I find this very puzzling. I really must say that I did not expect to see anyone trying to play the “Federal Reserve should defer to the Treasury on bank regulation” card that Kevin Warsh is...
Brad's history is accurate. But I'm not sure that this is the place for a history lesson. The question posed by Warsh is whether, in the year 2025, the regulatory functions of the Fed should be dissociated from its monetary policy and crisis management functions.
I cannot see any direct synergy between regulation and monetary policy. (Neither can the many countries that have established currency boards.) The argument must be indirect: regulation interacts with crisis management interacts with monetary policy. I will concede that monetary policy and crisis management are difficult to separate--they both rely on the same tool: buying and selling stuff for vast quantities of money.
The question, then, is whether crisis management depends on regulation. Here, I think Our Host has half a point, but only half a point. I can't see any connection for small banks. Federal Home Loan Banks successfully manage small-bank crises all the time, with no regulatory powers. I think that Brad's half-point applies to big banks: the ones that the Fed traditionally cares about. This kind of lender-of-last resort function entails close and tacit knowledge of the industry, including personal relations with the big players.
But is regulation the best way to acquire this tacit knowledge? Regulation is a rule-of-law thing. Law--a verbal activity--ends before tacit knowledge begins. Supervision is a lot closer to the mark, but supervisory reports are only verbal activities, albeit verbal activities that draw on tacit knowledge. What you really need is something more intimate. Central banks get this, in part, by their payment system oversight role. Senior central bankers have close social relations with senior bankers and shadow bankers. (Everybody knew Dick Fuld's motivations in 2008.) These are the essential roles, and they are not regulatory in any conventional sense of the term.
At least before 1996, the Bank of Japan had an interesting solution to the problem. It had no regulatory powers and I believe no supervisory powers at law. But the big banks agreed to have the BoJ stay close to them, the better to help the BoJ understand the banks for its crisis management purposes.
You have a point, but it's too easy to arbitrage based on a split between bank regulation and crisis management. This is already a problem as we saw back in 2008, but a formal split would introduce an all too easy and dangerous way to make lots of money. If I can figure this out, odds are there are financial players who have already figured this out which would explain a push for such separation given the political opportunity.
Contortions for the banks to take more risk, reap more profit ... until something goes terribly wrong. Then it is either bailout or oblivion. We can see something similar with the proposal to privatize Fannie Mae's profits, but make their catastrophic credit losses public.
Kevin Warsh seems to reason like a lawyer: he starts with his conclusion and then uses bits and pieces of history to support his argument, ignoring or trivializing facts that don't fit. His basic. objective, if Trump nominates him, is to make the FRB more responsive to whims of the Chaos Monkeys. Consequences be damned...
Also "interesting" in that Walsh questions not just the wisdom of giving the Fed it currently exercises but the constitutionality of doing so. When Hamilton first proposed the first bank, Madison, a congressman at the time, objected on the grounds of constitutionality. As president, of course, he accepted the second bank. Why? According to Madison, a national bank was "unconstitutional", but, really, so what? "Everyone" agreed that a national bank was a good idea, and anything that everyone recognizes as a "good idea" is ipso facto constitutional. Madison, unlike a lot of "conservatives", saw the constitution as a mixed bag of good and bad ideas that could and should be improved by an informal process rather than the cumbersome approach of amending, which would bog things down impossibly. A "dead" Constitution, as Justice Scalia insisted on calling it? Not while James Madison was alive!
To make things more complicated, Madison proposed a federal chartering power in the Constitutional convention. When a lawyer, he acted like a lawyer. When a President, he acted like a President.
"It was terrifying because it underscored how utterly dependent the U.S. economy was on the benevolence and balance-sheet strength of a single private citizen."
and
the peabrain flashed with the thought that the orange man is trying to achieve what J.P. had by gathering all the distributed power of the government into his hands.
We have a political party that has abdicated its responsibility to act as a co-equal party with the administration and the judiciary.
Should the Fed be protected from the political whims of somebody like Grump? Of course. Should the Fed be independent of political or democratic pressures concerning labor, jobs, living wages, environmental sustainability reforms, or for that matter, any democratically supported social spending, and so the taxes necessary to pay for that public infrastructure? Of course not.
The Fed's Econ 101 monetary policy response to the pandemic did not impress me. Raising interest rates punished the working classes for inflation caused by the supply chain shutdown of the pandemic, like after the world wars or any global disruption in trade, totally to be expected, and then, adding insult to injury, stiffs wage workers with corporate price gouging routinely ignored in the mainstream press.
Maybe a silver lining in this battle is if Trump is not satisfied with SCOTUS giving him autocratic control over every dept in the executive branch save the Fed, perhaps his insistence on having more control over the Fed and the economy will force a more decisive break between Trump and the billionaires that funded his election. I wouldn't hold my breath but I can still dream.
