Dear readers, we narrowly avoided a catastrophe. I use that word because an action by Congress to eliminate or neuter the power of the central bank to intervene as lender of last resort in a crisis is exactly the way to create a catastrophe. The 1929–1933 period of American history is evidence of how a catastrophe unfolds when the central bank of your country doesn’t intervene with emergency powers in a crisis.
What prompted Senator Toomey to try to hold up the massive government funding bill (continuing resolution and Cares Act combined) is still not understood by all the professionals I have spoken with. (See “Lawmakers reach compromise over GOP proposal to rein in Fed’s powers, clearing path for a stimulus package deal,” https://www.washingtonpost.com/us-policy/2020/12/19/stimulus-talks-race-against-government-shutddown-deadline/.) And for Toomey to do so in the face of the pandemic and when unemployment benefits are expiring for millions of Americans is incomprehensible.
Readers are invited to examine the operative language of Toomey’s initiative (Section 1005) which starts on page 541 of the 5593-page bill. The complete “Consolidated Appropriations Act, 2021” [H.R. 133] is available here: https://www.congress.gov/bill/116th-congress/house-bill/133. Think about how this move by Toomey would have impacted Section 13(3) of the Federal Reserve Act. (For historical background, see “Federal Reserve Credit Programs During the Meltdown,” https://www.federalreservehistory.org/essays/fed-credit-programs.) Fortunately, Fed Chair Jay Powell is a skilled lawyer and the insertion of one paragraph, directly below Toomey’s Section 1005, removed the threat to the Fed. (You will find this paragraph on page 544.)
“SEC. 1006. RULE OF CONSTRUCTION.
11 Except as expressly set forth in paragraphs (1) and
12 (2) of subsection (c) of section 4029 of the CARES Act,
13 as added by this Act, nothing in this Act shall be con-
14 strued to modify or limit the authority of the Board of
15 Governors of the Federal Reserve System under section
16 13(3) of the Federal Reserve Act (12 U.S.C. 343(3)) as
17 of the day before the date of enactment of the CARES
18 Act (Public Law 116–136).”
Fred Feldkamp sent me the following note. Hat tip to Fred for helping with this research. His years of prior experience in matters like this helped me to quickly (within a few hours) get through this nearly 6000-page document.
Fred wrote:
“The ‘Rule of Construction’ compromise at the end of the COVID bill seems to have removed doubt of the Fed’s ability to serve as US ‘lender of last resort’ in an emergency requiring it to contain a ‘flight to quality’ that destroys the US economy.”
Fred sent me the market reaction as he computes it using a formulation of credit spreads. He has years of experience with credit spread analysis and translation of changes in spreads into forecast scenarios applied to financial markets and asset prices. Bottom line: The Toomey holdup and language insertion widened spreads and hurt markets by an estimate that measured in the billions. Fortunately, that predicament lasted only one day.
Markets have reversed, and spreads are again tighter and tightening. This incident helps explain the brief stock market whipsaw coincident with the House final vote on H.R. 133 after the Toomey-Powell-Mnuchin-McConnell-Pelosi negotiations.
But why emasculate the Federal Reserve’s powers when they are desperately needed under emergency conditions and are clearly within the “lender of last resort” concept? During the Great Financial Crisis a decade ago, we watched as Congress was caught up in the “TARP” debate. We saw the market swoon before our eyes as the vote was proceeding. Does anyone want to repeat that fiasco? Does anyone still have confidence in a prompt response from our national legislature in a time of crisis?
There are reasons why Congress polls so low among America’s voters. What hasn’t translated for Americans is moving that disapproval to my representatives in Congress. We condemn the collective body but allow the individuals in it to continue to act without real accountability. We tolerate their constant blaming of one another. Hence, we get the government we deserve.
Therein lies a danger that Senator Toomey has exacerbated. He came close to succeeding. A near miss, but close. In a nearly evenly divided chamber, power gets concentrated in the hands of the very few, who can swing passage or failure of a congressional act. And that puts the central bank at higher risk. That means it puts all of us at higher risk.
We saw that risk realized once before when Senator Elizabeth Warren was able to remove the funding for a federal agency from the normal budget process and put it onto the back of the Federal Reserve. In 2011, the Consumer Financial Protection Bureau (CFPB) was created by Congress as an independent bureau within the Federal Reserve System but largely independent of the Fed. However, the Fed was saddled with paying the cost. That took CFPB out of the funding and oversight system that applies to other financial regulatory bodies like the Securities and Exchange Commission (SEC) and the Federal Deposit Insurance Corporation (FDIC).
Now, markets have calmed down and assume that the Toomey initiative is dead. But those of us who are professional worriers feel otherwise. The Fed is a convenient target for anything that goes wrong. It cannot defend itself against Congress, since it is a creature created by Congress. So it is up to those of us with private-sector voices to observe attacks on the Fed and to surface them with factual accuracy.
Let me comment further on 5593-page H.R. 133, which authorizes trillions in federal expenditure. The final copy was available to Members of the House for only a few hours before the vote. My suspicion is that most of the Members and most Senators didn’t read it and received only summary “cheat sheets” on its contents. Upon detailed scrutiny, one can find plenty of questionable expenditures in this “omnibus” bill. That is not unusual. We Americans have adopted this method of conducting our fiscal affairs, and it is very hard to change it. Attempts like the institution of line-item veto power or the exposing of “bridges to nowhere” may generate brief headlines, but Americans are largely complacent about the existing fiscal process. So that’s the way it is. We eat some “pork” whether we like it or not.
We’ll end this defense of the Fed and critique of Congress with a computation to reveal the true magnitude of 5593 pages. We tallied up the page counts of each of the following texts, including indexes and notes:
• The English Standard version of the Bible: 1326 pp.
• The Arthur Jeffrey translation of the Koran: 231 pp.
• The Book of Mormon, published by the Church of Jesus Christ of Latter-day Saints: 779 pp.
• The Stone edition of the Chumash (Torah with commentaries): 1313 pp.
• The Wealth of Nations, by Adam Smith: 568 pp.
• De Tocqueville’s Democracy in America: 910 pp.
• John Maynard Keynes’ The General Theory of Employment, Interest, and Money: 403 pp.
Here’s a photo of those 5530 pages from my library. Tongue in cheek: I’m 63 pages short.
David R. Kotok
Chairman of the Board & Chief Investment Officer
Email | Bio
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