Robert Shiller Pushes Fed as Stability Regulator

Oooh, because I have to be on a plane at an ungodly early hour tomorrow, I do not have time to do Robert Shiller’s New York Times piece, “” justice.

In short, I don’t agree with this mission creep by the Fed becoming official. First, as Shiller implies, the Fed has been moving in that direction, thanks to Alan Greenspan. Greenspan also de-emphasized the Fed’s role as financial regulator, resorted to bubble inducing negative real interest rates to combat what would likely have been a garden variety recession, and though adjustable rate mortgages were entirely a good thing. Greenspan’s legacy, in the form of the worst financial crisis since the Depression, is enough to question the wisdom of any policies implemented on his watch.

Second, the Fed simply isn’t big enough either in terms of its financial resource or its purview to accomplish such a goal. What can the Fed do about our massive current account deficit? It clearly can’t continue at current levels, and its reversal is going to heighten our economic duress. The Fed can’t make Japan stop offering yen financing for the carry trade. It could raise interest rates, which would encourage more savings, but that would slow growth.

Which leads us to third, this new goal can conflict with the Fed’s other aims, of generating full employment and stable prices.

Fourth, the Fed lacks the understanding of and ability to gather information about numerous markets and products that affect “market stability.” The Fed could not obtain documentation for collateralized debt obligation agreements, for instance, unless an investor felt generous and slipped the Fed a copy. It has very little understanding of the credit default swaps market, beyond the fact that if it came apart, that would be a very bad thing indeed.

From the New York Times:

The plan of Treasury Secretary Henry M. Paulson Jr. to overhaul the financial system includes a crucial proposal: it would officially transform the Federal Reserve into a “market stability regulator” rather than merely a banker’s bank.

This aspect of the Treasury plan is a natural step in a historical trend. The Fed is no longer just a regulatory agency presiding over a narrow group of businesses called banks. Rather, its mission increasingly is to maintain macro confidence — confidence that the entire financial system is functioning well as part of the whole economy.

In contrast, traditional securities regulators like the Securities and Exchange Commission have as their primary mission the maintenance of micro confidence — confidence that individual firms are disclosing the truth about their own internal operations and are not manipulating information.

But as the current financial crisis attests, it is macro confidence that requires the most subtle attention. The instability in even in the most modern economies accounts for the growing respect for the financial stabilization offered by central banks.

Moreover, the nature of financial institutions is changing, and as finance becomes more sophisticated, the traditional boundaries of banking have blurred. In the current crisis, for example, there have been significant liquidity problems associated with “special-purpose vehicles” or “conduits,” which issue asset-backed commercial paper. These entities resemble banks but are not technically banks. In the new financial order, in fact, we do not clearly know what is or is not a bank, so a narrow definition of the mission of the central bank is no longer appropriate.

In recent years, central banks have not always managed macro confidence magnificently. The Fed failed to identify the twin bubbles of the last decade — in the stock market and in real estate — and we have to hope that the Fed and its global counterparts will do better in the future. Central banks are the only active practitioners of the art of stabilizing macro confidence, and they are all we have to rely on.

The trend toward greater powers for the Fed isn’t new. In 1932, Congress extended the Fed’s power by giving it the authority “in unusual and exigent circumstances” to make discount-window loans to any organization or individual, not just to member banks. In 1980, Congress gave the Fed the authority to use its discount window in the normal course of business for all depository institutions, including savings associations and credit unions, and to set reserve requirements for them as well.

The Fed has been taking an expansive view of its own powers recently, for the most part with considerable public approval. Witness its decision to give a $29 billion line of credit to JPMorgan Chase to encourage the purchase and rescue of Bear Stearns. There was very little criticism of this move because so many people rightly feared the systemic effects on financial institutions if the Fed did not act. Bear might have had to dump its troubled assets on the market, and the whole financial house of cards could have collapsed. Because we sense that maintaining confidence in our financial system is so important, we are permitting the Fed to expand its role.

The trend toward greater reliance on central banks has been global. These institutions have been given more independence, as with the Bank of Mexico in 1994, both the Bank of England and the Bank of Japan in 1997, and the creation of the European Central Bank in 1998. Independence, of course, means more power.

Two of the Fed’s most important innovations were internationally coordinated measures. These were the establishment of the Term Auction Facility in December, for the auctioning of 28-day advances to depository institutions, and the creation last month of the Term Securities Lending Facility, which lends Treasury securities to so-called primary dealers — banks and securities firms like Goldman Sachs, Morgan Stanley and Lehman Brothers. The rising prestige of the world’s central bankers is apparent, as these have been perhaps the most significant international steps to deal with the financial crisis…

Mr. Bernanke’s own analysis of history, as well as that of other economists, emphasizes the essential importance of confidence in financial institutions and the subtlety of the issues involved in promoting such confidence.

