Nation of Beancounters

The new central bank

Posted in Uncategorized by Navin Kumar on September 1, 2012

John Cochrane notes that these aren’t your dad’s central banks:

Momentous changes are under way in what central banks are and what they do. We are used to thinking that central banks’ main task is to guide the economy by setting interest rates. Central banks’ main tools used to be “open-market” operations, i.e. purchasing short-term Treasury debt, and short-term lending to banks.

Since the 2008 financial crisis, however, the Federal Reserve has intervened in a wide variety of markets, including commercial paper, mortgages and long-term Treasury debt. At the height of the crisis, the Fed lent directly to teetering nonbank institutions, such as insurance giant AIG, and participated in several shotgun marriages, most notably between Bank of America and Merrill Lynch.

…In addition, the Fed is now a gargantuan financial regulator. Its inspectors examine too-big-to-fail banks, come up with creative “stress tests” for them to pass, and haggle over thousands of pages of regulation. When we think of the Fed 10 years from now, on current trends, we’re likely to think of it as financial czar first, with monetary policy the boring backwater.

He doesn’t regard regulatory status as a good thing:

Using its bank-regulation authority, the Fed declared that the banks that had robo-signed foreclosure  [in which foreclosure notices were automatically generated and sent to suspect defaulters] documents were guilty of “unsafe and unsound processes and practices”—though robo-signing has nothing to do with the banks taking too much risk.

The Fed then commanded that the banks provide $25 billion in “mortgage relief,” a simple transfer from bank shareholders to mortgage borrowers—though none of these borrowers was a victim of robo-signing.

…The Fed said candidly that it was acting “in conjunction” with the state attorneys general and the Justice Department. So much for an apolitical, independent Fed.

He sees a dark future ahead:

…you can see where we are going: Hey, nice bank you’ve got there. It would be a shame if the Consumer Financial Protection Bureau decided your credit cards were “abusive,” or if tomorrow’s “stress test” didn’t look so good for you. You know, we’ve really hoped you would lend more to support construction in the depressed parts of your home state.

Conversely, when the time comes to raise interest rates, how can the Fed not consider that doing so will hurt the profits of the too-big-to-fail banks now under its protection?

I don’t regard the shift to with as much horror as he does, but he’s right that it’s happened. India isn’t there yet, mostly on account of having an already tightly regulated banking/finance sector and no financial crisis to speak of but It Can Happen Here Too.

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