I would like to include in the record of this debate an article about the Fed's policy model sacrificing its maximum employment mandate and targeting 5 to 6 percent as unemployment. Speech by Janet L. Yellen, Vice Chair, Board of Governors…
I would like to include in the record of this debate an article about the Fed's policy model
sacrificing its maximum employment mandate and targeting 5 to 6 percent as unemployment.
Speech by Janet L. Yellen, Vice Chair, Board of Governors of the
Federal Reserve System at the Boston Economic Club Dinner, Boston,
Massachusetts June 6, 2012
Perspectives on Monetary Policy
Good evening. I'm honored to have the opportunity to
address the Boston Economic Club and I'm grateful to Chip
Case for inviting me to speak to you tonight. As most of you
probably know, Chip was one of the first economists to
document worrisome signs of a housing bubble in parts of the
United States. After sounding an early alarm in 2003, Chip
watched the bubble grow and was prescient in anticipating the
very serious toll that its unwinding would impose on the
economy. Chip recognized that declining house prices would
affect not just residential construction but also consumer
spending, the ability of households to borrow, and the health
of the financial system. In light of these pervasive
linkages, the repeat sales house price index that bears
Chip's name is one of the most closely watched of all U.S.
economic indicators. Indeed, as I will discuss this evening,
prolonged weakness in the housing sector remains one of
several serious headwinds facing the U.S. economy. Given
these headwinds, I believe that a highly accommodative
monetary policy will be needed for quite some time to help
the economy mend. Before continuing, let me emphasize that my
remarks reflect my own views and not necessarily those of
others in the Federal Reserve System.
Economic Conditions and the Outlook
In my remarks tonight, I will describe my perspective on
monetary policy. To begin, however, I'll highlight some of
the current conditions and key features of the economic
outlook that shape my views. To anticipate the main points,
the economy appears to be expanding at a moderate pace. The
unemployment rate is almost 1 percentage point lower than it
was a year ago, but we are still far from full employment.
Looking ahead, I anticipate that significant headwinds will
continue to restrain the pace of the recovery so that the
remaining employment gap is likely to close only slowly. At
the same time, inflation (abstracting from the transitory
effects of movements in oil prices) has been running near 2
percent over the past two years, and I expect it to remain at
or below the Federal Open Market Committee's (the FOMC's) 2
percent objective for the foreseeable future. As always,
considerable uncertainty attends the outlook for both growth
and inflation; events could prove either more positive or
negative than what I see as the most likely outcome. That
said, as I will explain, I consider the balance of risks to
be tilted toward a weaker economy.
Starting with the labor market, conditions have gradually
improved over the past year, albeit at an uneven pace.
Average monthly payroll gains picked up from about 145,000 in
the second half of 2011 to 225,000 during the first quarter
of this year. However, these gains fell back to around 75,000
a month in April and May. The deceleration of payroll
employment from the first to the second quarter was probably
exacerbated by some combination of seasonal adjustment
difficulties and an unusually mild winter that likely boosted
employment growth earlier in the year. Payback for that
earlier strength probably accounts for some of the weakness
we've seen recently. Smoothing through these fluctuations,
the average pace of job creation for the year to date, as
well as recent unemployment benefit claims data and other
indicators, appear to be consistent with an economy expanding
at only a moderate rate, close to its potential.
Such modest growth would imply little additional progress
in the near term in improving labor market conditions, which
remain very weak. Currently, the unemployment rate stands
around 3 percentage points above where it was at the onset of
the recession--a figure that is stark enough as it is, but
does not even take account of the millions more who have left
the labor force or who would have joined under more normal
circumstances in the past four years. All told, only about
half of the collapse in private payroll employment in 2008
and 2009 has been reversed. A critical question for monetary
policy is the extent to which these numbers reflect a
shortfall from full employment versus a rise in structural
unemployment. While the magnitude of structural unemployment
is uncertain, I read the evidence as suggesting that the bulk
of the rise during the recession was cyclical, not structural
in nature.
Consider figure 1, which presents three indicators of labor
market slack. The black solid line is the unemployment gap,
defined as the difference between the actual unemployment
rate and the Congressional Budget Office (CBO) estimate of
the rate consistent with inflation remaining stable over
time. The red dashed line is an index of the difficulty
households perceive in finding jobs, based on results from a
survey conducted by the Conference Board. And the red dotted
line is an index of firms' ability to fill jobs, based on a
survey conducted by the National Federation of Independent
Business. All three measures show similar cyclical movements
over the past 20 years, and all now stand at very high
levels. This similarity runs counter to claims that the CBO's
and other estimates of the unemployment gap overstate the
true amount of slack by placing insufficient weight on
structural explanations, such as a reduced efficiency of
matching workers to jobs, for the rise in unemployment since
2007. If that were the case, why would firms now find it so
easy to fill positions? Other evidence also points to the
dominant role of cyclical forces in the recent rise in
unemployment: job losses have been widespread, rather than
being concentrated in the construction and financial sectors,
and the co-movement of job vacancies and unemployment over
the past few years does not appear to be unusual.
As I mentioned, I expect several factors to restrain the
pace of the recovery and the corresponding improvement in the
labor market going forward. The housing sector remains a
source of very significant headwinds. Housing has typically
been a driver of economic recoveries, and we have seen some
modest improvement recently, but continued uncertainties over
the direction of house prices, and very restricted mortgage
credit availability for all but the most creditworthy buyers,
will likely weigh on housing demand for some time to come.
When housing demand does pick up more noticeably, the huge
overhang of both unoccupied dwellings and homes in the
foreclosure pipeline will likely allow a good deal of that
demand to be met for a time without a sizeable expansion in
homebuilding. Moreover, the enormous toll on household wealth
resulting from the collapse of house prices--almost a 35
percent decline from its 2006 peak, according to the Case-
Shiller index--imposes ongoing restraint on consumer
spending, and the loss of home equity has impaired many
households' ability to borrow.
A second headwind that will likely become more important
over coming months relates to fiscal policy. At the federal
level, stimulus-related policies are scheduled to wind down,
while both defense and nondefense purchases are expected to
decline in inflation-adjusted terms over the next several
years. Toward the end of this year, important decisions
regarding the extension of current federal tax and budget
policies loom. I will return to the associated uncertainties
and their potentially detrimental effects later.
