Peter Conti-Brown on *The Power and Independence of the Federal Reserve*

Peter Conti-Brown is an Assistant Professor at The Wharton School of the University of Pennsylvania. He joins the show to discuss his new book, *The Power and Independence of the Federal Reserve,* which exams the evolution of the Federal Reserve and what central bank independence really means. Peter also shares his thoughts on what a Trump presidency might mean for monetary policy.

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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Peter, welcome to the show.

Peter Conti-Brown: It's a pleasure to be here. Thanks for having me.

Beckworth: No, I read your book. I enjoyed it and I encourage our listeners to get their own copy and tear into it. Tell us, how did you get into becoming an historian of the Federal reserve and of central banking?

Conti-Brown: Yeah, so I started my career as a legal academic, not as a historian. And my first couple of articles were about kind of the legal structure of various financial institutions. I had an article on university endowments and then on the capital structures of banks. And as I was writing these banking pieces, of course the Fed looms large over banking regulation in a profound way. But the thing that I noticed is that the work done on the Fed, this behemoth in the exercise of governmental power over not just the economy, but indeed the very society, it was understudied.

Conti-Brown: Now, that's a curious thing to say because economists are like, is there anything more studied than the Federal Reserve or central banks? But for non-economists, it's really breathtaking the gap. So economists have a very, very clear model of the Fed and clear questions they ask about central banking policy and about monetary policy.

Conti-Brown: But what I noted as a legal academic is that there was not a scholarly discourse around in filling in the gaps of Feds legal power. Now, this came to a point during the financial crisis and especially around the decisions to invoke the Fed statutory authority to save or not to save various financial institutions. So as a legal academic, I got very excited about the Fed around the time of the financial crisis. And then as I dug more deeply, I thought in order to really take this on, I need more graduate training. And I would like to take this at the intersection, not just of law and economics, but also law, economics, politics, and especially history. So I went to get a PhD at Princeton and focus in financial history and then have made the Fed the focus of my scholarship since then.

Beckworth: That's amazing. You already had your law degree, then you decided to go back and get a PhD. You're a glutton for punishment. We are glad you are because we are benefiting from this great book. Now, you also are working on another book. So tell us about that.

Fed Power and Independence

Conti-Brown: Yeah. So the book that I've published, The Power and Independence of the Federal Reserve, it engages a lot with the Fed's history. I use a lot of examples from the Fed's history and service of an overall argument about the structure of the Fed internally and externally within its political context.

Conti-Brown: But it really is a book about public policy and it's a book, although I'm very proud of the book, it's not got a long shelf life. I mean it's really engaging in a conversation that is relevant today. In the process though, there is really no good single volume history of the Fed and that's the next project. So it's under contract with Harvard University press. It won't be out for another four years but it's called the Supreme Court of Finance, the rise and rise of the US Federal reserve.

Conti-Brown: And I'm taking it from what I'm arguing is really, it's early founding moment in about 1896, not 1913. And then taking just a grand tour through the Feds political history and using it as an opportunity to look at what we might call it, the long 20th century. I'm capping that about 1896 through the 2016 presidential election. And looking at the political forces and intellectual forces that work on the Fed inside and out to try and shape its policy making space.

Beckworth: Okay, well, we look forward to that in about four years. And we talked earlier about this book will be a compliment to what LML sir did in his massive what was it, three or four volumes on the Fed. And that's more of a monetary history. Yours will be more of a political, intellectual history.

Conti-Brown: That's right.

Beckworth: So if you want to be a true expert on the Fed, you've got to read all those books. Okay. Well, with that said, let's move to your new book, The Power and Independence of the Federal Reserve. Tell us about your motivation. Early in the book, share this with the listeners. What was the motivation for doing this at this point in time?

Conti-Brown: So there's been a discourse that's developed up until and indeed through the financial crisis about Fed independence, this curious term and it takes on new meaning even beyond what we think of as independent agencies in government. For central banks it's different. In fact, scholars studying central bank independence have done it so much. They even get their own acronym CBI. It's not quite GDP for economist. It's getting up there. And critics of central bank independence have really glommed onto this concept. So it's either the source of all of the Feds mystery conspiracy and the way that it conspiratorially exercises power over everyone, or it's this great sacred thing that has to be defended at all costs. And my book is essentially an argument that a pox on both their houses essentially.

Conti-Brown: I think that the concept of Fed independence as debated is functionally incoherent. And I say that because it's not clear that those who are talking about Fed independence are capturing the Fed as it actually exists, that they've built up an entity that in fact does not exist. And we're having arguments pass each other as it turns out about an entity that isn't the one that actually operates from constitution Avenue in Washington, DC and throughout the country.

Conti-Brown: So I wanted to put a lot of pressure on what I call the standard account of Fed independence, and then replace it with a more nuanced conversation that reveals fundamentally that the Fed is a political creature. It exists within a political system and I think very desirable and in certain respects, insulation of monetary policy from the day to day of electoral politics, that installation is a decision that every generation has to make and remake again.

Conti-Brown: It's not something that we can tie down in law and announce forever after and say, well, we have now made the Fed legally independent and so it shall stay forever and ever, amen. That's not how Fed independence works. And a part of my motivation as a legal scholar is to say to everyone else, you've been worshiping at the wrong alter, law is not doing the work that you think it is doing. I need sometimes it does the very opposite thing you anticipated. And so let's be more frank about the way that we've built this institution and recognize the way it is or is not insulated from politics and whether or not the installation is desirable across a range of the Fed's functions.

