Over his two decades as chairman of the Federal Reserve, Alan Greenspan repeatedly trekked to Capitol Hill to deliver testimony that developed an unlikely sense of majesty. News networks carried Greenspan’s remarks live, showing deferential senators transfixed by the chairman’s gnomic utterances. Markets rose and fell based on what he was perceived to believe about the economy’s direction. But Greenspan’s return last month to a Capitol Hill hearing room was a sad encore to those bravura performances. The 84-year-old arrived as little more than the president of an upstart consulting firm, Greenspan Associates LLC, and sheepishly took his seat. The agenda had changed, and Greenspan was no longer being asked to predict the future, but instead defend his past.
His bipartisan interlocutors, the Financial Crisis Inquiry Commission, had been empanelled with the goal of attributing responsibility for the country’s economic calamity. The Fed, which has been accused of inflating the housing bubble with low interest rates, is one of the leading suspects. That bubble, of course, culminated in a near-collapse of the country’s financial system—leading to the 2008 bank bailout coordinated in part by Greenspan’s successor Ben Bernanke—which still riles an increasingly angry electorate. The Federal Reserve has “been getting quite a bit of blame recently,” says Doug Holtz-Eakin, a commission member and former economic adviser to John McCain. “They had been rolled into the same list of characters that bailed out big banks. They’re part of the group of elites that people are unhappy about.”
That diminishing faith in the Fed has come to dominate the legislative endgame around Barack Obama’s current top priority, overhauling the country’s financial regulations. As the Senate debates a reform bill, Washington struggles with the question that will shape the core of the financial reform package: what will be the role of the Fed in the new regulatory structure?
For nearly a century, the Federal Reserve—with piles of cash and little public accountability—sat astride the hypothetical juncture of Wall Street and Pennsylvania Avenue. As the U.S. reached monetary policy’s holy grail of low inflation and low unemployment in the late 1990s, Greenspan was exalted as a sort of secular saint. The opacity of the Federal Reserve was a source of mystery and awe, its chairman’s inscrutability a testament to his intellect. He was showered with epithets—oracle, sage, maestro—that suggested that he applied policy with equal parts wisdom and artistry.
In 1998, the New Republic published “Praised Be Greenspan,” a story about a bond-trading firm that converted an empty office into a shrine to the Fed chairman and developed software “which translates any Greenspan sentence into a predicted market reaction, using a database of all his public remarks.” It took months for anyone to realize that the plausible scenario was a hoax derived in the imagination of writer Stephen Glass, later fired for fabricating facts. Two years later, Allan Meltzer, an economist at Carnegie Mellon University and author of a three-part history of the Fed, called the bank “one of the most prestigious institutions in Washington, a pillar of strength and a symbol of stability.”
Both the organization’s structure—which includes regional banks with close ties to the private lenders they regulate—and its stated focus on fighting inflation made the Fed oblivious to a national outbreak of bad loans. “Their culture puts monetary policy at the very top—it’s their priority and where their resources go,” says Travis Plunkett, legislative director for the Consumer Federation of America, which lobbies on behalf of reform and supports Democratic proposals. The Fed was built to clean up after bubbles, Plunkett points out, not puncture them.
But during the boom years, Fed skepticism was a lonely business, left to those with a broad distrust of the banking system. In 1999, libertarian Texas congressman Ron Paul presented his first bill to abolish the Federal Reserve system altogether. An obstetrician, Paul became known as “Dr. No” for his often solitary defiance against just about every point of congressional consensus. The bill Paul introduced in 1999 went nowhere. He reintroduced it in each new session of Congress, and never found another member of Congress to join him as a co-sponsor. When Paul ran for president in 2008, the media dismissed his proposal to abolish paper money and return to the gold standard as a clumsy throwback to 19th-century populism.
But the Fed’s decision to bail out financial firms after the collapse of Lehman Bros. in the fall of 2008 soured many who had previously held the Fed in awe. “No previous Fed ever came close to buying a trillion dollars of mortgages. No central bank in any civilized country does that,” says Meltzer. “The Fed has used its ability to print money to perform a lot of tasks that should be performed by the administration and Congress. That is a breach of its independence.”
Paul quickly found a wider audience for his assault on the central bank. His 2009 book End the Fed debuted at sixth on the New York Times bestseller list. That year, he introduced another bill to rein in the Fed—more modestly, it would remove all restrictions on congressional audits—and it found 319 co-sponsors from both parties. When the House passed a financial reform bill in December, on a largely party line vote, Paul’s audit language was part of it. The Fed would be left with depleted powers and, for the first time, Congress would be able to open its most closely guarded ledgers.
The central bank has responded with an unprecedented campaign to restore its public standing. It placated consumer advocates by speaking out on subprime lending and taking action on unsavoury credit-card practices. When Bernanke’s second term looked in doubt, he grovelled before senators for their votes. He was ultimately re-confirmed, albeit by a 70-30 vote that was the closest in history (having lost the support of some prominent former admirers, like McCain). Since beginning a new term, Bernanke and his staff now regularly tell Congress what they would like to see in a final bill—an unusually forward approach to lobbying from an institution that once proudly stayed far from politics, but has been forced to behave like any other federal bureaucracy desperately protecting its turf.
Already, the Fed seems to be doing better in the Senate than it did in the House. A centrepiece of Obama’s proposal is a new authority to protect ordinary borrowers from predatory financial practices, modelled on the Consumer Product Safety Commission that monitors everything from toys to toothpaste. While the House bill proposed a stand-alone Financial Products Safety Commission, the Senate’s version turned it into an autonomous body within the Federal Reserve. “Their political rehabilitation has been remarkable,” says Holtz-Eakin.
In addition, the Democrats’ Senate bill would give the Fed new powers to regulate—and potentially disband—large financial holding companies, the type of firms that legislators fear could again become “too big to fail” and require further bailouts. (At the same time, the Fed would lose supervision of small banks.) The House provisions to audit the Fed found less support among senators; New Hampshire Republican Judd Gregg called it a “dangerous move by this Congress to pander to the populist anger currently directed against our central bank, the Federal Reserve.”
The Senate is expected to finish with financial reform over the next few weeks after working through these and other issues, including derivatives reform. Whatever legislation passes will then have to be merged with the House bill—and the differences in how they treat the Fed are likely to dominate negotiations between the two chambers.
Holtz-Eakin, a former director of the Congressional Budget Office, expects that members of Congress will eventually conclude that a robust, independent Fed—no matter how irksome they find it now—can offer them plausible deniability in the future. “Independence only comes into question in crises,” says Holtz-Eakin. “It is convenient to have the independent Fed when things go wrong and they can blame them again.”