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Wednesday November 11, 2009 - 19:59:58 GMT
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What is not priced? Loss of Fed Independence!

I am a big fan of Ben Bernanke, but not in some slavish, Stockholm-effect way. He runs an agency that fell on its face when it came to one of its main charges…regulating the banking system and overseeing bank supervision.  Sadly, Secretary Geithner was in the pilot’s seat in this effort and look where he ended up.  The very fact that Geithner, who while NY Fed President missed the credit crisis, excessive bank leverage, risk concentrating derivatives sold and bought by banks (and others) and lower than low bank lending standards, becomes Treasury Secretary (okay I thought he was the right pick at the time…my bad) is central to why Congress (yes culpable agents in the crisis) must move to restrict Fed regulatory authority over the financial system. 


When it comes to the Fed keeping banks in line, it can’t be trusted.  It can’t be trusted for lots of reasons including the closeness of the banks to the regulators…as it turns out even close personal relationships based on the FOIA release of Geithner’s appointment log while NY Fed President.  But the conflict of interest to end all conflicts of interest is in the board of governors’ makeup at the NY Fed…chaired by none other than former Goldman senior executive and White House advisor Stephen Friedman…as it turns out he bought a large tranche of shares in Goldman around (coincidentally) the same time NY Fed President Geithner led the AIG takeover and in a snap decision may all AIG CDS counterparties whole in the midst of AIG-led negotiations for haircuts on the very same counterparty contingencies, of which Goldman was the beneficiary.


So I was gobsmacked when I read how upset some in the market are over the audacity of Congress to rewrite Fed regulatory authority law for the banking system.  With some assistance from Rep Frank, even Bernanke seems to get it (see the NYT article below) as he has hired a lobbyist to work the halls of Congress to defend Fed turf.  And Fed officials generally are making it pretty clear they fear the worst…the Fed will be one of several agencies at the regulatory table of the future.


The Fed may well have to be satisfied, at the end of the financial reform day, to have control over the money stock and short-term rates.  Control over emergency window lending could be a bridge too far (13.3 authority which allows Fed board full discretion to lone money to anyone or thing including me for my fishing reels as collateral), and greater transparency (who gets what from the Fed) is assured.  And the compromise bill already looks like something between Frank’s more Fed friendly bill and Dodd’s less friendly bill, while the draconian (end the Fed bill) Rep Paul’s bill, has lots of House support initially, the Fed may find it best to work with more moderate Frank and Dodd versions. 


So why is a loss of Fed independence not priced into assets?  Because people in financial markets suffer from malignant tunnel vision.  Last week I sent an email (also attached below) that argued the paradigm change in macroeconomic theory underway in academia could elevate bank regulatory supervision as the key tools of monetary policy while delegating the importance of official interest rates.  But one does not need to follow econ theory to understand that the future of the Fed will leave it with diluted power over the financial system once through the Congressional sausage machine (there is bipartisan support for reining in Fed control over the banks) and this means a greater role for politics in determining monetary policy.  This is not great news for the USD, US Treasuries and ultimately all US assets (real estate and equities).


David Gilmore



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