FT: Treasury proposes new powers for Fed

This article isn’t long on details. Treasury feels “enhanced regulatory powers” would be a “better tool than interest rates” to “contain asset price bubbles.”

Hmmm. The Fed isn’t currently charged with the task of containing asset bubbles to begin with. Its job is to maintain low inflation consistent with full employment. The prevailing view of the Fed’s role vis-a-vis asset bubbles during the Greenspan years was summed up by the man himself in 2004:

“It is far from obvious that bubbles, even if identified early, can be pre-empted at a lower cost than a substantial economic contraction and possible financial destabilization,” Greenspan told the American Economic Association in 2004.

The Fed has been rethinking this view of late.

I’m particularly curious about the part that mentions the Fed using its authority to order hedge funds to “curtail strategies” that put the wider economy at risk. How would the Fed do that? Hedge funds are ostensibly unregulated now. Would HFs report real-time data to the Fed on their positions and trades? The Fed would need to build a rather large bureaucracy to be an effective chaperon.

The Federal Reserve could use proposed new regulatory powers to try to stop credit and asset market excesses from reaching the point where they threaten economic stability, the US Treasury said on Tuesday.

David Nason, assistant secretary for financial institutions, said the Fed could even use its proposed “macro-prudential” authority to order banks, hedge funds and other entities to curtail strategies that put financial stability at risk.

By “leaning against the wind” in this way, the US central bank could “attempt to prevent broad economic dislocations caused by potential excesses”, he said.

His comments come amid debate inside the Fed as to whether it should try to do more to contain asset price bubbles, following the housing and dotcom busts. Some see enhanced regulatory powers as a better tool for this than interest rates.

The proposed new powers – outlined in a Treasury blueprint published last month – require legislation and may never be authorised. But policymakers see the plan as offering a template for future regulation.

The blueprint envisages giving the Fed roving authority to collect, analyse and publish market data from a wide range of institutions, from banks to hedge funds.

“The market stability regulator must have access to detailed information about all types of financial institutions,” said Mr Nason.

Hedge funds are uneasy about this proposal. However, many European central bankers are eager to acquire the kind of macro-prudential powers the Treasury would like to give to the Fed.

Meanwhile, data showed accelerating US house price declines and further declines in consumer confidence.

Incidentally, the WSJ published a fascinating op-ed today that argued the Fed should rethink its mandate. Since Phillps theorized his curve, it has been thought that there is a tradeoff between inflation and employment. Too low inflation reduces economic activity, lowering employment. But the author argues that the data don’t confirm this relationship, that low inflation years and the periods thereafter are marked by higher employment. With this in mind, he argues the Fed should start raising rates again not only to protect the dollar but to promote long-term growth.

That would boost the returns on my money market investments, so I’m supportive. Not to mention that a stronger dollar would bring oil and food prices back to earth….

Posted in Fed, Interest Rates |