If Jane D’Arista were President, here’s what she would do with the Fed


Story Transcript

PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Lyme, Connecticut, with Jane D’Arista. Jane used to be a House staffer working for the banking committee, then became the coordinator of the SAFER project at the PERI institute, which is a group of economists proposing financial reform. And she’s the author of this book, The Evolution of US Finance. Part one is, essentially, the origins of the Federal Reserve. Thanks for joining us.

JANE D’ARISTA, RESEARCH ASSOC., POLITICAL ECONOMY RESEARCH INSTITUTE: Thank you.

JAY: So let’s go back to the scenario we did in a previous interview. You’re now President Jane D’Arista. Whatever party it is that elected you controls both houses. What would you do with the Fed?

D’ARISTA: Well, I would recognize that the Fed operates on techniques and principles that no longer work.

JAY: Describe the Fed for us, to start with.

D’ARISTA: Okay.

JAY: A lot of people have described the Fed as a simply private institution. Others call it a private-public institution. I think a lot of people think or agree with, whichever of that is true, the Fed seems to be more concerned about bankers and the finance sector than any other people or parts of the economy. Describe what’s your take on this.

D’ARISTA: Well, the Fed was–that was the compromise in 1913. I mean, actually, Wilson won some in making it as public as it was, even then, in insisting that the board in Washington, purportedly, was the major institution and that they were public officials.

JAY: Because before that, banks–there was no central bank.

D’ARISTA: No, there was no central bank.

JAY: The banks issued their own currency and the sort of cabal of bankers essentially ran the finance sector entirely on their own.

D’ARISTA: Exactly.

JAY: And that would have been a picture of a no-Fed economy.

D’ARISTA: Exactly. And they thought they would continue it, you know, with a new central bank, that they would have the dominant voice. So the compromise was to create 12 reserve banks out across the country. In some ways, that was a compromise to benefit the farm economies, etc., the people who didn’t want Wall Street controlling it, as it had. I mean, Wall Street had been responsible for all of the problems that had emerged because of the stock market, etc. And so they wanted dispersion. They wanted the reserves of the system not to be held by private banks in New York, but to be held by another bank in a local economy that would hold those reserves.

JAY: I mean, sometimes this pre-Fed economy is kind of idyllically painted, but the truth of it is it was crash after crash.

D’ARISTA: After crash.

JAY: And a complete chaotic economy.

D’ARISTA: And in the end, of course, J. P. Morgan could not control the 1907 crash. And that’s when everybody said, you know, this won’t do; we’ve got to go forward and do something else. But the second point of having those 12 reserve banks was on the side of the bankers, who said, well, then we get to choose–we get to be on the boards of those banks, dominant members of the board, and we get to choose the presidents, and the presidents have a voice in the system. So that’s how we got this kind of quasi-public, quasi-private situation.

JAY: But the truth is, even though the president of the United States appoints the president or head of the Fed and the majority of the board, the majority of the national board, has there ever been an appointment by any president of either the head of the Fed or a board member of the Fed that the finance sector didn’t already agree with?

D’ARISTA: Yes, under Roosevelt. The appointment of Marriner Eccles of Utah was absolutely anathema to the financial sector, because his agenda, Eccles’ agenda, was to strengthen the public sector aspect of the Federal Reserve. And he did. It’s a long, complicated story, which I have told in my book, but he did manage to actually do that and make more decision-making at the level of the public sector [inaudible]

JAY: And post-World War II?

D’ARISTA: And then what happened after that, with coming into the Eisenhower administration and a whole different atmosphere about the economy and the role of the public–. And many things were being dismantled at that time–the Reconstruction Finance Corporation. You know. So, many of the Roosevelt things that were put in during the New Deal were going–rolled back. Therefore what happened was the–I would say the influence of the banking system on the Fed became much stronger at that point.

JAY: In modern times, is there either a chair–but even a single board member at the national level, or certainly at the regional levels, has there ever been one that really isn’t preapproved by the finance sector?

