How libertarian dogma led the Fed astray

[Bradley in DC]

http://www.ft.com/cms/s/0/705574f2-3...nclick_check=1

Ironically, the problem was made worse by the fact that the Fed was inconsistently libertarian. The central bank stuck to its hands-off approach during monetary expansion but abandoned it when constraint was necessary. And that, in turn, projected an unpredictable and inconsistent set of rules of the game.

[Paulitician]

ROFL, is this the same guy Tom Woods (and Mike Shedlock) responded to? He has no credibility...

At any rate, government being inconsistent is a problem though. That much (probably the only thing) he has right.

[Bern]

The problem was not just a flawed implementation of the system. The problem is systemic to the structure of the system. Mr. Kaufman has tunnel vision.

[Bradley in DC]

The problem was not just a flawed implementation of the system. The problem is systemic to the structure of the system. Mr. Kaufman has tunnel vision.

I think Kaufman is only opining about the system we have, not anything else.

ROFL, is this the same guy Tom Woods (and Mike Shedlock) responded to? He has no credibility...

At any rate, government being inconsistent is a problem though. That much (probably the only thing) he has right.

Kaufman, for better or for worse, is well known and respected. Regarding repealing Glass-Stegall, Dr. Paul voted against it because of the expansion of deposit insurance and the taxpayer liability (which we're seeing now). Removing government restrictions is otherwise a good idea.

[Paulitician]

Kaufman, for better or for worse, is well known and respected.

Sad...

Regarding repealing Glass-Stegall, Dr. Paul voted against it because of the expansion of deposit insurance and the taxpayer liability (which we're seeing now). Removing government restrictions is otherwise a good idea.

Yeah, the problem with such "deregulation" was that it wasn't really deregulation at all. Otherwise said expanion of depoist insurance and taxpayer liability would be completely off the table... IMO, the "deregulation" was a favor from congressmen to the bankers, who lobbied for, and probably mostly wrote, the damned bill

[Brian4Liberty]

Could you post the full article? The website requires a login...

Greenspan was a member of the Rand cult. Does that really make him a libertarian?

[Bradley in DC]

Could you post the full article? The website requires a login...

Greenspan was a member of the Rand cult. Does that really make him a libertarian?

How libertarian dogma led the Fed astray
By Henry Kaufman
Published: April 27 2009 19:16 | Last updated: April 27 2009 19:16
The Federal Reserve has been hobbled by at least two major shortcomings that were primarily responsible for the current and several previous credit crises. Its failure to spot the importance of changing financial markets and its commitment to laisser faire economics were big mistakes and justify a fundamental overhaul of the Fed.

The first of these shortcomings was its failure to recognize the significance for monetary policy of structural changes in the markets, changes that surfaced early in the postwar era. The Fed failed to grasp early on the significance of financial innovations that eased the creation of new credit. Perhaps the most far-reaching of these was the securitisation of hard-to-trade assets. This created the illusion that credit risk could be reduced if instruments became marketable.

Moreover, elaborate new techniques employed in securitisation (such as credit guarantees and insurance) blurred credit risks and raised – from my perspective, many years ago – the vexing question, “Who is the real guardian of credit?” Instead of addressing these issues, the Fed was highly supportive of securitisation.

One of the Fed’s biggest blind spots has been its failure to recognise the problems that huge financial conglomerates would pose for financial stability – including their key role in the current debt overload. The Fed allowed the Glass-Steagall Act to succumb without appreciating the negative consequences of allowing investment and commercial banks to be put together. Within two decades or so, financial conglomerates have come to utterly dominate financial markets and financial behaviour. But monetary policymakers failed to recognise that these behemoths were honeycombed with conflicts of interest that interfered with effective credit allocation.

Nor did the Fed recognise the crucial role that the large financial conglomerates have played in changing the public’s perception of liquidity. Traditionally, liquidity was an asset-based concept. But this shifted to the liability side, as liquidity came to be virtually synonymous with easy borrowing. That would not have happened without the marketing efforts of large institutions.

My second major concern about the conduct of monetary policy is the Fed’s prevailing economic libertarianism. At the heart of this economic dogma is the belief that markets know best and that those who compete well will prosper, while those who do not will fail.

How did this affect the Fed’s actions and behaviour? First, it explains to a large extent why the Fed did not strongly oppose the removal of Glass-Steagall restrictions.

Second, it also helps explain why the Fed failed to recognise that abandoning Glass-Steagall created more institutions that were “too big to fail”.

Third, it diminished the supervisory role of the Fed, especially its direct responsibility to regulate bank holding companies. To be sure, the Fed’s supervisory responsibilities have never been very visible in the monetary policy decision-making process. But its tilt toward an economic libertarian approach pushed supervision a notch down just at a time when financial market complexity was on the rise. Fourth, as hands-on supervision slackened, quantitative risk modelling became increasingly acceptable. This approach, especially quantitative modelling to assess the safety of a financial institution, was far from adequate. But it worked hand in glove with a philosophy that markets knew best.

Fifth, adherence to economic libertarianism inhibited the Fed from using the bully pulpit or moral suasion to constrain market excesses. It is difficult to believe that recourse to moral suasion by a Fed chairman would be ineffective. Such public pronouncements about financial excesses are hard to ignore, reaching the broad public as well as market participants.