Beckworth: Yeah. There is this almost religious devotion to the idea of the Fed's independence. And even now with Donald Trump being the president elect, there's new questions of it being raised. What will he do to the Fed? What we'll he do Janet Yellen? But this really it's a recent phenomenon and as you bring out your book, and it's fascinating to look at this, and it's interesting to kind of back and consider really, I mean the Fed is a creation of Congress and they represent the public body politics voice. So what Congress creates, Congress can change and destroy, get rid of. So it is a political creature and your book does a good job outlining this. And this almost myth like, it's not myth is the wrong word, but this is revered status of independence.

Beckworth: You really shine a light on it and reveal it's far more complicated. Well, let's begin as you do in your book by going over the history kind of this, you talk about the standard kind of history of the founding of the Fed, but then you say there's really three foundings of the Fed, three pivotal developments that really make the Fed as we know it today. So share that with us.

Three Pivotal Developments in Fed History

Conti-Brown: Sure. So in the standard history and a lot of scholars have really devoted their full attention when they think of the history of the Fed. All they want to talk about is 1913, and Woodrow Wilson in this progressive era moment which is when the Federal Reserve Act was passed by Congress and signed by the president.

Conti-Brown: And it's a great story. Roger Lowenstein has just written a book called The America's Bank and it's a lovely book that does a great job debating those questions. But there are a couple of really strange myths and I think David ‘myth’ is exactly the right word indeed. My publisher wanted to name my book the myths of Federal reserve independence.

Beckworth: Fascinating.

Conti-Brown: I said, no, because writing in this space draws the conspiracy theories and I was afraid that a book by that title would present some branding problems for me.

Conti-Brown: So we pushed back. But the one of the myths is that 1907, there was a financial panic and JP Morgan in his wisdom and power locked all the bankers of New York into his private library, saved the day. But in the process revealed to the world that America needed a central bank because JP Morgan was very old and wouldn't live forever.

Conti-Brown: And so Congress following that insight passed the Federal Reserve Act. There are some elements of this that are true. I mean, there really was a financial panic in 1907, JP Morgan did have a role to play. But just start with the dates. The financial panic happened in 1907. The Federal Reserve Act of 1913 happened appropriately in 1913. So this six year gap between those two events included three national elections, two presidential elections. It's simply not correct to call the Fed panic legislation when we've got two presidential elections that intercede between those two events.

Conti-Brown: So then if it wasn't this response to a panic, what was it a response to? And I think this is important, the idea that this is responded to something else because it sets up another strain in the Fed's history about how much it changes again and again and again.

Conti-Brown: But it is still important to know what happening in 1913. In 1913, they created a system of not a central bank, but 12 central banks with what I call in the book a Wilsonian compromise. And that's a Wilsonian compromise because all the feuding factions were arguing about central banking until 1913 didn't really have in mind something that Woodrow Wilson imposed on top of the system. And that was to have a publicly accountable board that sat in Washington DC whose chair would be the secretary of the treasury. And it would be fully accountable to the presidential administration.

Conti-Brown: His members would be appointed by the president, confirmed by the Senate. Again, nobody sought this out, but Wilson, everybody else was arguing about whether we should have it be focused in private hands in Washington or focused in private hands spread out throughout the country. That centralization versus decentralization was the big question, but central banking and the early 20th century was a Bank of England model where governmental participation was much much more limited, but that was not Wilson's idea. So we created this thing. One of the conspiracy theory books is called feature from Jekyll Island and it really was this creature that seemed kind of mysterious that was coming out of the 1913 legislation.

Conti-Brown: Now, importantly, in that founding moment, there was just great ambiguity as to who held the power within the system. Today you think of the Fed, you think Janet Yellen or you thought Ben Bernanke and Alan Greenspan, we associate the Fed so completely with the person of the Fed chair.

Conti-Brown: Now, under Janet Yellen, we hear a lot more from other members of the Federal open market committee on CNBC or what have you. That's relatively recent, but it's still very much wrapped up into the identity of the chair. That was not the case in 1913. Every tab was on its own bottom, so to speak.

Conti-Brown: Now, that original Federal reserve system, right, this was the Federal part of it. It was a Federalist system. It was mapping between these 12 Federal reserve bank scattered unevenly throughout the United States and a national board in Washington DC. That system failed and it failed dramatically.

Conti-Brown: My argument that it failed is not quite the same as what other people criticize the Fed for in this era causing the great depression. That's an interesting argument. I don't argue against that, but my argument that it failed is that it failed as a matter of leadership and accountability.

Conti-Brown: Nobody knew who within the Federal reserve system held power. Now, there was defacto power exercise for about 15 years by Benjamin Strong, who was the governor, Federal reserve bank of New York. But that was by pure, didn't have personality and social connections. There was nothing statutory about it. It would be like Paul Ryan saying, well I'm actually going to lead the United States today because I know the most about Republican governance. But that's not how it works.

Beckworth: Well, let me ask this one question about that period. My understanding is that it was the regional banks, 12 regional banks themselves did actual monetary policy, they did this accounting, they discovered open market operations. So in theory they each could do their own monetary policy. They were all constrained by the gold standard, but they had the ability to act independently. That's why Benjamin Strong's leadership was so important. Is that right?

Conti-Brown: That's close to being right. So the gold standard actually plays an uneven role in its history. Because we're celebrating today actually I think it's today or is like yesterday, the day in 1914 when the reserve banks opened their doors. And something else was happening in the fall of 1914, which was of course the beginning of world War I. And the gold standard is essentially an international gold standard when we're talking about an international economy as we'd very much were at that time.

Conti-Brown: But you're absolutely correct that the United States in this time, even independent of the gold standard, didn't have monetary policy, it had monetary policies. And it create some really interesting examples where you have a single state, right? Like the state of Mississippi or the state of Georgia, but which are divided among Federal reserve bank districts.

Conti-Brown: And they had different monetary policies for different parts of the state because they were under the guise of different Federal reserve banks. So Benjamin Strong leadership here is so important because he creates these ad hoc institutions that were not part of the statute, like the governor's council to engage in open market policy that were independent.

