prior uses of the term "Great Recession" (which was applied to earlier recessions) have been collected by Catherine Rampell of the NY Times using Nexis and were quoted by World Wide Words. WWW does not mention the prominent March 1 NY Times Op-Ed by economic historian Niall Ferguson.

On December 5, 2008 the U.S. Federal News Service reported: "Some economists are already calling this 'the Great Recession' because they fear it may be longer and deeper than any recession in recent history." As early as April 2008, Former Wall Street Journal writer Jesse Eisinger predicted in Portfolio that: "The next president will take office during what may well come to be known as the Great Recession."

One year ago, in March 2008, I contributed three posts for HuffPost about the Bankers' Panic of 2008. I was focused on regulatory shortcomings and what could be done about them, rather than the likely economic consequences.

A March 10, 2009 poll reports that 53 percent of respondents say the United States is at least somewhat likely to enter a 1930’s-like Depression within the next few years. The Rasmussen Reports national telephone survey found that 39 percent think this outcome is unlikely. The latest results are more pessimistic than those found in early January, when 44 percent said a 1930’s-like Depression was likely. It will be a big challenge to restore positive “animal spirits”. But the poll may be a sign of “blood is in the streets” –- Main Street as well as Wall Street.

FINANCIAL CRISIS | Missing Minsky

Dec. 27, 2008–Martin Wolf, at FT.com, wrote on December 24 that Keynes offers us the best way to think about the financial crisis:

We are all Keynesians now. When Barack Obama takes office he will propose a gigantic fiscal stimulus package. Such packages are being offered by many other governments. Even Germany is being dragged, kicking and screaming, into this race. The ghost of John Maynard Keynes, the father of macroeconomics, has returned [and] that of his most interesting disciple, Hyman Minsky.

Hyman Minsky

I first heard Hy Minsky talk in the 1960s. His main message was:

1. Financial systems have a built-in tendency to euphoria. The financial market does not tend toward stability. The opposite is true. Bankers and other financial actors borrow more and more heavily, making the system increasingly vulnerable to panic. Lenders start after a scare by being conservative, hedging their bets. But eventually confidence returns and speculation takes hold again. Then investors get to the Ponzi phase – manic use of credit, a euphoria or bubble.

2. The credit cycle tends to manic, but ends with panic. The Ponzi phase continues until some investors exit with their profits, or the central bank raises interest rates to reduce investor euphoria, and then a financial institution runs into difficulty. The failure causes a bankers' panic. Turning points in the five stages of the cycle are called “Minsky moments”.

3. The system tends to instability and must be regulated. Fashions in monetary theory have moved from a belief that Keynesian sophisticates could “fine-tune” the economy, to fear that the Fed had lost control of the ability to contain inflation, to a belief that markets work best with minimal interference. Hy rejected all these ideas, preaching consistently about the need for regulation and the importance of leaning against the excesses of what Keynes called the animal spirits of investors.

Born in Chicago, Hy taught at Brown, Berkeley and Washington University (St. Louis). He died 12 years ago in Rhinebeck, 77 years old, near Bard College’s Levy Institute, which has a special interest in business cycles and treated Hy as a star in his last six years. Hy didn’t live to see how closely this year’s meltdowns would follow his predicted scenario, with the Lehman failure being one of several clear Minsky moments.

Former Fed Governor Laurence Meyer, who spoke in New York City last week, has said of Minsky: “few have influenced my thinking about economics more than Hy.” If Hy had been listened to, we would have seen less permissiveness, fewer NINJA (No Income, No Job nor Assets) mortgage loans and more aggressive Federal Reserve and SEC oversight over highly leveraged instruments and institutions.

Fed Chairman Alan Greenspan and then-Governor Ben Bernanke were anxious not to “pop the bubble” because (citing the Milton Friedman-Anna Schwartz history) that’s the mistake the Fed made in 1928 - after the guy who knew what he was doing, FRBNY chief Benjamin Strong, died of TB. The Fed was concerned not to stifle financial innovation, arguing that it is ready with new weapons in the event of an asset-destroying credit freeze.

This last theory is now being tested. The stakes are high, beyond an academic debate. Whatever side one takes, any sensible person should be rooting for the outgoing and incoming Fed-Treasury teams to succeed in restoring confidence and the flow of credit.

Not My Dad's Fed

I went to work for the Fed in 1964, when William McChesney Martin, Jr. was Chairman. He would be surprised at the activism of today's Fed as it drops the equivalent of napalm on the dangerously frozen peaks of our financial landscape. Back then I was a financial economist in the Division of International Finance headed by Ralph Young, editor of the third edition of The Federal Reserve System: Purposes and Functions, 1954. (The first edition was drafted by the great Bray Hammond in 1939.)

The marble building at 21st and C Streets hasn't changed much since 1964. But three things definitely have - the link to gold, the size of Fed assets and the reach of the Fed into financial markets.

1. Link to gold broken. Back in 1964, the Treasury bought gold at a fixed price of $35 an ounce from private owners of gold, forbidden 30 years earlier from holding gold for speculative purposes. Purposes and Functions, 3rd edition says (97-99):

Gold is the ultimate basis of Federal Reserve credit and gold movements are an important factor in member bank use of Federal Reserve credit. The power of the Reserve Banks to create money is limited by the requirement of a 25 percent reserve in gold certificates against the total of deposits and issued Federal Reserve notes. All gold that enters the monetary mechanism becomes reserve money of the Federal Reserve Banks in the form of gold certificates. In practice most of their reserves are represented by a credit in a gold certificate account on the books of the Treasury.

The last connection between gold held by the Treasury and Federal Reserve Bank deposits was ended by President Nixon in 1971, under the pressure of the OPEC-led oil shortages. This also ended the gold standard and removed the cornerstone of the Bretton Woods system.

2. Increase in Federal Reserve assets. Fed assets from 1920 through 1953 are shown in Purposes and Functions, 3rd edition. They rose from $6 billion to $53 billion in 33 years.

Combined Assets, Federal Reserve Banks ($bil.), Year-End

Asset Category	1920	1930	1940	1953
Gold certificate reserves	2.06	2.94	19.69	21.34
U.S. Govt. securities	0.29	0.73	2.18	25.89
Discount loans to member banks	2.69	0.25	0.00	0.42
Subtotal	5.04	3.92	21.87	47.65
Other assets	1.21	1.28	1.28	5.18
Total	6.25	5.20	23.15	52.83

Source: CityEconomist based on data from The Federal Reserve System: Purposes and Functions, 3rd ed., 187.

Fast forward to November 2008. Fed assets were growly slowly toward the $1 trillion mark until the freeze hit and Fed assets (Reserve Bank credit) more than doubled from a year earlier, to $2.17 trillion as of December 3. The President of the Dallas Federal Reserve Bank opined in early November that Fed assets will reach $3 trillion by the end of 2008.

3. Market Operations

A "bills only" policy was abandoned in 1961, but a "bills preferably" goal still made sense because open market operations to pursue monetary policy are easiest to manage in the most liquid part of the market, the short end. In recent weeks, however, the Fed's efforts to defrost bank vaults have driven the return on Treasury bills to zero and the Fed has no choice but to operate at longer maturities.


Former Fed Governor Laurence Meyer is speaking to the New York Association for Business Economics on December 17. The title of his talk is: "Monetary Policy: Whatever It Takes." That says it all.