JIM LEHRER: Now, the crisis-driven changes in what the Federal Reserve does and how it does it. Jeffrey Brown has our story.
JEFFREY BROWN: When interest rates are about as low as they can go, what more can the Federal Reserve do?
Today, the Fed assured a nervous world that it will use, quote, “all available tools” to prop up the economy. Indeed, the Fed has been extraordinarily active in recent months, and there are some calls now to expand its future role as regulator and overseer of financial institutions.
We look at all this now with Steven Davidoff, professor of law at the University of Connecticut School of Law; John Cassidy, who writes about the Fed for the New Yorker and Portfolio magazines; and Philip Jefferson, professor of economics at Swarthmore College and former research economist at the Federal Reserve.
Well, Philip Jefferson, start us off with today. What does that phrase, “all available tools,” mean at this point? What’s left for the Fed to do?
PHILIP JEFFERSON, Former Federal Reserve Economist: Well, what it means is that the Fed stands ready to expand its balance sheet. That is, after you have exhausted interest rates, you ask the question, what can the Fed do? Well, it can buy assets from the private sector.
So, for example, one thing that the Fed has done since the fall, and said that they will continue to do, is buy some of these mortgage-backed securities.
Another thing that it said that it will explore or certainly keep on the table is buying Treasury long-term debt. And that’s useful because it can put some downward pressure on long-term interest rates.
The third thing that the Fed said that it will implement today is a program where — they called it the term asset-backed loan facility. And what that is, is a mechanism for providing loans to those who are willing to buy securities backed by consumer small-business loans, and that’s going to facilitate some liquidity and extension of loans for households and small businesses.
Fed uses new methods
JEFFREY BROWN: John Cassidy, how do you see this role, this new role, as the Fed is sort of carving out more space for itself apart from the traditional interest rates? How do you see it?
JOHN CASSIDY, The New Yorker/Portfolio Magazine: Well, I don't think the Fed has any option, really. What's happened is the private banking system, the private financial system has pretty much ground to a halt, so the Fed is stepping in and saying, well, if the banks won't lend to people, maybe we'll do it.
We have the power to print our own money, so we can affect interest rates other than the federal funds rate, which is the one they usually control. Now they're trying to bring down mortgage rates, with, as your previous guest said, by buying mortgage securities.
They've talked about trying to bring down long-term Treasury rates by buying Treasuries. That's all an attempt to try and get lending going again in the economy, which has pretty much ground to a halt over the last few months.
So I really don't think the Fed has much option here. And they seem to be having some success. I mean, mortgage rates have come down a bit since they started buying mortgage securities. You can get a 30-year fixed-rate loan now for close to 5 percent when it was over 6 percent at the end of last year.
So as I said, they're stepping into the breach, and it remains to be seen how successful they are.
JEFFREY BROWN: So, Steven Davidoff, even as it is taking on all these new roles and new commitments, there is now a lot of talk about giving it a further role in regulatory -- in the system, in oversight of financial institutions. First, what's the problem that needs to be fixed? And what role might the Fed play?
STEVEN DAVIDOFF, University of Connecticut School of Law: Well, there are multiple problems, as we've seen over the past year. One of the biggest is that there's no central agency that's looking out for systemic risk and regulating all of the hedge funds and various financial actors in our system.
And so one of the things that we need to do is look to build a regulator who, in the future, can deal with the next crisis and regulate systemic risk.
The second issue that we have is that we have a fractured regulatory system right now. We not only have the Federal Reserve. We have the Treasury. We have four different regulators for banks at the federal level. We have the SEC.
And so there are so many regulators that they keep stepping over each other's toes, so to speak, in this crisis. And so there's an idea to centralize regulators, and perhaps those powers will also go to the Fed to some extent.
Pros, cons of extra power
JEFFREY BROWN: You know, there's -- staying with you -- so many regulators, but I always found there's so much confusion about what the Fed actually is and what it does anyway. I mean, don't they have -- doesn't it have some of those kind of powers that you're talking about already?
STEVEN DAVIDOFF: Absolutely. The Fed now, it regulates our money market system. It's the government's banker. But it also regulates bank-holding companies, which are the large financial institutions, Citigroup, now Goldman Sachs.
And it actually has smaller responsibilities. It administers the Truth in Lending Act, which governs disclosure related to mortgages. So the Fed already has a wide array of responsibilities. The question is, how much more is it going to get? And if it doesn't get it, where do those powers go?
JEFFREY BROWN: Well, let me ask Philip Jefferson. How do you kind of vet the pros and cons of giving it that extra power?
