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Federal Reserve – insider dealing? R.I.P. central bank independence

from Thomas Palley

Federal Reserve Vice-Chair Richard Clarida has shot himself in the foot with what appears to be insider trading. That comes on the heels of prior concerns about inappropriate trading by regional Federal Reserve Bank Presidents Robert Kaplan and Eric Rosengren. Albeit unintentionally, the good news is these indiscretions may have done working families a favor by helping disprove the notion of central bank independence.

For years, many of us have argued that central bank independence is a charade aimed at facilitating control over central banks by financial interests. Here is a link to an article of mine titled “Central Bank Independence: A Rigged Debate Based on False Politics and Economics”.

In that paper I wrote every central banker “inevitably brings her own preferences, views, and prejudices to the policy table (p.77)”.  The implication is clear: appoint people with a Wall Street background and they will bring Wall Street policy preferences; appoint well-to-do financial economists with large stock portfolios and they will bring a personal concern with the stock market and asset prices.

Federal Reserve Presidents and Governors tend to be drawn from the banking community, Wall Street, and neoliberal academic economists. For decades, activists have requested that they be drawn from a broader political economic swathe of society to give working families better representation, but that request has been dismissed as lacking justification.

The Clarida-Kaplan-Rosengren affair argues otherwise. It is suggestive of how private interests are always in the room. It is also indicative of why handing the keys of the central bank to so-called independent bankers does not magically solve the problematic of monetary policy decision making, which is why analytical diversity is a matter of public import.

Messrs. Clarida, Kaplan, and Rosengren will survive and prosper. Wall Street will also continue to taint policymaking via its pre-pensation/post-pensation incentive model. The silver lining in the episode is the opportunity to bury the ideological doctrine of central bank independence and open the Federal Reserve to a broader set of ideas and personnel.

  1. Patrick Newman
    January 17, 2022 at 6:39 pm

    Same in UK where a Labour government (1997) outsourced monetary policy to the BoE and its quaint Monetary Policy Committee populated by safe economists and sound money people. Both interest rates and money supply should be part of the tool kit for managing the economy in the interests of the general citizens.

  2. January 18, 2022 at 6:59 am

    If bureaucrats ‘working in the public interest’ take over, the outcome may not be much better. It might be better that money supply and interest rates do not require management.

    As long as interest rates are positive, more money needs to be returned, which is money that does not yet exist, and therefore has to be created.

  3. January 18, 2022 at 2:05 pm

    On Central Banks’ independence:
    “The assets assigned the lowest risk, for which bank capital requirements were therefore low or nonexistent, were those that had the most political support…home mortgages” Paul Volcker 2018

    • Meta Capitalism
      January 21, 2022 at 3:39 am

      Alan Greenspan at the Federal Reserve was refusing to regulate subprime lending, saying, “We are not skilled enough in these areas and we shouldn’t be expected to [be].” For part of that period, from 2002 through 2004, one of us—Pat—served on the Consumer Advisory Council (CAC) of the Federal Reserve. The council was so named even though representatives from the banking industry held the majority of seats on the CAC, which was handpicked by the Fed. Pat and other CAC members alerted the board to the dangers of subprime loans and subprime mortgage-backed securities, and tried to convince the board to exercise its authority to regulate mortgages. At the time, only one Fed governor, Ned Gramlich, advocated for greater regulation of abusive subprime loans. Under Greenspan’s aegis, however, the board refused to take corrective action and failed to update its mortgage disclosures, which were so obsolete they were worthless to most consumers. Even worse, by 2004, Greenspan was encouraging homeowners to take out risky adjustable-rate mortgages instead of safer fixed-rate loans. (Engel, Kathleen C.. The Subprime Virus (pp. 7-8). Oxford University Press. Kindle Edition.)


      The Fed under Greenspan not only kept interest rates low, but also refused to intervene to protect consumers despite growing evidence of abusive mortgages. Likewise, Congress and federal regulatory agencies were unmoved by stories of defrauded consumers. The dominant ideology was that if there were problems with mortgage lending, the market would solve them. In addition, if consumers were taking on credit they couldn’t afford, that was their choice and their problem. The market’s job was to offer consumers choices, and consumers’ job was to take personal responsibility for the choices they made. On the corporate side, responsibility meant maximizing the bottom line for the benefit of shareholders, without regard for the consequences of abusive lending to consumers or society. (Engel, Kathleen C.. The Subprime Virus (p. 20). Oxford University Press. Kindle Edition.)


      Alan Greenspan at the Federal Reserve was refusing to regulate subprime lending, saying, “We are not skilled enough in these areas and we shouldn’t be expected to [be].” (Engel, Kathleen C.. The Subprime Virus (p. 7). Oxford University Press. Kindle Edition.)

      The con went likes this. Nicely dressed women (usually a minority herself having just got her brokers license so she could cash-in on the real estate boom fueled by the subprime lending, which was ever increasing the price of homes) comes into the home somewhere and pulls out her nice little flip-chart and begins her sales pitch provided by the bank pushing the toxic subprime loans. The mantra goes likes this: “You will save $600 a month on payments” as she flips through the various charts with pretty bar graphs showing those wonderful savings, all conveniently provided by the bank. Never once though is there a word about the downside of these toxic loans — when interest rates change so does your payment, or interest only payments don’t decrease the principle, or when balloon payments kick and you can’t refinance as promised was so easy, you are essentially screwed and will no doubt lose your home.