D’ARISTA: Well, hopefully, Mr. [Peter] Diamond, coming out of MIT, who, you know, has been recognized globally but is being blocked by the Republicans because they’re listening to the financial sector, maybe, you know, he might make it onto the board.

JAY: Okay. So let’s go back to [the] scenario. President D’Arista, you’ve decided, okay, this week we’re working on the Fed file. What do you do? How do you restructure this whole thing?

D’ARISTA: Well, as I said, we have to take into consideration that the banks have a much smaller role in the credit markets than they used to have, but they have the only role at this point, really, in monetary policy. They are the transmission belt. And as we talked earlier, I think, about the fact that it’s really the largest banks that the Fed uses for monetary policy, and then they disperse the effects of either loosening or tightening through the banking system by buying and selling in the federal funds market. But the fact is also that the banks, all of them, little ones too, took the view that reserve requirements, which is what the Fed required them to hold to back deposits, giving them out 10 percent of their demand deposits, are a tax. If you say I’ve got to have a reserve against this deposit, and the deposit is $100 but the reserve requirement is $10, I only get to lend out $90. All these other institutions can lend out a whole $100. I mean, you–someone pays a premium to an insurance company or buys a share in a mutual fund, etc., they get to use all their money. We don’t. Poor banks. The Fed said, yes, you’re quite right. And so what they wanted to do–first of all, they did cut back, at the end of the ’80s, on reserve requirements. There are no reserve requirements on savings accounts, so just demand deposits [snip] and bail out the banks, then, to take the demand deposits and sweep them at the end of the day into a mutual fund. So the amount of reserves that they were required to hold was miniscule. So we had a situation back in the ’50s in which the reserves of the banking system were 11 percent of their deposits. That was a cushion.

JAY: So if there’s a crash, they’re more likely to survive and not need public bailouts.

D’ARISTA: Exactly so. And now, as we went into this in 2007, they were down to less than 1 percent in reserves.

JAY: Well, let’s back up a step. So does President D’Arista get rid of all the banking appointees and make this a public institution with only public appointments?

D’ARISTA: In one way or another, yes, absolutely.

JAY: So you end the Fed as we know it, and you create a central bank, which essentially is all about public appointments. So you get rid of these regional banks?

D’ARISTA: Yes, either get rid of the regional banks or reduce the number, ’cause some of them, like Kansas City and–you know, some of them are just too close to one another.

JAY: But even then, according to your model, they wouldn’t be bank appointments anymore; they would be public appointments.

D’ARISTA: That’s right. And they would have committees that would reflect the business interests or the banking interests of the area. They would meet with them, and [inaudible] get their views, but they would have no voice.

JAY: So what do you make of Bernanke’s argument, and other chairs of the Fed, I’m sure, that number one, this would make the Fed too subject to political whim? Politicians that are trying to curry favor will develop policy that gets them reelected, not necessarily what’s good for the economy, even the alliance that developed between people like Ron Paul and some of the left of the Democratic Party to audit the Fed. And Bernanke doesn’t even think that the Fed should be audited because it somehow restricts their activities. So your proposal would sort of fly in the face of what Bernanke’s talking about.

D’ARISTA: Absolutely. And for this reason. The Fed has absolutely no constitutional reason to exist except with the approval of the US Congress. The Constitution says that the Congress shall coin money and regulate its value. The Congress delegated that authority to the Federal Reserve, created an agency that is an agency of the Congress, not of the administration. The problem has been that the Congress has not exercised oversight, and it should. It–and so we’re talking about operations, not who appoints.

JAY: And as we know, the majority of members of Congress who vote on these issues have received a significant amount of money from the finance sector. So even if there was congressional oversight, you have congressional oversight by members of Congress, many of whom are getting campaign contributions from the sector that also controls the Fed, or at least has the dominant say in the Fed. So you start to break this up, at least, with a more transparent public process, I suppose.

