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Monday, December 28, 2015 2:48 PM

Misguided Plans to Fix the Fed Part 1: Bernie Sanders

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Starting with a recent op-ed in the New York Times by Bernie Sanders, let's take a look at various proposals floating around to fix the Fed and other central banks.

Bernie Sanders says To Rein In Wall Street, Fix the Fed

Sanders: Wall Street is still out of control. Seven years ago, the Federal Reserve and the Treasury Department bailed out the largest financial institutions in this country because they were considered too big to fail. But almost every one is bigger today than it was before the bailout. If any were to fail again, taxpayers could be on the hook for another bailout, perhaps a larger one this time.

To rein in Wall Street, we should begin by reforming the Federal Reserve, which oversees financial institutions and which uses monetary policy to maintain price stability and full employment. Unfortunately, an institution that was created to serve all Americans has been hijacked by the very bankers it regulates.

Mish: That type of populist proposal will appeal to those who believe Wall Street is the problem. It will also appeal to those who understand the Fed is indeed in bed with Wall Street. But we must analyze Sanders' specific recommendations one-by-one.

Sanders: The recent decision by the Fed to raise interest rates is the latest example of the rigged economic system. Big bankers and their supporters in Congress have been telling us for years that runaway inflation is just around the corner. They have been dead wrong each time. Raising interest rates now is a disaster for small business owners who need loans to hire more workers and Americans who need more jobs and higher wages. As a rule, the Fed should not raise interest rates until unemployment is lower than 4 percent. Raising rates must be done only as a last resort — not to fight phantom inflation.

Mish: Sanders ignores the dotcom bubble, the housing bubble, and the bubbles now in both stocks and bonds. Those bubbles all have their roots in a Fed that kept rates too low, too long. The idea that rates should be tied to a single measure like unemployment is ludicrous. And at 4% unemployment rates, the Fed would seldom if ever hiked. The Fed does not know where interest rates should be, and neither does Sanders. 

Sanders: What went wrong at the Fed? The chief executives of some of the largest banks in America are allowed to serve on its boards. During the Wall Street crisis of 2007, Jamie Dimon, the chief executive and chairman of JPMorgan Chase, served on the New York Fed’s board of directors while his bank received more than $390 billion in financial assistance from the Fed. Next year, four of the 12 presidents at the regional Federal Reserve Banks will be former executives from one firm: Goldman Sachs. These are clear conflicts of interest, the kind that would not be allowed at other agencies. We would not tolerate the head of Exxon Mobil running the Environmental Protection Agency. We don’t allow the Federal Communications Commission to be dominated by Verizon executives. And we should not allow big bank executives to serve on the boards of the main agency in charge of regulating financial institutions.

Mish: The conflicts of interest are indeed obvious. The solution is to get rid of the Fed.

Sanders: The Fed must also make sure that financial institutions are investing in the productive economy by providing affordable loans to small businesses and consumers that create good jobs. How? First, we should prohibit commercial banks from gambling with the bank deposits of the American people. Second, the Fed must stop providing incentives for banks to keep money out of the economy. Since 2008, the Fed has been paying financial institutions interest on excess reserves parked at the central bank — reserves that have grown to an unprecedented $2.4 trillion. That is insane. Instead of paying banks interest on these reserves, the Fed should charge them a fee that would be used to provide direct loans to small businesses.

Mish: I agree the Fed should prohibit commercial banks from gambling with the bank deposits of the American people. The way to do that is end fractional reserve lending. Lending deposits that are supposed to be available on demand is fraudulent. Paying interest on excess reserves the Fed creates out of thin air is also fraudulent. However, the notion the Fed should charge interest on reserves to spur lending is ridiculous. Mathematically, every dollar the Fed prints has to be held by someone. When banks lend, the money eventually ends up as a deposit somewhere else. Moreover, efforts to force banks to make more loans will just encourage bad lending decisions and subsequent writeoffs.

Sanders: As a condition of receiving financial assistance from the Fed, large banks must commit to increasing lending to creditworthy small businesses and consumers, reducing credit card interest rates and fees, and providing help to underwater and struggling homeowners.

Mish: Banks should not be bailed out or given assistance ever. To do so creates a moral hazard.

Sanders: We also need transparency. Too much of the Fed’s business is conducted in secret, known only to the bankers on its various boards and committees. Full and unredacted transcripts of the Federal Open Market Committee must be released to the public within six months, not five years, which is the custom now. If we had made this reform in 2004, the American people would have learned about the housing bubble well in advance of the financial crisis.

Mish: The housing bubble was obvious to every thinking person. Yet, the idea minutes would prove the Fed knew are highly unlikely. The Fed has never spotted a bubble. And neither the Fed nor Sanders sees the bubbles we are in now. That said, I fully support transparency and the release of full and unredacted transcripts.

Sanders has some things right, but as many things wrong.

We should audit the Fed and end it, not attempt to fix it with absurd rules about where interest rates should be, coupled with preposterous efforts to force banks to lend.

Mike "Mish" Shedlock

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