Central Banks: the difficult balance between transparency and flexibility
What’s at stake
Over the past few months, the Fed has been required to release information about its emergency lending programs and discount window lending as a result of the Dodd-Frank Act and a Supreme Court appeal. This disclosure and the limits – introduced by the Dodd-Frank Act – on the Fed authority to use Section 13(3) of the Federal Reserve Act to extend credit to nonbank and private parties in “unusual and exigent circumstances" illustrate the difficulty of finding the right balance between the right of the public to know what the Fed is doing and the need for policy discretion. In a desire to regain credibility from the public and reduce the Fed bashing rage on Capitol Hill, the Fed announced last Thursday that its Chairman will hold four press conferences per year beginning on April 27 of this year “to provide additional context for the FOMC’s policy decisions.”
Discount lending between August 2007 and March 2010
The Fed released Thursday some 25,000 documents laying out just who tapped the Fed’s oldest and broadest emergency overnight facility between August 2007 and March 2010 after losing its Supreme Court appeal against a Freedom of Information lawsuit from Bloomberg (click here to read the original FOIA request).
FT Money Supply has started to dig in the pile of documents published and finds that the biggest day for the discount window was October 29 2008 when lending stood at $110bn. There is no big surprise in the names of the institutions but the concentration was unexpected. Questions will be asked about why Dexia and Depfa needed so much from the Fed rather than the ECB. That 74 per cent of the loans were to foreign banks will not win the Fed any friends in Congress.
Binyamin Appelbaum argues that the long list of banks that lined up at the window, which the Fed provided in the form of a daily loan register, shows a crisis stretching far beyond Wall Street. The discount window was unique because it was open to smaller banks, too. The discount window, which predates the crisis by almost a century, was created to help commercial banks weather cash squeezes.
The new NY Fed blog Liberty Street Economics has a timely post explaining why central banks have discount windows. It notes that the Fed has historically published the total amount of borrowing from the discount window on a weekly basis, but not information on individual loans. By allowing banks to borrow confidentially, this policy aims to make healthy institutions more willing to use the discount window during periods of market stress. It should be emphasized that confidentiality is not meant to protect the identities of individual banks per se, but rather to make the discount window more effective in dealing with market disturbances.
Dodd Frank and previous disclosure requirements
The financial reform law required that emergency measures be disclosed with a degree of transparency unheard of for the central bank.
Liberty Street Economics explains that under the Dodd-Frank Act the Fed will disclose counterparties and information about amounts, terms and conditions of discount window lending on an on-going basis with about a two-year time delay. It is expected that this time delay should help to mitigate any stigma that an immediate release of that information might convey.
On December 1, 2010, the Fed posted detailed information about entities that received loans or other financial assistance under a Section 13(3) credit facility between December 1, 2007, and July 21, 2010, and about persons or entities that participated in the agency MBS purchase program, used foreign currency liquidity swap lines, or borrowed through the TAF during that time frame. The Dodd-Frank Act also established a framework for the delayed disclosure of information on entities that, after July 21, 2010, received a loan from the discount window under Section 10B of the Federal Reserve Act or from a Section 13(3) facility, or participated in OMO transactions.
Pressure also on ECB for more disclosure
The Fed has not been the only central bank under pressure for disclosing more informationabout its emergency lending operations. Shahin Vallee, for example, argued a year ago that the ECB formalized actionable agreements for proper FX swap lines with the National Bank of Hungary and the National Bank of Poland in October 2009, but never made them public. When FT Alphaville asked the European central bank about the swap lines, a spokeswoman simply said: ‘no comment’. A reporter then asked about these arrangements at Jean-Claude Trichet’s press conference whose answer was “it is up to them to say what they want about the nature of our close relationship — which is very intimate.”
Dodd Frank and limitation of the Fed’s authority to extend emergency credit
The financial reform law puts also new limits on what the Fed can do under "unusual and exigent circumstances".
Skadden points that the Dodd-Frank Act amendments of Section 13(3) of the Federal Reserve Act– which provides authority to the Board of Governors to extend credit to nonbank, private parties in “unusual and exigent circumstances – represents a significant restriction on the prior authority that the Board of Governors used in the autumn of 2008. Going forward, any emergency lending programs and facilities authorized by the Federal Reserve under Section 13(3) of the Federal Reserve Act must have broad-based eligibility, and must be approved by the Secretary of the Treasury.
Heather Landy reports that it means no more Fed backstops for companies that agree to rescue-style acquisitions, such as JPMorgan Chase & Co.'s purchase of Bear Stearns & Co., no more bailoutsa la AIG and no more guarantees that the banks on the other side of trades with big, troubled firms will be made whole.
New quarterly press conferences
The Federal Reserve announced last Thursday that Chairman Ben Bernanke would hold four press conferences per year beginning on April 27 of this year.
The decision to hold press conferences continues a series of steps the Fed has taken over the last several decades toward more openness, as illustrated by this timeline of previous efforts to improve transparency compiled by Real Time Economics. In 1975, the Fed started to present testimony twice each year to Congress on the conduct of monetary policy. In 1979, the FOMC released its first semiannual economic projections. In 1983, the Fed published the first “Beige Book,” which summarizes economic conditions in each Federal Reserve District. In 1994, the FOMC began to release a statement disclosing changes in the federal funds rate target. In 2000: The FOMC began releasing a statement after every meeting and started to include an assessment of the balance of risks to achieving its objectives. In 2002, the results of the FOMC roll-call vote were added to the post-meeting statement. In 2004, the FOMC speeded up the release of its minutes: Now there is only a three-week lag, instead of waiting until after the next regularly scheduled meeting, which meant a lag of about six weeks. In 2007, the FOMC decided to release its economic projections four times a year.
Mark Thoma notes that unlike the changes in the 1970s and 1990s, the main motivation for making this particular move is that the Fed has lost credibility with the public during the crisis. The Fed’s initial move toward openness came in the 1975. The Fed had taken considerable and justifiable criticism over its response to the oil price shocks and other problems of the early 1970s that caused inflation to increase to levels far beyond what was tolerable at the time. In response, Congress asserted its oversight responsibility and authority by requiring the Chair of the Fed to present testimony before Congress twice each year explaining its monetary policy decisions. Unlike the change in 1975 that was mandated by Congress, the changes in the 1990s were motivated mainly by theoretical models in monetary economics that showed that the more information people have about the intentions of policymakers, the better the policy outcome. The Fed understands the difficult trade-offs it will face in the near future as the economy recovers. Its decision to hold press conferences is an attempt to provide additional clarity on policy and thereby protect itself from further damage.
Clive Crook argues that central banking under US conditions is not an easy subject to explain. Preserving the Fed’s anomalous but necessary freedom of macroeconomic action will be quite a test. A constitutional purist, even one persuaded of the case for central bank independence, would say that the Fed exceeded its proper role. A pragmatist would say, thank heaven it did. The biggest evasion by far was to have the Fed bail out financial institutions by taking immense quantities of questionably collateralized debt on to its balance sheet. That was fiscal policy, not “lender of last resort”. One problem for a more open Fed is that it cannot be entirely frank about what just happened. The truth is, it bent the rules. Another is that it runs the risk of being drawn further into US politics, a hazardous place for it to be. It is therefore not clear if a more prominent public voice will make this easier, or more difficult. It depends on how persuasive the chairman proves to be. If you engage the public’s attention, you had better engage its support.
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