Fed Opposed by Left and Right
On its front page today, the Washington Times reports that expanded powers for the Federal Reserve are being opposed by “odd allies.” The Fed’s imperial over-reach for additional regulatory powers is being opposed by Democrats and Republicans, and liberals and conservatives alike. As well it should be. As Senator Shelby observed, “Anointing the Fed as the systemic-risk regulator will make what has proven to be a bad bank regulator even worse.”
The regulation of financial services failed conspicuously to prevent the worst financial crisis since the Great Depression. The Fed failed most conspicuously as it was charged with oversight of all the major banks, including notably Citigroup and Bank of America. Bank regulation now functions to insulate banks from the consequences of their own bad acts. The regulatory system enables banks to engage in excessive risk taking.
The Obama Administration and Chairman Barney Frank of the House Financial Services Committee propose that an expanded role for the Fed and generally more of the same will improve matters. Instead, the proposed legislation will worsen the situation by codifying the status of the major financial institutions as “too-big-to-fail.” It would thereby provide them with special legal status. We have all seen this movie and how it ends. Fannie Mae and Freddie Mac had such a status and collapsed. Do we need 20 more such disasters?
Three cheers for all those opposing this destructive piece of legislation. End “too-big-to-fail” instead.
Wednesday Links
- Why there’s no way to enforce a ban on texting while driving.
- How onerous financial rules will only delay economic recovery and dampen long-term growth.
- It’s time to start over on health care reform: “If you’re going the wrong way down a road, the answer isn’t to step on the gas, but to turn around.”
- Is the current recession the worst since the Great Depression? You might be surprised…
- When “history” dials the wrong number.
Bernanke’s Part in the Housing Bubble
Recent weeks have seen a swirl of speculation over whether President Obama will or will not re-appoint Ben Bernanke to the Chairmanship of the Federal Reserve Board, when his current term as Chair expires in January 2010. Almost all of the debate has centered on his actions as Chairman. This narrow focus misses an important piece: his actions, and words, as a Fed governor during the build-up of the housing bubble.
What should have been Bernanke’s greatest strength as a Fed governor and later chair, his understanding of monetary theory and his knowledge of the Great Depression, has ended up being a weakness. While correct in his analysis of the role of “debt deflation” — where the deflation increases the real burden of debts and correspondingly weakens the balance sheet of both households and businesses — in the deepening of the Great Depression; his obsession with slaying the Great White Whale of Deflation provided intellectual cover for the Fed’s ignoring and contributing to the housing bubble. Like the proverbial general, he was fighting yesterday’s battle, rather than today’s.
While core inflation was moderate and increasing at a decreasing rate between 2001 and 2005, this measure ignores the dramatic up-tick in house prices during those years. First, housing makes up the single largest expense for most households, ignoring housing, especially after one subtracts out energy and food from the definition of inflation, gives a narrow and distorted picture of inflation. Even if one were to focus solely on rents, the 2000s were an era of increasing housing costs.
Separate from the impact of housing prices on inflation is the role which housing plays as the collateral for the primary piece of household debt: a mortgage. Even were the US to suffer a bout of mild deflation and the real burden of their mortgages increased, this would likely have little impact on household balance sheets in an environment of increasing home prices.
Admittedly Bernanke was then only a “governor” and not yet Chair of the Fed, but he was the Fed’s loudest voice when it came to combating deflation and arguing for lower rates. Additionally there have been zero public acknowledgements by either Bernanke or the Fed that its policy earlier this decade contributed to the housing bubble and financial crisis. Without admitting to the occasional mistake, we have no way of judging whether Bernanke has learned from any of his mistakes, and hence less likely to repeat them.
In weighing Bernanke’s record at the Fed, judgement should not solely consider his actions as Chair, but also consider his words and deeds while the housing bubble was inflating. How one responds to a impending disaster is as important as to how one helps to clean up after the disaster has struck.
Echoes of Smoot-Hawley
President Barack Obama appears to have learned something compared to candidate Obama: protectionism isn’t to America’s advantage. Unfortunately, it is not clear that Congress has learned the same lesson. Three free trade agreements negotiated by the Bush administration remain in limbo, while no one is pushing to reinstate the president’s so-called fast track negotiating authority.
