Center for Economic Policy Research
The Federal Reserve Board (or “Fed”) bears substantial responsibility for the current crisis. It allowed an $8 trillion housing bubble to expand unchecked even though the collapse of this bubble inevitably would lead to a serious recession.
Designed-in Conflicts of Interest
By design, the Federal Reserve is largely under the control of the financial industry. The presidents of the twelve regional Federal Reserve Banks are chosen through a process that is dominated by the banks. Under the current system, each regional bank has nine directors. Three of the directors are chosen directly by the member banks within the district. Three directors, who are supposed to represent the larger community, are selected by the first three directors. The final three directors, who are also supposed to represent the larger community, are appointed by the Board of Governors. The nine directors select the regional bank president who is the chief executive officer for the bank.
All of these bank presidents sit on the Open Market Committee that determines monetary policy, with the seven members of the Board of Governors appointed by the president. Five of these governors actually vote on monetary policy (four spots rotate among the banks, with the president of the New York Federal Reserve Bank being a permanent voting member).
In addition to their large role in determining monetary policy, the district banks also have substantial regulatory powers, especially the New York bank. In effect, the current structure of the Fed is a system in which the banks largely decide who regulate them.
There is no reason why the banks should have a special role in determining the country’s monetary policy, nor why they should pick their own regulators. Insofar as the Fed has policy responsibilities (it also engages in check-clearing operations and provides other bank services), all of its key officials should be appointed by the president and directly answerable to the Congress, not the banks.
If Fed officials were accountable to Congress then monetary policy might be designed to address the concerns of ordinary workers instead of banks. This would mean more emphasis on maintaining high levels of employment and less concern about modest rates of inflation.
The Fed also has largely ignored its responsibility to oversee the Community Reinvestment Act and other laws that ensure equal access to credit. To the extent it retains jurisdiction in these areas, it would benefit from oversight by consumers.
The Fed’s proceedings are excessively non-transparent. As it stands now, the Fed provides summary minutes of the meetings of the Open Market Committee, with a six-week lag. Full transcripts are made available after five years. There is no reason that these lags cannot be reduced. In principle, the meetings could be televised live so that the public could immediately understand the factors underlying the Fed’s decisions on monetary policy.
This type of transparency could have helped stem the growth of the stock and housing bubbles. Transcripts from the late 1990s, in contrast to their public statements, show that the Fed members were fully aware of the stock bubble and were waiting for it to burst. Investors might have been more reluctant to buy stock had they known that the country’s top economic officials believed the market was seriously inflated. Similarly, if the Fed had recognized the housing bubble, and the public had become aware of this fact, then many potential homebuyers might have been more reluctant to buy homes in severely over-valued markets.
Solution: Make the Fed a True Public Agency
These governance and transparency problems would be solved by transforming the Fed into a true public agency. Americans for Financial Reform is currently developing more detailed proposals to that end.