Conti-Brown: So these independent movements were happening throughout the system. When you had someone fill that power vacuum like Benjamin Strong, it worked pretty well. The problem is that with a personality is forming the role of leadership it's unstable and it's connected to, in this case, the tubercular Benjamin Strong. He died young and he was constantly sick. So when he dies he leaves a power vacuum and that power vacuum leads all kinds of policy uncertainty throughout the great depression.

Beckworth: You mentioned this ability to set monetary policy differently and you mentioned Mississippi and as you know there's these studies that have looked at that state during that time. It's really fascinating because macro macroeconomist we really wish we had better data, better empirical evidence and we simply can't do replications of recessions and it'd be socially costly. But this is one case where we get to kind of a natural experiment. We see the same state, same people, same state laws, different treatments North and South. Something you brought in your up in your book that was really fascinating, I learned is that these, not only were they sending different monetary policies, they were competing against each other and you give the example that two different banks just remind me which ones they were, but two different regional banks opened up branches in Havana Cuba. Tell us about that.

Conti-Brown: That's great. Were you reading the footnotes? I put that in the text result.

Beckworth: That's in the text. Yeah, Fascinating story.

Conti-Brown: I was apart, I remember going back and forth with the editor about whether I got to include that because it almost got cut because it was almost irrelevant to the broader decision

Beckworth: That's incredibly fascinating that these two regional banks both wanted to lay claim to Havana.

Conti-Brown: Yeah, exactly. So it was Chicago and I think Boston which have nothing to do geographically with Havana, Cuba. But Chicago for sure, Chicago was one of the most aggressive banks. And by bank I mean private enterprise seeking to manage their earnings.

Conti-Brown: And in a flip from the usual argument about monetizing the public debt with a central bank Chicago, the last time that we in the United States were very serious about paying the debt off entirely, it was in the 1920s, the public debt. And Andrew Mellon was saying to the Federal reserve banks, keep in mind, Andrew Mellon, who's the secretary of the treasury, is the chair of the Federal reserve system. Right? He's telling the Federal reserve banks stop holding US paper. We're trying to buy this back. And Chicago wouldn't because it was such a great investment.

Conti-Brown: Right. And this was really irritating to Andrew Mellon and finally, they resolved their problem. That was after years of fights, but that was the same motivation that sends them to Havana, Cuba to do a banking business mostly on behalf of US interests, but vying for the ability to be a banker's bank.

Conti-Brown: It's a function that's so different from the way we envisioned central banking today of providing that services that are today provided largely by other banks. Right? If you want to finance trade there are all kinds of ways that you would do it, but you would do it through the banking system. You wouldn't go to the central bank unless there were some sort of emergency. It's not so at the time when the reserve banks were vying for business to do discount bills of exchange throughout the world.

Beckworth: Very fascinating. So that was the first founding, which was the actual creation. And you have two other foundings or pivotal moments in Fed's history. What were they?

Conti-Brown: Right. And so the next two, and I should be clear, when I write in the book the three foundings of the Federal reserve I'm being a little cute and here's what I mean by that. The Fed is founded again, again and again. And my next book, I build on this idea of a multi founded institution and it's a book about 25 different foundings so that the Federal reserve in 2016 looks so different in governance and structure and function from the Fed in 2007. Right?

Conti-Brown: The crisis just as completely remade it, but I do focus on these other two foundings because I think they were incredibly pivotal. In 1935 is the second founding. So remember when we talk about the Federal reserve system, I talked about this in the book and right now I'm holding in my hand my favorite mug.

Conti-Brown: And it's this mug that I got from a friend of mine who is a Fed economists and it says board of governors of the Federal reserve system, and it has the Feds crest. And underneath that it says 100 years. It was commissioned in 2013. What I love about this mug is that it's announcing of the widely accepted lie. And that is the board of governors of the Federal reserve system is not 100 years old. It'll turn 120, 35. And this is important because what happened to the Fed in 1935 amounts to such a dramatic re-founding that I'd argued was more similar to the articles of Confederation being retired and replaced by US constitution as opposed to just let's add an amendment to the constitution. And this is one of the reasons why I think getting obsessed about 1913 and the progressive era makes no sense.

Conti-Brown: It's like turning to the articles of Confederation to tell us about gay marriage, essentially a useless enterprise, maybe not entirely so, but it's pretty close. What happened in 1935, then? Well, so remember that in the new deal from a legislative perspective the new deal moves in three phases. First, as a campaign promise, a set of campaign promises with essentially no content, right? FDR is campaigning in 1932 promising a new deal for America in the throws of depression and also in the throws of just a multi breaking bank banking panic. But FDR doesn't tell us what the new deal is and the campaign, right? So then it's the first 100 days and it's a burst of legislative activity. And that legislative activity is all over the map. It's about the cartelization of business, but it's also about coming after big business, it's about reforming the banking system through a bank holiday and creating a Federal open market committee to do open market operations.

Conti-Brown: But at the same time, leaving the Fed essentially as it was. And so this is the time when the Supreme Court is batting down some of those legislative efforts. And so there's a great deal of frenzy, but not a lot of clarity. Then comes the second new deal as historians call it. And this is a second burst of legislative activity that comes in the next congressional session, this is in 1935. So this is when we get such enduring parts of our political fabric as the Social Security Act, the Wagner Act, which creates the National Labor Relations Board. We get tax reform and then we get at the very end, a bill that was the least controversial of them which was the Banking Act of 1935. Now, remember that for all those Hamilton, the musical lovers out there of our listeners, the idea that central banking at the legislative level would be uncontroversial is almost un-American, right?

