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Bubble watching and bank supervision

Shahien Nasiripour of Huffington Post wrote a great story today about new language spotted in the FOMC meeting statement… and the pointed use of that language to send a message to the lawmakers who are deciding the new scope of the Fed’s authority…

The Federal Reserve is arguing that it must maintain supervisory authority over most of the nations banks so that it can spot speculative bubbles and use supervisory tools to reduce their effect… from Huffpo

~~~ “… minutes released Tuesday of the Federal Open Market Committee’s March 16 meeting, the Fed made clear that supervision does affect monetary policy by including the following language:

Members noted the importance of continued close monitoring of financial markets and institutions — including asset prices, levels of leverage, and underwriting standards — to help identify significant financial imbalances at an early stage.

At the time of the meeting the information collected in this process, including that by supervisory staff, had not revealed emerging misalignments in financial markets or widespread instances of excessive risktaking.

All members agreed that the Committee would continue to monitor the economic outlook and financial developments and would employ its policy tools as necessary to promote economic recovery and price stability.”~~~

The Federal Reserve has a very weak history of seeing speculative bubbles, the buildup of excessive leverage in the system or the relative value of securities pricing.

It appears that the Federal Reserve doesn’t think that the massive run in equity since last March is a speculative bubble.

Here is data that the large, professional staff economists at the Fed would have had available for study leading up to the crisis of 2007-2009 … from Lessons from the Banking Crisis: A Return to Narrow Banking (pg 21) by Paul de Grauwe…

~~~ “… What happened in the US economy between July 2006 and July 2007 to warrant an increase of 30 percent in the value of stocks? Or put differently, in July 2006 US stock market capitalization was $11.5 trillion.

One year later it was $15 trillion.

What happened to the US economy to make it possible that $3.5 trillion was added to the value of US corporations in just one year?

During the same year GDP increased by only 5 percent ($650 billion).

The answer is: almost nothing.

Fundamentals like productivity growth increased at their normal rate. The only reasonable answer is that there was excessive optimism about the future of the US economy.

Investors were caught by a wave of optimism that made them believe that the US was on a new and permanent growth path for the indefinite future. Such beliefs of future wonders can be found in almost all bubbles in history…” ~~~

It’s difficult to understand how continuing to supervise 5,000 small and medium banks would give the Fed the insight to see equity or bond market bubbles… these are “financial market” excesses… I do wonder if the Fed turns a blind eye to these excesses… former Chairman Greenspan used to like the idea of just cleaning up after bubbles burst… we have the mother of all cleanups on our hands now…

Congress must think clearly about assigning more authority to the Federal Reserve. If all the provisions of the Dodd legislation were enacted the Fed would have oversight for the following:

  • Full employment
  • Inflation
  • Interbank lending rates
  • Too big to fail banks
  • 5,000 smaller national banks
  • Clearing and settlement systems
  • Payment systems
  • Treasury auction sales
  • Derivatives oversight (through systemic risk council)
  • Potentially any systemically important firms

This is an enormous menu of responsibilities and authorties to assign to a quasi private institution.

Especially one that resists audit. It was painful to watch Congress and the media extract details of the bailouts from the Fed… and often these bailouts were rife with conflicts and inside dealing… GoOldman and AIG for example…

The fight for the new scope of the Federal Reserve will be the ultimate battlefield… there is so much money and influence at stake… at the end of this battle we will have shaped America’s national bank… will it be the Main Street Bank of America or will it be Wall Street’s central bank?

If the Fed believes that overseeing a great number of the countries banks gets us to the Main Street Bank of America I’m ready to hear that argument…

But I predict that the Fed’s heart lies with Wall Street and that will be the final ground that they defend…

Bring forward the artillery…