Washington Matters


Congress Swims in Dangerous Fed Waters


It's a glimpse of what's ahead.

 

There was a time when the chairman of the Federal Reserve would be grilled by Congress over interest rates being too high, or too low, or whether tax increases should be a part of deficit reduction -- in other words, criticism and debate over the Fed's critical tasks involving monetary and fiscal policy.

But these days the Fed and its current chief Ben Bernanke are being taken to task for what was said, or not said, to parties in the Bank of America acquisition of investment firm Merrill Lynch a few months ago.

 

And, ironically, Republicans in Congress are the loudest critics of Bernanke with praise coming from the Democratic White House for the Bush administration appointee whose term is up for renewal at the end of January.

 

Republicans (and some Democrats) are agitated over a new White House plan to give the Fed more regulatory power to prevent another crisis in the financial system, which some say caused the recession, and which certainly made things worse. Officials at the Fed have said they need more authority to step in, while critics say the Fed was deceptive and secretive in actions that it took involving Bear Stearns, Lehman Brothers and other financial firms. Shoved to the backseat in this debate is a closer look at innovative steps taken by the Fed to thaw a freeze in lending late last year.

 

Observers have been warning that expansion of the Fed's regulatory scope could drag the chairman before Congress to explain and defend actions taken, fostering hostility between Congress and the Fed that would spill over and harm the conduct of monetary policy.

 

Some of that is already happening. At a hearing June 25, a House committee got into the nitty gritty of who said what and whether the Fed bullied Bank of America into acquiring Merrill Lynch. One congressman accused the Fed of a cover up, while Bernanke denied that he tried to keep details of negotiations a secret.

 

Fed officials among themselves are debating the wisdom of taking on new powers. They raise doubts that the Fed can add a third mandate: the prevention of financial instability to the dual mandates it already has -- nurturing economic growth and controlling inflation. It's a big enough challenge enough for the Fed to explain itself to banking committees, but this latest grilling came at a hearing of the House Oversight and Government Reform Committee.

 

Because of those doubts and with the spectacle of the hearing, it's now a bit less likely that financial reform will include giving the Fed broad new powers. But the genie is out of the bottle. There will be more criticism of the Fed, more hearings, and more debate over who said what and when. And eventually more interference by lawmakers in how the Fed shapes and explains its crucial mission of promoting growth with stable inflation.

 

What difference will it make? The Fed doesn't directly control long-term interest rates for corporate borrowing, mortgages for homebuyers or for Treasury borrowing to finance budget deficits. Bond traders and investors move those rates. And the more attacks by politicians on the Fed, the more anxious the bond markets, and that means more volatile interest rates.

 




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