Why Congress is Furious at the Fed

An angry Congress wants to reshape the central bank. And you can't say it's entirely wrong

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The Federal Reserve system, that mysterious organization with the temple-like headquarters just off the Washington Mall and thick-walled outposts in cities across the land, is under assault. It's "the most serious attack that I have seen on the Federal Reserve in the many, many years that I've studied it as a scholar," says Columbia economist and former Fed governor Frederic Mishkin.

Texas libertarian-Republican-obstetrician-Congressman Ron Paul--a man not known for bipartisan consensus-building--has gotten 313 of his colleagues, more than 100 of them Democrats, to back a bill that would subject the Fed to audits by the Government Accountability Office, and the Financial Services Committee has approved a version of it. On the other side of Capitol Hill, Senate Banking Committee chairman Chris Dodd is pushing reforms that would strip the Fed of its power to regulate banks.

It has gotten so bad that Fed Chairman Ben Bernanke has resorted to the equivalent of heavy artillery, taking to the opinion pages of the Washington Post on Nov. 29 to express his concern that these measures "would significantly reduce the capacity of the Federal Reserve to perform its core functions." (For Fedspeak, this is seriously blunt language.)

The most core of the Fed's functions is running the country's monetary policy--that is, deciding how many dollars should be in circulation. Hardly anyone is calling for it to be stripped of this power. Yes, the good Dr. Paul does so in his best seller End the Fed, but this is not what you'd call a viable legislative proposal, which is why he's pushing his audit plan in Congress instead. But Bernanke and other Fed defenders argue that subjecting the organization to more outside scrutiny and taking away its side function of regulating banks would render it unable to manage monetary policy effectively.

To which a skeptic might respond, The Fed manages monetary policy effectively? Could have fooled me. That's one argument for altering the Federal Reserve's current arrangements. The other is that the Fed's current arrangements are really weird. The Fed is part government agency, part creature of the banking industry. This is by design; from its creation in 1913 (to prevent the bank panics that were periodically paralyzing the economy, as in 1907) until the early 1930s, in fact, the bankers who controlled the regional Federal Reserve banks had the upper hand. Congress changed the law in the early '30s to put Washington clearly in charge, and for almost two decades, the Fed was effectively an arm of the Treasury Department. After 1951, when Treasury restored the Fed's independence, it returned to hybrid status, with the presidentially appointed chairman wielding the most power but the president of the New York Fed--chosen by New York bankers--a close second.

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