Federal Reserve Bank President Evaluates Federal Reserve Board Actions Post-Crisis
Commentary by Steven Lofchie
President of the Federal Reserve Bank of New York William Dudley praised the Federal Reserve Board for providing support to firms during the financial crisis and criticized efforts either to make the Board's monetary policy more formulaic or to subject the Board to greater political control. At the Annual Meeting of the Virginia Association of Economists, President Dudley emphasized historical lessons and that the United States should maintain a strong central bank "insulated from short-term political pressures in [its] conduct of monetary policy."
Drawing conclusions from the 2008 crisis, President Dudley asserted that:
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The regulatory community did not fully grasp the vulnerability of the financial system. Accordingly, the Federal Reserve took actions to: (i) raise capital and liquidity requirements, (ii) put banks through annual stress tests, (iii) establish the Large Institution Supervision Coordination Committee to evaluate large firms, and (iv) set up the Office of Financial Stability.
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The financial system needs to explain its actions with greater transparency. To increase transparency, Mr. Dudley stated, the Federal Reserve now (i) issues statements after each Federal Open Market Committee meeting, and (ii) holds a press conference four times per year to explain the Committee's releases and its economic projections.
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Some large financial institutions had become too-big-to-fail. Title II of the Dodd-Frank Act presently establishes a process to ensure that any financial firm can be resolved without threatening the viability of the financial system and without putting taxpayer funds at risk.
Commentary
President Dudley asserts that when the Board extended credit in the financial crisis, "it intervened to prevent the failure of several systemically important institutions, including firms it did not supervise – namely Bear Stearns and AIG." The gist of Mr. Dudley's remarks seems to be: if the Board made any mistakes leading to the crisis, it was not realizing that others would screw up. Wouldn't it have been fairer to say that if the Board had not existed as a lender of last resort, the entire financial system might have collapsed, including institutions that were supervised by the Board? Isn't it the case that a large number of banks would have failed without access to the Fed's Discount Window?
There is no disagreement with the fact that the Board did step in as a lender of last resort. But there is an inconsistency between simultaneously claiming the need to learn from mistakes and the claim to have succeeded brilliantly. According to Mr. Dudley, whatever mistakes the Board might have made leading up to the financial crisis, without the Board's wise conduct since that event, "the recovery would have been slower, the unemployment rate would have been higher, and there would have been a greater risk of deflation." To those who worry that the Board's policies have unduly distorted market forces, Mr. Dudley "simply responds" that "monetary policy always affects financial markets." Shouldn't a response be a little less simple? Like by how much and for how long