Really, really liked Lombard Street as accessible economic history. The necessity of a big central bank to head-off and backstop market failures and then in turn the moral hazard of this guarantee necessitating some fair market regulations, is all the more convincing for how begrudgingly Bagehot seems to come to his conclusions. He remains wary of central banks and regulations but comes to recognize their essential role in macro economic expansion. When I read Kindleberger's Manias, Panics, and Crashes it struck me as a massive collection of supporting evidence for Begehot's practical insights and economic theory. Bagehotian!
The sense I got from reading about the Federal Reserve System back in 2009-2010 was that was very cleverly constructed to make it as resistant to political pressure as possible. I really hope it stays that way.
Great piece. I think this establishes you as an authority I would trust to offer a conclusion on whether Warsh is right on his second point.
I too missed the start of 08. So, I get why you would forgive him for that, away from his refusal to learn from it. But his behavior in the early 00s was less forgivable. I guess you get at that indirectly with your reference to him not learning. But I could see him beclowning himself in real time, to use one of your felicitous turns of phrase. He is a social climber. To paraphrase Trainspotting, at least Bessent is his own wanker.
I'm reading Howe's What God Hath Wrought now.Howe seems to side with Clay and against Jackson, who reminds me a lot of Trump.
Warsh recapitulates the populist and Jeffersonian nostalgia and to my mind crackpottery of small government and yeoman farmers and such. My point is that after 200 years America is still trapped in twee arguments like small is inherently better. These arguments seem to assume that you can have twee government institutions and still have a gigantic population of great complexity as you show in Slouching Toward Utopia.
Well, I for one think this was a great recap. I appreciated it—a lot more, apparently, than some others. These occasional nuggets are why I’m a paying subscriber!
Many years ago you described non-linear systems as having regions of linear-like behavior separated by regions of chaos. I am of the opinion that we are in a region of chaos - a transitional moment. Everything we thought was solid and established is up for grabs.
I myself am focusing on a few ideas that I think are the most important to advance and/or preserve. What is "most important" is going to vary from one person to the next, and that's probably ok.
Everyone is going to be proposing everything. It will be hard to focus on the most important, but I think it will also be really valuable.
I don't know at all whether this is "most important" in the financial/banking policy arena or not. You would know much better than me. But we should expect more and more of people challenging everything.
This reads to me like an essay on an application form to become the next Fed chairman under Donald Trump. Especially ironic when I recall how the Republicans all backed the Fed when Clinton tried to reform bank regulation.
Brad's history is accurate. But I'm not sure that this is the place for a history lesson. The question posed by Warsh is whether, in the year 2025, the regulatory functions of the Fed should be dissociated from its monetary policy and crisis management functions.
I cannot see any direct synergy between regulation and monetary policy. (Neither can the many countries that have established currency boards.) The argument must be indirect: regulation interacts with crisis management interacts with monetary policy. I will concede that monetary policy and crisis management are difficult to separate--they both rely on the same tool: buying and selling stuff for vast quantities of money.
The question, then, is whether crisis management depends on regulation. Here, I think Our Host has half a point, but only half a point. I can't see any connection for small banks. Federal Home Loan Banks successfully manage small-bank crises all the time, with no regulatory powers. I think that Brad's half-point applies to big banks: the ones that the Fed traditionally cares about. This kind of lender-of-last resort function entails close and tacit knowledge of the industry, including personal relations with the big players.
But is regulation the best way to acquire this tacit knowledge? Regulation is a rule-of-law thing. Law--a verbal activity--ends before tacit knowledge begins. Supervision is a lot closer to the mark, but supervisory reports are only verbal activities, albeit verbal activities that draw on tacit knowledge. What you really need is something more intimate. Central banks get this, in part, by their payment system oversight role. Senior central bankers have close social relations with senior bankers and shadow bankers. (Everybody knew Dick Fuld's motivations in 2008.) These are the essential roles, and they are not regulatory in any conventional sense of the term.
At least before 1996, the Bank of Japan had an interesting solution to the problem. It had no regulatory powers and I believe no supervisory powers at law. But the big banks agreed to have the BoJ stay close to them, the better to help the BoJ understand the banks for its crisis management purposes.
You have a point, but it's too easy to arbitrage based on a split between bank regulation and crisis management. This is already a problem as we saw back in 2008, but a formal split would introduce an all too easy and dangerous way to make lots of money. If I can figure this out, odds are there are financial players who have already figured this out which would explain a push for such separation given the political opportunity.
Contortions for the banks to take more risk, reap more profit ... until something goes terribly wrong. Then it is either bailout or oblivion. We can see something similar with the proposal to privatize Fannie Mae's profits, but make their catastrophic credit losses public.
Kevin Warsh seems to reason like a lawyer: he starts with his conclusion and then uses bits and pieces of history to support his argument, ignoring or trivializing facts that don't fit. His basic. objective, if Trump nominates him, is to make the FRB more responsive to whims of the Chaos Monkeys. Consequences be damned...
