Opposing Roles of the Federal Reserve

I have been reading that one of the legacies of Alan Greenspan’s tenure at the Fed is his tolerance for experimentation, innovation, and greater risk-taking by the banks. I have no problem with innovation or risk-taking because they are some of the important factors that have have driven this economy and country. The only problem I do have with the Fed’s allowance for such risk-taking (only to bail out those who risked/gambled too much) is that I think it conflicts with the Fed’s own mission statement.

The Fed states that its duties fall into four general areas:

• conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates
• supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers
• maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
• providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system

Now these are broad, general pronouncements, but I think there is an argument to be made that if the Fed is encouraging risk-taking that it is not following its duty of, say for example, “supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system.” Again, I have no problem with risk-taking, so I guess my beef is just a nit-picky one of lack of uniformity.

A second topic I want to discuss involves the effects the Fed’s policies have on the economy. I was googling around the web and I found an interesting powerpoint presentation that provides a summary of Edward Chancellor’s presentation to The Global Borrowers and Investors Forum on June 23, 2005. It’s entitled The Destabilizing Stability of the Greenspan Era and basically outlines three arguments against the Fed policy at that time (a policy which I’m just going to assume is still being followed by Bernanke).

The most interesting argument came from a Hyman Minsky hypothesis: “each stage [of the business cycle] nurtures forces that lead to its own destruction.” The three cyclical financial stats are described as “hedge,” “speculative,” and “Ponzi.” I don’t think there could be a more apt description of what occurred in the most recent of failed business cycles, the subprime market.

But getting back to one of the general themes: the pursuit of stabilization can lead to destabilization. Very Sophoclean in that the attempts to avoid the prophecy in the end actually fulfill the prophecy. But in the real world, we can never tell that if those steps weren’t taken that things would have been worse.

In an attempt to sum up, though the Fed may have given itself conflicting roles and duties and though it may destabilize by its attempts to stabilize, the Fed must in the end do its best to protect the economy through whatever means and authority it has. Meanwhile I’ll continue to be amused by apparent contradictions and will try to better understand what is going on in the world.