Politics Threatens the Fed

Author: David R. Kotok, Post Date: February 12, 2018

“Yet there is also good reason to worry,” wrote the Economist on a page 10 editorial dated February 3, 2018. We agree.

They made the case with this summary: “An independent central bank can be better trusted to act swiftly to curb inflation. That trust also gives it freedom to cut interest rates when the economy turns down. The kinds of problems set by a booming world economy and elevated asset prices are best tackled by experts at some distance from politics. What central banks need is not the appointment of officials who are less inclined to disappoint their political masters.”

Could the turmoil in the US central bank’s composition and its interface with politics be one of the hidden ingredients that exacerbate market turmoil and worsen violent volatility? The answer may be yes.

Consider the evidence.

Our Federal Reserve functions without a full Board of Governors because of politics. The new chairman, Jay Powell, has two colleagues seated on a seven-member board. A third nominee is now in political trouble because a Senator doesn’t like his views. The nomination of Marvin Goodfriend squeaked through the Senate committee on a partisan 13 to 12 vote. We shall see if he is confirmed or if he falls to the wayside. Three other vacancies on the board await nominations by President Trump. So right now the five voting presidents outnumber the three voting governors, and that is likely to be the situation for months. Some might argue that ratio is a good thing, as regional bank presidents are selected by their banks and are not subject to Senate confirmation of presidential appointments.

Please note that this situation is not unique to Trump. It started under Bush and continued under Obama. Even in the midst of the worst financial crisis since the Great Depression, the Fed’s Board of Governors chaired by Bernanke had two vacancies. In those days the Board had a requirement for a supermajority five votes to rule on an emergency action. So Bernanke had to live under a unanimity rule imposed by a US Senate that was unwilling to confirm appointees.

Meanwhile, the Fed has the political problem of less than robust congressional objection to how the Congress raids the central bank. The most recent example was hidden in the budget deal. Christopher Condon of Bloomberg caught it and reported it in a story entitled “Congress Raids Fed’s Surplus for $2.5 billion in Budget Deal.” For those with Bloomberg access, the time stamp entry is 2018-02-09 16:39;01,750 GMT. Condon reports that the Congressional raid on the Fed’s surplus reduced the Fed’s account to $7.5 billion and forced America’s central bank to send the money to the Treasury.

Please note that the Fed routinely sends any accumulated surplus to the Treasury, but this $2.5 billion was a sleight-of-hand maneuver by politicians to get the budget deal through. This transfer was NOT part of the regular remittances process. It means that those remittances will be reduced by $2.5 billion.

Congress previously pulled a fast one like this by raiding the Fed’s surplus to finance a highway spending program. And before that it forced the Fed to fund the Consumer Financial Protection Bureau. What is next? Can you imagine an emergency funding measure that raids the Fed for hurricane disaster relief or mosquito control or anything else on a list that could become open-ended? Remember that this type of raid bypasses the traditional budget-determined spending and taxing mechanism. It hides things from scrutiny. Only a journalist with skills can ferret it out and make it public.

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