On Wednesday, the Wall Street Journal savaged the Federal Reserve Board’s apparent decision to sit on an application from a “narrow” bank to arbitrage interest on excess reserves (IOER). The Journal channeled criticism from bloggers and Bloomberg that accepted that the bank in question, TNB, really is “The Narrow Bank” as it styles itself. Commentators also asserted that the Fed opposed this upstart to protect banking behemoths. But, it isn’t the narrowness of TNB’s charter that troubles the Fed – on safety-and-soundness grounds, regulators love this no-risk bank model. The Fed’s problem with TNB is that its small idea exposed for full public view a far bigger problem: all of the Fed’s emergency post-crisis responses have made it far more than a “central bank” as we commonly understand this centuries-old concept. The Fed now is also a bank performing intermediation tasks across the national economy and as the ultimate arbiter of winners and losers across the financial market and over the spectrum of U.S. income and wealth inequality.
TNB is in fact the tip of a Fed-built iceberg towards which various parts of the economy are sailing. As Bill Nelson, the Bank Policy Institute’s chief economist, pointed out last week, the Fed’s post-crisis policy is so distant from its well-known, “conventional” approach that an entire new Fed has emerged.
As of this writing, the Fed sits atop $4.2 trillion in a portfolio that it can’t figure out how to reduce even though it says it wants to go back to Mr. Nelson’s interest-rate – not portfolio – monetary policy. The Fed’s idea now of a minimal portfolio appears to be somewhere in the $3 trillion range or about 400 percent above its pre-crisis holdings. The Fed wants also to normalize interest rates, but fears that the new neutral rate might be in the real one-percent range, binding it to a policy in which rates hover close to the zero lower bound with little room for macroeconomic or systemic error. Interest rates are now so low that even a hint that a quarter point here or there might surprise the market sets off tremors that could quickly turn into temblors. The Fed’s power is still grander because the rates it sets drive global markets because the dollars on which it sets them clear transactions across the globe. And, for all of the reasons above, the rules the Fed sets for global banks drive global finance, at least until enough of it moves out of the Fed’s reach to confound its edicts and exacerbate U.S. economic equality.
The last few days of 2008 reminiscences have included many from former Chairman Bernanke about why what he did worked and how the inequality, slow growth, and market fragility ever since are everyone else’s fault. I’ll give Mr. Bernanke and his fellow op-ed writers and panelists credit: fast action a decade ago this week pushed the U.S. and global economy off the precipice. Reasonable caution may then have kept the Fed’s hand on the steering wheel until Mr. Bernanke signaled a bit of change in 2013, but the abrupt course reversal after the “taper tantrum” proved only that the central bank listens all too much to the market and far too little to underlying macroeconomic forces. It was clear in 2013 that quantitative easing was redesigning the global financial market and reordering economic inequality. As BIS research has proven, we now have a Fed so bent on preserving markets that its post-crisis policy has had a persistent benefit only for stock prices, not output.
Robust recovery – if that’s what we have now – has come due to risky yield-chasing and Trump-led fiscal- and regulatory-policy changes, most of which may well be reversed at the touch of a tweet. The Fed should instead have stepped back in 2013 and allowed its portfolio to run off before Treasury depended on its income, markets traded on its pricing, and interest rates sunk to levels that fired up yield-chasing and global asset bubbles. What if the leverage ratio and other rules didn’t make it impossible for big banks with huge excess-reserve balances to offer higher interest rates to money-market fund clients? What if – even better – the Fed stopped rigging the rules of the game and banks made money by lending, not IOER?
TNB is a creature of the Fed’s own making – no bank before it would ever have thought a business lay in being the Fed’s intermediary. Now, sadly, it’s a great idea, but only because the Fed has proven itself incapable of coming up with better ones.