Senate Banking on Federal Reserve Reform
Senate Banking Committee
“Federal Reserve Accountability and Reform”
Tuesday, March 3, 2015
Key Topics & Takeaways
· Rules for Monetary Policy: Taylor said the Fed should be allowed to choose and describe its monetary policy strategy and could amend the rule as needed as long as it describes why. Taylor said experience and research have shown that a rules-based monetary strategy leads to better performance, and that his suggested reform would not chain the Fed or threaten its independence.
· The Fed’s Regulatory Role: Sen. Rounds asked how Congress can preserve the independence of the Fed to set monetary policy while also holding it accountable as a regulator like any other federal agency. Kupiec suggested that Congress could strip the Fed of its regulatory powers, but added that it does have the right to audit supervisory activities.
· Too Big to Fail: Sen. Warren said the Dodd-Frank Act was meant to end “backdoor bailouts” and asked about the Fed’s proposed rule on emergency lending. Meltzer congratulated Warren “for keeping this issue alive” and called it a disgrace. He said the only way to get the Fed out of the “too big to fail business” is to passed the Brown-Vitter bill that would hold banks responsible for their own errors and require banks to hold more capital.
· Regulation and Liquidity: Sen. Shelby said new rules have increased compliance costs for banks and are holding back the economy, while the Fed’s quantitative easing is meant to stimulate growth. He asked if the regulatory burden on financial institutions is limiting the effect of monetary policy. Kupiec said he believes it has, while Meltzer said he was not sure.
Speaker
· Dr. John B. Taylor, Stanford University
· Dr. Paul Kupiec, American Enterprise Institute
· Dr. Allan Meltzer, Carnegie Mellon University
· Peter Conti-Brown, Stanford Law School
Opening Statements
In his opening statement, Chairman Richard Shelby (R-Ala.) said that many actions by the Federal Reserve since the financial crisis have emphasized the need for greater accountability. He noted that while many stress the importance of Fed independence, this does not mean immunity from congressional oversight.
Shelby said the Fed’s current structure has allowed it to extend its reach in many ways, with its jurisdiction now covering almost every aspect of the financial system. He stated that the Federal Reserve has extensive new rulemaking power to regulate entities it previously could not because of the Dodd-Frank Act, but the legislation did nothing to address whether the Fed was structured properly to account for these new powers.
In his opening statement, Ranking Member Sherrod Brown (D-Ohio) said the Federal Reserve was designed to be accountable to Congress and the people, with the governors confirmed by Congress and the Fed chair reporting to Congress at least twice a year. He stated that over time, the Fed has become more accountable and more transparent than ever before in its history.
Brown said he has concerns about the slow pace of the economic recovery, but that the Federal Reserve’s monetary policy has supported sustained growth. He commented that some are proposing to second guess the decisions of an independent central bank “under the guise of additional transparency and accountability.”
Brown said the financial crisis taught us that vigilance in the oversight of Wall Street risk-taking is important and that the Fed gained its new authorities over the largest banks as a result of “extraordinary excesses.” Rather than attempting to “interfere or even dictate” monetary policy, Brown said Congress should focus on whether the Fed is protecting consumers and strengthening financial stability, and consider whether the Fed appropriately holds the other financial regulators accountable.
Testimony
John Taylor, Stanford University, said in his testimony that accountability at the Federal Reserve could be improved by requiring the Fed to describe its strategy for monetary policy. He said the Fed should be allowed to choose the strategy and amend it as needed, as long as the strategy and need for change is described. Taylor said experience and research have shown that a rules-based monetary strategy leads to better performance, and that his suggested reform would not “chain” the Fed or threaten its independence.
Allan Meltzer, Carnegie Mellon University, said in his testimony that Congress has the responsibility to oversee the Fed, but lacks the ability. He suggested Congress needs to implement a rule to which the Fed can be held accountable.
On the regulation of large financial institutions, Meltzer said large banks’ shareholders would be more effective watchdogs for responsible policies, and endorsed S.798, the Terminating Bailouts for Taxpayer Fairness Act, introduced by Sens. Brown and David Vitter (R-La.) last Congress to impose much higher capital standards on the largest financial institutions.
Paul Kupiec, American Enterprise Institute, said in his testimony that Congress retains responsibility for oversight of the Fed in many ways, including through Government Accountability Office (GAO) audits, but that these audits are not permitted to examine monetary policy.
He further commented that the Fed’s regulatory activities “merit additional oversight.” He offered three suggestions where Congress should focus: 1) Fed involvement with the Financial Stability Board (FSB); 2) the Fed’s stress tests, which he said are very expensive have little evidence to suggest their cost effectiveness; and 3) the Fed’s participation in insurance regulation workstreams at the FSB. Kupiec said the Fed plays a critical role in the FSB, but does not consult Congress before agreeing to the body’s directives even though they “look a lot like international treaties.”