Sixth, the Fed’s increasingly libertarian philosophy underpinned its view that it could not know how to recognise a credit bubble but knew what to do once a bubble burst. This is a philosophy plagued with fallacies. Credit bubbles can be detected in a number of ways, such as rapid growth of credit, very high price/earnings ratios and very narrow yield spreads between high- and low-quality debt.

By guiding monetary policy in a libertarian direction, the Fed played a central role in creating a financial environment defined by excessive credit growth and unrestrained profit seeking. Major participants came to fear that if they failed to embrace the new world of securitised debt, proxy debt instruments, and quantitative risk analysis, they stood a very good chance of seeing their market shares shrink, top staff defect, and profits dwindle.

Ironically, the problem was made worse by the fact that the Fed was inconsistently libertarian. The central bank stuck to its hands-off approach during monetary expansion but abandoned it when constraint was necessary. And that, in turn, projected an unpredictable and inconsistent set of rules of the game.

We should, therefore, fundamentally re-examine the role of the Fed and the supervision of our financial institutions. Are the current arrangements within the Fed structure adequate – from its regional representation to its compensation for chairman and governors to its terms of office for governors? How can the Fed’s decision-making process be improved? If we were to create a new central bank from the ground up, how would it differ? At a minimum, the Fed’s sensitivity to financial excesses must be improved.

The writer is president, Henry Kaufman & Company

[Bern]

By guiding monetary policy in a libertarian direction,

This makes no sense whatsoever. Central planning/control is completely incompatible with free markets / laisser faire economics / economic libertarianism. The whole article is an exercise in Orwellian double speak.

He's arguing that Fed policy was flawed, not that the Fed system is flawed. His article is also geared to poison people against the concepts of free market economics. It's a red herring.

[acptulsa]

How dogmatic Fed spin is attempting to lead the definition of libertarian astray.

[AutoDas]

You can be against bad de/re-regulation like when Ron Paul was against the repeal of the Glass-Steagall Act (I'm guessing because it didn't address the real problem which was the FDIC)

[Bradley in DC]

You can be against bad de/re-regulation like when Ron Paul was against the repeal of the Glass-Steagall Act (I'm guessing because it didn't address the real problem which was the FDIC)

He favored repeal of G-S but not a very large reregulation bill that greatly expanded taxpayer liability (as we're seeing now). So, right on!

[angelatc]

http://www.ft.com/cms/s/0/705574f2-3...nclick_check=1

Ironically, the problem was made worse by the fact that the Fed was inconsistently libertarian. The central bank stuck to its hands-off approach during monetary expansion but abandoned it when constraint was necessary. And that, in turn, projected an unpredictable and inconsistent set of rules of the game.

That's the way Keynes' theory works. When the economy is expanding, you let it grow *and* you don't run deficits. When it contracts, you do run deficits to give it a kick start.

The decision to run massive deficits in an growing economy is hardly a libertarian position.

[angelatc]

He favored repeal of G-S but not a very large reregulation bill that greatly expanded taxpayer liability (as we're seeing now). So, right on!

And didn't the repeal of G-S remove state's rights?

[acptulsa]

That's the way Keynes' theory works. When the economy is expanding, you let it grow *and* you don't run deficits.

Well then, maybe we should give Keynes a break. Obviously his system has never been given a proper trial.

Nah. It has been proven to have problems enough even without deficits during expansion.

[Bradley in DC]

And didn't the repeal of G-S remove state's rights?

No (banking and commerce). Are you thinking of Riegel-Neal?

[angelatc]

Well then, maybe we should give Keynes a break. Obviously his system has never been given a proper trial.

Nah. It has been proven to have problems enough even without deficits during expansion.

I am not defending Keynes! Lord help us all! I was just explaining his theory.

[Bradley in DC]

This makes no sense whatsoever. Central planning/control is completely incompatible with free markets / laisser faire economics / economic libertarianism.

Just to be clear, I'm not arguing Kaufman's position. I just thought it would be of interest to the forum.

[sailor]

A sentance "How libertarian dogma led the Fed astray" is like saying "How Christian ascetism led a brothel astray".

If the fed was libertarian it would have disolved itself. Plain and simple.

[AutoDas]

He favored repeal of G-S but not a very large reregulation bill that greatly expanded taxpayer liability (as we're seeing now). So, right on!

Really? I thought I heard him say he was against the repeal.

[Bradley in DC]

Really? I thought I heard him say he was against the repeal.

We opposed the bill the repealed it, but not because we opposed the repeal. In fact we proposed an "amendment in the nature of a substitute" that repealed the act without all of the other 800 pages of new regulations--ours was one page.

[Bradley in DC]

I am not defending Keynes! Lord help us all! I was just explaining his theory.

She weighs the same as a duck, she's a witch, burn her, burn her!

[Bradley in DC]

http://cei.org/articles/2009/04/29/f...ict-each-other

[Bern]

^ See, I'm not the only one who saw the article as a red herring.

[Bradley in DC]

^ See, I'm not the only one who saw the article as a red herring.

Hey, I report, you decide! (I think that's how it goes)

[Aratus]

There are times when Libertarianism is American Pragmatism 101