Former Fed Chairmen Pipe Up on Politics

With U.S. facing a credit crisis, all eyes turn to Fed chairmen past and present for leadership.
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The Federal Reserve has moved from being behind the curve on the current credit crisis to leading the central bank into areas that stretch its legal mandate, possibly to a breaking point. The expanded role of the Fed -- including the Bear Stearns (BSC) intervention and tapping into taxpayer dollars -- has many questioning its future.

Fed chairmen past and present have raised their political profile recently, speaking their minds about the Fed's actions and the 2008 political campaigns.

Ben Bernanke appeared this week at the Group of Seven meetings, where the credit crisis has taken center stage. He urged haste on reforming regulations here at home:

"Indeed, many of the necessary changes that have been identified -- including increasing transparency, improving risk management and attaining better coordination among regulators -- could provide important support to the process of normalizing our financial markets."

Treasury Secretary Henry Paulson had released a

package

to reform the regulatory environment last week. A Democratic congress, however, has not embraced the Bush administration's plan.

Bernanke may have offered some input into the new regulations. At the start of his term, data from

the Bernanke Political Index

showed that he met infrequently with officials from the Bush administration -- about as often as Alan Greenspan -- and remained mostly apolitical.

New data

from Bernanke's recent schedules suggests that has changed. He has met much more frequently with administration officials recently -- in particular with Paulson and members of the Treasury Department.

Of course, the Fed and Treasury officials negotiated the Bear Stearns deal to

JPMorgan Chase

(JPM) - Get Report

together, which could account for some of the heightened activity.

All three major presidential candidates have expressed confidence in Bernanke's abilities.

Former Fed Chairman Paul Volcker criticized the Fed's actions in a speech in New York.

"The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles and practices."

He wonders whether the Fed taking on bad debt will break the central bank:

"What appears to be in substance a direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in time of crisis: Lend freely at high rates against good collateral; test it to the point of no return."

Of course, the Fed filled a vacuum that the administration wasn't filling. The media and the general public mostly applauded the unusual actions without questioning their legality.

Volcker wonders why other federal agencies and surrogates such as

Fannie Mae

or

Freddie Mac

have not taken action. It's a question many have been asking.

Volcker also opined on the many similarities between today's economy and that of the early 1970s. Think back: The Vietnam War raged on amid fears of recession, a weak dollar, and surging oil and commodity prices. It sounds eerily familiar. Investors should remember what followed in the late '70s: a period of stagflation and poor returns on the stock market. As Fed chairman, Volcker eventually cleaned up the excesses of the '70s in the early '80s by fighting inflation with higher interest rates and supporting the dollar.

Volcker has greater concerns about the direction of the country than the Fed and says that the economy plays a small role in his outlook. He believes the average American has lost faith in the political system. He hopes it can be restored, and for the first time has decided to publicly endorse a presidential candidate: Barack Obama. Obama has passed ethics reform legislation in both the Illinois State Senate and the U.S. Senate.

Alan Greenspan also supports a presidential candidate. He has said publicly that he will vote for Sen. John McCain (R., Ariz.). Both fell out of favor with some Republicans for opposing the Bush tax cuts, though McCain now disavows his vote. He has endorsed extending the Bush tax cuts.

Of course, the focus on Greenspan hasn't been taxes, but rather his role in the subprime crisis. He has defended himself in

The Wall Street Journal

and in the

Financial Times

, writing:

"Doubtless, each individual housing bubble has its own idiosyncratic characteristics and some point to Fed monetary policy complicity in the US bubble. But the US bubble was close to median world experience and the evidence of monetary policy adding to the bubble is statistically very fragile."

Greenspan agrees with Bernanke on where to point the finger for the problem, at investment banks like

Goldman Sachs

(GS) - Get Report

and

Citigroup

(C) - Get Report

:

"The core of the subprime problem lies with the misjudgments of the investment community. Subprime did not break from its localized niche status until 2005. As Ben Bernanke recently put it: "The deterioration in underwriting standards ... appears to have begun in late 2005." I assume that judgment reflected the increased delinquency behavior that is now evident for loans initiated in late 2005 and subsequently."

Furthermore, Greenspan feels the Fed shouldn't "lean on the wind" to stop bubbles before they happen. He wrote: "I know of no instance in which such a policy has been successful." And Greenspan offers a warning that contradicts Bernanke and Volcker in the

WSJ

, asking for more time to perceive the cause of the credit crisis problem:

"The wrong evaluation of this period -- and how to avoid the problems associated with it -- will give you the wrong answers and the wrong policies."