      I know the way the Ponzi scheme works because my wife and I bought a home in a blue-collar neighborhood where many homeowners (HO) worked for Boeing just down the hill. We worked at Microsoft but refused to buy a home in Redmond where two incomes would be required to maintain the mortgage. The banks targeted such blue-collar neighborhoods relentlessly, I suspect, because they knew many of these homeowners were living month-to-month on their stagnant wages and would jump at the chance to lower their monthly mortgage payments. After repeated salespeople trying to come flip their charts for us we invited them in for giggles-n-laughs and to see how they sold this Ponzi scheme. The lady even bragged she had one herself; I would wager she doesn’t have one (or her home) any longer. Our home is paid off now, and gifted to our daughter and her new husband while we are now living in Japan, so they can continue to further their academic careers in science and medicine rather then settle for stagnant wages the rest of their lives.

      The 2007-2008 GFC was created by banks and predatory finance and corrupt ratings agencies and Greenspan et. al. who preached a dystopian form of market fundamentalism.

      Bad Debt: Any debt that is defaulted on is called bad – at least for the creditor. But many debts are the result of predatory lending practices. In such cases the term “bad loan” is more appropriate. This is especially true of NINJA loans, subprime home mortgage and auto loans, payday loans, and high-interest credit card debt, as well as student loans and hospital loans in default.

      As economies sink deeper into debt (usually by following policies demanded by creditors), more debts cannot be paid – that is, paid without destroying the debtor’s economic viability. In such cases what is bad are demands for payment that strip debtors of their homes, or force entire economies into a downward spiral. Exploitative loans beyond the reasonable ability of borrowers to pay should be forgiven. What is good for such individuals (or national economies) is not to pay such debts. It is the bad creditor or vulture bondholder who should bear the moral opprobrium for acting against social norms of equity. The response to a bad debt should be a good writeoff. (See Bankruptcy and Clean Slate.)

      Bailout: A transfer of wealth to creditors, to save them from losing on loans gone bad when the financial bubble burst in 2008. U.S. creditors demanded public bailouts by Congress and the Federal Reserve (and in Europe by the European Central Bank and IMF), as if they were victims rather than the victimizers. Creditors were bailed out, and the bad debts left in place. (See Junk Mortgage and NINJA Loans.)

      Somebody has to lose when banks make bad loans or bondholders over-lend. Bailouts usually save creditors at public expense. Reimbursing bankers, uninsured creditors and speculators to save them from loss preserves economic control in the hands of the financial sector (see Rentier, Oligarchy and Who/Whom). As Federal Deposit Insurance Corp. head Sheila Bair explained regarding the 2008 bailout: “It’s all about the bondholders.” Banks were saved from being nationalized or socialized to save their bondholders and large uninsured depositors.

      The aim of such bailouts is to enable the financial sector to pursue its impossible dream that the miracle of compound interest can keep exponentially increasing society’s debt burden without crashing the economy. In the United States the Federal Reserve provided banks with more than $4 trillion of reserves by pretending that the crash was only a temporary illiquidity problem. In Europe, taxpayers were obliged to make up the loss, imposing deep depression on Ireland and Greece. (Hudson, Michael, 2017. J IS FOR JUNK ECONOMICS: A Guide To Reality In An Age Of Deception . ISLET/Verlag. Kindle Locations 912-934.)

  4. Ken Zimmerman
    January 27, 2022 at 10:31 am

    This article is adapted from the Federal Reserve Bank of Philadelphia’s publication “The First Bank of the United States: A Chapter in the History of Central Banking.” Andrew T. Hill.

    One prominent architect of the fledgling country — Alexander Hamilton, the first secretary of the Treasury under the new Constitution — had ambitious ideas about how to solve some of these problems. [from the US Confederation] One of those was creating a national bank. In December 1790, Hamilton submitted a report to Congress in which he outlined his proposal. Hamilton used the charter of the Bank of England as the basis for his plan. He argued that an American version of this institution could issue paper money (also called banknotes or currency), provide a safe place to keep public funds, offer banking facilities for commercial transactions, and act as the government’s fiscal agent, including collecting the government’s tax revenues and paying the government’s debts.

    Not everyone agreed with Hamilton’s plan. Thomas Jefferson was afraid that a national bank would create a financial monopoly that might undermine state banks and adopt policies that favored financiers and merchants, who tended to be creditors, over plantation owners and family farmers, who tended to be debtors. Such an institution clashed with Jefferson’s vision of the United States as a chiefly agrarian society, not one based on banking, commerce, and industry. Jefferson also argued that the Constitution did not grant the government the authority to establish corporations, including a national bank. Despite the opposing voices, Hamilton’s bill cleared both the House and the Senate after much debate. [With considerable help from President Washington] President Washington signed the bill into law in February 1791.