Conti-Brown: I mean, this is the, we fight about money. This is what politicians do. Political parties organize around these ideas, right? But this was so uncontroversial because people were focused on other things. And it only happened because of one of the most colorful people in Fed history, Amanda Eccles, a man for whom the Fed building Constitution Avenue is named, it's the Eccles building. He was asked by Franklin Roosevelt to become the, it was called the governor of the Federal reserve board is kind of a chief executive. He was under the secretary of the treasury and Eccles said, essentially, no way in hell. Eccles is, keep in mind, Eccles is a Mormon from Utah he's a son of a bigamist father. He becomes billionaire banker, survives the banking crises but is as left wing as they come.

Conti-Brown: He's further out on the left than Franklin Roosevelt. If we're defining left versus right, whether the government should be participating in what would we'd later call or a Keynesian approach to fiscal policy. So he comes in and he just says, I'm not going to participate in this. Unless I can rewrite the Federal Reserve Act and Roosevelt says, okay, do it. This is before the court packing plan has sucked away Roosevelt's power. And so that endorsement was enough. And with it came the replacement of the Federal reserve board which was Wilson's crown jewel of the system. With this new board of governance. So what did that change? Well, the secretary of the treasury was out. They created this new technocratic institution that wouldn't be dominated by politicians. At the same time, there would no longer be monetary policies. There'd be a monetary policy.

Conti-Brown: The Federal reserve banks were demoted both functionally and then I love this little quip working history because it's almost like adding insult to injury. Not only is Eccles saying Federal banks, you no longer to have your own central banking policy. He's also telling them, you also don't get to have the vaunted title of a central banker because before 1935, these reserve bank heads were called governors, which in central banking parlance means the head of a central bank.

Conti-Brown: And the members of the Federal reserve board were not called governors. They were called members, right? So they were functionaries. They were bureaucrats. And now they became the governors in Washington, DC and the reserve banks became presidents, which was the title used for any corner savings and loan. So this was a radical transformation. I'm sorry, I've gone on so long on this second model.

Beckworth: That's fine.

Conti-Brown: But it was radical transformation and the way the paper was allocated within the system to answer the question that had been so vexing during the depression, which was to whom should we turn when we criticize the Fed. Or who holds the power from the system after Marriner was the answer was the Fed chair.

Beckworth: What was the next important founding after that?

Conti-Brown: Well, let me try to summarize that more briefly, but they're spending six years on a book. You live and breathe it, you realize this is this narrative just starts coming back to you. Okay. So Marriner Eccles stays in an office for a while as relevant actually for Donald Trump, Janet Yellen for reasons we can discuss later.

Conti-Brown: After World War II, after Roosevelt had died, Roosevelt was Eccles great patron and Truman becomes president. Truman and Eccles did not have the same relationship. And during World War II, ironically, the secretary of treasury goes, we expect to see what the beginnings of Fed independence, a separate policymaking body separate from the president. But during the end of the depression and throughout World War II, the Fed just announces that it's going to be a sub Bureau of the treasury.

Conti-Brown: It will do nothing separate from the administration and indeed it announced this publicly right after Pearl Harbor, but that it will peg the interest rate of governmental debt and stabilize that interest, whatever the consequences for inflation.

Conti-Brown: Well, Truman, like any president loves that idea and wants it in place. He wants to keep interest rates low and stable and sees Eccles who went from kind of left wing proto-Keynesian to the most hawkish of inflationary hawks.

Conti-Brown: And so Truman doesn't like that, he wants to remove him from his position, which he does. And he says you know what, I'm not going to reappoint you as Fed chair. And then trying to nudge him out entirely. He says, but I will appoint you to the vice chair, now that's designed in Washington speak to basically say, go back to Utah.

Conti-Brown: But Eccles doesn't fight. He says, okay, great. I'll take that vice chairmanship because this is an important statutory quirk. Any Fed chair actually has two statutory roles. She serves as a governor of the Federal reserve on the board of governors on a 14 year term. And then on a four year term, she'll be chair. So Eccles was serving both and he had many, many more years left on his term as governor, even as his term as chair was over.

Conti-Brown: So he stays on. Eccles the Fed chair from 1934 till 1946 stays on and he stays on to wreak havoc on the Truman administration. Well, this eventually comes to a head. Truman tells the Fed that if they don't stop making speeches, like they're going to desert the peg and keep interest rates low, that they're doing exactly what Mr. Stalin wants.

Conti-Brown: This is red baiting of the highest. For the only time in the Fed's history, he summons all members of the Federal open market committee to the oval office where he gives them a tongue lashing about their responsibilities and then immediately issues press releases, mischaracterizing the nature of the FOMCs commitments coming out of that meeting. So this is going back and forth and it is spilling on the front pages of newspapers. Bankers are talking about little little else, a great war between the Fed and treasury. And eventually they announce on accord, this is in March of 1951 and the accord, I consider the third founding. Now, note that unlike the first two, there's nothing legislative about the accord. And indeed as a lawyer, when I read the accord and I quote it in full in the book, it's a sentence and it has no content to it.

Conti-Brown: It essentially says that the secretary of the treasury and the Federal open market committee have agreed to help with the orderly. I'm doing this from memory. So it's not exactly right. So the orderly maintenance of the government's financing needs, but also avoiding the need to monetize the public debt. And that's it. Well, what does that mean? Nothing, but it becomes this iconic moment that announces that the Fed is no longer bound to respect the views of the president, the secretary of the treasury when making monetary policy.

Beckworth: So these three foundings are interesting, Marriner Eccles is particularly interesting. I really liked the story you told in the book what you just shared. Most people would save face by leaving the port of governors if they were going to be demoted. But I appreciate his dedication, his ability and maybe his desire to poke at the president Truman is definitely fascinating story.