A third factor weighing on the outlook is the likely
sluggish pace of economic growth abroad. Strains in global
financial markets have resurfaced in recent months,
reflecting renewed uncertainty about the resolution of the
European situation. Risk premiums on sovereign debt and other
securities have risen again in many European countries, while
European banks continue to face pressure to shrink their
balance sheets. Even without a further intensification of
stresses, the slowdown in economic activity in Europe will
likely hold back U.S. export growth. Moreover, the perceived
risks surrounding the European situation are already having a
meaningful effect on financial conditions here in the United
States, further weighing on the prospects for U.S. growth.
Given these formidable challenges, most private sector
forecasters expect only gradual improvement in the labor
market and I share their view. Figure 2 shows the
unemployment rate together with the median forecast from last
month's Survey of Professional Forecasters (SPF), the dashed
blue line. The figure also shows the central tendency of the
unemployment projections that my FOMC colleagues and I made
at our April meeting: Those projections reflect our
assessments of the economic outlook given our own individual
judgements about the appropriate path of monetary policy.
Included in the figure as well is the central tendency of
FOMC participants' estimates of the longer-run normal
unemployment rate, which ranges from 5.2 percent to 6
percent. Like private forecasters, most FOMC participants
expect the unemployment rate to remain well above its longer-
run normal value over the next several years.
Of course, considerable uncertainty attends this outlook:
The shaded area provides an estimate of the 70 percent
confidence interval for the future path of the unemployment
rate based on historical experience and model simulations.
Its width suggests that these projections could be quite far
off, in either direction. Nevertheless, the figure shows that
labor market slack at present is so large that even a very
large and favorable forecast error would not change the
conclusion that slack will likely remain substantial for
quite some time.
Turning to inflation, figure 3 summarizes private and FOMC
forecasts. Overall consumer price inflation has fluctuated
quite a bit in recent years, largely reflecting movements in
prices for oil and other commodities. In early 2011 and again
earlier this year, prices of crude oil, and thus of gasoline,
rose noticeably. Smoothing through these fluctuations,
inflation as measured by the price index for personal
consumption expenditures (PCE) averaged near 2 percent over
the past two years. In recent weeks, however, oil and
gasoline prices have moderated and are now showing through to
the headline inflation figures. Looking ahead, most FOMC
participants at the time of our April meeting expected
inflation to be at, or a bit below, our long-run objective of
2 percent through 2014; private forecasters on average also
expect inflation to be close to 2 percent. As with
unemployment, uncertainty around the inflation projection is
substantial.
In the view of some observers; the stability of inflation
in the face of high unemployment in recent years constitutes
evidence
that much of the remaining unemployment is structural and not
cyclical. They reason that if there were truly substantial
slack in the labor market, simple accelerationist ``Phillips
curve'' models would predict more noticeable downward
pressure on inflation. However, substantial cross-country
evidence suggests that, in low-inflation environments,
inflation is notably less responsive to downward pressure
from labor market slack than it is when inflation is
elevated.
In other words, the short-run Phillips curve may flatten
out. One important reason for this non-linearity, in my view,
is downward nominal wage rigidity--that is, the reluctance or
inability of many firms to cut nominal wages.
The solid blue bars in figure 4 present a snapshot of the
distribution of nominal wage changes for individual jobs
during the depth of the current labor market slump, based on
data collected by the Bureau of Labor Statistics. For
comparison, the dashed red line presents a hypothetical
distribution of wage changes, using a normal distribution
that approximates the actual distribution of wage changes
greater than zero. The distribution of actual wage changes
shows that a relatively high percentage of workers saw no
change in their nominal wage, and relatively few experienced
modest wage cuts. This pile-up phenomenon at zero suggests
that, even when the unemployment rate was around 10 percent,
many firms were reluctant to cut nominal wage rates. In the
absence of this barrier, nominal gains in wages and unit
labor costs would have likely been even more subdued given
the severity of the economic downturn, with the result that
inflation would probably now be running at a lower rate.
Anchored inflation expectations are another reason why
inflation has remained close to 2 percent in the face of very
low resource utilization. As shown in figure 5, survey
measures of longer-horizon inflation expectations have
remained nearly constant since the mid-1990s even as actual
inflation has fluctuated. As a result, the current slump has
not generated the downward spiral of falling expected and
actual inflation that a simple accelerationist model of
inflation might have predicted. Indeed, keeping inflation
expectations from declining has been an important success of
monetary policy over the past few years. At the same time,
the fact that longer-term inflation expectations have not
risen above 2 percent has also proved extremely valuable, for
it has freed the FOMC to take strong actions to support the
economic recovery without greatly worrying that higher energy
and commodity prices would become ingrained in inflation and
inflation expectations, as they did in the 1970s.
While my modal outlook calls for only a gradual reduction
in labor market slack and a stable pace of inflation near the
FOMC's longer-run objective of 2 percent, I see substantial
risks to this outlook, particularly to the downside. As I
mentioned before, even without any political gridlock, fiscal
policy is bound to become substantially less accommodative
from early 2013 on. However, federal fiscal policy could turn
even more restrictive if the Congress does not reach
agreement on several important tax and budget policy issues
before the end of this year; in fact, the CBO recently warned
that the potential hit to gross domestic product (GDP) growth
could be sufficient to push the economy into recession in
2013. The deterioration of financial conditions in Europe of
late, coupled with notable declines in global equity markets,
also serve as a reminder that highly destabilizing outcomes
cannot be ruled out. Finally, besides these clearly
identifiable sources of risk, there remains the broader issue
that economic forecasters have repeatedly overestimated the
strength of the recovery and so still may be too optimistic
about the prospects that growth will strengthen.
Although I view the bulk of the increase in unemployment
since 2007 as cyclical, I am concerned that it could become a
permanent problem if the recovery were to stall. In this
economic downturn, the fraction of the workforce unemployed
for six months or more has climbed much more than in previous
recessions, and remains at a remarkably high level. Continued
high unemployment could wreak long-term damage by eroding the
skills and labor force attachment of workers suffering long-
term unemployment, thereby turning what was initially
cyclical into structural unemployment. This risk provides
another important reason to support the recovery by
maintaining a highly accommodative stance of monetary policy.