Peter Conti-Brown, Stanford Law School, said in his testimony that central bank independence enables the Fed to “take the long view” on monetary policy, and that the legislative task is to balance this against the demand for accountability. He suggested structural rather than functional reforms to improve accountability to ensure that regulated banks cannot exercise undue influence over their regulators. He expressed support for Sen. Jack Reed’s (D-R.I.) proposal to require that the New York Fed president be confirmed by Congress, saying this would help ensure that the New York Fed serves the public. He alternatively suggested rendering the reserve banks fully subordinate to the publicly-accountable Fed Board of Governors and stripping them of voting power on the Federal Open Markets Committee (FOMC).
Question and Answer
Structural Reform
Shelby noted that Richard Fisher, president of the Federal Reserve Bank of Dallas, said too much power in concentrated in the New York Fed and proposed rotating the vice chairmanship of the FOMC and giving reserve bank presidents more votes. He asked the panelists if they would support these proposals.
Taylor and Brown called it a good start, and Kupiec added that “it makes a lot of sense to diversify the New York power base.”
Shelby asked how to structure a monetary policy rule to allow the central bank flexibility while ensuring proper oversight. Taylor responded that the key is to allow the Fed to design and describe its own strategy that it could change as necessary. He said Congress requiring that the Fed have such a strategy would not lead to micromanagement or threaten the Fed’s independence. Meltzer said the Fed pays too much attention to the latest news for an institution that is designed to solve long-term problems. He said following a rule would help it to keep focus.
Sen. Mike Rounds (R-S.D.) asked how the Taylor Rule would contribute to economic stability and help businesses. Taylor said the predictability would help because it makes decision-making easier for businesses. He added that history shows that economies perform better under rule-based monetary policy.
Income Inequality
Sen. Brown noted that income inequality is growing and that it is “entirely appropriate” for the Fed to care about this issue. He asked if the panelists agreed. Taylor said the Fed is concerned, but that institutions need to have limited purposes and not try to solve every problem in America. He commented that if the Fed can get monetary policy right, then public policy will be better able to address other issues. Meltzer agreed, saying any organization does better work when it focuses on a single motive.
Audit the Fed
Sen. Brown asked why Congress should not ask the GAO to audit monetary policy. Brown answered that it would not help to throw the “organizational complexity” of the GAO at the Fed, which is already one of the most complex agencies in the government. He instead advocated for a focus on structural reform that would make it clear what individuals can be held accountable.
Rounds asked how Congress can preserve the independence of the Fed to set monetary policy while also holding it accountable as a regulator like any other federal agency. Kupiec suggested that Congress could strip the Fed of its regulatory powers, but added that it does have the right to audit supervisory activities.
Sen. Elizabeth Warren (D-Mass.) said the biggest bailouts from the financial crisis were never voted on by Congress, but were “backdoor bailouts” in the form of emergency lending to the biggest institutions. She said the Dodd-Frank Act was meant to end such bailouts, and asked about the Fed’s proposed rule on emergency lending.
Meltzer congratulated Warren “for keeping this issue alive” and called it a disgrace. He said the only way to get the Fed out of the “too big to fail business” is to pass the Brown-Vitter bill that would hold banks responsible for their own errors and require banks to hold more capital.
Warren asked if Meltzer would support establishing in advance that emergency lending would be given at a penalty rate rather than below-market rates for only a short period of time, and never for institutions that are at or near insolvency. Meltzer supported these provisions.
Warren closed by calling this a “critically important aspect of Dodd-Frank that the Fed has glossed over,” giving the banks every reason to take on excessive risks because they would expect future bailouts.
Vitter asked if any of the panelists doubted that any of the “mega institutions” would be bailed out if threatened today. All the panelists agreed that the institutions would be bailed out, and Brown added that capital levels for banks are so low that he could not envision a seamless use of Orderly Liquidation Authority.
Vitter asked how the panelists feel about current capital requirements, saying he believes they should be higher. Taylor said raising capital levels would be the best and easiest way to solve the problem, but also mentioned bankruptcy reform as a potential solution. Kupiec also supported higher capital, and called for more objective rules that are easier to understand. Brown said the Basel requirements made improvements, “but tripling very little still leaves you with very little.”
Financial Regulation and Liquidity
Shelby said new rules have increased compliance costs for banks and are holding back the economy, while the Fed’s quantitative easing is meant to stimulate growth. He asked if the regulatory burden on financial institutions is limiting the effect of monetary policy. Kupiec said he believes it has, while Meltzer said he was not sure.
Stress Tests
Shelby asked about the Fed’s stress tests for banks and for ideas to make them more efficient. Kupiec said auditing the stress test would be good to determine their cost-effectiveness. He said the tests are not objective and unproductive, and added that they could breed a false sense of confidence.