It's unfortunate that you have to spend so much of you valuable time shining light on liars.
Also "interesting" in that Walsh questions not just the wisdom of giving the Fed it currently exercises but the constitutionality of doing so. When Hamilton first proposed the first bank, Madison, a congressman at the time, objected on the grounds of constitutionality. As president, of course, he accepted the second bank. Why? According to Madison, a national bank was "unconstitutional", but, really, so what? "Everyone" agreed that a national bank was a good idea, and anything that everyone recognizes as a "good idea" is ipso facto constitutional. Madison, unlike a lot of "conservatives", saw the constitution as a mixed bag of good and bad ideas that could and should be improved by an informal process rather than the cumbersome approach of amending, which would bog things down impossibly. A "dead" Constitution, as Justice Scalia insisted on calling it? Not while James Madison was alive!
To make things more complicated, Madison proposed a federal chartering power in the Constitutional convention. When a lawyer, he acted like a lawyer. When a President, he acted like a President.
I got to this point in the post:
"It was terrifying because it underscored how utterly dependent the U.S. economy was on the benevolence and balance-sheet strength of a single private citizen."
and
the peabrain flashed with the thought that the orange man is trying to achieve what J.P. had by gathering all the distributed power of the government into his hands.
We have a political party that has abdicated its responsibility to act as a co-equal party with the administration and the judiciary.
All the weaknesses of our system are now exposed.
Should the Fed be protected from the political whims of somebody like Grump? Of course. Should the Fed be independent of political or democratic pressures concerning labor, jobs, living wages, environmental sustainability reforms, or for that matter, any democratically supported social spending, and so the taxes necessary to pay for that public infrastructure? Of course not.
The Fed's Econ 101 monetary policy response to the pandemic did not impress me. Raising interest rates punished the working classes for inflation caused by the supply chain shutdown of the pandemic, like after the world wars or any global disruption in trade, totally to be expected, and then, adding insult to injury, stiffs wage workers with corporate price gouging routinely ignored in the mainstream press.
Maybe a silver lining in this battle is if Trump is not satisfied with SCOTUS giving him autocratic control over every dept in the executive branch save the Fed, perhaps his insistence on having more control over the Fed and the economy will force a more decisive break between Trump and the billionaires that funded his election. I wouldn't hold my breath but I can still dream.
Really, really liked Lombard Street as accessible economic history. The necessity of a big central bank to head-off and backstop market failures and then in turn the moral hazard of this guarantee necessitating some fair market regulations, is all the more convincing for how begrudgingly Bagehot seems to come to his conclusions. He remains wary of central banks and regulations but comes to recognize their essential role in macro economic expansion. When I read Kindleberger's Manias, Panics, and Crashes it struck me as a massive collection of supporting evidence for Begehot's practical insights and economic theory. Bagehotian!
The sense I got from reading about the Federal Reserve System back in 2009-2010 was that was very cleverly constructed to make it as resistant to political pressure as possible. I really hope it stays that way.
Great piece. I think this establishes you as an authority I would trust to offer a conclusion on whether Warsh is right on his second point.
I too missed the start of 08. So, I get why you would forgive him for that, away from his refusal to learn from it. But his behavior in the early 00s was less forgivable. I guess you get at that indirectly with your reference to him not learning. But I could see him beclowning himself in real time, to use one of your felicitous turns of phrase. He is a social climber. To paraphrase Trainspotting, at least Bessent is his own wanker.
I'm reading Howe's What God Hath Wrought now.Howe seems to side with Clay and against Jackson, who reminds me a lot of Trump.
Warsh recapitulates the populist and Jeffersonian nostalgia and to my mind crackpottery of small government and yeoman farmers and such. My point is that after 200 years America is still trapped in twee arguments like small is inherently better. These arguments seem to assume that you can have twee government institutions and still have a gigantic population of great complexity as you show in Slouching Toward Utopia.
Well, I for one think this was a great recap. I appreciated it—a lot more, apparently, than some others. These occasional nuggets are why I’m a paying subscriber!
Many years ago you described non-linear systems as having regions of linear-like behavior separated by regions of chaos. I am of the opinion that we are in a region of chaos - a transitional moment. Everything we thought was solid and established is up for grabs.
I myself am focusing on a few ideas that I think are the most important to advance and/or preserve. What is "most important" is going to vary from one person to the next, and that's probably ok.
Everyone is going to be proposing everything. It will be hard to focus on the most important, but I think it will also be really valuable.
I don't know at all whether this is "most important" in the financial/banking policy arena or not. You would know much better than me. But we should expect more and more of people challenging everything.
Thanks Professor! Happy Subscriber <:-) hand-waving>
hand-waving back!
This reads to me like an essay on an application form to become the next Fed chairman under Donald Trump. Especially ironic when I recall how the Republicans all backed the Fed when Clinton tried to reform bank regulation.