It's the Wrong Time to 'Reform' the Fed

Ever since its creation in 1913, the Federal Reserve has grappled with a daunting political contradiction. The Fed is charged with preventing the collapse of the financial system, whose health is essential for the "real economy" of production and jobs. But financial bailouts usually occur when mistakes or misdeeds by bankers make them public pariahs. To do its job, then, the Fed protects—or seems to protect—an unpopular, disgraced, and undeserving group. We are now witnessing this contradiction in full bloom. (Click here to follow Robert Samuelson).

The Fed has become a congressional scapegoat for assorted economic frustrations: 10.2 percent unemployment; expensive rescues of fragile financial institutions; outsize Wall Street bonuses; and the crisis itself. The denunciations transcend rhetorical outbursts. The House Financial Services Committee recently voted to require the Government Accountability Office (GAO) to "audit" the Fed's monetary policy—its efforts to influence interest rates and credit conditions. In the Senate, Christopher Dodd, chairman of the Banking, Housing, and Urban Affairs Committee, has proposed stripping the Fed of all powers to regulate financial institutions—its actions to police lending and management practices. These powers would go to a new agency.

Lost in this politically charged climate is the reality that the Fed, more than any other government agency, arguably stopped last fall's financial panic from becoming a global depression. The Fed pumped out more than $1 trillion in new credit, created special lending programs to support faltering segments of the credit markets, and rescued financial institutions, notably AIG, whose bankruptcy might have triggered a chain reaction of failures. These were seat-of-the-pants responses, taken in the midst of crisis and pervasive uncertainty. We will never know what might have happened without them. The second-guessing now occurs when there's less fear and more information.

What's also overlooked is that the Fed isn't the supersecretive, unaccountable agency of political stereotype. In 2009 Fed officials from chairman Ben Bernanke on down have testified 32 times before congressional committees. The Fed makes detailed disclosures about its policies. After every meeting of the Federal Open Market Committee (FOMC), it issues a statement explaining why it has—or hasn't—changed its interest-rate target. Until 1994 there were no announcements after FOMC meetings. Economists and investors had to guess.

Contrary to conventional wisdom, the Fed's activities are already widely audited. Deloitte & Touche examines the Fed's financial statements, which are published. The GAO can audit many Fed activities, including its banking regulation and supervision of the payments system. What it's barred from auditing is the conduct of monetary policy, including relations with foreign central banks.

Congress has so far sensibly put this off limits. "Audit" has a different meaning in the context of the GAO than in everyday usage. It means examine, investigate, evaluate, and, often, criticize. It's not just number crunching. The GAO could be used by Congress to influence or intimidate the Fed through selective investigations, which would involve access to the Fed's internal documents and interviews with policymakers. The Fed might be pressured to finance government deficits or to adopt an "undue focus on the short term," vice chairman Donald Kohn testified before Congress. Historically, similar pressures have caused other central banks to unleash inflationary torrents of money, Kohn said.

This is not inevitable, but even the impression that the Fed's "independence" is compromised could perversely undermine confidence in the dollar, leading to higher interest rates or a rapid fall in the dollar's foreign-exchange value. Massive projected government budget deficits compound the effect. Similar objections apply to Dodd's proposal to end the Fed's power to regulate financial institutions. If the present crisis teaches anything, it is that the Fed needs to know more—not less—about large financial institutions.

The Fed isn't infallible. Its mistakes contributed to the crisis. Its present low-interest-rate policy poses dangers of fostering inflation or new "asset bubbles." But the congressional Fed bashing poses greater dangers. Ironically, the destructive remedies now being peddled are part of "financial reform" legislation. If this be "reform," we'd be better off without it.

Robert Samuelson is also the author of The Great Inflation and Its Aftermath: The Past and Future of American AffluenceandUntruth: Why the Conventional Wisdom Is (Almost Always) Wrong.