For more information on this hearing, please click here.
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Senate Banking Committee
“Federal Reserve Accountability and Reform”
Tuesday, March 3, 2015
Key Topics & Takeaways
· Rules for Monetary Policy: Taylor said the Fed should be allowed to choose and describe its monetary policy strategy and could amend the rule as needed as long as it describes why. Taylor said experience and research have shown that a rules-based monetary strategy leads to better performance, and that his suggested reform would not chain the Fed or threaten its independence.
· The Fed’s Regulatory Role: Sen. Rounds asked how Congress can preserve the independence of the Fed to set monetary policy while also holding it accountable as a regulator like any other federal agency. Kupiec suggested that Congress could strip the Fed of its regulatory powers, but added that it does have the right to audit supervisory activities.
· Too Big to Fail: Sen. Warren said the Dodd-Frank Act was meant to end “backdoor bailouts” and asked about the Fed’s proposed rule on emergency lending. Meltzer congratulated Warren “for keeping this issue alive” and called it a disgrace. He said the only way to get the Fed out of the “too big to fail business” is to passed the Brown-Vitter bill that would hold banks responsible for their own errors and require banks to hold more capital.
· Regulation and Liquidity: Sen. Shelby said new rules have increased compliance costs for banks and are holding back the economy, while the Fed’s quantitative easing is meant to stimulate growth. He asked if the regulatory burden on financial institutions is limiting the effect of monetary policy. Kupiec said he believes it has, while Meltzer said he was not sure.
Speaker
· Dr. John B. Taylor, Stanford University
· Dr. Paul Kupiec, American Enterprise Institute
· Dr. Allan Meltzer, Carnegie Mellon University
· Peter Conti-Brown, Stanford Law School
Opening Statements
In his opening statement, Chairman Richard Shelby (R-Ala.) said that many actions by the Federal Reserve since the financial crisis have emphasized the need for greater accountability. He noted that while many stress the importance of Fed independence, this does not mean immunity from congressional oversight.
Shelby said the Fed’s current structure has allowed it to extend its reach in many ways, with its jurisdiction now covering almost every aspect of the financial system. He stated that the Federal Reserve has extensive new rulemaking power to regulate entities it previously could not because of the Dodd-Frank Act, but the legislation did nothing to address whether the Fed was structured properly to account for these new powers.
In his opening statement, Ranking Member Sherrod Brown (D-Ohio) said the Federal Reserve was designed to be accountable to Congress and the people, with the governors confirmed by Congress and the Fed chair reporting to Congress at least twice a year. He stated that over time, the Fed has become more accountable and more transparent than ever before in its history.
Brown said he has concerns about the slow pace of the economic recovery, but that the Federal Reserve’s monetary policy has supported sustained growth. He commented that some are proposing to second guess the decisions of an independent central bank “under the guise of additional transparency and accountability.”
Brown said the financial crisis taught us that vigilance in the oversight of Wall Street risk-taking is important and that the Fed gained its new authorities over the largest banks as a result of “extraordinary excesses.” Rather than attempting to “interfere or even dictate” monetary policy, Brown said Congress should focus on whether the Fed is protecting consumers and strengthening financial stability, and consider whether the Fed appropriately holds the other financial regulators accountable.
Testimony
John Taylor, Stanford University, said in his testimony that accountability at the Federal Reserve could be improved by requiring the Fed to describe its strategy for monetary policy. He said the Fed should be allowed to choose the strategy and amend it as needed, as long as the strategy and need for change is described. Taylor said experience and research have shown that a rules-based monetary strategy leads to better performance, and that his suggested reform would not “chain” the Fed or threaten its independence.
Allan Meltzer, Carnegie Mellon University, said in his testimony that Congress has the responsibility to oversee the Fed, but lacks the ability. He suggested Congress needs to implement a rule to which the Fed can be held accountable.
On the regulation of large financial institutions, Meltzer said large banks’ shareholders would be more effective watchdogs for responsible policies, and endorsed S.798, the Terminating Bailouts for Taxpayer Fairness Act, introduced by Sens. Brown and David Vitter (R-La.) last Congress to impose much higher capital standards on the largest financial institutions.
Paul Kupiec, American Enterprise Institute, said in his testimony that Congress retains responsibility for oversight of the Fed in many ways, including through Government Accountability Office (GAO) audits, but that these audits are not permitted to examine monetary policy.
He further commented that the Fed’s regulatory activities “merit additional oversight.” He offered three suggestions where Congress should focus: 1) Fed involvement with the Financial Stability Board (FSB); 2) the Fed’s stress tests, which he said are very expensive have little evidence to suggest their cost effectiveness; and 3) the Fed’s participation in insurance regulation workstreams at the FSB. Kupiec said the Fed plays a critical role in the FSB, but does not consult Congress before agreeing to the body’s directives even though they “look a lot like international treaties.”
