Chair Janet Yellen testifies before Congress this week with the Federal Reserve facing its gravest political threat since the drafters of the Dodd-Frank act tried to strip it of its supervisory powers.
The Fed is being pressured from the left and the right. Senator Elizabeth Warren of Massachusetts and other Democrats have blasted the central bank for being too cozy with the banks it oversees. Republicans, including potential 2016 presidential contender Senator Rand Paul of Kentucky, have focused on its aggressive monetary policy.
Lawmakers from both parties are demanding greater transparency and accountability from an institution that has the power to impose capital requirements for banks and influence how much Americans pay for a mortgage or an auto loan.
“They’re under attack,” said Hester Peirce, a former Republican staff attorney to the Senate Banking Committee, where Yellen begins two days of congressional testimony at 10 a.m. Tuesday.
If critics from both parties forge common ground, the resulting legislation may deliver the most significant overhaul of Fed authority since the Full Employment and Balanced Growth Act of 1978. That law shaped the modern Fed, giving it mandates for full employment and stable prices and requiring the chairman to testify before Congress twice a year.
Both parties face obstacles in efforts to curb the Fed’s authority. While Republicans now control both houses of Congress after the first change in command of the Senate since the 2008 financial crisis, they still need to attract at least six Democratic Senate votes to advance legislation. Any bill that limits the Fed’s independence on monetary policy faces the threat of a presidential veto. Democrats must attract votes from across the aisle.
The parties could find agreement in their unhappiness with the Fed’s financial supervision, criticism that dates to its role in taxpayer-funded bailouts of firms including American International Group Inc. during the financial crisis.
“Both sides have raised concerns about the Fed’s role on regulation,” said Aaron Klein, a Democratic former chief economist for the Senate banking panel who’s now at the Bipartisan Policy Center in Washington.
Those concerns “could end up resulting in a change that limits their regulatory and supervisory powers,” said Peirce, now a senior research fellow at George Mason University in Arlington, Virginia.
Fed spokesman David Skidmore declined to comment on pending legislation.
Republican Senate Banking Committee Chairman Richard Shelby of Alabama says he’ll hold hearings on the need for greater transparency. The Fed has more than quadrupled its balance sheet to $4.5 trillion since 2008 as it bought bonds to suppress longer-term interest rates.
“My concern about the Federal Reserve right now is the portfolio,” Shelby said Jan. 29 in a Bloomberg Television interview. “All the bonds, all the securities they’ve bought. What are they going to do with them?”
The measure that has attracted the most vehement opposition from the Fed has been Paul’s “Audit the Fed” bill, which would subject monetary policy to regular audits by the Government Accountability Office. Twenty-nine Republican senators, including Majority Leader Mitch McConnell of Kentucky, and one Democrat are co-sponsors.
It’s “unseemly that an organization that we’ve given the power, the monopoly, of making money uses that power then to try to thwart transparency,” Paul said in an interview this month in Des Moines, Iowa.
Fed officials counter that the word “audit” is a misnomer because the Board of Governors and the 12 reserve banks already are all subject to several reviews. The GAO audits the board’s programs and operations and the Fed’s annual financial statements are audited by Deloitte & Touche LLP.
Five of 12 regional Fed presidents have spoken out against Paul’s bill. Their opposition unites so-called hawks, including Philadelphia Fed President Charles Plosser, and doves, such as Narayana Kocherlakota of Minneapolis.
Fed Governor Jerome Powell also spoke out against the bill in a Feb. 9 speech, saying it represents a “substantial risk of political interference” in monetary policy.
Yellen on Jan. 30 met with more than two dozen Capitol Hill aides from both parties as part of the Fed’s efforts to provide an overview of monetary and regulatory actions. Fed staff brought up the audit bill without prompting and said the central bank is opposed.
Shelby, who isn’t a co-sponsor of Paul’s bill, in last month’s interview said he he was “very interested in some type of audit of the Fed, especially the portfolio.”
The White House has made its opposition known.
“It is important we not have any encroachments on the independence of the central bank” to conduct monetary policy, Deputy Press Secretary Jennifer Friedman said in a statement.
Another target of the Fed’s ire is a proposal from Representative Bill Huizenga, a Michigan Republican, that would require the Fed to use a rule to guide monetary policy. Huizenga heads the House Financial Services panel’s subcommittee on monetary policy.
“It would be a terrible mistake to ask the Federal Reserve to specify a mathematical rule” for changing interest rates, Yellen testified to lawmakers in July. Doing so would have made for a “dreadful” recovery from the recession.
New Jersey Republican Representative Scott Garrett has introduced a bill that reflects his party’s frustration that the Fed isn’t open enough on supervision and regulation. His Federal Reserve Accountability and Transparency Act would require the central bank to perform a cost-benefit analysis of any new banking rule, submit internal audits and performance reviews to Congress and send a top official to testify before lawmakers on financial rule-making.
A particular target of congressional critics, especially Democrats, has been the Federal Reserve Bank of New York, the first among equals of the regional reserve branches. It supervises the largest Wall Street firms, and its president has a permanent vote on the policy setting Federal Open Market Committee, while other presidents rotate onto the panel.
Warren grilled New York Fed President William C. Dudley at a November hearing and said his regulators were too close to big banks. Warren said in a Feb. 10 statement while she doesn’t back Paul’s bill, she’ll “strongly support” more congressional oversight of Fed regulation and supervision.
Democratic Senator Jack Reed of Rhode Island has re-introduced a bill to require the New York Fed president be confirmed by the Senate. Currently, the 12 district bank chiefs are selected by their banks’ directors and approved by the Fed board in Washington. Governors already need Senate confirmation.
Dallas Fed President Richard Fisher, who retires next month, proposed his own Fed reforms, including stripping the New York Fed of its permanent FOMC vote.
Fisher’s proposal, which he said was meant to address concerns that too much power is concentrated at the New York Fed, last week won the backing of the 6,500-member Independent Community Bankers of America, an influential Washington lobby.
One proposal on Fed governance, by Republican Senator David Vitter of Louisiana, has become law. It requires at least one member of the seven-member Board of Governors to have community banking experience.
Fed officials have reason to be skittish. The central bank nearly lost its supervisory authority in 2009, when then-Senator Christopher Dodd, a Democrat, proposed creating a single financial industry regulator. That was dropped amid White House opposition, and the Dodd-Frank act passed a year later.
“There’s a view shared by Democrats and Republicans that the board has to up its game on supervision” said Sarah Binder, a senior fellow in governance studies at the Brookings Institution in Washington who studies the Fed relationship with Congress. “Republicans want to impose greater accountability to rein in what they see as an unaccountable Fed.”