The Conduct of Policy with Unconventional Tools
Now turning to monetary policy, I will begin by discussing
the FOMC's reliance on unconventional tools to address the
disappointing pace of recovery. I will then elaborate my
rationale for supporting a highly accommodative policy
stance.
As you know, since late 2008, the FOMC's standard policy
tool, the target federal funds rate, has been maintained at
the zero lower bound. To provide further accommodation, we
have employed two unconventional tools to support the
recovery--extended forward guidance about the future path of
the federal funds rate, and large-scale asset purchases and
other balance sheet actions that have greatly increased the
size and duration of the Federal Reserve's portfolio.
These two tools have become increasingly important because
the recovery from the recession has turned out to be
persistently slower than either the FOMC or private
forecasters anticipated. Figure 6 illustrates the magnitude
of the disappointment by comparing Blue Chip forecasts for
real GDP growth made two years ago with ones made earlier
this year. As shown by the dashed blue line, private
forecasters in early 2010 anticipated that real GDP would
expand at an average annual rate of just over 3 percent from
2010 through 2014. However, actual growth in 2011 and early
2012 has turned out to be much weaker than expected, and, as
indicated by the dotted red line, private forecasters now
anticipate only a modest acceleration in real activity over
the next few years.
In response to the evolving outlook, the FOMC has
progressively added policy accommodation using both of its
unconventional tools. For example, since the federal funds
rate target was brought down to a range of 0 to \1/4\ percent
in December 2008, the FOMC has gradually adjusted its forward
guidance about the anticipated future path of the federal
funds rate. In each meeting statement from March 2009 through
June 2011, the Committee indicated its expectation that
economic conditions ``are likely to warrant exceptionally low
levels of the federal funds rate for an extended period.'' At
the August 2011 meeting, the Committee decided to provide
more specific information about the likely time horizon by
substituting the phrase ``at least through mid-2013'' for the
phrase ``for an extended period''; at the January 2012
meeting, this horizon was extended to ``at least through late
2014.'' Has this guidance worked? Figure 7 illustrates how
dramatically forecasters' expectations of future short-term
interest rates have changed. As the dashed blue line
indicates, the Blue Chip consensus forecast made in early
2010 anticipated that the Treasury-bill rate would now stand
at close to 3\1/2\ percent; today, in contrast, private
forecasters expect short-term interest rates to remain very
low in 2014.
Of course, much of this revision in interest rate
projections would likely have occurred in the absence of
explicit forward guidance; given the deterioration in
projections of real activity due to the unanticipated
persistence of headwinds, and the continued subdued outlook
for inflation, forecasters would naturally have anticipated a
greater need for the FOMC to provide continued monetary
accommodation. However, I believe the changes over time in
the language of the FOMC statement, coupled with information
provided by Chairman Bernanke and others in speeches and
congressional testimony, helped the public understand better
the Committee's likely policy response given the slower-than-
expected economic recovery. As a result, forecasters and
market participants appear to have marked down their
expectations for future short-term interest rates by more
than they otherwise would have, thereby putting additional
downward pressure on long-term interest rates, improving
broader financial conditions, and lending support to
aggregate demand.
The FOMC has also provided further monetary accommodation
over time by altering the size and composition of the Federal
Reserve's securities holdings, shown in figure 8. The
expansion in the volume of securities held by the Federal
Reserve is shown in the left panel of the figure. During 2009
and early 2010, the Federal Reserve purchased about $1.4
trillion in agency mortgage-backed securities and agency debt
securities and about $300 billion in longer-term Treasury
securities. In November 2010, the Committee initiated an
additional $600 billion in purchases of longer-term Treasury
securities, which were completed at the end of June of last
year. Last September, the FOMC decided to implement the
``Maturity Extension Program,'' which affected the maturity
composition of our Treasury holdings as shown in the right
panel. Through this program, the FOMC is extending the
average maturity of its securities holdings by selling $400
billion of Treasury securities with remaining maturities of 3
years or less and purchasing an equivalent amount of Treasury
securities with remaining maturities of 6 to 30 years. These
transactions are currently scheduled to be completed at the
end of this month.
Research by Federal Reserve staff and others suggests that
our balance sheet operations have had substantial effects on
longer-term Treasury yields, principally by reducing term
premiums on longer-dated Treasury securities. Figure 9
provides an estimate, based on Federal Reserve Board staff
calculations, of the cumulative reduction of the term premium
on 10-year Treasury securities from the three balance sheet
programs. These results suggest that our portfolio actions
are currently keeping 10-year Treasury yields roughly 60
basis points lower than they otherwise would be. Other
evidence suggests that this downward pressure has had
favorable spillover effects on other financial markets,
leading to lower long-term borrowing costs for households and
firms, higher equity valuations, and other improvements in
financial conditions that in turn have supported consumption,
investment, and net exports. Because the term premium effect
depends on both the Federal Reserve's current and expected
future asset holdings, most of this effect--without further
actions--will likely wane over the next few years as the
effect depends less and less on the current elevated level of
the balance sheet and increasingly on the level of holdings
during and after the normalization of our portfolio.
The Rationale for Highly Accommodative Policy
I have already noted that, in my view, an extended period
of highly accommodative policy is necessary to combat the
persistent headwinds to recovery. I will next explain how
I've reached this policy judgment. In evaluating the stance
of policy, I find the prescriptions from simple policy rules
a logical starting point. A wide range of such rules has been
examined in the academic literature, the most famous of which
is that proposed by John Taylor in his 1993 study. Rules of
the general sort proposed by Taylor (1993) capture well our
statutory mandate to promote maximum employment and price
stability by prescribing that the federal funds rate should
respond to the deviation of inflation from its longer-run
goal and to the output gap, given that the economy should be
at or close to full employment when the output gap--the
difference between actual GDP and an estimate of potential
output--is closed. Moreover, research suggests that such
simple rules can be reasonably robust to uncertainty about
the true structure of the economy, as they perform well in a
variety of models. Today, I will consider the prescriptions
of two such benchmark rules--Taylor's 1993 rule, and a
variant that is twice as responsive to economic slack. In my
view, this latter rule is more consistent with the FOMC's
commitment to follow a balanced approach to promoting our
dual mandate, and so I will refer to it as the ``balanced-
approach'' rule.
