by | September 15, 2009 1:53 am
This article is written by InvestorPlace’s Neil George.
The are a lot of folks who are still steamed about how the Federal Reserve Bank allowed credit markets to expand willy nilly, leading up to the financial disasters of the past year. Perhaps as a way to stem that anger toward white collar guys running the Fed, a blue collar guy has been named to head the New York Federal Reserve Bank.
Denis Hughes is supposedly a union electrician and a 40-year member of the International Brotherhood of Electrical Workers (IBEW). Now, you might think that the White House might call on such a guy if the wiring on the trading desks is on the blink, but to actually run the New York Fed?
The truth is Denis probably hasn’t picked up his tool belt for awhile now. His specialty is more along the lines of collecting union dues, not wiring. And not just for the IBEW – Denis has been the head of the New York American Federation of Labor and the Congress of Industrial Organizations (AFL-CIO) for the last 10 years.
Now Denis might be a good union boss, but is his skill set what we need overseeing the most important branch of the Fed? The New York Fed focuses on keeping an eye on the trillions of dollars that move in and out of the largest banks and markets of the world. So perhaps it might be a good idea to have a Fed chief that understands the nuances of such instruments as collateralized debt obligations and interest rate swaps.
Denis replaces Steve Friedman, of Goldman Sachs fame, and before Steve, we had Tim Geithner, both of whom at least had some work experience on Wall Street.
Then again, while it’s easy to take pot-shots at a union boss as Fed chief, at the same time, the Wall Street guys haven’t been doing such a great job now, have they?
Folks criticizing the Fed tend to focus on the opaque nature of its operations, as well as the long-term risks of the huge monetization of debt over the past several months. But really, that’s behind us. And perhaps having a blue collar guy asking questions might be what the Fed needs to clean up its act.
Most folks don’t actually understand what the Fed is supposed to do. Even market gurus get all focused on the regular meetings of the Fed’s Open Market Committee (FOMC) with anticipation of whether interest rates are going up or down. And it’s easy to think that the Fed sets interest rates, given all of the media hype at every meeting.
But when was the last time you applied for a business, car or home loan? Did you ring up the Fed to get your rate? Neither did your bank.
So, what is the Fed’s mission?
Officially, the Fed is charged with maintaining money policy that has two purposes: maximum employment and stable prices. But that mission has been expanded to also include regulating banks and financials, as well as providing payment, financial transfers and depository functions for financial institutions both inside and outside the U.S.
So unlike many other central banks that have just one focus – namely, price stability – the Fed has to run the banking markets, plus try to stimulate the economy so that businesses will supposedly create and maintain more jobs in the U.S. economy.
And while its open market buying and selling of securities and providing special lending deals are used to create or reduce money supplies in various corners of the U.S. market, it also has a nice collection of regulations at its disposal that can be used to target very specific imbalances or bubbles in the credit markets, all well before they get out of hand.
Historically, however, the Fed has been very reluctant to use some of its key tools in its belt. This is perhaps where Denis might come in handy.
First up is Regulation T, which is the amount of margin that investors are allowed to have for buying stocks. It’s been set at 50% for decades, but it could have easily have been tightened to control many a stock market bubble.
Second is Regulation G, which limits credit from commercial and non-financial loans. This again could easily be tightened if corporate credit is getting too easy.
Third is Regulation U, which is a big one. This is similar to T, but covers banks lending to institutions that in turn, use credit to trade in the financial markets. Think hedge fund leverage and how, again, this could have been used to tighten down on the leverage and abuse in the Credit Default Swap (CDS) and Collateralized Debt Obligation (CDO) markets by non-bank speculators.
Fourth is Regulation D, which covers reserve rates for banks, including how assets are carried and valued. The Fed, of course, could’ve easily insisted on higher reserve rates on mortgage loan portfolios over the years, but instead worked to liberalize risk weightings by banks of their whole home loan assets.
Fifth is Regulation F, which gives the Fed the ability to step in and restrict how much liability one bank has to another. This is key, as we’ve learned the hard way, with the near or actual failure of several banks and major financials.
Sixth is Regulation S, which simply gives the Fed the ability to control recordkeeping by banks. While simple, it has been ignored, as we’ve seen in many of the syndicated loans, Collateralized Loan Obligations and specific mortgage-backed bonds in which banks have few records to actually pinpoint direct connections between assets and the loans or bonds themselves.
Seventh and eighth are Regulations W and Y. These give the Fed the ability to restrict banks from lending to non-bank affiliates and control of access to bank loans between banks and non-banking affiliates.
Again, given that most of the major banks that needed a Fed bailout involved primarily not their whole loan assets, but rather assets in their trading or other non-bank affiliates, a little use of these two regulations could have saved the markets a whole lot of trouble these past two years.
So, let’s see what our blue collar guy can do. And perhaps, just maybe, he might think about pulling on his new tool belt and re-wiring the Fed and the markets. Somebody had better do so.
Neil George is the editor of Stocks That Pay You.
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