    The Bank of the United States, now commonly referred to as the First Bank of the United States, opened for business in Philadelphia on December 12, 1791, with a twenty-year charter. Branches opened in Boston, New York, Charleston, and Baltimore in 1792, followed by branches in Norfolk (1800), Savannah (1802), Washington, D.C. (1802), and New Orleans (1805). The bank was overseen by a board of twenty-five directors. Thomas Willing, who had been president of the Bank of North America, accepted the job as the new national bank’s president.

    The Bank of the United States started with capitalization of $10 million, $2 million of which was owned by the government and the remaining $8 million by private investors. The size of its capitalization made the Bank not only the largest financial institution, but the largest corporation of any type in the new nation. The bank’s sale of shares was the largest initial public offering (IPO) in the country to date. Many of the initial investors were foreign, a fact that did not sit well with many Americans, even though the foreign shareholders could not vote. The IPO did not offer shares for immediate delivery but rather subscriptions, or “scrips,” that acted as a down payment on the purchase of bank stock. When the bank subscriptions went on sale in July 1791, they sold so quickly that many would-be investors were left out, prompting fierce bidding in the secondary market for scrips.

    The Bank acted as the federal government’s fiscal agent, collecting tax revenues, securing the government’s funds, making loans to the government, transferring government deposits through the bank’s branch network, and paying the government’s bills. The bank also managed the U.S. Treasury’s interest payments to European investors in U.S. government securities. Although the U.S. government, the largest shareholder, did not directly manage the bank, it did garner a portion of the bank’s profits. The Treasury secretary had the authority to inspect the bank’s books, require statements of the bank’s condition as frequently as once each week, and remove the government’s deposits at any time for any reason. To avoid inflation and the appearance of impropriety, the Bank was forbidden from buying U.S. government bonds.

    In addition to its activities on behalf of the government, the Bank of the United States also operated as a commercial bank, which meant it accepted deposits from the public and made loans to private citizens and businesses. Its banknotes (paper currency) most commonly entered circulation through the loan process. It extended more loans and issued more currency than any other bank in the nation because it was the largest financial institution in the United States and the only institution holding federal government deposits and possessing branches throughout the nation. Banknotes issued by the Bank of the United States were widely accepted throughout the country. And unlike notes issued by state banks, Bank of the United States notes were the only ones accepted as payment of federal taxes.

    Unlike modern central banks, the Bank of the United States did not set monetary policy as we know it today. It did not regulate or act as a lender of last resort for other financial institutions, and it did not hold their reserves. Nonetheless, its prominence as one of the largest corporations in America and its branches’ broad geographic position in the emerging American economy allowed it to conduct a rudimentary monetary policy. The bank’s notes, backed by substantial gold reserves, gave the country a relatively stable national currency. By managing its lending policies and the ow of funds through its accounts, the bank could — and did — alter the supply of money and credit in the economy and hence the level of interest rates charged to borrowers.

    These actions, which had effects similar to today’s monetary policy, can be seen most clearly in the Bank’s interactions with state banks. In the course of business, the Bank would accumulate the notes of the state banks and hold them in its vault. When it wanted to slow the growth of money and credit, it would present the notes to banks for collection in gold or silver, thereby reducing state banks’ reserves and putting the brakes on their ability to circulate new banknotes. To speed up the growth of money and credit, the Bank would hold on to the state banks’ notes, thereby increasing state banks’ reserves and allowing those banks to issue more banknotes by making loans. The Bank’s branches were all located in the fledgling nation’s port cities. This made it easier for the federal government to collect tax revenues, most of which came from customs duties. Locating the branches in ports also made it easier for the Bank to nance international trade and help the Treasury fund the government’s operations through sales of U.S. government securities to foreigners. Furthermore, the Bank’s branch system gave it another advantage: it could move its notes around the country more readily than could a state bank. The Bank’s branches also helped to fund and encourage the country’s westward expansion, particularly with the establishment of a branch in New Orleans.

    Although the Bank’s charter did not expire until 1811, discussions about renewing it began much earlier. In 1808, the Bank’s shareholders asked Congress to extend the charter. In March 1809, Secretary of the Treasury Albert Gallatin recommended renewing the Bank’s charter. Congress let the matter languish until January 1810. At that time, the House gave the request for renewal a quick reading but took no action. Finally, in January 1811, both chambers of Congress engaged in a debate on whether to renew. Later that month, the House voted against renewal by just one vote. In February, Gallatin again recommended renewing the Bank’s charter. The Senate vote, however, resulted in a tie. The vice president, George Clinton of New York, cast the tie-breaking vote, and the charter renewal was again defeated by one vote.

    By 1811, many of those who had opposed the bank in 1790-91 still opposed it for the same reasons and said the charter should be allowed to expire. By this point, Alexander Hamilton was dead — killed in a duel with Aaron Burr — and his pro-Bank Federalist Party was out of power, while the Democratic-Republican Party was in control. Furthermore, by 1811, the number of state banks had increased greatly, and those financial institutions feared both competition from a national bank and its power.

    This article is adapted from the Federal Reserve Bank of Philadelphia’s publication “The First Bank of the United States: A Chapter in the History of Central Banking.” Andrew T. Hill.

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