To show the prescriptions these rules would have called for
at the April FOMC meeting, I start with an illustrative
baseline outlook constructed using the projections for
unemployment, inflation, and the federal funds rate that FOMC
participants reported in April. I then employ the dynamics of
one of the Federal Reserve's economic models, the FRB/US
model, to solve for the joint paths of these three variables
if the short-term interest rate had instead been set
according to the Taylor (1993) rule or the balanced-approach
rule, subject, in both cases, to the zero lower bound
constraint on the federal funds rate. The dashed red line in
figure 10 shows the resulting path for the federal funds rate
under Taylor (1993) and the solid blue line with open circles
illustrates the corresponding path using the balanced-
approach rule. In both simulations, the private sector fully
understands that monetary policy follows the particular rule
in force. Figure 10 shows that the Taylor rule calls for
monetary policy to tighten immediately, while the balanced-
approach rule prescribes raising the federal funds rate in
the fourth quarter of 2014--the earliest date consistent with
the FOMC's current forward guidance of ``exceptionally low
levels for the federal funds rate at least through late
2014.''
Although simple rules provide a useful starting point in
determining appropriate policy, they by no means deserve the
``last word''--especially in current circumstances. An
alternative approach, also illustrated in figure 10, is to
compute an ``optimal control'' path for the federal funds
rate using an economic model--FRB/US, in this case. Such a
path is chosen to minimize the value of a specific ``loss
function'' conditional on a baseline forecast of economic
conditions. The loss function attempts to quantify the social
costs resulting from deviations of inflation from the
Committee's longer-run goal and from deviations of
unemployment from its longer-run normal rate. The solid green
line with dots in figure 10 shows the ``optimal control''
path for the federal funds rate, again conditioned on the
illustrative baseline outlook. This policy involves keeping
the federal funds rate close to zero until late 2015, four
quarters longer than the balanced-approach rule prescription
and several years longer than the Taylor rule. Importantly,
optimal control calls for a later lift-off date even though
this benchmark--unlike the simple policy rules--implicitly
takes full account of the additional stimulus to real
activity and inflation being provided over time by the
Federal Reserve's other policy tool, the past and projected
changes to the size and maturity of its securities holdings.
Figure 11 shows that, by keeping the federal funds rate at
its current level for longer, monetary policy under the
balanced-approach rule achieves a more rapid reduction of the
unemployment rate than monetary policy under the Taylor
(1993) rule does, while nonetheless keeping inflation near 2
percent. But the improvement in labor market conditions is
even more notable under the optimal control path, even as
inflation remains close to the FOMC's long-run inflation
objective.
As I noted, simple rules have the advantage of delivering
good policy outcomes across a broad range of models, and are
thereby relatively robust to our limited understanding of the
precise working of the economy--in contrast to optimal-
control policies, whose prescriptions are sensitive to the
specification of the particular model used in the analysis.
However, simple rules also have their shortcomings, leading
them to significantly understate the case for keeping policy
persistently accommodative in current circumstances.
One of these shortcomings is that the rules do not adjust
for the constraints that the zero lower bound has placed on
conventional monetary policy since late 2008. A second is
that they do not fully take account of the protracted nature
of the forces that have been restraining aggregate demand in
the aftermath of the housing bust. As I've emphasized, the
pace of the current recovery has turned out to be
persistently slower than most observers expected, and
forecasters expect it to remain quite moderate by historical
standards. The headwinds that explain this disappointing
performance represent a substantial departure from normal
cyclical dynamics. As a result, the economy's equilibrium
real federal funds rate--that is, the rate that would be
consistent with full employment over the medium run--is
probably well below its historical average, which the
intercept of simple policy rules is supposed to approximate.
By failing to fully adjust for this decline, the
prescriptions of simple policy rules--which provide a useful
benchmark under normal circumstances--could be significantly
too restrictive now and could remain so for some time to
come. In this regard, I think it is informative that the Blue
Chip consensus forecast released in March showed the real
three-month Treasury bill rate settling down at only 1\1/4\
percent late in the decade, down 120 basis points from the
long-run projections made prior to the recession.
Looking Ahead
Recent labor market reports and financial developments
serve as a reminder that the economy remains vulnerable to
setbacks. Indeed, the simulations I described above did not
take into account this new information. In our policy
deliberations at the upcoming FOMC meeting we will assess the
effects of these developments on the economic forecast. If
the Committee were to judge that the recovery is unlikely to
proceed at a satisfactory pace (for example, that the
forecast entails little or no improvement in the labor market
over the next few years), or that the downside risks to the
outlook had become sufficiently great, or that inflation
appeared to be in danger of declining notably below its 2
percent objective, I am convinced that scope remains for the
FOMC to provide further policy accommodation either through
its forward guidance or through additional balance-sheet
actions. In taking these decisions, however, we would need to
balance two considerations.
On the one hand, our unconventional tools have some
limitations and costs. For example, the effects of forward
guidance are likely to be weaker the longer the horizon of
the guidance, implying that it may be difficult to provide
much more stimulus through this channel. As for our balance
sheet operations, although we have now acquired some
experience with this tool, there is still considerable
uncertainty about its likely economic effects. Moreover, some
have expressed concern that a substantial further expansion
of the balance sheet could interfere with the Fed's ability
to execute a smooth exit from its accommodative policies at
the appropriate time. I disagree with this view: The FOMC has
tested a variety of tools to ensure that we will be able to
raise short-term interest rates when needed while gradually
returning the portfolio to a more normal size and
composition. But even if unjustified, such concerns could in
theory reduce confidence in the Federal Reserve and so lead
to an undesired increase in inflation expectations.
On the other hand, risk management considerations arising
from today's unusual circumstances strengthen the case for
additional accommodation beyond that called for by simple
policy rules and optimal control under the modal outlook. In
particular, as I have noted, there are a number of
significant downside risks to the economic outlook, and hence
it may well be appropriate to insure against adverse shocks
that could push the economy into territory where a self-
reinforcing downward spiral of economic weakness would be
difficult to arrest.