Beckworth: But I think what this last founding speaks to what you just mentioned, it speaks to how the Federal reserve itself can take shape, take form by these implicit understandings, these developments that aren't necessarily written into law. And the next part of your book, you actually go on to say, hey, the infrastructure was there so that the accord puts the infrastructure in place for the Fed as we know it, but it still took three strong personalities.

Beckworth: And you specifically point out William, Chesney Martin, Paul Volcker and Alan Greenspan that under their leadership, if the Fed, it kind of transforms into what we know today. And so what's fascinating and looking at this and then looking at the treasury cord absent those personalities, absent the accord, we have a very different central bank today and it's not due to legislation. It's not due some new law. It's due to personalities and just things happening the way they did. So nothing is set in stone for the Fed and it's easy for us in this day and age. And I see reporters, I'm guilty of it too. We just assume this is the way the Fed is and always has been. But no, it's very much a living organism that can change with the times.

Beckworth: So you go on to talk about how it kind of grew into what we know at through the leadership of these three important Fed chairman. We can come back to them latter date. But I want to move on and talk about the structure as we have at today, some of the issues that face them. So let's talk about the board of governors. What do we know about them? What legally are they able to do? And let's just speak to that first, I guess.

Evolving Responsibilities of the Board of Governors

Conti-Brown: Yeah, sure. So what do the governors do? Well, the answer is everything, right? So everything within the Federal reserve system. What do I mean by that? Well, the comparison I make in the book and from a statutory perspective, they're essentially identical, is to the Supreme Court, right? So when justice Scalia died, as we know, all hell broke loose in Washington DC as the parties jockeyed between them on who got to name his successor, right? But justice Scalia was not the chief justice. That's John Roberts. He was just one of nine justices. But we treat the Supreme Court as a committee of experts who vote on the disposition of questions of law and public policy that are such importance. The board of governors is structured exactly the same. The Fed chair, indeed, I think actually the chief justice has more statutory authority than the Fed chair.

Conti-Brown: The Fed chair will appear before Congress twice a year. But that's something in statute can be done by anyone within the board of governors and presides over meetings, but subject to the board of governors supervision. So eight from a secretary perspective, the governors have all the authority, but of course to hear that just sounds incredibly odd. That's not the way the Fed is run. If Jay Powell resigned or as so many others have on the board of governors, Fed watchers will pay attention. There are currently two vacancies on the board of governors, for example, but America sure doesn't except when the Fed chair comes to the end of her term, well then America is paying attention. So the board of governors level by tradition and not by law, so much of the power and authority has been concentrated in the person of the chair.

Conti-Brown: And that represents a problem for Fed independence as it's conventionally understood. And what I mean by that is that if Fed independence means we need to insulate the exercise of monetary policy making from the day to day of political of politics then having a system where the president, it just puts all of the power and authority into a single person means that that single person is going to be beholden to the president and is not going to be so separate from political wins. We have seen that in practice at the Fed historically.

Conti-Brown: I would argue that we don't see that today. I don't think Janet Yellen is a particularly political animal in the partisan sense of that word. So this would be in contradiction of accusations from then candidate Donald Trump. But there is no question that the virtue of decision by committee is to have multiple voices, multiple power centers pulling at these ideas. That's the benefit of committee. If we've placed in fact, if not in law, all of that authority in the person into a single person then that can be much more problematic.

Beckworth: Well, we see that with Volker. He's a strong personality and he had to be to get through the recession he engineered in the early 80s. And then with Greenspan, I think with Greenspan, you could argue he takes that almost cult of personality to a peak. Since then though, we had Bernanke. Right. So one of the critiques of Bernanke is he's almost too academic. He's too nice. He's too open to discussions where Greenspan definitely shaped agendas is fascinating to read in your book how a number of people, I think Peter Kennan that was offered a job at the Fed and he came and spoke to Greenspan, hey, would I be able to go out and negotiate international issues? And Greenspan said, no, you're not going to do that. And a lot of these, Alan Blinder and other individual, you mentioned in the book, a lot of these governors felt shut out. The staff in Greenspan kind of ran the shop.

Beckworth: But since then, again, Bernanke at least this is my impression, you probably can answer this better than I know this better than I do. Bernanke is much more academic, kind of like an academic department, a seminar room, FOMC meeting them. My sense is Yellen is the same way as well. So do we see some of that concern coming down given the more academic nature of FOMC now?

Conti-Brown: Well, so Bernanke is really interesting because he starts toward an idea of, let's run this like a seminar and not like a dictatorship. But remember that of course Ben Bernanke has the bad luck of starting his Fed chairmanship in 2006 as things are getting out of control.

Conti-Brown: And so at the height of the crisis, he abandons that governing by consensus mode and essentially comes together with what we might call an executive committee of the Fed, which consists of him, Tim Geithner, the New York Fed president, Don Cone, who was vice chair of the Fed and then Kevin Warsh, who's the governor. And they make most of the important policy decisions together and it's Ben Bernanke buck stops with him. And then in the minutes that they have FOMC minutes from the crisis that we're now getting a release.

Conti-Brown: This just inflamed the rage of so many members of the Federal open market committee. Fed president Jeffrey Larker was just, was just apoplectic about the engineering that Tim Geithner had been doing for Bank of America, which resides in the Richmond district, not the New York district. Just to give one example. So by the end of the crisis, we return again to more of a consensus driven view. But for most of Bernanke's chairmanship despite the fact that he did not like the cult of personality, he thought it was harmful to the Fed and wanting to fight it. He picked up that power. He used it.

Beckworth: We'll transition in the heated battle.

Conti-Brown: Exactly.

Beckworth: Yeah. Well it's understandable in one level, you're in the middle of a fight. You're going to have to make some quick decisions, but you're getting back to the problem that you speak to that all the power is concentrated in one person.