And past protectionist actions are now bearing ill fruit. The “stimulus” bill required that construction money be spent in the U.S. Although the provision was amended in response to foreign criticism, some Canadian firms have been adversely affected. So Canadian cities have begun boycotting American products.
Canadian municipal leaders threatened to retaliate against the “Buy America” movement in the United States on Saturday, warning trade restrictions will hurt both countries’ economies.
The Federation of Canadian Municipalities endorsed a controversial proposal to support communities that refuse to buy products from countries that put trade restrictions on products and services from Canada.
The measure is a response to a provision in the U.S. economic stimulus package passed by Congress in February that says public works projects should use iron, steel and other goods made in the United States.
The United States is Canada’s largest trading partner, and Canadians have complained the restrictions will bar their companies from billions of dollars in business that they have previously had access to.
“This U.S. protectionist policy is hurting Canadian firms, costing Canadian jobs and damaging Canadian efforts to grow our economy in the midst of a worldwide recession,” said Sherbrooke, Quebec, Mayor Jean Perrault, also president of the federation that represents cities and towns across Canada.
The municipal officials meeting at the federation’s convention in Whistler, British Columbia, endorsed the measure despite complaints by Canadian trade officials.
Trade Minister Stockwell Day told the group on Friday that Ottawa was actively negotiating with Washington to get the “Buy American” restrictions removed.
Thankfully, this bilateral spat isn’t likely to spark another Great Depression. However, it illustrates how protectionism is self-defeating. Other countries will not stand by silently as American legislators attempt to bar their products from the American market. And U.S. workers will be the ultimate victims as the cycle of retaliation spreads.
Chuck Schumer Endorses Hoover Plan
On Meet the Press last Sunday, Sen. Chuck Schumer (D-NY) said
Those on the hard right say, “Cut government spending, let’s go back to the old Reagan days.” Well, the last president who did this when we were in this type of situation was Herbert Hoover. Herbert Hoover said the government should do nothing when we were in a recession, not a depression. We did nothing and it related [sic] to a depression.
Reality check: Did President Hoover cut federal spending during the recession that became a depression? Not by a long shot.
Source: OMB
Federal spending was $3.1 billion (those were the days!) in 1929, the year Hoover took office and the stock market crashed. It rose modestly for two years, then shot up in 1932. It dropped a bit in nominal terms in 1933, though deflation meant that the real budget increased. Then, presumably reflecting Roosevelt’s policies, it shot up again in 1934. In real terms, the federal budget was almost twice as high after Hoover’s four years as it was when he took office.
President Bush, President Obama, and Senator Schumer are all supporting Herbert Hoover’s failed policy of increasing spending to fight recession. Let’s hope they don’t have the same results and turn a recession into a Great Depression.
Cato adjunct scholar Ilya Somin dissects the “Herbert Hoover did nothing” fallacy at Volokh.com.
What Did the New Deal Do?
There has been much recent debate about whether or not President Franklin Roosevelt’s New Deal policies increased the nation’s economic pain during the Great Depression or led to its end. In today’s Cato Daily Podcast, Regulation Magazine managing editor Thomas A. Firey reveals why erroneous stories about the effects of the New Deal survive despite decades of economic research that tell a different, more nuanced story:
Listening to the fight today among commentators on the left and the right talking about the New Deal and making various claims about it, as far as a stimulus—they’re almost all wrong, and what’s most disturbing to me as an economic historian is this is actually pretty well-plowed ground, so I don’t know how they can be wrong and how no one’s calling them out on it….
…The two stylized stories, the one that nothing got better and the other that the New Deal miraculously fixed everything—both are very clearly wrong when you look at the numbers. But no one wants to tell the real story, because, first of all, it doesn’t fall nicely in an ideological story on either side, and, second of all, it requires work. You have to read stuff and do research and care about the facts, and, let’s be honest, in this political environment, very few people do those things or care about the facts.
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