For example, Mr. Bernanke has said that a significant motivation for starting the Term Auction Facility was to make it possible for troubled banks to borrow from the Fed discount window without encountering “the so-called stigma problem.” What is stigma? We are not talking about emotions here, but about banks’ efforts to act in such a way as to maintain the confidence of people who deal with them. We are talking about discovering subtle instabilities in the house of cards, and fixing them.

Confidence is too complex for the consumer confidence indexes — which are based on surveys of ordinary people — to measure adequately. It has to do with confidence in specific institutions — confidence that they will behave properly and that the leaders who are trying to promote others’ confidence will act in a constructive way.

Formalizing the Fed’s transformation into a market stability regulator makes sense. The Fed has already begun to play this role. And by doing so, it is taking a significant step toward reducing the fundamental instability of our economy.

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16 comments

  1. S

    “Confidence is too complex for the consumer confidence indexes — which are based on surveys of ordinary people — to measure adequately”

    Earth to Shiller ordinary people are the absolute majority by a long shot in the US, hard as that is to fathom. You know all the jobs that are disappearing in the tens of thousands monthly. The heralded financial sector, the creative genius behind the future of america, obviously isn’t sophisticated enough to get it either. Frankly they just know the complex was always zero sum. So it is a relief to know that a few academics with little experience in markets are at the ready with the never ending monetary bong hit. Most worrying financial “innovation” is going national, which is a depressing anecdote about the myth sold the American people about their comparitive advantage in this new paradigm. There is something grossly ironic that we still have officials and pundits talking about confidence when the reality is foreign central banks hold the golden share. The moment they exercise is the moment this whole charade ends.

    Funny that NY Fed president wins kudos in the Press for his “performance,” which is exactly what is was, a performance. As for the Senate (rs), they are an even bigger embarrasment. With every speech and “creative” initiative, the insitutions of government lose more credibility. Americans will never see their government take the necessary actions to correct the malignancies that are hollowing out the economy and national character. Too much is at stake from a policy standpoint, past, present and future. Necessary corrective action would given the lie to the entire global complex sold (imposed) to (on) Americans. The corrective action will have to come from foreigners, who will act the moment they deem the world has moved off eastern daylight time.

  2. Francois

    “Confidence is too complex for the consumer confidence indexes — which are based on surveys of ordinary people — to measure adequately.”

    Does he mean that it should be based on surveys of extraordinary people? WTF is sooo complex with confidence? Confidence is the impression one possess when he/she can answer “Yes” to the question: “Do you trust this individual/institution enough to deal with him/she/it. THAT is too complex? Give me a break!!

    “It has to do with confidence in specific institutions.” As opposed to nonspecific institutions? What in the world does Schiller mean by that?

    “Formalizing the Fed’s transformation into a market stability regulator makes sense.”

    I agree with Yves’s reserves about that one and strongly disagree with Schiller, in no small part for the reasons S mentioned in his excellent post above. All it does is leaving the politicos off the hook to tackle the tough debate needed, while giving them the golden opportunity to play Monday morning quarterbacks and scoring free TV time to lambast civil servants left with an impossible job during Congressional hearings. The moronic show of last Thursday is a good example of that. More appropriate would have been a Commission mandated by Congress to elucidate the whole mess. At least the right questions could have been asked and expert support provided to the Commissioners, hence, less probability of grade-AAA BS from JPM and the Fed during the Q&A sessions.

    Are we in deep doodoo or what?

  3. Anonymous

    Re: The Fed has been taking an expansive view of its own powers recently, for the most part with considerable public approval.

    I had to puke when I read that and wondered what kind of crap this guy is snorting?

    >> considerable public approval???

    Is there a poll or rating from anyone or this just some touting opinion that is worth more than a tube of glue?

  4. TallIndian

    The newspaper of Wen Ho Lee, Whitewater, and Judith Miller strike again.

    Arguably one of the funniest lines

    There was very little criticism of this move because so many people rightly feared the systemic effects on financial institutions if the Fed did not act. Bear might have had to dump its troubled assets on the market, and the whole financial house of cards could have collapsed.

    What does this guy do all read, Maureen Dowd and watch Larry Kudlow on TV?

  5. Anonymous

    First off, there is a lot of distortion to what powers The fed may have:

    Re: “In 1932, Congress extended the Fed’s power by giving it the authority “in unusual and exigent circumstances” to make discount-window loans to any organization or individual, not just to member banks.”

    This is Fed history:

    President Franklin Roosevelt signed a bill into law that added Section 13(b) to the Federal Reserve Act, which authorized the Federal Reserve to “make credit available for the purpose of supplying working capital to established industrial and commercial businesses,” according to the Federal Reserve Board’s 1934 annual report.

