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Can the Federal Reserve be Independent? October 03, 2007 |
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I had earlier argued about a confused Federal Reserve Board. Now it is clear that the confused Fed is not independent after all. Bloomberg news today (reproduced below) describes how the Fed took a U-turn in its policy after it received a call from the former U.S. Treasury Secretary Robert Rubin (now at Citigroup) in mid-August. It was quite obvious to me since my years at the Fed that this agency works at the behest of mega players, not necessarily in the best interest of the multitude. What is wrong for the Fed to listen to prominent players in the banking community? It is true that the crisis of August 2007 left no option for the Fed but to reverse its course by lowering the discount rate of interest. Without this action financial markets would have perhaps faced greater turmoil. So the band-aid in the form of a lower discount rate was necessary to stop the bleeding. But who was bleeding? The Main Street had been bleeding for many years with massive debts, lower real incomes and zero savings. Turmoil in the financial markets was not inducing any further bleeding. Financial bleeding of households in Main Street will not stop until their mortgage loan balances are cut and the interest payments are reduced. Fed's reduction in the discount rate and then loweing of the short-term bank rate have not alleviated the problems of Main Street. Such Fed actions merely help those "investors" (we should say arbitrageurs) who had borrowed from Japananese banks at 0.5% to lend to Main Street at rates 6-9% with a high degree of leverage. The values of these investments were sinking as the credit crunch was spreading. As a result, the arbitrageurs were facing recalls of the loans they made from insured banks as their equities were being wiped out. Investors at Citigroup would know this better than others. The Main Street would not have suffered at all if the arbitrageurs lost their equities generated from usurious profit generating loans. Fed's reversal of action will hurt the Main Street on two counts: (i) higher prices of commodities and (ii) inducements to arbitrageurs to continue their current practice of usurious profit generating loan strategy. But there will be a natural correction, eventually, when the Main Street fully understands the sources of its problems to elect leaders who will reform policies in their best long-term interests like safe banking and banning of short selling of financial securities. Safe banking would have prevented lending for highly leveraged arbitrage strategies. Borrowing yen is like selling this currency short. If the Japanese capital could be made available cheaply to U.S. home mortgage holders, there is nothing wrong. But this was not the case. Home mortgage holders are paying very high rates due to the arbitrage strategies. So if the arbitrageurs made windfalls from their strategies, they should bear the risk of losing some of their usuriously generated profits when home mortgage holders cannot repay loans made at exorbitant rates. Why should the Central Banker be dragged to alter this natural outcome, at a cost (due to inflation and no relief on mortgage rates) to the vast majority of households? Sankarshan Acharya Citizens for Development and Pro-Prosperity.Com
Bernanke Spoke With Rubin as Credit Crisis Worsened (Update1) By Craig Torres Oct. 3, 2007 (Bloomberg) -- The Federal Reserve's Aug. 7 decision to keep interest rates unchanged set off a chain of high-level discussions with Wall Street executives, money managers and cabinet officials that culminated in Chairman Ben S. Bernanke's public about-face 10 days later, according to records of his schedule. Starting with a phone call from former Treasury Secretary Robert Rubin the day after the August rate meeting, Bernanke's appointments included Lewis Ranieri, founder of Hyperion Capital Management Inc., and Raymond Dalio, president of Bridgewater Associates. The information on Bernanke's calls and contacts was obtained under the Freedom of Information Act by Kenneth H. Thomas, a lecturer at the University of Pennsylvania's Wharton School in Philadelphia. The records depict a chairman who ``has made a very good effort to get up to date with what is going on,'' Thomas said. David Skidmore, a Fed spokesman in Washington, confirmed the authenticity of the document provided by Thomas to Bloomberg News. He said he couldn't provide details of discussions that Bernanke, 53, had with Rubin and others. The conversations came against the backdrop of the worst global credit rout in almost a decade. After $38 billion in cash injections into the banking system failed to boost liquidity, the Fed on Aug. 17 cut its discount rate by half a percentage point, to 5.75 percent, and signaled a September reduction in the benchmark federal funds rate. The Fed cut the key rate a half-percentage point to 4.75 percent on Sept. 18. Rubin's Message Rubin, 69, now chairman of the executive committee at Citigroup Inc. in New York, told Bernanke that the Fed made the right decision on Aug. 7, even as traders complained the central bank was oblivious to weakening markets, according to a person familiar with the conversation. On Aug. 9, Bernanke met from 11 a.m. to noon with Ranieri, a former vice chairman of Salomon Brothers Inc. and a pioneer in the mortgage-backed securities market. Fed Governor Randall Kroszner and Community Affairs Director Sandra Braunstein, who also runs an enforcement team, joined the conversation with Ranieri. Ranieri, 60, wasn't available for comment. Dalio visited Bernanke at 2 p.m. the same day. Bridgewater is the fourth-largest U.S. hedge fund firm, with $32.10 billion in assets under management as of July 1, according to HedgeFund Intelligence's Absolute Return magazine. Dalio's office in Westport, Connecticut, didn't return telephone calls seeking comment. Exchange With King According to the Fed records, Bernanke consulted throughout the month with staff experts, investors, congressional officials, community groups and Bank of England Governor Mervyn King. Bernanke and King spoke by telephone at 1:30 p.m. on Aug. 17, following the U.S. discount-rate cut that morning. Bernanke was also in frequent contact with Treasury Secretary Henry Paulson, who said in an interview last month that he meets the chairman regularly. Bernanke's schedule lists 35 Fed conference calls from Aug. 9 to Aug. 31, including at least two during the central bank's summer retreat at Jackson Hole, Wyoming. During the first full day of the symposium, Bernanke said in a speech that he would do what was needed to keep the six-year economic expansion going. On the eve of the Aug. 7 rate decision, Bernanke received a briefing from Fed staff on markets. He also spoke with Timothy Geithner, president of the Fed's New York branch and the central bank's chief liaison with Wall Street. Adding Reserves In the days after the rate meeting, as Bernanke touched base with executives and investors, credit costs climbed. The Fed added more reserves to the banking system than any time after the terrorist attacks of Sept. 11, 2001, in an attempt to increase liquidity. Yield differences between high-grade debt and riskier credit widened, according to a macroeconomic risk index tracked by Citigroup Global Markets. The index rose to 0.98 on Aug. 17, with a reading of one being a measure of high risk aversion, up from 0.89 on the day before the rate decision. Wayne Passmore, a Fed expert on mortgage finance, met with Bernanke at least four times in August, including before and during Bernanke's Aug. 2 meeting with Freddie Mac Chairman Richard Syron, the schedule shows. ``He is going up and down his staff,'' gathering information on markets, Thomas said, referring to Bernanke. The chairman continued to get reports on market conditions from investors after cutting the discount rate. On Aug. 23, the schedule says Bernanke took a call from John Brennan, 53, chief executive officer of Vanguard Group. Senior Fed economists Brian Madigan, now in charge of the Monetary Affairs Division, and Patrick Parkinson, a financial stability expert, participated. Vanguard managed $1.1 trillion in mutual fund assets at the end of 2006, according to the company's Web site. Officials for the Valley Forge, Pennsylvania-based firm couldn't be reached for comment. To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net Last Updated: October 3, 2007 01:06 EDT
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