Since the great credit crunch began, Fed Chair Ben Bernanke has been a one-man band.
Need a fix for crippled banks? Ben was there with oodles of cash, freely dispensed from the Fed’s discount window.
Want to stimulate lending? Ben instituted his Quantitative Easing program that lowered interest rates for overnight bank borrowing effectively to zero.
Looking to prop up the crumbling housing sector? Ben stepped in by having the Fed purchase hundreds of billions of dollars in mortgage debt.
Over the past year, whenever any sector of the economy has been perceived to be in trouble, Congress and the White House have looked to Bernanke to invent a new program. No matter the economic difficulty, Bernanke has been Johnnie-on-the-spot.
Apparently, no financial issue is too big or too trivial to warrant Bernanke’s attention. Recently, the Fed Chair has been under pressure to extend more aid to the ailing car companies; broaden credit programs for small businesses; underwrite consumer credit; and to provide supports for the sagging commercial real estate market.
As Bernanke convenes the rate-setting Federal Open Market Committee for meetings today and tomorrow, all eyes have turned once again towards the Chairman. The question is not if but when the Fed will bring an end to its seemingly limited largesse.
How the Withdrawal May Start
Bernanke understands that the central bank must begin to withdraw its unprecedented economic stimulus to avoid a surge of inflation that could undermine the economic stabilization that has been achieved during the course of the recovery. From all accounts, it is likely that Bernanke’s first move will be to extricate the Fed from its entanglement with the housing market.
The Fed Chair is still going forward with plans to purchase about $1.5 trillion in mortgage debt as a means to continue the central bank’s support for the housing sector. But, at the same time, he has signaled that by March 2010, he would like to supplant the central bank’s unprecedented backing for the housing market with private investment.
Chairman Bernanke’s master plan may be hamstrung by politics.
Difficult for Bernanke to Withdraw?
Theoretically, monetary policy is supposed to independent and free from political pressure. This premise will be severely tested in the coming months as Bernanke attempts to disengage the Fed from its unprecedented involvement in the domestic housing market.
Under Bernanke’s leadership, the central bank is already the biggest buyer of mortgage-backed securities originated by Fannie Mae and Freddie Mac. There is broad agreement that Fed purchases of housing debt have helped lower borrowing costs and boosted a part of the economy that was at the epicenter of the financial crisis. According to data released by home lender Freddie Mac, the average rate on a 30-year mortgage last week was 5.03 percent, down from 6.46 percent at the same time last year.
New home sales, however, unexpectedly fell in September even as the end of the $8,000 tax credit for first-time homebuyers approached. This dropoff in sales has prompted prominent elected officials on both sides of the political aisle to propose a further extension of the credit into next year and to enlarge the program to include other purchaser categories.
This new round of incentives couldn’t come at a worse time for Bernanke and Fed. Just as Bernanke is looking to diminish the central bank’s role in the mortgage market by liquidating its portfolio, Congress and the White House may try to stop him on the grounds that the housing market has yet to fully recover.
At the same time that the Fed is looking to transition its housing portfolio into the hands of private investors, it is also wrestling the timing of its path to higher interest rates. Elected officials like Connecticut Democrat Chris Dodd, Chair of the Senate’s Banking Committee, have openly expressed grave concern that the housing sector may crater if Bernanke follows through with his plan to divest the central bank of its private mortgage holdings while edging interest rates higher.
Since its creation in 1913, the Fed has largely operated without Congressional or White House oversight. In its role as the chief architect of U.S. monetary policy, many have viewed the Fed as a virtual fourth branch of government.
Maverick Texas Republican and former Rresidential candidate Ron Paul has authored a bill that would pry open the otherwise secretive practices of the Fed by subjecting it to congressional oversight and audits. To date, the bill has more than 300 sponsors.
Although Fed has been remarkably more transparent under Bernanke’s direction than his autocratic predecessor Alan Greenspan, many economists fear that such a bill would spell the end of an independent central bank. As Bernanke considers his options, especially as it pertains to the housing market, the threat of a bill that could curtail the Fed’s continued autonomy may be the hammer that prevents him from acting in the independent manner that he believes is best for the economy.
Since this crisis began, I haven’t fully endorsed the breadth of actions taken by Bernanke. But from day one, he has been decisive as well as a beacon of relative calm and reason.
Stripping the Fed of its independence at this critical juncture would be a mistake. Using the threat of this action as a means to influence monetary policy is an even bigger error.
Unless Congress believes that it can do a better job, it should let Bernanke do his without unnecessary political interference.
John Cohn is a senior partner in the Globe West Financial Group based in West Los Angeles. He may be contacted at www.globewestfinancial.com
