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The Dominance and Size of the Federal Reserve

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I wrote the following on September 11th, 2009:


For my last employer, back in 2004, since I had a big position on in the hedge funds in equity sensitive life insurers, I went to a Morgan Stanley “teach-in” on esoteric issues on reserving and required capital.  Strangely for me, I arrived first, and waited for others to show.  If you’ve ever met me, you would see me at such a time pull out my “reserve reading,” and redeem the wait time by catching up on my reading.

Well, being there first did have an advantage in greeting people.  “Who are you with?”  The answer was usually some asset management firm.  But when two particularly well-dressed fellows showed up, the answer was “The Federal Reserve.”

“Huh?” I responded.  “What interest would the Fed have in insurance reserving?”

“We follow all areas of the financial markets,” he smiled as he and his partner took a seat behind me.  Aside from the presenter that Morgan Stanley brought in, I think I was the only actuary in the room, which made for an interesting dynamic.  I tried not to ask any “inside game” questions, but poked at some of the assumptions embedded in the analyses.  The guys from the Fed were quiet as clams.  Sure beats working for a living.

Now, it wasn’t the first time I had bumped into economists from the Federal Reserve at conferences.  Half a year earlier, I bumped into some of them at a Credit Suisse conference on insurance.  Why they wasted time listening to pitches from management teams that they do not regulate was beyond me.

So, after my recent piece, Waiting for the Death of the Chicago School, and the Keynesian School also, Redux, when I read the piece Priceless: How The Federal Reserve Bought The Economics Profession, I said to myself, “I knew about that.  Why didn’t I write about that?”

The Fed hires Ph.D. economists.  Lots of them.  It gives the Fed a large contingent of intellectual defenders.  It helps them marginalize critics.  Because of their size, they have considerable sway over academic journals, and over invitations to prestigious conferences (dey got money mon).

There is a kind of paradigm a la Thomas Kuhn here, (Structure of Scientific Revolutions) where the dominant paradigm is well-supported economically, and self-interested, but it is false, and being attacked by poorly-funded nobodies who only have the truth on their side.

The Fed does not need most of the people that work for them.  They have two main functions — monetary policy and banking supervision.  They could do those tasks with 20% or less of the personnel.  Not that I want to unemploy a bunch of economists, but why should they be implicitly funded by the US government?  Why should they be doing academic studies?

Now, some will say that it is a private institution, and it can do as it wishes.  It is not a purely private institution:

  • Chairman and board members are appointed by the president and approved by the Senate.
  • Congress has an oversight role on what the Fed does.
  • Profits from the Fed flow back to the Treasury.
  • They have considerable influence over the theories of economics that are used to evaluate their performance.
  • They administer many of the major money transfer systems between institutions.
  • They are a major player in regulating the banks (or not) — if the Fed doesn’t get the other regulators to cooperate, you have a mess like we did 2003-2007.
  • They affect the value of our currency in the long run, and in the short-to-intermediate run, induce booms and busts in our economy, banks and bond markets.
  • Given the systematic risk that engenders, many suggest that the the Fed should regulate that as well.

A purely private institution should not have that level of influence across the economy as a whole.  The antitrust folks get concerned over any entity monopolizing an industry, but this is a greater monopoly still, were it purely private.

The Fed is a chameleon — it’s public when it wants to be, private when it wants to be and both or neither if that serve them well at the moment.  I support the idea of auditing the Fed, but I really think we need is a broader debate on what the Fed should do in our country, and whether the authority and size of the institution should not be reduced.


Back to the present — I used to interact frequently with the staff of a certain Congressman (not Ron Paul) active in questioning the validity of the Fed.  One of the staffers commented to me that the Fed’s size made them an incredibly effective lobbyist in dealing with all manner of issues, and with their sway over most macroeconomists, they were effectively able to silence debate on Capitol Hill aside from the “peanut gallery” — Cato Institute, American Enterprise Institute, and Heritage Foundation, who are routinely ignored.

I would only comment that the proof is in the pudding; the Fed is risking its credibility through abnormal monetary policy.  I don’t think it will come to a good end, and after that, maybe people will ask why we gave this much power to a group of unelected technocrats.

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David Merkel

David Merkel

2010-present, David is working on setting up his own equity asset management shop, tentatively called Aleph Investments. From 2008-2010, he was the Chief Economist and Director of Research of Finacorp Securities. He did many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, he was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, he was a leading commentator at the investment website His background as a life actuary has given him a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that he deals with in this blog. All of these goals rely on the help of Jesus Christ and his readers.
David Merkel

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