Conclusion
In my remarks this evening I have sought to explain why, in
my view, a highly accommodative monetary policy will remain
appropriate for some time to come. My views concerning the
stance of monetary policy reflect the FOMC's firm commitment
to the goals of maximum employment and stable prices, my
appraisal of the medium term outlook (which is importantly
shaped by the persistent legacy of the housing bust and
ensuing financial crisis), and by my assessment of the
balance of risks facing the economy. Of course, as I've
emphasized, the outlook is uncertain and the Committee will
need to adjust policy as appropriate as actual conditions
unfold. For this reason, the FOMC's forward guidance is
explicitly conditioned on its anticipation of ``low rates of
resource utilization and a subdued outlook for inflation over
the medium run.'' If the recovery were to proceed faster than
expected or if inflation pressures were to pick up
materially, the FOMC could adjust policy by bringing forward
the expected date of tightening. In contrast, if the
Committee judges that the recovery is proceeding at an
insufficient pace, we could undertake portfolio actions such
as additional asset purchases or a further maturity extension
program. It is for this reason that the FOMC emphasized, in
its statement following the April meeting, that it would
``regularly review the size and composition of its securities
holdings and is prepared to adjust those holdings as
appropriate to promote a stronger economic recovery in a
context of price stability.''
I would also like to include in the record of this debate an article from Bloomberg News that talks about how secret Fed loans gave
banks billions that were undisclosed to Congress.
[From: Bloomberg Markets Magazine,
Nov. 27, 2011]
Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress
(By Bob Ivry, Bradley Keoun, and Phi Kuntz)
The Federal Reserve and the big banks fought for more than
two years to keep details of the largest bailout in U.S.
history a secret. Now, the rest of the world can see what it
was missing. The Fed didn't tell anyone which banks were in
trouble so deep they required a combined $1.2 trillion on
Dec. 5, 2008, their single neediest day. Bankers didn't
mention that they took tens of billions of dollars in
emergency loans at the same time they were assuring investors
their firms were healthy. And no one calculated until now
that banks reaped an estimated $13 billion of income by
taking advantage of the Fed's below-market rates, Bloomberg
Markets magazine reports in its January issue.
Saved by the bailout, bankers lobbied against government
regulations, a job made easier by the Fed, which never
disclosed the details of the rescue to lawmakers even as
Congress doled out more money and debated new rules aimed at
preventing the next collapse.
A fresh narrative of the financial crisis of 2007 to 2009
emerges from 29,000 pages of Fed documents obtained under the
Freedom of Information Act and central bank records of more
than 21,000 transactions. While Fed officials say that almost
all of the loans were repaid and there have been no losses,
details suggest taxpayers paid a price beyond dollars as the
secret funding helped preserve a broken status quo and
enabled the biggest banks to grow even bigger.
``Change Their Votes''
``When you see the dollars the banks got, it's hard to make
the case these were successful institutions,'' says Sherrod
Brown, a Democratic Senator from Ohio who in 2010 introduced
an unsuccessful bill to limit bank size. ``This is an issue
that can unite the Tea Party and Occupy Wall Street. There
are lawmakers in both parties who would change their votes
now.'' The size of the bailout came to light after Bloomberg
LP, the parent of Bloomberg News, won a court case against
the Fed and a group of the biggest U.S. banks called Clearing
House Association LLC to force lending details into the open.
The Fed, headed by Chairman Ben S. Bernanke, argued that
revealing borrower details would create a stigma--investors
and counterparties would shun firms that used the central
bank as lender of last resort--and that needy institutions
would be reluctant to borrow in the next crisis. Clearing
House Association fought Bloomberg's lawsuit up to the U.S.
Supreme Court, which declined to hear the banks' appeal in
March 2011.
$7.77 Trillion
The amount of money the central bank parceled out was
surprising even to Gary H. Stern, president of the Federal
Reserve Bank of Minneapolis from 1985 to 2009, who says he
``wasn't aware of the magnitude.'' It dwarfed the Treasury
Department's better-known $700 billion Troubled Asset Relief
Program, or TARP. Add up guarantees and lending limits, and
the Fed had committed $7.77 trillion as of March 2009 to
rescuing the financial system, more than half the value of
everything produced in the U.S. that year.
``TARP at least had some strings attached,'' says Brad
Miller, a North Carolina Democrat on the House Financial
Services Committee, referring to the program's executive-pay
ceiling. ``With the Fed programs, there was nothing.''
Bankers didn't disclose the extent of their borrowing. On
Nov. 26, 2008, then-Bank of America (BAC) Corp. Chief
Executive Officer Kenneth D. Lewis wrote to shareholders that
he headed ``one of the strongest and most stable major banks
in the world.'' He didn't say that his Charlotte, North
Carolina-based firm owed the central bank $86 billion that
day.
``Motivate Others''
JPMorgan Chase & Co. CEO Jamie Dimon told shareholders in a
March 26, 2010, letter that his bank used the Fed's Term
Auction Facility ``at the request of the Federal Reserve to
help motivate others to use the system.'' He didn't say that
the New York-based bank's total TAF borrowings were almost
twice its cash holdings or that its peak borrowing of $48
billion on Feb. 26, 2009, came more than a year after the
program's creation.
Howard Opinsky, a spokesman for JPMorgan (JPM), declined to
comment about Dimon's statement or the company's Fed
borrowings. Jerry Dubrowski, a spokesman for Bank of America,
also declined to comment.
The Fed has been lending money to banks through its so-
called discount window since just after its founding in 1913.
Starting in August 2007, when confidence in banks began to
wane, it created a variety of ways to bolster the financial
system with cash or easily traded securities. By the end of
2008, the central bank had established or expanded ii lending
facilities catering to banks, securities firms and
corporations that couldn't get short-term loans from their
usual sources.
``Core Function''
``Supporting financial-market stability in times of extreme
market stress is a core function of central banks,'' says
William B. English, director of the Fed's Division of
Monetary Affairs. ``Our lending programs served to prevent a
collapse of the financial system and to keep credit flowing
to American families and businesses.''
The Fed has said that all loans were backed by appropriate
collateral. That the central bank didn't lose money should
``lead to praise of the Fed, that they took this
extraordinary step and they got it right,'' says Phillip
Swagel, a former assistant Treasury secretary under Henry M.
