Is the Fed Mostly Smoke and Mirrors?

By Rich Miller


The Inside Story of How the World's Most

Powerful Financial Institution Drives the Markets

By Martin Mayer

Free Press -- 350pp -- $27.50

It may be hard to remember, but it wasn't so long ago that the Federal Reserve kept its monetary policy decisions to itself. Rather than openly announcing a shift in its stance, the central bank quietly worked its will in the money market, buying or selling securities to add or drain cash from the banking system. Wall Street dealers employed high-priced Fed watchers (many of them former central bank employees) to monitor the ebb and flow of bank reserves, trying to figure out whether monetary policy was indeed being altered. Sometimes, it took weeks to discern the answer.

All that changed after Fed Chairman Alan Greenspan decided seven years ago to publicize the central bank's interest-rate moves once they were made. Now, each meeting of the Fed--whether the central bank changes rates or not--triggers a chorus of instant analysis of what it means for the economy and for the financial markets. And Wall Street no longer has a monopoly on Fed-watching. Everyone is in on the game, from the CEO managing a global corporation to the cab driver parsing his portfolio while hustling fares. In the process, the Fed's power and prestige have seemingly reached new peaks.

But that's an illusion, argues veteran financial journalist Martin Mayer. And he makes a persuasive case in his intriguing, infuriating new book, The Fed: The Inside Story of How the World's Most Powerful Financial Institution Drives the Markets. Far from being the master of money, Mayer avers, Greenspan is more like a magician whose power over the economy is much less than popularly perceived. Why? Well, despite the hoopla that surrounds the Fed's actions, the central bank still carries out policy the old-fashioned way--by adjusting the level of reserves in the banking system. The trouble, according to Mayer, is that banks and bank loans are less important to the economy than they used to be. Now, the financial markets are king, and the Fed's impact there is more indirect, says Mayer, who has been writing about business and finance for 40 years.

Sure, Greenspan & Co. can pump a lot of liquidity into the economy. But they can't guarantee that it will translate into faster economic growth. If companies are suffering from falling profits and if consumers are worried by rising unemployment, they may opt to save, rather than spend, the money the Fed indirectly supplies. And thanks to the more sophisticated markets, people have a lot more places to park that cash. "The truth is that liquidity, the only significant weapon remaining in the central bank's arsenal as decision-making moves to the markets, will not necessarily go where you want it to go when you need it to go there," Mayer writes.

His book is the third major one on the Fed in less than a year. It follows Greenspan: The Man Behind Money by Justin Martin, a painstakingly detailed review of the Fed chief's life, from cradle to central bank; and Maestro: Greenspan's Fed and the American Boom, a fly-on-the-wall account by investigative reporter Bob Woodward that promised more revelations than it delivered. Unlike its two predecessors, this addition to the Fed compendium focuses on the central bank as an institution rather than on Greenspan the man. That decision shapes the book, for good and bad. By concentrating on the history and structure of the Fed, Mayer comes up with some interesting insights into how the central bank does--and doesn't--work. But the insights are often obscured by a style of writing as impenetrable as the Fed itself. The book also suffers from some sloppy reporting that's surprising in a journalist with more than 30 books to his credit.

As author in 1975 of the widely acclaimed The Bankers, Mayer does a predictably good job detailing how the Fed has emerged as what he calls "the cock of the walk in American financial regulation." Under the 1999 Gramm-Leach-Bliley bill, the Fed beat out its rivals and was named "umbrella supervisor" for the newly deregulated financial system. In that role, it oversees the banking, securities, and insurance businesses of the giant holding companies at the system's core. It was, Mayer says, a "miraculous accomplishment" for the central bank and a tribute to Greenspan's influence after years of internecine warfare with the other financial regulatory agencies.

But Mayer frets--rightly--that the Fed may not be up to its new role as financial czar. For one thing, it lacks expertise about the securities and insurance businesses that it now oversees. Even more worrying, Mayer says, is the structure of the Fed itself. It's an institution run by a powerful, hidebound, Washington staff that's beholden only to Chairman Greenspan. As such, it may be neither flexible nor open enough to keep up with the demands of a rapidly evolving marketplace. "The worst aspect of the staff domination of the Fed is that staffs always and everywhere believe in secrecy (their power, after all, comes from the exclusive control of information)," Mayer writes. "And the desperate need of the financial system looking ahead is for disclosure," since the more investors know, the less likely they are to be sideswiped by events.

The author, though, is on shakier ground when he takes on the Federal Reserve for arranging the bailout of giant hedge fund Long Term Capital Management (LTCM) in 1998. In an accusation that is not backed up by much evidence, he suggests that the central bank arranged the rescue not to save the financial system from disintegration but to save itself from embarrassment. To hear Mayer tell it, the Fed was so afraid that an LTCM collapse would expose its own regulatory lapses that it opted instead for a rescue of the hedge fund. But that seems a stretch, considering the fierce criticism that the Fed came in for anyway, both for its lax oversight and for the bailout itself.

That's not the only example of careless reporting. The book is peppered with tiny, annoying inaccuracies, from a misspelled name here to a mistaken time frame there. On their own, they don't amount to much. But taken together with an opaque writing style that would make the inscrutable Greenspan proud, they could be enough to make some readers throw up their hands in exasperation--and toss the book aside.

That would be a shame. Mayer has some important things to say. His book is a welcome antidote to the cult of Greenspan that has grown up over the past decade. It's nasty-tasting medicine, but in the end, it's good for you.

Miller covers the Fed and economics from Washington.

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