The Federal Reserve has created numerous conflicts of interest – becoming a competitor in the repo market is just one of its sins.
That was the pointed testimony of Dr. Charles Calomiris, – a Henry Kaufman Professor of Financial Institutions, Columbia Business School, Columbia University – who was speaking in front of the House Financial Services Committee at a hearing entitled “Examining the Relationship Between Prudential Regulation and Monetary Policy at the Federal Reserve.”
Asked by Keith Rothfus, a Republican from the State of Pennsylvania, whether the Fed’s balance sheet –a consequence, according to Rothus, of the Fed’s unconventional monetary policy – raised any conflicts of interest, Dr. Calomiris replied:
There are multiple conflicts that have arisen from the new powers the Fed has taken on in the last several years. One obvious one that’s actually related to the supplementary leveraged requirement is that the Fed has become a competitor in the repo market.
As part of the Dodd–Frank reforms the Federal Reserve was given new powers to regulate, supervise and examine big banks; and although this hearing was ostensibly about the wisdom of taking on this policy, the exchange between Rothfus and Calomiris was one of several in which politicians and witnesses took the opportunity to bash the Fed.
Repos are extremely sophisticated securities that allow holders to sell US Treasuries overnight and then buy them back the next day.
The supplementary leveraged (ratio) requirement was a new standard set initially by Basel III and then by the Fed as well, for the minimum percentage and type of assets in so-called systematically important financial institutions.
As part of what Rothfus called its “unconventional monetary policy”, the Fed bought up several new assets.
The following is taken from a 2013 Forbes article written when the Fed was just beginning to enter repos:
“To the rescue comes a plan hatched deep in the bowels of the New York Fed by one Brian Sack, who has since moved on to become a master of the universe at hedge fund D.E. Shaw. The plan, which has been undergoing field tests since 2009, is for the Fed to become a major borrower in the reverse repo market, offering interest rates that are too good to refuse, backed by the highest quality collateral money can hire. If done on a large enough scale and not just as a temporary backstop to make sure short term interest rates don’t go negative, this scheme could theoretically reabsorb the trillions of dollars which the Fed dumped onto the economy, keeping that cash from washing into commodity and other real markets.”
By increasing the amount the biggest banks could hold in reserve, while limiting the types of assets it was allowed to hold, all while trading in the repo market, the Fed was effectively playing both sides, Dr. Calomiris argued.
Earlier in the hearing, Dr. Calomiris also accused the Fed of being too political:
The Federal Reserve is now more politicized than it has been at any time in its history, and consequently it is also less independent in its actions than at any time in its history, with the exception of the years 1936-1951 when it lacked effective monetary policy authority.
Calomiris wasn’t the only one lobbing criticism at the central bank.
Brad Sherman, a California Democrat, called it anti-Democratic:
When we’re talking about the structure of the Fed, we see a dramatically anti-Democratic institution exercising governmental power. First, the New York bank gets a seat on the open market committee whereas the California bank, twice as many people, doesn’t. Second, substantial Fed power is in the hands of those who are put on the board in an election by banks. This is the only institution of governmental power in our country where we have not one person one vote but one billion dollars of banking, one vote.