March 16, 2017 / 8:35 PM / in 10 months

Cox: Please don't let the Fed become the new SEC

NEW YORK (Reuters Breakingviews) - For the first time since self-professed, easy-money real-estate developer Donald Trump became president, the Federal Reserve raised its benchmark interest rate. All hell has not broken loose. That may be of some comfort to Janet Yellen, chair of the U.S. central bank, and her colleagues, who reasonably might have feared a backlash from a White House promising economic sparks.

As official rates rise, even if by just 25-basis-point increments, the cost of money goes up across the board for families looking to buy houses, drivers trading in their cars, teenagers heading to college or consumers brandishing credit cards at the mall – and even for property moguls. That’s why Trump candidly admitted during the campaign that lower interest rates have been very good to him. A 30-year bull market in bonds arguably helped him turn a small portfolio of buildings and golf clubs, along with some cash bequeathed by his father, into extraordinary wealth and a platform to work from the Oval Office.

His unpredictable style, however, has left open the question of how he will approach the Fed’s independence should a duty to keep the economy from boiling over run up against a pledge to return GDP growth to 3 percent or higher. Aside from the diminishing force of his Twitter handle, Trump has a nearly unprecedented opportunity to overhaul the central bank thanks to a raft of vacancies on its important steering body, the Board of Governors.

With three vacancies to fill pretty much immediately, and perhaps two more prying loose in the first half of 2018 should Yellen decide to retire, Trump could stack the seven-member Fed leadership squad with people whose views are more to his liking. This would extend beyond monetary policy to include banking regulation and financial-market stability, matters within the purview of the world’s most influential central bank.

Given some of Trump’s iconoclastic cabinet picks, such as those leading the Energy Department and the Environmental Protection Agency, and a demonstrated desire from legislators in both parties to rein in its powers, Fed independence cannot be a foregone conclusion.

The worry is that an increasingly politicized Fed – one where members of Congress and the executive branch meddle in the minutiae of decisions relating to the institution’s mandates of maximizing U.S. employment and keeping prices stable – fails to do its job well. The flawed experience of the Securities and Exchange Commission, America’s main enforcer of investor protection, offers an example of how such a thing might damage the Fed.

It's easy to knock the SEC. Indeed, it has become something of a punching bag for politicians blaming it for failing to prevent, among other fiascos: Bernie Madoff's massive Ponzi scheme, the bankruptcies of Enron and WorldCom, and the demise of onetime Wall Street titans Lehman Brothers and Bear Stearns, for which it was the primary regulator. A 2010 report entitled "The SEC: Designed for Failure" by the minority staff at a House of Representatives committee makes for particularly gruesome reading.

And that’s sort of the problem. The agency must plead annually to Congress for its budget, despite raising revenue from fines and other enforcement mechanisms. That creates an unholy symbiosis whereby lawmakers on the one hand excoriate its processes as “technologically backward,” as California Representative Darrell Issa, a Republican, did for, among other crimes, using Google Finance and other commercially available resources to scrutinize corporate filings. Then they delineate its budget in ways that impede making long-term investments in better analytical tools.

The nomination process is also fraught with politics. Under the 1934 law that created the SEC, Congress mandated that five commissioners would be appointed by the president with the advice and consent of the Senate. But “not more than three of such commissioners shall be members of the same political party, and in making appointments members of different political parties shall be appointed alternately as nearly as may be practicable.”

While the idea may have sounded right at the time, it has effectively foisted the extreme partisan divisiveness that characterizes America’s political class upon the leadership of the SEC, which should be a group willing and able to fulfill its mission of protecting investors without fear or favor. This partly explains how an initiative like the fiduciary rule, which states that investment advisers must act in the best interest of their clients, wound up outside the SEC’s oversight. Politics at the commission prevented it from taking up the proposal, which whatever one thinks of its design, hardly belongs under the Department of Labor’s remit.

Nominations to the Fed board have become terribly fractious, too. Yellen was confirmed by a 56-26 vote in 2014. Vice Chairman Stanley Fischer received 27 votes against his nomination later that same year. By contrast, Alan Greenspan was confirmed to replace Paul Volcker in 1987 with only two senators objecting. The trajectory is moving toward more partisanship, which gives Trump, whose party also controls the Senate, an extraordinary opportunity.

Some senators may know better than to fiddle with Fed independence. It didn’t work out well for the American economy when Arthur Burns supinely crafted policy to benefit President Richard Nixon. Indeed, after Burns, the smaller chamber changed the way the nation appointed the chairman. Up until then, while all Fed board members faced a confirmation vote for their 14-year terms, the president picked the chair without Senate approval. With the 1977 Federal Reserve Reform Act, the Senate gave itself that right.

While this might suggest that checks and balances can help insulate an institution like the Fed from presidential whims, it only works if the Senate can be relied upon to defend its independence. If today’s Senate does not, then Americans can expect the future of monetary policy and bank regulation to have an unhealthy SEC flavor.


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