Beckworth: Now, you mentioned in the book along these lines, very interestingly, the Lehman decision, so the Federal reserve they okay the deal for a Bear Stearns. Later they okay AIG, but they don't Lehman and Lehman's this pivotal event, this big shock that really turns the financial crisis into a global systemic one. And they claimed legally they couldn't. Now this speaks also to the influence of the lawyer. We'll talk about that in a minute too. But I think you provided a good case that their argument really wasn't sound. So speak of that.

Would it have been Legal to Bail Out Lehman?

Conti-Brown: So this is something that Ben Bernanke continues to swear by this idea that Lehman could not be saved because of law, right? It would have been illegal for them to do so. And this is one of the most fascinating invocations of law and Fed history. So here's the structure of their argument. The section of the reserve act that gives them authority to lend in unusual and exigent circumstances has gained some notoriety. It's section 13-3 of the act, and what 13-3 says is that in the unusual and existent circumstances, the Fed can lend as it was written at the time to any individual partnership or corporation. So essentially anyone, so long as a couple of factors are satisfied. Number one, the board of governors votes with at least five votes, five out of seven.

Conti-Brown: Number two, that it's a loan, not a grant. So it's got to be a lent against collateral. And then number three, that collateral has to be secured to the satisfaction of the Federal reserve bank. And those are the only restrictions. There are a couple of others that are irrelevant, but those are the only main restrictions. And Bernanke's argument is that Lehman was banked. So there was no way that the lend money bankrupt entity. Now that has some beguiling appeal. You're like, oh, of course, it has to be secured, it has to be a secured loan, and then you can't secure it if you don't have the security. But what's the difference between illiquidity and insolvency if your business is finance? Right? Well, of course in a fire sale, everything that's a liquid starts to bring down the balance sheet of these entities and they look insolvent.

Conti-Brown: And the argument might be made while Lehman brothers was insolvent, even in the best of times. But that's not the question that the statute tees up for the Fed. That statute says, is the loan secured to the satisfaction of the Federal reserve bank. In administrative law we would call that a discretionary standard that leaves, that's a grant of discretion to the agency. So Bernanke's argument is it was illegal, only makes sense if the Federal reserve bank in this case it would have been the Federal reserve bank of New York was saying, we refuse to be satisfied with their security, but that's not what the New York Fed said. The New York Fed, they were making this decision as one. This was a discretionary decision and they made it, they made that call. And I'll confess that when this happened, as someone who was following this very closely indeed, I had already started writing about the Fed at that point.

Conti-Brown: I thought finally we've just seen Freddie and Fannie put into conservatorship. We went through this whole hullabaloo with Bear Stearns last March. Someone needs to go, they've got to send a message. Right? Well, that was exactly the climate of the time Lehman brothers had gone through three successive suitors, each one getting through due diligence, the Korean Development Bank pulling out at the end. Bank of America ending up in the arms of Merrill Lynch. And then finally, most dramatically Barclays that wanted to buy Lehman.

Conti-Brown: But the UK FSA and chancellor of the Exchequer refused to sign off. And so they had been living situation where politically it was completely infeasible for them to do this from a market perspective in terms of buying Lehman, that was their first choice and their second choice and their third choice, those all fell through.

Conti-Brown: So the Fed made the affirmative decision. We're not going to intervene. Now, was that the right decision? Was that the wrong decision? I'm one who still thinks that that was probably the right decision because the counterfactual, even though it looks like it ushered in the financial crisis. The counterfactual is also incredibly problematic to see the Fed doing everything for everyone at every instance. But again, that's not the debate that Ben Bernanke wants to have. That's not the debate that the Fed wat to have.

Beckworth: Right. This is invoking a legal argument.

Conti-Brown: He's saying, oh, would that I could have done something. And I admire Ben Bernanke for a lot of things. And what I see him doing here is serving two functions. Number one, we know, be it with ample evidence that Fed chairs are very interested in their legacy. If the consensus is that Ben Bernanke screwed up, that they should have bailed out Lehman, that this was an error, then this would be an instance of malpractice in central banking anals that would really taint his legacy.

Conti-Brown: So I think he's interested in link legacy when he makes this argument. But number two and more interestingly and really showing just what a political figure Fed chairs are, is by claiming that they lacked legal authority in the most significant point of inflection in the financial crisis. They are able to operate the political process around Fed reform and financial reform in a way that favors them rather than disfavor stuff. And that's exactly what we saw in Dodd-Frank Dodd-Frank, when seem there was bipartisan consensus, which may or may not be right, that the Fed screwed up and made so many mistakes.

Conti-Brown: The Fed emerges from that legislative process with more power than ever. And that's in part because they're saying, well, we would have saved, we would have avoided all of this if only we had had the legal authority. And I think that's what's so fascinating, really tells you a couple of different things. One, if the lawyers really were making this argument and the book, I take that argument at face value, it's a terrible argument, right? It's that legal analysis is quite shoddy. And that just shows how much lawyers have after Dodd-Frank. The power of the lawyer is just exceptional. But it also tells us just how much Fed chairs live and breathe in a political environment. And we'll make arguments in that environment.

Beckworth: Well, I mean, I'm not a legal scholar, but it strikes me that if the Fed and the treasury department could find ways to bail out AIG afterwards and they found out ways to find support for various turns and others beforehand, this was really deep down, a matter of political opinions or some other reason. It wasn't truly legal. You can find lawyers and then legal reasoning to wiggle through whatever you need, especially in this circumstance.

Conti-Brown: Yeah.

Beckworth: One last thing, and I'm going to move on because our time is short. I'm speaking to the power of the Fed chair and how resilient it is. Maybe speaking also to the influence the Fed chair faces. One of the questions again coming up is what will Donald Trump the president elect do with Janet Yellen? One option is he waits out her time, I believe 2017.

Conti-Brown: Yep, January.

