Lombardi: Stock Market Commentary & Forecasts, Financial & Economic Analysis Since 1986

The Fed in the Hot Seat

Wednesday, January 20th, 2010
By for Profit Confidential

“The Financial World According to Inya” Column,
by Inya Ivkovic, MA

I watched a good Sunday movie, “The City of Ember.” Sci-fi movies are not usually my cup of tea, but I liked it for a number of reasons, one among them for giving me an angle for this article. The movie plot is relatively simple. The aboveground world is self-destructing and, in an underground palace, the “Builders” of the City of Ember have just finished building, in essence, an elaborate bomb shelter. Having placed instructions in a sealed, time-locked metal box on how to get out of it, the Builders set the timer to precisely 200 years, believing that would be enough time for whatever calamity is happening aboveground to be over.

The box is then entrusted to the first mayor to be looked over religiously. Unfortunately, the seventh mayor dies unexpectedly before relaying the necessary information to the next mayor, and the story of the box and its relevance to the city’s inhabitants gets lost. Eventually, the box reaches year zero and it unlocks automatically. The only problem is that no one could care less. The fate of the City of Ember now rests with two curious and industrious teenagers who decided to do all the heavy lifting themselves instead of the city’s somewhat delusional adults.

What I found amusing about this movie was not the delusional adults so much as the one person who saw things fairly clearly: the city’s mayor, who had the power to change things, yet opted to maintain the status quo for as long as possible, all the while making sure his various needs were met. Those needs primarily focusing on hoarding the food. For obvious reasons, the mayor never goes hungry and he is the only person in the city sporting a huge belly.

But after 200 years underground, the City of Ember is falling apart. The generator and the water and food supplies are all in shambles. After all, it was never meant to last past two centuries, but its inhabitants don’t know that. So, when the generator starts failing more frequently, thrusting the city into abominable darkness, the mayor, who knows that the city will surely crumble and its people die of hunger and who knows from what else that may be lurking in the dark, has two solutions. One solution is for the mayor only: a well-insulated room in the endless tunnels beneath the underground city, full of food and light. The other solution is for the citizens: to commission an inquiry into why the generator is failing and, upon gaining that priceless insight, to free their wonderful City of Ember
from darkness.

Sound familiar?

Our own City of Ember has its own inquiry — the Financial Crisis Inquiry, commissioned to find out how we got to where we were in 2008 and what we had to endure in 2009. Pointing fingers seems to be the preferred technique of investigation. During the second day of the hearings, we have one regulator accusing the other; that is, the Federal Deposit Insurance Corporation accusing the Federal Reserve of not dealing with the subprime mortgages market seven years before it blew up in everyone’s faces. Some of those questioning the Fed are even calling for the taking away of its regulatory function altogether.

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However, Paul Volcker, former Fed head honcho and now an adviser to the White House, and other relevant voices on Capitol Hill, are defending the role the Fed plays, if not its actions during the recent crisis. The Fed’s defenders agree that the U.S. central bank should take on some of the blame for the recent crisis, but that taking its authority in regulation and supervisory matters would be a grave mistake.

In fact, what would make better sense to the Fed’s defenders is to consolidate bank supervision into a single regulator, preferably the Fed. The supporting argument is that, had financial institutions, such as Lehman Brothers, AIG and Countrywide, not been outside the Fed’s jurisdiction and subject to comparably less comprehensive regulation, the events leading up to the Great Recession might not have unraveled the way they did.

The Fed also defended itself by releasing a paper last week and sending it to the Senate’s Committee on Banking, Housing and Urban Affairs, arguing that, to maintain financial stability and monetary policy, its role should be expanded to the supervision of bank holding companies, too. The Fed paper also admits to its flaws
and failings, and puts emphasis on the Fed’s new and improved oversight policies and procedures, including the “cross-firm, horizontal exams,” the purpose of which is to expose and access vulnerabilities of entities within its purview and their impact on the macroeconomy.

As Volcker put it, “What seems to me beyond dispute, given recent events, is that monetary policy and the structure and condition of the banking and financial system are irretrievably intertwined.”

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Inya Ivkovic