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Is central bank independence gone?
It's another bail-out of sorts today, although you won't hear it described as such:
The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve. The program will consist of a series of Treasury bills, apart from Treasury's current borrowing program, which will provide cash for use in the Federal Reserve initiatives.
Here is the link. How long will it take to win back Fed independence? There used to be talk that "The Paulson Plan" would centralize various kinds of financial regulation in the Fed. But, as it turns out, under the "beta" version of the plan, the Fed goes hat in hand to...Paulson. I guess that's why they call it The Paulson Plan.
Posted by Tyler Cowen on September 17, 2008 at 10:52 AM in Current Affairs | Permalink
Comments
If I get it correctly, the Presidential candidates don't share the same opinion on what would be a proper solution to the current financial crisis. Therefore, I guess the solution will come after the elected administration has sorted out in what order to do with all the pressing charges. Both sides seem to be eager to change things, and this appears to be on the upper end of the agenda, so I'm assuming the answer won't come after February.
Posted by: Bertil at Sep 17, 2008 11:04:49 AM
The Fed is not, has never been, nor will it ever be independent. It is a private institution granted monopoly status by the government. Its monopoly, and thus its power is enforced by the government, and thus it cannot be independent. This is the same kind of ambiguity that surrounded FNM and FRE, were they or weren't they government institutions? They received below market rate funding due to their implicit government backing. It was always an illusion that they were 'private'. I fail to see how the Fed is any different, besides the fact that the idea that it is independent has been pounded into the heads of so many for so long that it is just accepted.
Posted by: Danny at Sep 17, 2008 11:58:40 AM
i don't see how this has anything to do with independence. the whole point of independence is (1) circumvents dynamic inconsistency from myopic political pressures (2) stops the central bank from being forced to finance the government's debt. neither is currently the case.
Posted by: camello at Sep 17, 2008 12:00:10 PM
Someone needs to answer why the loan came from the Fed and not the US Treasury. The Fed is NOT part of the US Government it is a privately owned system. Although as Tyler points out, it is becoming less and less independent each day.
People need to remember that the Fed is less than 100 years old. In that time it has not exactly covered itself in glory. I fear that the decision around AIG will have far more consequences long term than the loan made to JP Morgan to buy Bear Stearns.
Posted by: joe at Sep 17, 2008 12:00:26 PM
This is getting to be an expensive few days - how soon before the rating agencies place the US's AAA rating under review?
Posted by: nick at Sep 17, 2008 12:01:01 PM
Joe,
They wanted to do a treasury conservatorship at first, but that would have set up a credit default event, which was the whole purpose of saving AIG. The Fed can 'loan' anyone money, if its charter is read loosely. The treasury, on the other hand, is much more restricted as to what it can do. It took an act of Congress to take over FNM and FRE.
Posted by: Danny at Sep 17, 2008 12:14:59 PM
Maybe you forget: "If you owe the bank a million, you have a problem. If you owe a thousand billion, they have a problem."
Maybe the independence of the US Treasury is at risk as much or more than the independence of the Fed?
Posted by: Diversity at Sep 17, 2008 12:15:45 PM
Danny,
CDS written on AIG is not the issue as I understand it; its CDS written by AIG that's at issue. The only reason a credit default event would matter that much would be if a) there was huge notional amount of CDS outstanding on AIG parent or b) that a credit event would somehow terminate the swap portfolio written by AIG Financial Products, where most of the written CDS contracts lie.
Your explanation makes sense if either of those two, or both, are correct.
Posted by: joe at Sep 17, 2008 12:26:12 PM
Joe,
I would guess a is most likely very true, if only as a hedge to other exposure. I overstated when I said 'whole reason', as the fact that AIG bonds sit in so many portfolios, it would effect money market funds, among many other things, I'm sure was involved in the thinking process. On b tho, I think you're right. I wrote too hastily. A conservatorship would not have changed much on the CDS they wrote.
Another problem with a treasury conservatorship, besides being illegal, I believe, is that AIG is regulated by states and a direct federal takeover would have created a total regulatory mess. It just made more sense for the Fed to loosely interpret its charter. It really is no different than what the Fed did during the great depression, not that I approve of its actions. So there is precedent, while there is no precedent for treasury action without congressional approval.
Posted by: Danny at Sep 17, 2008 1:03:04 PM
The Treasury is doing a bailout of the Federal Reserve.
Posted by: at Sep 17, 2008 1:51:56 PM
I don't think I understand how this undercuts the Fed's independence. The Fed requested this new plan. I believe this is Helicopter Ben printing money, no?
Posted by: Damir at Sep 17, 2008 5:52:47 PM
The Fed is imitating a real bank. The Treasury sells some new securities and deposits the money in its account at the Fed. The Fed now has more money it can loan out, without resorting to the printing press.
The Treasury normally keeps some money at the Fed to handle various payments it makes, much like a business has a checking account. The new procedure is like the Treasury funding the Fed by making time deposits in much larger amounts.
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