Beckworth: Yeah, and then they partway and that's probably the best case scenario if he doesn't want to keep her. But you bring up in your book another potential option. Not in the case of Yellen and Trump, but you mentioned the Fed chair under Thomas McCabe. He effectively was pushed out by the president. On the surface he left, but all the evidence points to Truman firing a Fed chair, which was pretty shocking to read. In fact, you mentioned in the book that later there were some senators and Congressman who wanted to have an inquiry into this, but he was forcibly pushed out. And so it wouldn't be unprecedented for Donald Trump to force out Janet Yellen early. I'm pretty sure it would still create a political firestorm, but there is a precedent for it.

Next Fed Chair under President-Elect Trump

Conti-Brown: Yeah, I think there is. And there's legal ambiguity about whether the president can fire a Fed chair yet the Fed chair has the same legal status as the FBI director, which is to say they serve on a fixed term four years for the Fed chair, 10 years for the FBI director.

Conti-Brown: But there's no removability protection, for the governor there is, for the seven governors there's four cause removability protection. So if the president wants to fire a governor, he's got to have a reason. And that reason the courts have determined has to be more than a policy difference. Now, Trump has said that not going to do that, it would be incredibly stupid for Trump to do this. From the time he's sworn in, there will be a year in 11 days left on Yellen's term.

Conti-Brown: And it would take so much political capital, I would wager much more than he has to launch that fight. And Yellen would not go quietly into the night. I think that would be a mistake. The more interesting question to me, and as we're seeing day by day, how the president elect is handling personnel issues is who has been sufficiently loyal to the Trump campaign to merit consideration for this greatest of prizes. And this is a bit of Fed watchers a part of their game.

Beckworth: What names do you have?

Conti-Brown: So if Mitt Romney had been president, there would have been the three obvious names would have been Greg MannQ, Glenn Hubbard, and John Taylor. They are Republican partisans in the sense that they've served Republican administrations in the past. They're very well regarded. Right? They each hold shared professorships at elite universities and are well regarded by Democrats and Republicans alike.

Conti-Brown: Trump has had exactly one PhD economists identify as embracing his economic program during the campaign, that's Peter Navarro from UC Irvine. And Peter Navarro I think he would have such a hard time getting that appointment. Because people would see... And this is the central tension, right? President Trump, much like any president, but especially I would say the antecedent, here's president Nixon is going to want a loyalist and he's going to want a loyalist who's going to keep one eye on Trump's electoral prospects. And the other eye on the Fed. Now, our modern conception of Fed independence that is incredibly fragile is that the Fed chair keeps both eyes on the Fed's institutional credibility and is indifferent to electoral concerns.

Conti-Brown: Whether that's ever fully possible, it's a separate question, but that's the conception. I think Janet Yellen has actually done a very good job of kind of keeping her head down and focusing on those issues.

Beckworth: Yeah.

Conti-Brown: Basically bottom line is I think a fight is brewing. I think there's going to be a big ugly fight.

Beckworth: Interesting.

Conti-Brown: And my guess is my money is going to be on a Janet Yellen reappointment because it's going to be the least bad option. Donald Trump, I think he's going to have a very hard time getting-

Beckworth: He's sending mixed signals here. Right? So he at one point praised or other times more recently he was bashing her for the low interest rates. But it will be interesting to see, I mean nothing else. He will hear the appointments to the board that presumably be much easier for him since he has a Republican Senate to work with.

Beckworth: I want to move on in our time that's left and talk about some of your critiques that come up and then maybe we can jump to your proposals to reform the Federal reserve. So you mentioned in chapter four you call the double government of the Federal reserve and you speak to the influence of the economists and the lawyers at the Federal reserve. And I'll just give the two examples of you do. Edwin Truman, who was the head of the international finance division at the Fed, he actually went out and negotiated on behalf of the US government and other countries whenever there was a financial crisis and say the Asian crisis.

Beckworth: But he went out and represented US interest, had a lot of influence. The other individual you mentioned in that chapter is Scott Al-

Conti-Brown: Scott Alvarez.

Beckworth: Scott Alvarez, thank you. He's the chief lawyer for the Federal reserve and he makes a lot of important decisions. And these two individuals they're civil servants, they've worked their way up. They were never appointed by anyone in Congress or the president or approved by anyone in the Senate or in Congress. And that creates questions of accountability. And then the next chapter you bring up on similar concern for the regional Fed presidents. They get to vote on the FOMC, same vote as a governor who is appointed and approved by Senate, but they're not. And so both of these raise concerns. That's I'd say, constitutional concerns, you write in your book. So speak to your reforms that you would usher in that would address these issues.

Regional Fed Presidents: Concerns and Proposed Reforms

Conti-Brown: Right. Well, so these reforms are, if I were the Grand Poobah of the Federal reserve system, right? And got to write the Federal reserve act to my liking. And that's an important qualification. And one reason why I haven't joined any of the political efforts to open up the Federal reserve act for rewriting legislative rewriting.

Conti-Brown: And the reason for that is in part because I'm a scholar, I'm not an activist, I'm not particularly political in this space or partisan. But in part because I'm not convinced that we would get out of the legislative process on the other side would look anything like I would like it to be. So let me just lay that marker there to say I think that we might be in a world of second or third or fourth best but still an optimal outcome from a factual.

Conti-Brown: Now that's kind of a dodge and let me not dodge it. So let me say, if I were writing without those constraints in mind. I have a couple of problems with especially the Fed's lawyer. And to a lesser extent the head of international finance. And the reason is because these two positions, unlike say the Feds director of research and statistics, an incredibly influential role, research and statistics. And there's another very important role, which is the director of monetary affairs. Those two roles they have huge influence who occupies those positions will matter enormously. And there's no doubt about it, but what they're doing can't be done by people who don't have experience doing that work. It's almost required that you come up through the ranks to have those positions.