    I would like you all to not the term, “working capital”:

    Working capital is calculated as current assets minus current liabilities. A company can be endowed with assets and profitability, but short of liquidity, if these assets cannot readily be converted into cash.

    By definition, Working capital management entails short term decisions – generally, relating to the next one year period – which are “reversible”.

    What are the terms for this acquisition/loan????

  6. Richard Kline

    *AARRRGHH* What a stiff-the-stupid-proles shillfest. What isn’t redefinition smoke in this piece is ‘sign here, my good man’ snake oil.

    “. . . [The]nature of financial institutions is changing . . . the traditional boundaries of banking have blurred . . . In the new financial order, in fact, we do not clearly know what is or is not a bank . . . .” Bob, you just stated _the problem_ not immovable parameters of our financial universe. We’ve allowed non-banks to lend and borrow, at high volume, to maximum recklessness, solely for personal gain, with zero oversight. That is something that can certainly be GREATLY RESTRICTED by regulation, and must be. Oh, sharpies will always find flash ways to gamble with the funds of others. Let’s have them follow some basic rules and cut them off before they can take the rest of us down with them. And while we’re at it, let’s tax them plenty for the privilege of doing business onshore.

    “Two of the Feds important recent innovations are {the TAF and the TSLF}.” No, these weren’t ‘innovations,’ those inventive, risk-taking, heroic deeds seemingly implied by that term, Bob. These were acts of stone desperation to keep the present insolvency of the financial industry, commercial and speculative both, from killing the banking industry, economy, and currency simultaneously. We don’t face a “confidence” problem, we face a ‘confidence _man_’ problem which has created an involvency problem.

    In addressing the drivers and structures of our present Subcrime Bubble, I am deeply opposed to concentrating yet more authority in the ever-hidden hands of Our Benevolent Chairman. The charge of the Fed has been to grow the banking system. The Fed bungled or stifled it’s regulatory tasks under Greenspan, so those tasks should be reassgined to a different super-agency insulated from direct pressure from the industry and charged with keeping the banks solvent and alive since they can’t seem to manage to to this unaided what with all their ‘heroic innovation’ WHICH THE REST OF US COULD WELL DO ENTIRELY WITHOUT! If there’s an us and them concerning the plutocrats, Bob, it’s clear you’re not with us. In the class war of the last generation, the rich have won big, long, and often, but now that it’s time to clink the cuffs you ask us to clink the guineas for them hey again?

    We need two keys on the banking industry, as I’ve opined before; checks and balances. This means that if the Fed is the Moderator we need a _real_ Regulator. Not more smooth operators like Robert Shiller.

  7. Richard Kline

    Regarding Greenspan’s negative real rates in ’02-’03, I don’t think he did this simply to avoid ‘a garden variety recession,’ which I agree is what we likely would have had. I believed then, and do now, that St. Alan went negative because that garden variety recession would have put off and so likely prevented the massive tax cuts for the plutocracy which were his heart’s desire. Politically, they those cuts couldn’t have been sold in a recession, mild or not, so sane or not steps to put off a recession were necessary. —And so Greenspan screwed the public to make sure the tax cut went through. Probably, he thought he could clean up the mess down the road; he’s that self-inflated, and had ‘succeeded’ before, but he knew what he was doing and why, to my perspective. If, as may be the case, Greenie only showed nonfeasance and misfeasance in his ‘failure to regulate’ the speculative risks of the financial industry, I am of the view that he most definitely showed malfeasance in his inflate-o-rates. The failure to regulate was the greater ill, to me, but his dropping money from helicopters to the brokrs and bankers was done to insure the plutocracy could cash in on a once in a century sociopolitical window of stupidity.

    And Shiller wants to give _more_ authority to the inheritor of that office? . . . “Worked once, didn’t it? They’re stupid enough to smoke that ‘xplodin’ ceeegar twice, me thinks. And I get commission! *clacka-clacka-clacka-ping*”

  8. Anonymous

    If the Federal Reserve has clearly proven itself to be a TOTAL failure as a regulator, why would you concentrate yet more regulatory powers into the hands of the Fed?

    They watched while Rome burned. Where is the accountability for what happened here? High officials at Fed/Treasury need to be fired. After all this, they are still admitting nothing and are still being fawned on by the media as our “saviours”.

    The response to the crisis is yet more “deification of the Fed” and its “almighty powers”. Can our system get any dumber?