Paulson and now a professor of international economic policy
at the University of Maryland. The Fed initially released
lending data in aggregate form only. Information on which
banks borrowed, when, how much and at what interest rate was
kept from public view.
The secrecy extended even to members of President George W.
Bush's administration who managed TARP. Top aides to Paulson
weren't privy to Fed lending details during the creation of
the program that provided crisis funding to more than 700
banks, say two former senior Treasury officials who requested
anonymity because they weren't authorized to speak.
Big Six
The Treasury Department relied on the recommendations of
the Fed to decide which banks were healthy enough to get TARP
money and how much, the former officials say. The six biggest
U.S. banks, which received $160 billion of TARP funds,
borrowed as much as $460 billion from the Fed, measured by
peak daily debt calculated by Bloomberg using data obtained
from the central bank. Paulson didn't respond to a request
for comment.
The six--JPMorgan, Bank of America, Citigroup Inc. (C),
Wells Fargo & Co. (WFC), Goldman Sachs Group Inc. (GS) and
Morgan Stanley--accounted for 63 percent of the average daily
debt to the Fed by all publicly traded U.S. banks, money
managers and investment- services firms, the data show. By
comparison, they had about half of the industry's assets
before the bailout, which lasted from August 2007 through
April 2010. The daily debt figure excludes cash that banks
passed along to money-market funds.
Bank Supervision
While the emergency response prevented financial collapse,
the Fed shouldn't have allowed conditions to get to that
point, says Joshua Rosner, a banking analyst with Graham
Fisher & Co. in New York who predicted problems from lax
mortgage underwriting as far back as 2001. The Fed, the
primary supervisor for large financial companies, should have
been more vigilant as the housing bubble formed, and the
scale of its lending shows the ``supervision of the banks
prior to the crisis was far worse than we had imagined,''
Rosner says.
Bernanke in an April 2009 speech said that the Fed provided
emergency loans only to ``sound institutions,'' even though
its internal assessments described at least one of the
biggest borrowers, Citigroup, as ``marginal.''
On Jan. 14, 2009, six days before the company's central
bank loans peaked, the New York Fed gave CEO Vikram Pandit a
report declaring Citigroup's financial strength to be
``superficial,'' bolstered largely by its $45 billion of
Treasury funds. The document was released in early 2011 by
the Financial Crisis Inquiry Commission, a panel empowered by
Congress to probe the causes of the crisis.
``Need Transparency''
Andrea Priest, a spokeswoman for the New York Fed, declined
to comment, as did Jon Diat, a spokesman for Citigroup.
``I believe that the Fed should have independence in
conducting highly technical monetary policy, but when they
are putting taxpayer resources at risk, we need transparency
and accountability,'' says Alabama Senator Richard Shelby,
the top Republican on the Senate Banking Committee.
Judd Gregg, a former New Hampshire senator who was a lead
Republican negotiator on TARP, and Barney Frank, a
Massachusetts Democrat who chaired the House Financial
Services Committee, both say they were kept in the dark.
``We didn't know the specifics,'' says Gregg, who's now an
adviser to Goldman Sachs.
``We were aware emergency efforts were going on,'' Frank
says. ``We didn't know the specifics.''
Disclose Lending
Frank co-sponsored the Dodd-Frank Wall Street Reform and
Consumer Protection Act, billed as a fix for financial-
industry excesses. Congress debated that legislation in 2010
without a full understanding of how deeply the banks had
depended on the Fed for survival. It would have been
``totally appropriate'' to disclose the lending data by mid-
2009, says David Jones, a former economist at the Federal
Reserve Bank of New York who has written four books about the
central bank.
``The Fed is the second-most-important appointed body in
the U.S., next to the Supreme Court, and we're dealing with a
democracy,'' Jones says. ``Our representatives in Congress
deserve to have this kind of information so they can oversee
the Fed.''
The Dodd-Frank law required the Fed to release details of
some emergency-lending programs in December 2010. It also
mandated disclosure of discount-window borrowers after a two-
year lag.
Protecting TARP
TARP and the Fed lending programs went ``hand in hand,''
says Sherrill Shaffer, a banking professor at the University
of Wyoming in Laramie and a former chief economist at the New
York Fed. While the TARP
money helped insulate the central bank from losses, the Fed's
willingness to supply seemingly unlimited financing to the
banks assured they wouldn't collapse, protecting the
Treasury's TARP investments, he says.
``Even though the Treasury was in the headlines, the Fed
was really behind the scenes engineering it,'' Shaffer says.
Congress, at the urging of Bernanke and Paulson, created
TARP in October 2008 after the bankruptcy of Lehman Brothers
Holdings Inc. made it difficult for financial institutions to
get loans. Bank of America and New York-based Citigroup each
received $45 billion from TARP. At the time, both were
tapping the Fed. Citigroup hit its peak borrowing of $99.5
billion in January 2009, while Bank of America topped out in
February 2009 at $91.4 billion.
No Clue
Lawmakers knew none of this.
They had no clue that one bank, New York-based Morgan
Stanley (MS), took $107 billion in Fed loans in September
2008, enough to pay off one-tenth of the country's delinquent
mortgages. The firm's peak borrowing occurred the same day
Congress rejected the proposed TARP bill, triggering the
biggest point drop ever in the Dow Jones Industrial Average.
(INDU) The bill later passed, and Morgan Stanley got $10
billion of TARP funds, though Paulson said only ``healthy
institutions'' were eligible.
Mark Lake, a spokesman for Morgan Stanley, declined to
comment, as did spokesmen for Citigroup and Goldman Sachs.
Had lawmakers known, it ``could have changed the whole
approach to reform legislation,'' says Ted Kaufman, a former
Democratic Senator from Delaware who, with Brown, introduced
the bill to limit bank size.
Moral Hazard
Kaufman says some banks are so big that their failure could
trigger a chain reaction in the financial system. The cost of
borrowing for so-called too-big-to-fail banks is lower than
that of smaller firms because lenders believe the government
won't let them go under. The perceived safety net creates
what economists call moral hazard--the belief that bankers
will take greater risks because they'll enjoy any profits
while shifting losses to taxpayers.
If Congress had been aware of the extent of the Fed rescue,
Kaufman says, he would have been able to line up more support
for breaking up the biggest banks.
