The Fed’s New Foray Into Crony Capitalism

I’ve been teaching economics for decades, and until 2008 I taught my students that the Federal Reserve Bank (Fed) engages in monetary policy through open market operations by buying and selling government securities.  (They have other policy tools too.)  They dealt in government securities partly because their operations would alter the money supply without directly influencing specific firms or sectors of the economy.

This was so firmly accepted as the way the Fed operated that at the end of the 1990s, when the federal budget was in surplus, there was some concern that the national debt would get so low that it would interfere with the Fed’s ability to purchase government bonds through open market operations.

My classroom lectures on this subject changed in 2008, when the Fed provided $85 billion to bail out AIG.  Since then it has engaged in continual bailouts of financial firms and purchases of non-government securities.  The latest was announced today (September 13, 2012) when the Fed made an open-ended commitment to buy $40 billion in mortgage-backed securities every month as long as the economy was stagnating.

The Fed has moved from engaging in monetary policy in a way that was neutral toward various businesses and industries in the economy to one in which monetary policy is targeted toward specific firms and industries.  This current foray, specifically targeted at the housing market, is crony capitalism.

Partly, the cronies who benefit are those in real estate, and in the financial sector.  Policies like this illustrate that the “Occupy Wall Street” people have a legitimate gripe.  But also, in this case, with the stimulatory monetary policy coming so close to the presidential election, the Fed’s move certainly gives the appearance that Mr. Bernanke is doing a favor for President Obama.

Moves like this generate a risk to the Fed’s independence.  When the Fed’s monetary policy was neutral toward various businesses and sectors in the economy, it might make an argument that the Fed will work better if kept free from political control.  But when the Fed engages in special interest politics, its argument for independence is substantially weakened.  I’m sure Mr. Bernanke realizes this, but is willing to take the risk.  He knows that if President Obama is not re-elected, he will not be reappointed.

Randall G. Holcombe is Research Fellow at the Independent Institute and DeVoe Moore Professor of Economics at Florida State University. His Independent books include Housing America: Building Out of a Crisis (edited with Benjamin Powell); and Writing Off Ideas: Taxation, Foundations, and Philanthropy in America .
Full Biography and Recent Publications
Beacon Posts by Randall Holcombe | Full Biography and Publications
  • Catalyst