Peter Conti-Brown, Stanford Law School, said in his testimony that central bank independence enables the Fed to “take the long view” on monetary policy, and that the legislative task is to balance this against the demand for accountability. He suggested structural rather than functional reforms to improve accountability to ensure that regulated banks cannot exercise undue influence over their regulators. He expressed support for Sen. Jack Reed’s (D-R.I.) proposal to require that the New York Fed president be confirmed by Congress, saying this would help ensure that the New York Fed serves the public. He alternatively suggested rendering the reserve banks fully subordinate to the publicly-accountable Fed Board of Governors and stripping them of voting power on the Federal Open Markets Committee (FOMC).
Question and Answer
Structural Reform
Shelby noted that Richard Fisher, president of the Federal Reserve Bank of Dallas, said too much power in concentrated in the New York Fed and proposed rotating the vice chairmanship of the FOMC and giving reserve bank presidents more votes. He asked the panelists if they would support these proposals.
Taylor and Brown called it a good start, and Kupiec added that “it makes a lot of sense to diversify the New York power base.”
Shelby asked how to structure a monetary policy rule to allow the central bank flexibility while ensuring proper oversight. Taylor responded that the key is to allow the Fed to design and describe its own strategy that it could change as necessary. He said Congress requiring that the Fed have such a strategy would not lead to micromanagement or threaten the Fed’s independence. Meltzer said the Fed pays too much attention to the latest news for an institution that is designed to solve long-term problems. He said following a rule would help it to keep focus.
Sen. Mike Rounds (R-S.D.) asked how the Taylor Rule would contribute to economic stability and help businesses. Taylor said the predictability would help because it makes decision-making easier for businesses. He added that history shows that economies perform better under rule-based monetary policy.
Income Inequality
Sen. Brown noted that income inequality is growing and that it is “entirely appropriate” for the Fed to care about this issue. He asked if the panelists agreed. Taylor said the Fed is concerned, but that institutions need to have limited purposes and not try to solve every problem in America. He commented that if the Fed can get monetary policy right, then public policy will be better able to address other issues. Meltzer agreed, saying any organization does better work when it focuses on a single motive.
Audit the Fed
Sen. Brown asked why Congress should not ask the GAO to audit monetary policy. Brown answered that it would not help to throw the “organizational complexity” of the GAO at the Fed, which is already one of the most complex agencies in the government. He instead advocated for a focus on structural reform that would make it clear what individuals can be held accountable.
Rounds asked how Congress can preserve the independence of the Fed to set monetary policy while also holding it accountable as a regulator like any other federal agency. Kupiec suggested that Congress could strip the Fed of its regulatory powers, but added that it does have the right to audit supervisory activities.
Sen. Elizabeth Warren (D-Mass.) said the biggest bailouts from the financial crisis were never voted on by Congress, but were “backdoor bailouts” in the form of emergency lending to the biggest institutions. She said the Dodd-Frank Act was meant to end such bailouts, and asked about the Fed’s proposed rule on emergency lending.
Meltzer congratulated Warren “for keeping this issue alive” and called it a disgrace. He said the only way to get the Fed out of the “too big to fail business” is to pass the Brown-Vitter bill that would hold banks responsible for their own errors and require banks to hold more capital.
Warren asked if Meltzer would support establishing in advance that emergency lending would be given at a penalty rate rather than below-market rates for only a short period of time, and never for institutions that are at or near insolvency. Meltzer supported these provisions.
Warren closed by calling this a “critically important aspect of Dodd-Frank that the Fed has glossed over,” giving the banks every reason to take on excessive risks because they would expect future bailouts.
Vitter asked if any of the panelists doubted that any of the “mega institutions” would be bailed out if threatened today. All the panelists agreed that the institutions would be bailed out, and Brown added that capital levels for banks are so low that he could not envision a seamless use of Orderly Liquidation Authority.
Vitter asked how the panelists feel about current capital requirements, saying he believes they should be higher. Taylor said raising capital levels would be the best and easiest way to solve the problem, but also mentioned bankruptcy reform as a potential solution. Kupiec also supported higher capital, and called for more objective rules that are easier to understand. Brown said the Basel requirements made improvements, “but tripling very little still leaves you with very little.”
Financial Regulation and Liquidity
Shelby said new rules have increased compliance costs for banks and are holding back the economy, while the Fed’s quantitative easing is meant to stimulate growth. He asked if the regulatory burden on financial institutions is limiting the effect of monetary policy. Kupiec said he believes it has, while Meltzer said he was not sure.
Stress Tests
Shelby asked about the Fed’s stress tests for banks and for ideas to make them more efficient. Kupiec said auditing the stress test would be good to determine their cost-effectiveness. He said the tests are not objective and unproductive, and added that they could breed a false sense of confidence.
For more information on this hearing, please click here.