PHILIP JEFFERSON: Well, here's an important aspect of this. The Fed has traditionally regulated banks. And over time, they've built up an expertise with respect to bank regulation, so that when they go in and look at the books of a bank, they know what to look for, what the red flags are.
Now, let's think about what would happen if we all of a sudden gave the Fed the power to regulate hedge funds and other financial institutions that they historically have not had the power to regulate. Well, what does it mean, then, to go in and look at a hedge fund's books, given the type of innovative assets that these funds tend to come up with?
Experts, even working with those firms, didn't understand those assets last fall or when we were extending them. Now, do we all of a sudden think that a Fed or even the SEC, if they were to go into these private firms and look at their books and provide oversight, would actually know what they're seeing and realize what the red flags are?
JEFFREY BROWN: Well, John Cassidy, what's your answer to that? I mean, shouldn't somebody know what they're looking at?
JOHN CASSIDY: I think they should, but I really think that's a question for the long term. You know, Ben Bernanke, the chairman of the Fed, likes to say, when you're in a crisis, let's put the fire out first and then worry about the fire code later. And I think he's dead right on that.
You know, the fire is raging. If we don't solve the financial situation and the banking crisis, there won't be a financial system to regulate. So I think we can worry about that down the road, but Bernanke will probably be part of the commission which President Obama is putting together under Volcker to consider these questions.
But I really think at the moment, you know, the emphasis has got to be on, what are we going to do about the banks? How are we going to protect people who are facing foreclosure? Let's deal with the crisis now and worry about the long-term questions, you know, if and when things look a little better.
Nationalizing banks an option
JEFFREY BROWN: And what do you want them to do right now, vis-a-vis the banks, for example? I mean, we heard in Judy Woodruff's earlier piece, we heard the new treasury secretary talk about coming up with a new plan. What could the Fed's role be there?
JOHN CASSIDY: Well, the Fed's role is really to support what the Treasury decides. I mean, it's a political decision. Do we nationalize the banks? Do we try and resurrect the old TARP program, i.e., buying bad assets off them? Or do we stick with the attitude we've had a bit recently, approach we've had recently which is just injecting money in them and letting them do what they want with it?
It seems to me that the best economic solution would be partial nationalization at the moment, but that's sort of political poison. And the Obama administration has indicated that it doesn't want to nationalize the banks, except very much as a last resort, so it looks like we're going to be pouring more money into them, but putting conditions on how they use the money. That seems to be the way things are heading.
I personally think we'd be better just -- if we're going to have to nationalize them, let's do it now, strip out, separate the bad loans, put them in bad banks, recapitalize what's left, i.e., re-float them on the stock exchange.
We're not talking about the government owning these banks for years and years. We're talking about taking them public for a while and re-floating them as healthy concerns so they could start lending again. I think that would probably -- from an economic point of view -- be the best thing to do, but it may just not be politically feasible at the moment.
Regulatory system needs updating
JEFFREY BROWN: Well, Steven Davidoff, you raised I guess some of the legal and regulatory questions here about whether the Fed should take on this role. Are there alternatives to the Fed playing that role to kind of correct the problems that you referred to earlier?
STEVEN DAVIDOFF: Well, I think John made a very good point, which is right now we're trying to put out a fire. And right now we just don't have the regulatory system set up for the Fed and the Treasury to act how they should.
That's why we needed the TARP. We would need more legislation for them to act. They've basically been making it up as they go along.
So one of the things that we have and the problems that we have right now is the Fed really lacks this lender-of-last-resort capacity, the ability to provide liquidity to the market and to banks when they need it. So one of the things that we need to do is look at that function and where it's going to go.
And, generally, I just think that, although we have the crisis going on now, we really have a once-in-a-lifetime chance to reform our fractured regulatory system, which really got us into this mess, and there's really a political will.
I testified before the Senate last week. I think the senators are very aware that we have a 1930s financial regulatory system for a very modern financial system of capital markets right now and that change needs to come.
And not only does change need to come, but we need to set up a system so that, when the next crisis comes, the Fed or whoever we decide -- it can be an independent agency, if we want more congressional oversight -- can act to intervene if an institution is about to fail and we decide that it's too big to fail, so to speak.
And so we need to act on this now, in terms of regulatory reform, or else we'll lose the political will. So it's a two-track process.
JEFFREY BROWN: All right. All right. Well, issues for the short and long term on the table. Steven Davidoff, John Cassidy, and Philip Jefferson, thank you, all three.