Should the mandate of the US Fed be re-written?

Often we hear the Fed Chairperson say that their policy is being effected in order to fulfill their mandate to keep employment high in the US.  Realistically, in a changing world in which most jobs are service jobs and require education, this mandate should perhaps be dropped.

President Obama and his Secretaries of Education well understand the need to educate for jobs.  Political correctness sometimes masks the basic requirements for change. No one thinks the US Fed can help this process.

As we wait for the anticipated tiny rise in the interest rate, but at least a rise, the power of the Fed is patently clear.  The real question we should be asking is: Has the Fed become too powerful in the US?  Who is benefitting from Fed policies?

In the important new film “The Big Short” on character notes that Ben Benanke has just left the White House.  The character remarks:  “There’s going to be a bailout.”

On the one hand, no one stepped up to plate to address the economic crisis in 2008 except the Fed.  In anticipation of future crises, small and large, does it not behoove legislators to think about and act on a new leadership role when these inevitable events occur?

Preetinder Singh “Preet” Bharara is an Indian American attorney and the U.S. Attorney for the Southern District of New York. His office has prosecuted people worldwide and has prosecuted nearly 100 Wall Street executives.

Bharara has won nine out of 10 cases against a parade of disgraced Albany lawmakers since taking the helm of the Southern District of New York in 2009, prevailing in three trials and garnering six guilty pleas.  In his crosshairs were two of New York’s biggest political animals: former Assembly Speaker Sheldon Silver and former Senate Majority Leader Dean Skelos.  He has won convictions against both of them.

Mr. Bharara may also be hunting the biggest game of all in New York: Gov. Andrew Cuomo, whom he has criticized for disbanding the Moreland Commission on public corruption. Last week, word broke that Mr. Bharara is investigating $1 billion in funding provided by the governor to help revive Buffalo. Mr. Cuomo said over the weekend that he had no role in awarding the so-called “Buffalo billion” to bidders.

Aggressive and media-savvy, Mr. Bharara portrays himself as the white knight cleaning up the “cauldron of corruption” in Albany. Even in the case he lost, the defendant ended up behind bars. In 2011, a federal jury found William Boyland not guilty, but the Democratic assemblyman was convicted three years later, courtesy of Mr. Bharara’s Eastern District counterpart Loretta Lynch, who is now U.S. attorney general.

“Bharara is on the warpath,” said James Cohen, a criminal-defense professor at Fordham University Law School. “He thinks the whole thing is a sewer, and he’s in a position to make some change.”

To do it, the prosecutor has used techniques perfected in fighting terrorists and organized crime, employing stings, wiretaps, video surveillance and undercover FBI agents to catch politicians in the act.

He then uses his perch to wage a media campaign that generates momentum and sets the stage for a trial or, in the majority of cases, a guilty plea. He has used similar tactics to snare miscreants on Wall Street, where his track record is even more impressive, winning more than 80 convictions and guilty pleas, although one of his insider-trading victories was thrown out on appeal last year.

Bharara has won 11 corruption cases against state legislators by following the money.

In the NY Assembly the Chairman of the Ethics  committee has never been allowed to hold a hearing.  If you are allowed to have outside income, you can hide it as a bribe.  If you oppose one of the leaders you are banished.

But you can not trade in exchange for getting something to line the pockets of yourself or a family member.  You take an oath of office to serve the public.  You are guilty of public corruption.  Bharara is making sure these laws stick.

Of the three remaining mainstream Democratic candidates, all three propose changing rules for the financial sector.  Only Mrs. Clinton would not re-instate Glass Steagall, the wall her husband broke down between investment and commercial banking activities.  It is well  to remember that both Clintons have made  fortune lecturing to the banking industry and that the Clinton campaign is based on contributions from banking.  The Clinton son-in-law runs a hedge fund that was set up for him by Goldman Sachs.

Simon Johnson writes:  The three candidates disagree on whether there should be legislation to re-erect a wall between the rather dull business of ordinary commercial banking and other kinds of finance (such as issuing and trading securities, commonly known as investment banking).

This issue is sometimes referred to as “reinstating Glass-Steagall,” a reference to the Depression-era legislation – the Banking Act of 1933 – that separated commercial and investment banking. This is a slight misnomer: the most credible bipartisan proposal on the table takes a much-modernized approach to distinguishing and making more transparent different kinds of finance activities. Sanders and O’Malley are in favor of this general idea; Clinton is not (yet).

This argument that some financial firms that got into trouble in 2008 were standalone banks like Lehman or an insurance company like AIG.  What happened “last time” is rarely a good guide to fighting wars or anticipating future financial crises. The world moves on, in terms of technology and risks. We must adjust our thinking accordingly.

At worst, the argument is just plain wrong. Some of the greatest threats in 2008 were posed by banks – such as Citigroup – built on the premise that integrating commercial and investment banking would bring stability and better service. Sandy Weill, the primary architect of the modern Citigroup, regrets that construction – and regrets lobbying for the repeal of Glass-Steagall.

Second, leading representatives of big banks argue that much has changed since 2008 – and that big banks have become significantly safer. Unfortunately, this is a great exaggeration.

Ensuring a financial system’s stability is a multifaceted endeavor – complex enough to keep many diligent people fully employed. But it also comes down to this: how much loss-absorbing shareholder equity is on the balance sheets of the largest financial firms?

In the run-up to the 2008 crisis, the largest US banks had around 4% equity relative to their assets. This was not enough to withstand the storm. (Here I’m using tangible equity relative to tangible assets, as recommended by Tom Hoenig, Vice Chairman of the Federal Deposit Insurance Corporation, and a beacon of clarity on these issues.)

Now, under the most generous possible calculation, the surviving megabanks have on average about 5% equity relative to total assets – that is, they are 95% financed with debt. Is this the major and profound change that will prove sufficient as we head through the credit cycle? No, it is not.

Finally, some observers – although relatively few at this point – argue that the biggest banks have greatly improved their control and compliance systems, and that the mismanagement of risk on a systemically significant scale is no longer possible.

This view is simply implausible. Consider all the instances of money laundering and sanctions busting (with evidence against Credit Agricole and  Deutsche Bank and almost every major international bank in the past few years).

This is the equivalent of near misses in aviation. If the US had the equivalent of the National Transportation Safety Board for finance, we would receive detailed public reports on what exactly is – still, after all these years – going wrong. Sadly, what we actually get is plea bargains in which all relevant details are kept secret. The regulators and law-enforcement officials are letting us down – and jeopardizing the safety of the financial system – on a regular basis.

The best argument for a modern Glass-Steagall act is the simplest. We should want a lot more loss-absorbing shareholder equity. We should ensure that various activities by “shadow banks” (structures that operate with bank-like features, as Lehman Brothers did) are properly regulated.

Building support for legislation to simplify the biggest banks would greatly strengthen the hand of those regulators who want to require more shareholder equity and better regulation for the shadows. These policies are complements, not substitutes.