OAKLAND, Calif., April 4, 2008—This week, Treasury Secretary Henry Paulson announced his proposal to overhaul the Federal Reserve. Describing the blueprint not as a quick fix, but rather a long-term plan to address unnecessary complexities and to streamline regulatory processes, Paulson recommended adopting it gradually.
While some critics argue that the proposal should go much further to revamp a system long overdue for major reform, and others have condemned supposed “deregulatory” aspects of the plan, the net effect will be the consolidation of regulatory burdens under the Federal Reserve, with some of its current responsibilities simply shifted to other federal agencies. Overall, it would be a stark expansion of the regulatory state.
Independent Institute Senior Fellow William Shughart says that scrapping some agencies like “the Office of Thrift Supervision and the Commodity Futures Trading Commission while increasing the Fed’s regulatory responsibility of financial markets is reminiscent of the political overreaction to 9/11 that led to the creation of the Department of Homeland Security.” He sees the proposed federal Mortgage Commission and Office of National Insurance as “Orwellian Washington power grabs.”
Senior Fellow Robert Higgs, author of the Institute’s recent book, Depression, War and Cold War (Oxford University Press), likewise sees this as just another bureaucratic takeover, opportunistically launched at a time of crisis. “This development is but the latest in a long series of missteps. The Fed is given great powers, which it misuses to disastrous effect. It then uses the disaster of its own making as the pretext for assuming even greater future powers. The only escape from this misbegotten monetary central planning is the separation of money and banking from state.”
Unfortunately, the federal government does not recognize culpability. “The current troubles are the result of inflationary policies pursued by the Fed in the last five years which resulted in a money monopoly,” says Senior Fellow Alvaro Vargas Llosa. Although the government now seeks to avoid irresponsible lending and borrowing and the tying of globally traded mortgages to sophisticated financial instruments, such practices were “simply the market response to the perverse incentives created by the Fed's inflation of money.”
The most troubling aspect of the plan explicitly charges the Fed with ensuring “market stability,” says Shughart. If Wall Street executives, the market’s best forecasters in such matters, fail to foresee such economic debacles, we can hardly expect better from politically appointed bureaucrats. Under the plan, according to Shughart, “the average consumer can expect higher fees on financial market transactions to help defray financial institutions' compliance costs,” as well as more paperwork and an erosion of the important distinctions between state and national banks, as well as “thrifts” and commercial banks.
In such Institute books as Money and the Nation State and Depression, War, and Cold War, economic instability is shown to be directly traceable to the Federal Reserve’s central banking powers. As Higgs concludes, “In monetary matters, as in all other areas, the free market is superior to central planning for the promotion of the broad public interest.”
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