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Federal Reserve Grabs New Powers

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While inflation hawks understandably keep a close watch on the Federal Reserve’s money-creation activities, an equally worrisome Fed activity is taking place right under their noses. Under cover of addressing the financial crisis and recession, the Fed has become the central allocator of credit.

As San Jose State University economics professor Jeffrey Rogers Hummel points out in The Independent Review (Spring 2011), Fed chairman Ben Bernanke “has so expanded the Fed’s discretionary actions beyond merely controlling the money stock that it has become a gigantic, financial central planner…. [T]he Fed that emerged from the crisis is no longer the same as the Fed before the crisis.”

It is standard operating procedure (though of course illegitimate by free-market standards) for a Fed chairman to inflate the money supply supposedly to provide increased liquidity during an economic crisis. It is then left to the market (distorted, to be sure) to “allocate” the money. What’s new is that under the Bernanke Fed’s self-expanded powers, the central bank is allocating credit to chosen financial institutions, including insolvent rather than merely illiquid ones. That is apparently unprecedented in the United States.

Just as central planning of the economy in general, besides violating individual freedom, can’t serve the general interest because the planner necessarily lacks the required information, so it is with the central planning of the allocation of credit. Bernanke cannot know better than the collective intelligence of the market which firms should get capital and which shouldn’t. Creating credit out of thin air in order to allocate it according to a central plan is an assault on the market. But it is also an assault if Bernanke “merely” moves existing capital from one part of the market to another.

The first direct allocation of credit came when the New York Federal Reserve Bank set up a company called Maiden Lane, which directly bailed out Bear Stearns in March 2008. Additional similar subsidiaries were established to perform other bailouts, such as that for AIG. Bernanke also helped the Treasury carry out TARP, the multibillion-dollar Troubled Asset Relief Program. “The Fed … provided the bulk (if not all) of the money to these subsidiaries, whose other sources of funds never amounted to more than a few billion dollars,” Hummel writes.

Hummel quotes economic historian Michael Bordo, who warned that such powers “exposed the Fed to the temptation to politicize its selection of recipients of its credit.”

Who got the money? Hummel says it primarily went to depository institutions, the U.S. Treasury, federal agencies such as the mortgage guarantors Fannie Mae and Freddie Mac, and finally, holders of mortgage-backed securities, the instruments that contributed so much to the housing and financial bust. It was the first time the Fed bought that kind of securities.

As late as last year, the Fed was devising new ways to borrow and allocate credit by setting up various “term deposit” facilities.

Bernanke has been dubbed “Helicopter Ben” because of his so-called quantitative easing, which people assume distributes fiat money evenly across the economy, as if from a helicopter. But for Hummel, “A better moniker would therefore be ‘Bailout Ben.’” He adds, “Helicopter Ben talks a good line about being ready to unleash quantitative easing, but this talk only imparts an aura of justification for the Fed’s incredibly expanded role in allocating the country’s scarce supply of savings.”

One can hardly overstate the extent to which Bernanke’s new powers move the U.S. economy further down the road to corporate statism. In his 1936 General Theory, John Maynard Keynes called for “a somewhat comprehensive socialisation of investment” as the “only means” of driving the interest rate on capital to zero and to secure full employment. I doubt that’s Bernanke’s precise intention, but in a society that calls itself free, no one should have such power. A free economy leaves savings and investment to the uncoerced choices of individuals, just as it leaves money and banking to the market.

Bernanke, an admirer of Franklin Roosevelt and his experimental response to the Great Depression, promises to give up his new extraordinary powers once the economy is well. But those words are small comfort to anyone familiar with the dynamics of government.

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    Sheldon Richman is vice president of The Future of Freedom Foundation and editor of FFF's monthly journal, Future of Freedom. For 15 years he was editor of The Freeman, published by the Foundation for Economic Education in Irvington, New York. He is the author of FFF's award-winning book Separating School & State: How to Liberate America's Families; Your Money or Your Life: Why We Must Abolish the Income Tax; and Tethered Citizens: Time to Repeal the Welfare State. Calling for the abolition, not the reform, of public schooling. Separating School & State has become a landmark book in both libertarian and educational circles. In his column in the Financial Times, Michael Prowse wrote: "I recommend a subversive tract, Separating School & State by Sheldon Richman of the Cato Institute, a Washington think tank... . I also think that Mr. Richman is right to fear that state education undermines personal responsibility..." Sheldon's articles on economic policy, education, civil liberties, American history, foreign policy, and the Middle East have appeared in the Washington Post, Wall Street Journal, American Scholar, Chicago Tribune, USA Today, Washington Times, The American Conservative, Insight, Cato Policy Report, Journal of Economic Development, The Freeman, The World & I, Reason, Washington Report on Middle East Affairs, Middle East Policy, Liberty magazine, and other publications. He is a contributor to the The Concise Encyclopedia of Economics. A former newspaper reporter and senior editor at the Cato Institute and the Institute for Humane Studies, Sheldon is a graduate of Temple University in Philadelphia. He blogs at Free Association. Send him e-mail.