Conti-Brown: So having it function as part of a spoil system or even going through a political accountability process, it's not clear to me what you would get from that accountability. You wouldn't get nothing, but so much of what they're doing is so technocratic, so technical that I could see politics doing much more harm than good. But I think that the chief counsel position, and to a slightly lesser extent, the international finance division are different and part because international finance is essentially a diplomatic role and they're interfacing with foreign governments and they're developing international and foreign affairs policy. And constitutionally, and I think just from a good policy perspective, who gets to shape America's foreign policy is the person that America chooses. Now, to be clear, there's no secret. I wrote an op-ed during the campaign about how terrible Donald Trump would be for the Federal reserve.

Conti-Brown: I was not a Trump fan and I voted for Hillary Clinton. But even though my person lost, I still absolutely think, and from an even just kind of a Churchillian perspective, that the democratic process may be terrible, but it's the best we've got. And so even when it yields someone who I don't like or whose values I don't share and his policy perspectives, I don't share. This is the person that America has chosen in its curious way. And so getting to make those personnel decisions and shape that policy is very important. And the international finance head is making foreign policy, that's my argument.

Conti-Brown: From the lawyer's perspective, I feel even more confident as a lawyer myself because the Fed has this legal authority but not only is just breathtakingly broad, but with respect to every aspect of monetary policy defining the Fed's legal authority around monetary policy, there's no judicial check.

Conti-Brown: So unlike other agencies of government that can be sued and have their policies reviewed, as I mentioned, as I go into great detail in the book, this is the part that I think is most tedious for the non-lawyers to read because it's just to get into the weeds a little bit.

Conti-Brown: But the courts have kind of carved out exceptions where there they've said we're not going to tread into the judicial review of monetary policy. And so that gives the lawyer interpreting the scope of the Fed's legal authority so much more power and so little accountability. Indeed, I have submitted FOIA requests to get those legal memoranda, those legal analysis on contentious questions. And they get denied every single time. And so not only can we not have a court checking the work of these lawyers, we also can't even see what that work is. And that to me is very troubling.

Beckworth: Yup. Okay. Let's quickly address the issue with the regional bank presidents. You see it as unconstitutional. Why and what would you do about it?

Conti-Brown: So I've loved that we've spent an hour talking about my book without talking about this issue because it's very often the thing that people grab onto very first because anytime you throw out the epithet that something about the Fed is unconstitutional, then that's flies to the honey. But I do think there are constitutional problems here. And what are they? And I want to be very specific about what it is. This has nothing to do with the constitutional argument that Thomas Jefferson and Alexander Hamilton were having about the status of the bank of the United States. It has to do with whether those who engage in Federal policy as officers of principle officers of the United States can do so outside of the constitutional structure of presidential appointment with Senate confirmation. And it depends on the kind of power they're exercising.

Conti-Brown: Not everyone who's identified in statute and giving any kind of authority and by statute has to be appointed by the president, confirmed by the Senate. But what the Federal open market committee does is make some of the most important decisions that affect all of us. And the logic of having banker, essentially private bankers, they're not themselves private bankers that are appointed in large part by their private sector boards. The logic of their participation at the Federal open market committee was barely present in 1913 when this compromise was struck and it no longer obtains in 2016. So having a 19 person board, 12 of whom with votes at any given time making our monetary policy seems to me to be suboptimal for a number of reasons. Number one, it gives the illusion of geographic diversity when in fact we only have one person representing all of the United States West of Dallas and two people representing the state of Missouri, right?

Conti-Brown: This isn't geographic diversity and it gives the illusion of independence and independence minded technical expertise. When these people weren't appointed by a community of central bankers or a community of economists or whoever it would be that we would associate most closely with technical independent minded expertise. They're appointed by their private sector boards. And again, there might be advantages to this and I identify many of those advantages. I think there are advantages to this, but the costs are pretty extraordinary.

Conti-Brown: And the main cost I see is that unlike other conspiracy theories about the Fed that start to be very antisemitic in nature, for example, those conspiracy theories, you can just dismiss out of hand. They're stupid. They're coming from this kind of a fevered mind about central banks. They're not worthy of discussion. But when people say, oh, the central bank is owned by walls and central bankers at the Fed answer to private banks, there's actually not just a nugget of truth in that or a kernel of truth. There's a whole Cobb of truth in that argument. And I'm just not convinced that that kind of quasi private governance model for such highly sensitive policy decisions is appropriate. And I also think that it's rather plainly unconstitutional as if... By that word unconstitutional, we mean how does it square against not only the constitution, but also the way that the constitution has been interpreted by the Supreme Court. And those opinions by the Supreme Court make pretty clear that this governance structure just doesn't pass muster.

Beckworth: So what would you do?

Conti-Brown: I would keep the Federal reserve banks, I would even keep them in the policy discussion. I would just make it so that they did not get appointed to their positions by the private sector and instead they would be appointed by their position. I think overly politicizing the Fed is not a good idea. So I would not give that authority back to the president and the Senate. I would just make them very plain lay. What I think already happened in 1935, 90% of the way there. I would just make it clear that they are subservient to the more politically accountable board of governors. So I would give the board the authority to appoint or remove the Federal reserve bank presidents as the board sees fit without the private sector applying the outset. Well, it plays to that.

Beckworth: Very interesting. I will note in closing, you make your incredible observation that the regional bank presidents really have been having more say on the FMC because there have been these open positions of board of governors and all 12 of them even though they didn't all vote. They're all there. Their voices are heard. They vote regularly. There's this really been this proportionate, balanced way to toward them at FMC, under president Obama.

Beckworth: Well, on that note, we have to end our guest today has been Peter Conti-Brown. Peter, thank you for being on the show.

Conti-Brown: It was such a pleasure. Thank you for having me.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.