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The Institutional Flaw At the Heart of the Federal Reserve

Politics / Central Banks Jun 14, 2012 - 08:04 AM GMT

By: Jesse


Best Financial Markets Analysis ArticleThis is a long 'thought piece' by Simon Johnson, an eminent US economist and professor at the MIT Sloan School of Management.

It exposes the inherent conflicts of interest at the New York Fed, the history behind that structural flaw, and the problems it creates in a time of high powered money and financialization, with the Fed assuming even more regulatory powers from a craven Congress.

This is nothing new to readers here. The Fed is an institution fouled by privilege and insider dealing, involved so deeply in white collar crime as to be completely ensnared in the credibility trap of its own making.

We saw the heart of the problem when an arrogantly defiant Jamie Dimon faced down the august Senators, many of whom are at least his part time employees.

So it is heartening when someone who is clearly in the establishment and not so easily dismissed or shouted down is willing to stand and say that there is a problem, it is not incidental, and it will create more and serious problems in the future.

Certainly Simon Johnson is no Andrew Jackson, and most likely appropriately so as he is not a politician.  But his reputation and careful thinking will provide 'cover' for other economists and thinkers who are reluctant to speak out because of the academic and career sanctions that can be imposed on them by the banking cartel and their friends and associates in the universities, think tanks, major media, and positions of political power. And so it is an act of principled moral courage, which is something that has been in short supply for quite a few years now.

Obama was elected by the people as a reformer, but he has failed to deliver and often spectacularly so, probably due to a weakness in his character and circumstance, and a preference to facilitate rather than to lead.  And that is a tragedy, because it still leaves the nation desperately in need of reform and renewal that will almost certainly not be coming from the Republican party of Big Money and unwavering devotion to the hypocrisy of special privilege.

The Banks must be restrained, and the financial system reformed, with balance restored to the economy, before there can be any sustained growth and recovery.

If the suffering becomes great enough, change will inevitably come, but it may not be orderly or as controllable as the monied interests often like to think.

An Institutional Flaw At The Heart Of The Federal Reserve
By Simon Johnson
June 14, 2012

On the PBS NewsHour in late May, Treasury Secretary Timothy Geithner indicated that the continued presence of Jamie Dimon, the chief executive of JPMorgan Chase, on the board on the Federal Reserve Bank of New York creates a perception problem that should be addressed. He used the diplomatic language favored by finance ministers, but the message was loud and clear: Mr. Dimon should resign from the board of the New York Fed.

Mr. Dimon has been an effective opponent of financial reform over the past four years. He remains an outspoken advocate of the view that global mega-banks can manage their own risks, and he has stated publicly that the new international and national rules on capital requirements are “Anti-American.”

Mr. Dimon now finds himself at the center of a number of official investigations into how his bank could have lost so much money so quickly in its London-based trading operation – including whether adverse material information was disclosed to regulators and to markets in a timely manner.

The Wall Street Journal reported this week that serious concerns about the London trading operation had been raised – but not made public – two years ago; the New York Times has reported similar concerns. On Wednesday, the Senate Banking Committee interviewed Mr. Dimon; the event was inconclusive, perhaps because JPMorgan Chase is a major donor to some members of the committee.

On Monday, Lee Bollinger, chairman of the board of the New York Federal Reserve Bank and president of Columbia University, weighed in to contradict Mr. Geithner in no uncertain terms. The Wall Street Journal reported Mr. Bollinger’s view: Mr. Dimon should stay on the New York Fed’s board, and critics attacking the Fed have a “false understanding” of how it works. (Please note the correction to the original Wall Street Journal story, with an important change to the reporting of what Mr. Bollinger said.) This is a remarkable statement in part because Mr. Geithner is himself a former president of the New York Fed, so it is hard to see how he would have a false understanding of how the Fed works.

More generally, however, Mr. Bollinger’s intervention is inadvertently helpful, as it opens the door to a more productive conversation about the exact nature of the institutional weakness that lurks at the heart of the Federal Reserve System and that threatens our financial stability more broadly....

The problem is that sensible liquidity support can easily become inappropriate subsidies, particularly when some financial institutions are considered too big to fail. Outsiders will never observe the real-time information on which central banks make decisions, so we need to be able to trust the people running our central bank, otherwise the system will go badly wrong — again...

Mr. Bollinger’s intervention brings a fresh spotlight to a deep governance problem at the heart of the Federal Reserve System – prominent financial sector executives and their close allies are much too involved in how the New York Fed operates. This is partly an anachronistic holdover from the original Federal Reserve Act of 1913 – and reflects the political milieu of that time, in which bankers had to be persuaded to accept a central bank (for more background and a lot of relevant technical detail, I recommend Edwin Walter Kemmerer’s “The ABC of the Federal Reserve System,” published in 1920).

But it is also an all-too-accurate reflection of where we stand today with regard to global mega-banks and the large, nontransparent and highly dangerous subsidies they extract from the rest of society by being too big to fail.

The people who run global mega-banks get the upside when things go well – they are paid based on their return on equity unadjusted for risk, so they prefer a lot of debt piled on top of very little equity. When things go badly, the downside is someone else’s problem – in the first instance, typically, the Federal Reserve’s...

In the run-up to 2007, the complacency of the entire Fed System can be traced in part to the cozy relationship between the New York Fed (headed then by Mr. Geithner) and the Wall Street elite. We cannot let this happen again. Yet all too often with regard to financial reform today, we find the Fed lagging rather than leading the thinking and the implementation that Dodd-Frank calls for on many issues...

Read the rest here.

By Jesse

Welcome to Jesse's Café Américain - These are personal observations about the economy and the markets. In plewis

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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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