Ben Bernanke, chairman of the Federal Reserve, insists that the Fed can protect consumers effectively against defective or dangerous financial products. He and his allies are therefore signaling opposition to – and even defiance of – key parts of the Treasury’s plan for regulatory reform, which involve setting up a new Consumer Financial Protection Agency.
The Fed is a well-regarded institution in general and Bernanke is currently riding a wave of personal popularity and prestige, but are these claims vis-à-vis consumers plausible?
The heart of the problem here lies with the Federal Reserve Act. As it currently stands, the all-important Section 2A reads, “The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
This is what the Fed does – in practice by trying to keep unemployment down (ideally around the 4-5% mark, although that can change over time) and inflation low (no more than 2%, roughly).
Formal objectives matter for central banks because they have to weigh trade-offs – “if we try to lower unemployment, what will that do to inflation?” etc – carefully in deciding where to set short-term interest rates and other dimensions of their support to the credit system.
Consumer protection is not in this mix and you can tell. No one can seriously tell you what a great job the Fed has done protecting consumers. For example, the Fed has dragged its feet for years on coming up with a sensible definition of the Annual Percentage Rate on loans, i.e., a measure that includes all costs. As a result, many borrowers have been misled effectively by lenders.
More broadly, Alan Greenspan famously stood by despite being warned by his colleagues about the housing bubble and the associated abuses of consumers. As the housing frenzy developed in 2003 and low income people got sucked in and – many of them – suckered, Ben Bernanke argued for a further lowering of interest rates on the basis of short-run macroeconomic considerations; apparently he was oblivious to the dangers that implied to consumer-as-borrowers.
As Rep. Barney Frank (D-Mass.) said at the height of the housing madness in 2007, “If I was going to list the top 87 entities in Washington in order of the history of their efforts on consumer protection, the Fed would not make it.”
What would happen if you tried to add formal protection of consumers to the top level of Fed priorities and to make it central to Bernanke’s job?
This would surely require amending the Federal Reserve Act, otherwise consumer protection would remain a second class citizen at the Fed. The Fed is not a government department, it’s an independent entity. If you don’t give the Fed specific legislative direction and detailed reporting requirements for a particular task, it won’t get done.
And even that may not be enough. The Fed has plenty of powers to help consumers, but it just hasn’t used them. The American Banker (subscription required) quotes Barney Frank on this also, “One of the greatest unused examples of power were the consumer protection powers we’ve given the Fed.”
Why? Again, Frank – as chair of the House Financial Services Committee – should know, “If you look at the Fed governors, their focus has been on the safety and soundness of the banking system, not consumers.”
The tip off here is that banks of all kinds want enforcement of consumer protection laws to stay with existing bank regulators where, John C. Dugan, Comptroller of the Currency claimed recently “it works well.” But he doesn’t mean that this arrangement protects consumers. He means that it protects banks and the banking system – whenever necessary (like now) consumers can be squeezed to improve the banks’ bottom line.
The Federal Reserve never has and never will put consumers first.
By Simon Johnson
A slightly different version of this post originally appeared on the NYT.com’s Economix blog. It is reproduced here with permission. If you wish to repost this material in its entirety, please contact the New York Times.