Yesterday, a little-noticed deadline expired on one of the strongest letters yet from the House GOP to the Federal Reserve. In it, the FRB was asked tough questions about the reverse-repurchase program (RRP), questions that echo market worries and internal fears. The FRB often delays or defers responding to these rousing demands, but it could be forced to do so in a couple of weeks if Republicans take control in the Senate. To be sure, “control” means little in Congress these days and the FRB likely won’t come under new law any time soon. But, the challenges to its independence are in my view the most acute they’ve been in decades. With the exit strategy upon us, the FRB will need to pick its way across both a political and a policy minefield to normalize its balance sheet and stabilize the world’s economy.
What letter? The letter came to the FRB from one of its most aggressive critics, Rep. Scott Garrett (R-NJ, along with Oversight and Investigations Subcommittee head Patrick McHenry (R-NC). They asked a series of pointed questions about the RRP on which the FRB counts to close out QE3. The Members want RRP to be taken out of the toolkit, arguing that it could exacerbate liquidity stress. For back-up, they quote Federal Reserve Bank Presidents Dudley and Rosengren, and they could well cite others who fear that, even with the $300 billion cap the FRB recently put on the RRP, it could redefine the financial-market landscape in dangerous ways.
The letter goes on to question the Fed’s statutory authority to go into the market with a brand-new liquidity tool open to MMFs, how the FRB will handle what they see as conflicts of interest embedded in the RRP, and what the Fed would do if market demand pushes the RRP above the cap. They also want a clear date for RRP termination and an exit plan for this part of the Fed’s own exit plan.
In short, Reps. Garrett and McHenry want the FRB out of RRP before the central banks even gets much into it. I expect the FRB will send back a polite non-committal RRP defense that will satisfy no one, and then get back to mobilizing the RRP for action in the event charging interest rates on excess reserves fails to do the entire tapering trick.
For now, this is business as usual – the Fed takes strong hits from the House, bats them aside, and promotes its view of necessary accommodative policy. Can this last for long?
As I said, not with such impunity if Republicans take the Senate. Sen. Shelby is a vigorous FRB critic with several reform options already in his pocket. With unlikely allies like Sen. Elizabeth Warren and Sen. Brown, he will have a powerful bipartisan coalition with which to force the FRB’s formidable back up against a formidable political wall.