Earl Ofari Hutchinson's take on the politics of the day
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In an exclusive interview on The Hutchinson Report Newsmaker Hour with host Earl Ofari Hutchinson on KTYM 1460 AM Los Angeles on February 10, Mark A. Calabria, Director of Financial Regulation Studies at the Cato Institute
EOH: What is justified in the criticism of the Federal Reserve?
MAC: The Federal Reserve is looked at as one of the stewards of our economy. Anytime the economy is performing poorly, the Federal Reserve is going to take some heat, just as the president would, regardless of whom ever that person or party would be. To a very large degree, some of this is a function of the weakness of the economy, and once the economy starts moving stronger, I think some of the criticisms will go away. The other part is the Federal Reserve played a key role in the decision making in 2008 in terms of the rescues of Bear Stearns, AIG and other companies. I would say before 2008 the typical person on the street had no idea they even had these powers to do these rescues. It woke a lot of people up. We didn’t know they could lend to J.P. Morgan to buy Bear Stearns or AIG. The original purpose of the bank bailout was to buy all of these mortgage assets. It didn’t do that, but then the Fed bought a trillion dollars in mortgage backed securities, showing it could do the same thing Congress does without the democratic accountability that comes with it. Interest income for savers has declined by about $400 billion a year. When we had the economic stimulus in 2009 there was $800 billion tracked over several years. Interest rates that led to the decline in interest income per household has more than offset the stimulus. Savers have really taken a hit and a lot of anger has been felt in that regard. There is a sense of “what is that leading to?” I think the thinking on the part of Chairman Bernanke and others is that you need to have this loose monetary policy so you can turn the labor market around. The problem is we have had essentially zero interest rates for a number of years with only modest improvement in the labor market. So there is a sense of pumping all this money into the system and it hasn’t created jobs on main street. We’ve seen prices go up and because many of these products are bought on world markets, that means products trade and world market go up higher in price for us. Part of the increases are driven by monetary policy. Lowering the dollar helps exports, so it’s a push and pull.
EOH: You’re keeping inflation down, but not creating mass employment. What’s going wrong?
MAC: The economics profession in general feels in the long run there is no trade off. Higher inflation will not create jobs. The debate in the economics profession is “do you get that trade off in less than a year’s time.” That debate is not settled. Some of the comment you see runs the gambit that there is this tradeoff that if I take 3% inflation I can get 7% unemployment. That doesn’t exist. Bernanke’s job is complicated and not a matter of choosing a trade off. The theory behind low interest rates creating jobs is: lower the cost of credit, businesses will borrow more, they will invest, build capital, hire people. Usually the interest rate in effect on consumers and investors is usually a wash.
Most of the impact on monetary policy by trying to lower interest rates to get the economy turned around is geared at the demand side of the market for borrowing. Every market is driven by demand and supply and part of the problem is banks are unwilling to take long dated assets on their balance sheets. For instance, you get a mortgage with good credit at 4%. The average life in this environment is about 8 or 9 years. The likelihood if a bank makes that loan and holds it on its balance sheets, the cost over the life of the mortgage is higher than 4%. This is partly what did in the savings and loan industry in the ‘80s. Banks have learned that lesson and have tried to avoid it by passing on the loans. That has limited the availability of credit. My concern is that the Federal Reserve is taking the approach that the problem in the economy is the price of credit. I think the real problem is the availability of credit. The banking industry never decreased lending, they have just changed their lending. In today’s low interest rates they can borrow from the Federal Reserve at close to zero and lend that money to the treasury at 3% risk free. Banks make a profit and there is no incentive to lend to the private sector. I think if we raised interest rates a little, we would push banks away from government lending and more toward the private sector.
EOH: Is there over micro managing on the part of Ben Bernanke and the other federal reserve governors?
MAC: I think here is. There really is no more important price in the economy than the interest rate. Inflation doesn’t hit all goods equally. It changes relative prices which changes the choices between what we buy. I worry that the Federal Reserve is throwing sand in the wheels of the economy. I would rather see interest rates move toward what would balance investors, savers and borrowers. The availability of credit is needed here.
EOH: Criticism is that the Federal Reserve is operating on behalf of the banking industry. Your thoughts?
MAC: I think there is validity. Federal Reserve regional banks are not considered part of the government. They are treated as quasi-government. Their boards are picked by the banks and public directors. The Federal Reserve in Washing has to approve them but it has always existed in a shadow world between government and private sector. For that reason I think it lacks accountability. It has also tied itself closely to the banks in order to do monetary policy. The Federal Reserve sells and buys treasury bills with the banking system. The Fed is not working with the local community banks in terms of monetary policy, it’s working with the New York banks which then work with the local banks. The Bear Stearns and Lehman’s of the world are their monetary policy partners and you have a privileged sector of the banking industry that gets treated differently. We’ve moved away from arms-length regulation. We’ve got into the situation where the Fed is looking out for the bankers and vice versa.
EOH: Do you feel the Fed needs to be audited?
MAC: I think we absolutely have to. What we need to know is who they are lending to, how much and on what terms. We need to know what sort of rescues and assistance is going on. Some of that has come out, and you have had some sort of audits, but we need a broader audit of actual monetary policy. Part of this is the role of the Government Accounting arm of Congress that does program evaluation to try to educate members. Most Congresspersons do not understand monetary policy and the purpose would be to educate the public and Congress on being able to provide appropriate oversight. I think we need to have a real audit of monetary policy for the Fed and the rescue program so we know who’s being helped and benefits, and bring accountability and transparency. The Federal Reserve is not independent from Congress, but from the treasury and the executive branch. There is no daylight between treasury and the Federal Reserve and there is a revolving door between them in terms of staff. Congress is as close as you get to being accountable, because we elect them. A dollar when the Federal Reserve was created, is only worth a nickel today.