Byron L. Dorgan, a former Democratic senator from North
Dakota, says the knowledge might have helped pass legislation
to reinstate the Glass-Steagall Act, which for most of the
last century separated customer deposits from the riskier
practices of investment banking.
``Had people known about the hundreds of billions in loans
to the biggest financial institutions, they would have
demanded Congress take much more courageous actions to stop
the practices that caused this near financial collapse,''
says Dorgan, who retired in January.
Getting Bigger
Instead, the Fed and its secret financing helped America's
biggest financial firms get bigger and go on to pay employees
as much as they did at the height of the housing bubble.
Total assets held by the six biggest U.S. banks increased
39 percent to $9.5 trillion on Sept. 30, 2011, from $6.8
trillion on the same day in 2006, according to Fed data.
For so few banks to hold so many assets is ``un-American,''
says Richard W. Fisher, president of the Federal Reserve Bank
of Dallas. ``All of these gargantuan institutions are too big
to regulate. I'm in favor of breaking them up and slimming
them down.''
Employees at the six biggest banks made twice the average
for all U.S. workers in 2010, based on Bureau of Labor
Statistics hourly compensation cost data. The banks spent
$146.3 billion on compensation in 2010, or an average of
$126,342 per worker, according to data compiled by Bloomberg.
That's up almost 20 percent from five years earlier compared
with less than 15 percent for the average worker. Average pay
at the banks in 2010 was about the same as in 2007, before
the bailouts.
``Wanted to Pretend''
``The pay levels came back so fast at some of these firms
that it appeared they really wanted to pretend they hadn't
been bailed out,'' says Anil Kashyap, a former Fed economist
who's now a professor of economics at the University of
Chicago Booth School of Business. ``They shouldn't be
surprised that a lot of people find some of the stuff that
happened totally outrageous.''
Bank of America took over Merrill Lynch & Co. at the urging
of then-Treasury Secretary Paulson after buying the biggest
U.S. home lender, Countrywide Financial Corp. When the
Merrill Lynch purchase was announced on Sept. 15, 2008, Bank
of America had $14.4 billion in emergency Fed loans and
Merrill Lynch had $8.1 billion. By the end of the month, Bank
of America's loans had reached $25 billion and Merrill
Lynch's had exceeded $60 billion, helping both firms keep the
deal on track.
Prevent Collapse
Wells Fargo bought Wachovia Corp., the fourth-largest U.S.
bank by deposits before the 2008 acquisition. Because
depositors were pulling their money from Wachovia, the Fed
channeled $50 billion in secret loans to the Charlotte, North
Carolina-based bank through two emergency-financing programs
to prevent collapse before Wells Fargo could complete the
purchase. ``These programs proved to be very successful at
providing financial markets the additional liquidity and
confidence they needed at a time of unprecedented
uncertainty,'' says Ancel Martinez, a spokesman for Wells
Fargo.
JPMorgan absorbed the country's largest savings and loan,
Seattle-based Washington Mutual Inc., and investment bank
Bear Stearns Cos. The New York Fed, then headed by Timothy F.
Geithner, who's now Treasury secretary, helped JPMorgan
complete the Bear Stearns deal by providing $29 billion of
financing, which was disclosed at the time. The Fed also
supplied Bear Stearns with $30 billion of secret loans to
keep the company from failing before the acquisition closed,
central bank data show. The loans were made through a program
set up to provide emergency funding to brokerage firms.
``Regulatory Discretion''
``Some might claim that the Fed was picking winners and
losers, but what the Fed was doing was exercising its
professional regulatory discretion,'' says John Deane, a
former speechwriter at the New York Fed who's now executive
vice president for policy at the Financial Services Forum, a
Washington-based group consisting of the CEOs of 20 of the
world's biggest financial firms. ``The Fed clearly felt it
had what it needed within the requirements of the law to
continue to lend to Bear and Wachovia.''
The bill introduced by Brown and Kaufman in April 2010
would have mandated shrinking the six largest firms.
``When a few banks have advantages, the little guys get
squeezed,'' Brown says. ``That, to me, is not what capitalism
should be.''
Kaufman says he's passionate about curbing too-big-to-fail
banks because he fears another crisis.
``Can We Survive?''
``The amount of pain that people, through no fault of their
own, had to endure--and the prospect of putting them through
it again--is appalling,'' Kaufman says. ``The public has no
more appetite for bailouts. What would happen tomorrow if one
of these big banks got in trouble? Can we survive that?''
Lobbying expenditures by the six banks that would have been
affected by the legislation rose to $29.4 million in 2010
compared with $22.1 million in 2006, the last full year
before credit markets seized up--a gain of 33 percent,
according to OpenSecrets.org, a research group that tracks
money in U.S. politics. Lobbying by the American Bankers
Association, a trade organization, increased at about the
same rate, OpenSecrets.org reported.
Lobbyists argued the virtues of bigger banks. They're more
stable, better able to serve large companies and more
competitive internationally, and breaking them up would cost
jobs and cause ``long-term damage to the U.S. economy,''
according to a Nov. 13, 2009, letter to members of Congress
from the FSF.
The group's website cites Nobel Prize-winning economist
Oliver E. Williamson, a professor emeritus at the University
of California, Berkeley, for demonstrating the greater
efficiency of large companies.
``Serious Burden''
In an interview, Williamson says that the organization took
his research out of context and that efficiency is only one
factor in deciding whether to preserve too-big-to-fail banks.
``The banks that were too big got even bigger, and the
problems that we had to begin with are magnified in the
process,'' Williamson says. ``The big banks have incentives
to take risks they wouldn't take if they didn't have
government support. It's a serious burden on the rest of the
economy.''
Deane says his group didn't mean to imply that Williamson
endorsed big banks.
Top officials in President Barack Obama's administration
sided with the FSF in arguing against legislative curbs on
the size of banks.
Geithner, Kaufman
On May 4, 2010, Geithner visited Kaufman in his Capitol
Hill office. As president of the New York Fed in 2007 and
2008, Geithner helped design and run the central bank's
lending programs. The New York Fed supervised four of the six
biggest U.S. banks and, during the credit crunch, put
together a daily confidential report on Wall Street's
financial condition. Geithner was copied on these reports,
based on a sampling of e-mails released by the Financial
Crisis Inquiry Commission.
