Fed’s aggressive acts draw praise, and scrutiny

/ Source: The Associated Press

The Federal Reserve has taken its boldest action since the Great Depression, invoking rarely used powers in an effort to contain a panic threatening to undermine the economy. The central bank acted with speed the White House and Congress only could envy.

The Fed is largely free from many constraints that bog down other policymakers. Also, it is the only U.S. institution with the authority and ability to create money out of thin air.

For now, the steps orchestrated by Chairman Ben Bernanke, in the first critical test of his leadership since succeeding Alan Greenspan in early 2006, are earning praise from the Bush administration, Congress and presidential contenders Barack Obama, Hillary Rodham Clinton and John McCain.

But the Fed's moves are raising questions about whether its regulatory powers, established in the early 20th century, need overhauling and whether it took on some responsibilities that Congress and the administration should have shouldered.

In a remarkable week, the Fed:

  • Engineered the fire sale of bankruptcy-headed Bear Stearns Cos. to J.P. Morgan Chase & Co. with a $30 billion loan.
  • Offered emergency loans to other securities dealers under terms normally reserved for regulated banks.
  • Slashed a key short-term interest rate by three quarters of a percentage point, to 2.25 percent. The cut was sixth since September.

These steps followed moves to lend $100 billion in cash to banks and $200 billion in Treasury bonds to cash-strapped investment banks. The goal was to keep the financial system from seizing up.

"I spent 35 years on Wall Street, have been a Fed watcher for a long time and I have never seen the potential for a more severe credit crisis than this one," said David Jones, chief economist at DMJ Advisors and a former Wall Street economist. "It looks like we turned the corner precisely because of what the Fed did."

Was this the first look at a more activist Fed or just a targeted response to a looming economic meltdown?

Either way, the financial sector and its regulators are expected to come under congressional scrutiny in the days ahead.

Lawmakers from both parties are coming up with suggestions for restructuring the regulation of financial markets. The Treasury Department is working on its own blueprint for change.

Rep. Barney Frank, chairman of the House Financial Services Committee, is proposing new regulations on investment banks similar to those that apply to regular banks. That includes mandatory requirements for cash reserves to cushion losses.

Frank, D-Mass., said the Fed or other government entity should be designated as a "financial services regulator" with the power to limit risky practices.

White House spokeswoman Dana Perino said the administration would study the concept and other ideas "as we consider if there's additional things that we need to do."

Bear Stearns' unraveling and the credit woes facing other financial companies brought new attention to the Fed, which is part of the government and part of the commercial banking system.

Congress created the Fed in 1913 to prevent financial panics such as runs on banks and set it up as an independent entity. Its powers grew in 1933 and 1935. Although the Fed is subject to congressional oversight, its decisions do not have to be ratified by the president or Congress. Fed officials are not paid with money appropriated by Congress.

It has a seven-member board of governors, led now by Bernanke, and headquarters in Washington. Fed members are nominated by the president and confirmed by the Senate. There are two vacancies currently.

The system includes 12 Reserve Banks in major cities. These banks have their own boards of directors, two-thirds of whom are elected by commercial banks in the region and one-third by the Fed board in Washington.

With this combined government-financial industry heritage, the Fed serves as the nation's central bank. It manages the money supply, sets or influences certain key short-term interest rates, engages in open market buys and sales of government securities, and oversees and provides financial services to banks.

Because of the Fed's direct influence over interest rates, the money supply, and the larger economy, some have called the Fed chairman the second most powerful job in Washington after the president.

Economist Lawrence Chimerine, president of Radnor Consulting in Philadelphia, faults the Fed, particularly under Greenspan, for not paying more attention to what was happening in mortgage markets and to the rise in subprime lending. He said Bernanke's Fed complicated the situation by "raising rates too much and being too slow to start reducing them."

Still, Chimerine said, "I don't think there's any question Bernanke did the right thing" with the recent moves. "If Bear Stearns had gone bankrupt and if this credit crunch continued to spread, we would have had a real mess."

Alice Rivlin, a former Fed vice chairman, said she does not think Bernanke exceeded his authority, even though he acted under creaky legal provisions not used since the 1930s. "The Fed has been very aggressive and imaginative, and has taken very strong actions to get the credit markets functioning again," she said. "And that's good."

Anthony Ryan, assistant treasury secretary for financial markets, said the current framework for regulating financial institutions "is a reflection of literally decades of evolution. And we have a very fragmented regulatory structure."

Before addressing any changes, "we need to continue to make sure we work through the current challenges in the markets. This has to be job one," he said in an interview with C-SPAN to air Sunday. "And the actions by the Federal Reserve to help facilitate orderliness and stability is very, very important."