STAFF NEWS & ANALYSIS
Fight to Maintain Fed for Small Banks
By Staff News & Analysis - April 26, 2010

The Federal Reserve's independence may rest in the hands of people like Ralph Larry Lyons, chief executive officer of Central Virginia Bankshares Inc., with assets of $473 million. Lyons is among the hundreds of community bankers lobbying Congress to keep the Fed as their regulator. A bill sponsored by Senate Banking Committee Chairman Christopher Dodd of Connecticut would limit the Fed's authority to 36 of the country's largest banks, those with assets of at least $50 billion, tying the Fed nameplate to firms such as Goldman Sachs Group Inc. and JPMorgan Chase & Co. "It would be a shame for the Federal Reserve (pictured left) to lose the community-bank perspective," says Lyons, 61, whose bank is in Powhatan County, about 30 miles from Richmond. The county is home to 28,000 people, 27 Baptist churches and the Sons of the South motorcycle club – whose president, Joe Svedics, is a customer of the bank. – Bloomberg

Dominant Social Theme: Smaller is better?

Free-Market Analysis: So small banks want to retain the Federal Reserve as their regulator. We wonder why. It could be that the alternative the Dodd bill is offering is worse, but the article, excerpted above, taken on face value is somewhat bizarre to say the least. What did the Fed ever do for small banks except offer them another level of officious and inept bureaucracy? Here's some more:

Fed Chairman Ben S. Bernanke, 56, has said the Dodd bill would turn the Fed into "the too-big-to-fail regulator" and limit the flow of information from small lenders that the Fed uses to keep its finger on the pulse of the economy. Narrowing the central bank's purview to the largest firms would also weaken it politically, making it harder to deflect efforts in Congress to limit its power or interfere in interest-rate decisions, says Fed historian Allan Meltzer.

"They need constituents, they need people to support them," says Meltzer, a professor at Carnegie Mellon University in Pittsburgh. "They have bankers in every district. That has been very important in guarding them against Congress." Binding the Fed closer to Wall Street institutions at a time of public outrage over the cost of taxpayer bailouts would be "wildly risky," St. Louis Fed President James Bullard, 49, said in an interview. He called the proposal a "step in the wrong direction."

A Bloomberg News poll last month found that 57 percent of Americans have a mostly unfavorable or very unfavorable view of Wall Street. The poll of 1,002 adults was conducted March 19-22 by Selzer & Co. of Des Moines, Iowa and has a margin of error of plus or minus 3.1 percentage points. The Fed is counting on support from 844 state-member banks and a handful of mostly Republican senators. The American Bankers Association and the Independent Community Bankers of America are contacting legislators to argue in favor of preserving a role for the Fed.

A careful reading might lead one to the conclusion that the small banks are worried that the Fed, in regulating only large banks, will become even more of a force for centralization. But this strikes us, to some degree, as a kind of lobbying equivalent of the Stockholm Syndrome, where those who are taken captive gradually adopt their captors' point of view. We've read and heard plenty about the Fed's bias toward larger financial entities when it comes to regulatory issues. The smaller banks should be fighting to reduce the Fed's power and authority, not trying to perpetuate its regulatory focus. The reasons given for smaller banks support for the Fed seem odd indeed.

The first reason, apparently, is that smaller banks fear the Fed might lose their valuable input, thus making the Fed less acute when it comes to detecting economic downturns and the like. The trouble with this logic is that the Fed didn't exactly cover itself with glory when it came to predicting past problems. In fact, the Fed's chairman, Ben Bernanke, gave a series of speeches right before the financial crisis hit that were intended to minimize any concern over the mortgage market and subsequent contagion. They will go down in history as a stunningly wrong-headed analysis.

Just as strange, from our perspective, is the idea that the Fed's "independence" is at risk if it doesn't retain its small banking regulatory charter. The Fed has done little or nothing it seems to us, that makes its independence from Congress especially valuable. In fact, when one looks at the current economic environment, one wonders exactly what benefit defenders of the Fed believe that it accrues from its vaunted isolation from bureaucratic clutches.

It's not as if the US economy is in great shape, or as if the Fed had some sort of plan that it tried to put into effect that Congress thwarted. True, over the past two years, the Fed apparently printed trillions of extra dollars to inject into failing financial institutions, but we don't remember Congress fighting very hard against this monetary expansion, nor do we believe it will prove ultimately very successful, as the odds of resultant price inflation, or even hyperinflation, are commensurately high.

Finally, there is the idea, imputed in this article, that the Fed is not part of Wall Street and that "binding it closer" to Wall Street would be "wildly risky." The Fed is undoubtedly a quasi-public entity in the sense that it was chartered by Congress and serves at Congress' pleasure. But there is no doubt, as well, that the Fed is directly associated with Wall Street and that Wall Street would not be the same entity without it.

The euphoric surges of money that stimulate both booms and busts are directly responsible for Wall Street's appeal to Main Street and individual investors, in our opinion. Without the Fed's monetary stimulation, there would likely be no great stock market booms and thus no modern Wall Street as we know it. The Fed is joined at the hip to Wall Street and vice versa. To pretend that Wall Street and the Federal Reserve are not similar entities with similar goals – and run by much the same people – is contradict an essential reality.

The problem of central banking, as we've pointed out, is one of mercantilism, where some private entities gain competitive advantages by pulling the levers of government at the expense of others. The levers that the Fed offers the financial industry are extremely powerful, and the ability to print money is a power so expansive and fundamental that it ought not to belong to any individual entity.

The Federal Reserve, in fact, does not need to maintain its independence. Nor does it need to continue to regulate small banks. It simply, fundamentally, ought to go out of business. If it did, and money once again became privatized, then the banking itself would become more rational. Banks, generally, would become responsive to the communities they served. If a private gold and silver standard arose, small banks would gradually assume the profiles and postures of previous centuries.

While there were certainly difficulties with US banks before the advent of the Fed, local banks were, we would suggest, fundamentally more responsive organizations than they are now. The argument that the American government should be having, in our estimation, is over money itself, and who is to control it and print it. Instead, the political argument has focused on what sectors the Fed should regulate. This seems to be a willful mischaracterization of the conclusions the financial crisis offers.

After Thoughts

The financial crisis was caused, of course, by the over-printing of money, which created first a tremendous boom and then a bust. This was the Fed's responsibility. The remedy should focus on money itself and how it should be issued into the economy, and whether it should be debt-based money at all. The argument about whether the Fed should continue to regulate small banks seems to us something of a side-show. In the long run, if the Fed continues to operate as it does now, it won't make a difference.

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