At the meeting with Kaufman, Geithner argued that the issue
of limiting bank size was too complex for Congress and that
people who know the markets should handle these decisions,
Kaufman says. According to Kaufman, Geithner said he
preferred that bank supervisors from around the world,
meeting in Basel, Switzerland, make rules increasing the
amount of money banks need to hold in reserve. Passing laws
in the U.S. would undercut his efforts in Basel, Geithner
said, according to Kaufman.
Anthony Coley, a spokesman for Geithner, declined to
comment.
``Punishing Success''
Lobbyists for the big banks made the winning case that
forcing them to break up was ``punishing success,'' Brown
says. Now that they can see how much the banks were borrowing
from the Fed, senators might think differently, he says.
The Fed supported curbing too-big-to-fail banks, including
giving regulators the power to close large financial firms
and implementing tougher supervision for big banks, says Fed
General Counsel Scott G. Alvarez. The Fed didn't take a
position on whether large banks should be dismantled before
they get into trouble.
Dodd-Frank does provide a mechanism for regulators to break
up the biggest banks. It established the Financial Stability
Oversight Council that could order teetering banks to shut
down in an orderly way. The council is headed by Geithner.
``Dodd-Frank does not solve the problem of too big to
fail,'' says Shelby, the Alabama Republican. ``Moral hazard
and taxpayer exposure still very much exist.''
Below Market
Dean Baker, co-director of the Center for Economic and
Policy Research in Washington, says banks ``were either in
bad shape or taking advantage of the Fed giving them a good
deal. The former contradicts their public statements. The
latter--getting loans at below-market rates during a
financial crisis--is quite a gift.''
The Fed says it typically makes emergency loans more
expensive than those available in the marketplace to
discourage banks from abusing the privilege. During the
crisis, Fed loans were among the cheapest around, with
funding available for as low as 0.01 percent in December
2008, according to data from the central bank and money-
market rates tracked by Bloomberg.
The Fed funds also benefited firms by allowing them to
avoid selling assets to pay investors and depositors who
pulled their money. So the assets stayed on the banks' books,
earning interest.
Banks report the difference between what they earn on loans
and investments and their borrowing expenses. The figure,
known as net interest margin, provides a clue to how much
profit the firms turned on their Fed loans, the costs of
which were included in those expenses. To calculate how much
banks stood to make, Bloomberg multiplied their tax-adjusted
net interest margins by their average Fed debt during
reporting periods in which they took emergency loans.
Added Income
The 190 firms for which data were available would have
produced income of $13 billion, assuming all of the bailout
funds were invested at the margins reported, the data show.
The six biggest U.S. banks' share of the estimated subsidy
was $4.8 billion, or 23 percent of their combined net income
during the time they were borrowing from the Fed. Citigroup
would have taken in the most, with $1.8 billion.
``The net interest margin is an effective way of getting at
the benefits that these large banks received from the Fed,''
says Gerald A. Hanweck, a former Fed economist who's now a
finance professor at George Mason University in Fairfax,
Virginia.
While the method isn't perfect, it's impossible to state
the banks' exact profits or savings from their Fed loans
because the numbers aren't disclosed and there isn't enough
publicly available data to figure it out.
Opinsky, the JPMorgan spokesman, says he doesn't think the
calculation is fair because ``in all likelihood, such funds
were likely invested in very short-term investments,'' which
typically bring lower returns.
Standing Access
Even without tapping the Fed, the banks get a subsidy by
having standing access to the central bank's money, says
Viral Acharya, a New York University economics professor who
has worked as an academic adviser to the New York Fed.
``Banks don't give lines of credit to corporations for
free,'' he says. ``Why should all these government guarantees
and liquidity facilities be for free?''
In the September 2008 meeting at which Paulson and Bernanke
briefed lawmakers on the need for TARP, Bernanke said that if
nothing was done, ``unemployment would rise--to 8 or 9
percent from the prevailing 6.1 percent,'' Paulson wrote in
``On the Brink'' (Business Plus, 2010).
Occupy Wall Street
The U.S. jobless rate hasn't dipped below 8.8 percent since
March 2009, 3.6 million homes have been foreclosed since
August 2007, according to data provider RealtyTrac Inc., and
police have clashed with Occupy Wall Street protesters, who
say government policies favor the wealthiest citizens, in New
York, Boston, Seattle and Oakland, California.
The Tea Party, which supports a more limited role for
government, has its roots in anger over the Wall Street
bailouts, says Neil M. Barofsky, former TARP special
inspector general and a Bloomberg Television contributing
editor.
``The lack of transparency is not just frustrating; it
really blocked accountability,'' Barofsky says. ``When people
don't know the details, they fill in the blanks. They believe
in conspiracies.''
In the end, Geithner had his way. The Brown-Kaufman
proposal to limit the size of banks was defeated, 60 to 31.
Bank supervisors meeting in Switzerland did mandate minimum
reserves that institutions will have to hold, with higher
levels for the world's largest banks, including the six
biggest in the U.S. Those rules can be changed by individual
countries. They take full effect in 2019.
Meanwhile, Kaufman says, ``we're absolutely, totally, 100
percent not prepared for another financial crisis.''
This is all about disclosure and accountability. You know, the Fed's not some kind of hocus-pocus, black box operation. The Fed essentially supplants the constitutional mandate in article I, section 8 that belongs to the Congress of the United States.
Let's look at some recent history here: 2008, subprime meltdown, collateralized debt obligations go back to mortgage-backed securities. Neighborhoods in Cleveland melting down, people losing their homes. The Fed looked the other way.
And we're saying, don't go into the Fed; it will be political. Yes, it's political. We have unemployment because of politics. We have people losing their homes because of politics. We have banks getting uncalculated amounts of money from the Federal Reserve, and we don't even know about it.
Meanwhile, people can't get a loan to keep their home or keep their business.
Audit the Fed? You bet we should audit the Fed. We have to have accountability. It's time the Congress stood up for its constitutional role. Article I, section 8: power to coin and create money.
It's time that we stood up for America's 99 percent. It's time that we stood up to the Federal Reserve that right now acts like it's some kind of high, exalted priesthood, unaccountable in a democracy.
Let's change that by voting for the Paul bill.