Monday, January 11, 2010

Financial Bubbles and the Fed – More Than Meets The Eye

As explained in an October 5, 2007, speech given by Federal Reserve Board Governor Kevin Warsh, “episodes of financial instability and the sharp economic downturns that sometimes ensued were a driving force in the creation of the Federal Reserve” in 1913. The ability to set monetary policies and the regulatory powers granted the Fed were supposed to offer the overall economy a certain degree of protection from boom and bust cycles in the world of big business by stabilizing the banking industry. Yet, as the world has witnessed, the bursting of recent financial bubbles have had devastating affects on the economy as a whole, with the busting of the housing bubble pushing the entire globe to the brink of economic depression, leaving many – particularly those struggling to find a way to survive the current economic situation -- to wonder about Fed policies and who, in fact, they really serve. 

One issue that many find disturbing is the degree to which the upper echelons of government, the financial industries, and the Federal Reserve Board are intertwined. As pointed out by the Independent, a British publication, in a July 22, 2008, article about the influence of Goldman Sachs, there seems to be “a revolving door between the firm and public office,” with such notable names as Hank Paulson, Goldman Sachs chief executive, chosen by George Bush to serve as Treasury secretary, and Robert Zoellick, who was a deputy in the State Department under Condoleeza Rice before being put in charge of the World Bank, being just a couple of the many that move smoothly between the world of finance and the world of politics.

According to a May 8, 2009, Washington Post article, former Goldman Sachs Chairman and ex-presidential economic adviser Stephen Friedman stepped down from his position as the chairman of the Federal Reserve Bank of New York “after questions were raised about his role as a director of Goldman Sachs and his purchases of stock in the company, which is regulated by the New York Fed.”  The current members of the Federal Reserve Board, headed by Ben S. Bernanke, formerly Chairman of the President's Council of Economic Advisers, have also moved smoothly between the political and financial industry realms. Elizabeth A. Duke, for example, was previously a Wachovia Executive Vice President, and has held a variety of positions in other banks, including president, chief operating officer, and chief executive officer. She has also been the Chairman of the American Bankers Association and a member of the Fannie Mae National Advisory Council.

Kevin M. Warsh was Vice President and Executive Director in the Mergers and Acquisitions Department of Morgan Stanley and Company before he came to the Federal Reserve Board. He also was, according to the Federal Reserve website, “Special Assistant to the President for Economic Policy and was Executive Secretary of the National Economic Council from 2002 until February 2006. His primary areas of responsibility included domestic finance, banking, securities, and consumer protection. He advised the President and senior administration officials on issues related to the U.S. economy and capital markets. Mr. Warsh participated in the President's Working Group on Financial Markets and served as the administration's chief liaison to the independent financial regulatory agencies.”

During the run-up period to our current fiscal crisis, Alan Greenspan and then Ben Bernanke were in charge of the monetary policies that the Federal Reserve Board is responsible for, policies that are supposed to, according to the Federal Reserve Board website, provide the nation with “a safe, flexible, and stable monetary and financial system.” Thus, the current Federal Reserve Board Chairman’s public point of view concerning the economic malaise we see now is interesting, though not surprising.

According to an article by Caitlin McDevitt, published at on January 4, 2010, “Fed Chairman Ben Bernanke insisted that low interest rates were not the root cause of the most recent real estate bubble.” The Wall Street Journal, in an article published on January 3, 2010, explained that “Bernanke, though, said Sunday that lenders -- and companies that packaged loans-- built the housing bubble, while regulators, including the Fed, did little to hold them back.”

This position – considering the incestuous relationship between the banking and finance industries and the regulatory bodies that are supposed to govern them – is more than a bit disingenuous. As stated in a May 28, 2009, article in the Washington Post, the Federal Reserve Board, the Federal Deposit Insurance Corp., the Office of Thrift Supervision, and the Office of the Comptroller of the Currency currently share “responsibility for the safety and soundness of banks.”

As explained in the article, “under the current system, banks can choose their regulator. Because the OCC, OTS and FDIC are funded by fees from the banks, the regulators have an incentive to compete for business by offering more lenient oversight. The system also divides supervision of the largest financial conglomerates among multiple agencies, each with responsibility for certain subsidiaries, creating gaps in coverage that companies have exploited.” Congress and the president also have the ability to regulate the financial industries, as well as – as has been the case during the past decade or so – deregulate.

In fact, as detailed in an absolutely fascinating and terribly enlightening 231-page report prepared by Essential Information and the Consumer Education Foundation, for a solid decade, Washington, DC – flooded with billions from financial industry leaders, as well as with thousands of dedicated lobbyists – has been in deregulation mode. And, many of those deregulation steps are directly related to the fiscal nightmare faced today. Furthermore, as should surprise nobody, the benefits of that deregulation fell heavily on the side of the financial industries, those that today suck up trillions of taxpayer dollars because they are deemed too big to fail.

When the average person not formally schooled in economics can see, as many did with the housing bubble, trouble looming on the fiscal horizon, it is nonsensical to think that the Federal Reserve Board had no idea as to what the results of their action and inaction would be. Perhaps the low interest rates and other monetary policies had little to do with the current situation, but it is undeniable that their refusal to regulate has again left the average person prey to the devastating affects of big business generated boom and bust cycles, leaving little doubt as to whose interests such regulatory agencies as the Federal Reserve Board serve and protect.

by Sharon Secor

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