Norris on the Fed’s Culpability

Floyd Norris makes some very good points about the Federal Reserve this morning in The New York Times, noting that it has not gotten the scrutiny that other regulators have despite having a huge role in creating the crisis (by looking the other way and not doing its job under Alan Greenspan):

Remarkably, the institution that had the most direct responsibility to prevent the debacle — the Federal Reserve — has taken little heat for its own failures. There has been no Congressional hearing where Fed officials were treated to anything like the grilling the division chiefs of the Securities and Exchange Commission received three weeks ago.

Instead, the Congress appears ready to increase the Fed’s powers.

Sometimes nothing succeeds like failure.

This is a good rundown of the litany of Fed errors:

It decided that it did not need to worry itself over rising asset prices. So it stood by, first in the technology stock bubble, then in the housing bubble. It saw credit getting excessively loose, and leverage piling up, but comforted us with assurances that if there was a bubble, the Fed knew how to clean up after it burst, principally by cutting interest rates.

It championed letting the shadow financial system grow without oversight, and shied away from doing anything about highly risky mortgages.

Perhaps most important, the Fed and other regulators had no idea how much risk they had allowed into the system. They knew that various financial innovations were designed to let banks make more money without being required to put up more capital, but they did not figure out that that meant the capital there might be inadequate. They threw up their hands at the complexity of it all, and said banks could use their own models to assess risk…

But it was the Fed that encouraged Bank of America to buy Merrill Lynch without much due diligence. And it supported Citigroup’s offer to buy Wachovia, a deal that thankfully was not completed.

Norris’s most interesting point is that expanding the Fed’s powers at a time when everyone agrees we need more transparency may not be a good idea. The Fed is kind of a black box about as transparent as the NSA.

But the Fed also has a major disadvantage. Unlike the S.E.C., which instinctively looks for more disclosure and more openness, bank regulators are inclined to secrecy, particularly in times of stress. They want us to trust they have the situation in hand.

Even now, the banks being bailed out have not been required to detail the toxic securities they own. Without that information, it is impossible for even sophisticated analysts to assess whether each bank has taken all the write-downs it should. That is one reason banks are hesitant to trust each other.

Exactly. All that stuff needs to be disclosed and put online so markets can get an idea what’s out there and begin the endgame of taking out the losers and strengthening the winners. Maybe it’s not as bad as we think, but I wouldn’t bet on it. If that were the case, the banks and regulators surely would already have come out with it, though I’m probably giving them too much credit.

Norris also gets in a couple of funnies to boot. This quote makes Greenspan look even more clownish:

“The real lesson here appears to be that bank regulators cannot fully or accurately forecast whether, for example, subprime mortgages will turn toxic or whether a particular tranche of a collateralized debt obligation will default, or even if the financial system will seize up,” he said in a speech last week to the Economic Club of New York. It sounded to me a little like a failing student protesting, “Dad, nobody could have passed that test.”

I hadn’t seen this poll, but it’s a good one:

It’s not much fun to be a banker these days. One leading European banker says a poll showed that the only groups now held in lower regard are prostitutes and convicted felons. There are plenty of people who would be quite happy to see a few bankers join the latter group.

Worse than the press even!

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.