  9. RK

    When the monkey steals the keys to all the cages in
    the zoo, you’re going to have a problem. In our great
    nation, there are a limited number of potential institutions which could exercise authority over those
    “monkeys” which have destabilized the financial system, and from the perspective of competence, independence and the possession of a clear understanding of the inter-market linkages, the list is as ugly as it is short.
    !. Congress
    2. The President
    3. The Courts
    4. The Treasury
    5. The Fed
    6. An agency yet to be named
    The big problem is that the “monkeys” will ALWAYS
    be smarter than 1-4, and ALMOST ALWAYS smarter
    than 5-6. They will also always be wealthier, and
    hence more influential, than 1-6, and will find ways
    to neuter rules they consider onerous, with a packed Supreme court on their side, should congress or the president fail to support them.
    In the end, there is only one regulator who can clean up the AUGEAN STABLE. His name is Mr. Market.

  10. Anonymous

    What the hell happened to Robert Schiller……

    He has become Col. Kurtz. (Apocolypse now !) Oh, the horror !

  11. Anonymous

    The Fed has already begun to play this role. And by doing so, it is taking a significant step toward reducing the fundamental instability of our economy.

    The only thing they have done for me is force my investments out of a dying currency, and rigged markets, There are simply better places to put ones money and it doesn’t have to be in dollars.

  12. Anonymous

    We can all see that the Fed. isn’t going to solve this disaster. All they are doing is keeping the patient(U.S. economy) on “life support”.

    They’re “stabilizing” the patient while the industrialists “deleverage” [read] get liquid and get the heck out of dodge before its to late.

    Uncle Ben’s “big plan” is to maintain this charade long enough for our countries capital to be sucked up and flown away somewhere safe.

    This is going to be the biggest “rip off” of all time. It seems that “globalization” means that the industrial parasites can canabalize their own country. Capital no longer has any boarders or loyalty.

    We are now victims of our own foreign policy. Welcome to Third World status.

  13. Anonymous

    Re: “Two of the Feds important recent innovations are {the TAF and the TSLF}.”

    Re: “what the hell happened to Robert Schiller..”

    See: MEFO Bonds and the roots of The Fed:

    An imaginary company

    Hjalmar Schacht formed the limited liability company Metallurgische Forschungsgesellschaft, m.b.H., or “MEFO” for short. The company’s “mefo bills” served as bills of exchange, convertible into Reichsmark upon demand. MEFO had no actual existence or operations and was solely a balance sheet entity. The bills were mainly issued as payment to armaments manufacturers.
    Mefo bills were issued to last for six months initially, but with the provision for indefinite three-month extensions. The total amount of mefo bills issued was kept secret.

    Re: chacht negotiated several trade agreements with countries in South America, and South-East Europe, ensuring that Germany would continue to receive raw materials from those countries, but that they would be paid in Reichsmarks; thus ensuring that the deficit would not get any worse; whilst allowing the Nazis to deal with the gap which had already developed. Schacht also found an innovative solution to the problem of the government deficit by using mefo bills. He was appointed General Plenipotentiary for the War Economy in May 1934[6] and was awarded honorary membership of the Nazi Party and the Golden Swastika in January 1937.

    Schacht had been president of the Reichsbank between 1923 and 1930, but had been dismissed. Now he would return in triumph. He felt vindicated. Within weeks, the ingenious solution to Germany’s pressing financial woes would burst forth from his inventive brain.

    “It was necessary,” Schacht later explained, “to discover a method that would avoid inflating the investment holdings of the Reichsbank immoderately and consequently increasing the circulation of money excessively.”

    “Therefore,” he went on, “I had to find some means of getting the sums that were lying idle in pockets and banks, without meaning for it to be long term and without having it undergo the risk of depreciation. That was the reasoning behind the Mefo bonds.”

    What were these “Mefo” bonds? Mefo was a contraction of the Metallurgische Forschungs-GmbH (Metallurgic Research Company). With a startup capitalization of one billion marks – which Hitler and Schacht arranged to be provided by the four giant firms of Krupp, Siemens, Deutsche Werke and Rheinmetall — this company would eventually promote many billions of marks worth of investment.

  14. Anonymous

    Opaqueness doesn’t lead to confidence. It leads to people gaming the system, corruption, and cronyism.

    The new goal seems to be about managing expectations. We seem to be turning Red.

  15. Anonymous

    quoted,
    “What were these “Mefo” bonds? Mefo was a contraction of the Metallurgische Forschungs-GmbH (Metallurgic Research Company). With a startup capitalization of one billion marks – which Hitler and Schacht arranged to be provided by the four giant firms of Krupp, Siemens, Deutsche Werke and Rheinmetall — this company would eventually promote many billions of marks worth of investment.”

    Well, unfortunately for us we don’t have any industries that can second as a bank.

    Remember, our only export is debt. We print money, we don’t generate it. i.e. record high trade deficit.

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