February 10, 2017 / 6:13 PM / 6 months ago

Review: Defending America against the Fed

U.S. Federal Reserve Chair Janet Yellen adjusts her glasses as she testifies before the Senate Banking Committee on Capitol Hill in Washington July 15, 2014.Kevin Lamarque

NEW YORK (Reuters Breakingviews) - The U.S. Federal Reserve can be a dry topic. Danielle DiMartino Booth makes it anything but. Her new book "Fed Up: An Insider's Take on Why the Federal Reserve is Bad for America," lays out the critique in intelligent, entertaining style. With the insistence of someone who saw the 2008 financial crisis coming and was largely ignored, she pulls few punches.

Booth offers humanizing glimpses of her personal evolution as a banker and journalist, as an employee of the Federal Reserve Bank of Dallas who didn't fit into the cosseted academic culture, and as a mother with sick new babies at the height of the unraveling of the U.S. and global financial system. However, it's her convincing tale of complacency at the heart of the Fed, and a failure to do much about it even after the crisis, that carries valid lessons today.

The U.S. central bank has conducted lengthy self-examinations over why it missed the meltdown despite strong warnings from people like Booth – and perhaps slightly less vigorous ones from her bosses, primarily Dallas Fed President Richard Fisher. Yet the institution still carries a deep feeling of groupthink.

Booth calls this out in no uncertain terms. At the academic level, she writes, armies of overqualified researchers worried more about peer reviews of their abstract research than the usefulness of what they were doing, and preferred not to rock the boat.

On the policymaking Federal Open Market Committee, she accuses successive Fed Chairs Alan Greenspan, Ben Bernanke and Janet Yellen of being (or at least becoming) too confident in their own views and economic models. Dissent – such as the practical, anecdotal variety provided by Fisher – was routinely squelched or sneered at.

Fisher was, Booth says, possibly too entertaining for the other members of the FOMC, a body that comprises the seven Washington Fed governors, the president of the New York arm, and four of the other 11 regional reserve banks. The likes of Fisher, who headed the Dallas Fed from 2005 to 2015, attend meetings but rotate in and out of the voting panel that sets monetary policy.

There's a black-and-white artifice to Booth's account: at times it's as if a few brave souls from Texas took on the entire East and West Coast establishment. But her main point is a good one. Very few of the Fed's staff or even, often, its governors have real-world experience to counter the central bank's ivory-tower tendencies.

Take the discount window the Fed used during the crisis to offer liquidity to a wider range of financial firms than ever before. "The academics naively assumed that just because the window was opened it would be used. The people who had been in the market ... knew the stigma associated with the discount window. Borrowers might as well invite speculators into the boardroom to short their stock."

The book revisits the proximate causes of the financial crisis, including bad mortgage lending, misconceived structured-debt products, ill-understood derivatives and excessive leverage. Booth ticks through landmark moments like the collapse of Lehman Brothers and the bailout of American International Group, all made worse by the hubris of those in charge. She doesn't have much time for the triumvirate of Bernanke, then New York Fed boss Tim Geithner and Treasury Secretary Hank Paulson as they attempted to patch up the financial system.

More illuminating is Booth's sense that far too little has changed since the crunch. She saves her most dismissive comments for the current Fed chair, whom she describes variously as "tiny, colorless Yellen," "a Keynesian on steroids" and "Bernanke in lipstick and a skirt."

She's also right to wonder why, as the effects of the crisis have faded, the Fed hasn't raised interest rates to more historically typical levels, or started pruning its now $4.5 trillion balance sheet. It seems as though almost any worry has been sufficient to hold the FOMC back, even when economic trends look healthy. In his latter years at the Fed, Fisher's corporate contacts were concerned about tax and regulation, not the cost or availability of debt.

Low rates have penalized savers and insurance companies and arguably helped the rich more than the poor. They have also distorted financial markets. Many financiers, though, like the assurance that the Fed will come to their rescue if the price of stocks and other assets starts to tumble. Hence Booth's reference to the outsized influence of Goldman Sachs in the central bank's thinking and the presence of alumni like New York Fed President Bill Dudley.

As well as criticisms, Booth offers some prescriptions. She recommends releasing the Fed from its dual employment and inflation mandate to focus solely on the latter. A more original suggestion is to limit the number of academic Ph.D.s on staff in favor of business people and other practitioners. Cutting Fed governors' terms to five years from 14 and giving all regional Fed presidents permanent FOMC votes would raise the real-world voices of the outposts versus the ivory-tower center. Essentially, she says, "mix it up."

The Fed isn't, however, quite the dominant cause of America's problems that she suggests. Bank executives and those in charge of fiscal policy, for instance, deserve a hefty share of the blame.

But Booth highlights the danger of central bankers being seen as almost omnipotent when the record shows their fallibility. The loss of humility is a constant risk. She quotes a Lithuanian central banker: "We are magic people. Each time we take something and give to the markets – a rabbit out of the hat." That's a sentiment Yellen and her peers should strive to resist.

Breakingviews

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