D’ARISTA: Yes, you do. And they’re–I mean, we’re already appointing the board. Why aren’t we appointing the presidents of the reserve banks or whatever regional situation we decide makes more sense in the current context? So, yes, I mean, the democratization of the Fed is a very important issue. But it’s not the only issue, and too many people really focus too much on that and not actually on the operations of the Fed. The Fed gave up reserve requirements as a tool. It allowed the banks to sweep the accounts out, not have required reserves. It allowed–and then Gramm-Leach-Bliley in 1999, the so-called “Modernization Act”, came in and said, you, the banks, asked for this, and got–we can borrow for traditional as well as special things. So they no longer–the large banks were no longer dependent on deposits. They could go in and borrow money from the other financial institutions. So that’s when we got this terrible situation going, where the financial sector borrowing from one another, investment banks borrowing as well, in the market for the repurchase agreements, took us to the brink of disaster, because, [as] I was explaining to you on another occasion, they were borrowing money, pledging assets against it, taking the money that they received to buy more assets to borrow more, and that was the pyramidal Ponzi scheme, which collapsed. And part of the problem there was they were liquefying the markets irrespective of the Federal Reserve. They were creating liquidity in this fashion themselves, but they were also becoming so interconnected with one another that if one of them went, the others were going to follow.

JAY: And this liquidity was, to a large extent, used in gambling against each other in derivatives schemes, Ponzi schemes, etc., etc., rather than into the productive sector of the economy. So is there a role for your new Fed (I don’t know what you would call it; maybe you could still call it the Federal Reserve; then you don’t have to change the name of your book) to say to the banking system, you can’t have this money if it isn’t going into the productive sector?

D’ARISTA: That is correct. In other words, the Fed has to go back to using tools which will control the supply of credit as well as the interest rate, which only influences the demand for credit and which has proved to be very weak. People will borrow even when the interest rate is high if there’s a lot of money around.

JAY: And is there also a role for the Fed to strengthen small community banks and regional banks and actually diminish how much support for the big six?

D’ARISTA: Absolutely. That too.

JAY: How would that work?

D’ARISTA: Well, first of all, I would like to completely change the balance sheet of the Fed and how it affects the financial sector. In other words, I would like to have the Fed say, we are going to go out and buy an asset from whomever, because we recognize the financial sector is a whole big thing. I’m going to buy mortgage-backed securities from a mutual fund, a money market mutual fund. They’ve got a lot of them. And they’ve got a hole in their balance sheet now. And I’m giving them a reserve which they will carry on the liability side of their balance sheet. So that reserve I give them will be equivalent to the purchase of a share by a customer. It increases their liabilities, their potential to lend [inaudible] I just took away. So they’re going to lend.

JAY: But do you not also in some way have to link it to actually then taking that and putting it out there in the productive economy? Or do you not have to also strengthen, in some way, some kind of public-option banks to do the same thing? Otherwise you wind up just–don’t you wind up with the same thing, that they now take the money and go, I mean, potentially offshore or whatever other speculative activity they might like?

D’ARISTA: That’s quite right.

JAY: You have to somehow make this link to getting into the productive sector of the economy.

D’ARISTA: You have to do that. You have to do that. And it means that you would then either change the value of that liability–we’ve given you a free liability. You have to pay a customer if he gives you a liability, but we’re giving it to you for free. We have expectations of how you’re going to use it, and we will watch your balance sheet to see that you do so. And if we don’t deal with you, then you will have no access to the Federal Reserve for liquidity.

JAY: So this changes the whole who’s our client. Right now it looks like the client of the Fed really is not the American economy; the client of the Fed is bankers and the big banks. So you change who’s the client.

D’ARISTA: Yes. That would change who is the client.

JAY: Okay. I’ll vote for you for president. Thanks for joining us.

D’ARISTA: Thank you.

JAY: And thank you for joining us on The Real News Network.

End of Transcript

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Jane D'Arista

Jane D'Arista is a research associate with the Political Economy Research Institute (PERI), University of Massachusetts, Amherst where she also co-founded an Economists' Committee for Financial Reform called SAFER (Stable, Accountable, Efficient & Fair Reform) and gave testimony to Congress on financial reform. Jane served as a staff economist for the Banking and Commerce Committees of the U.S. House of Representatives, as a principal analyst in the international division of the Congressional Budget Office. Representing Americans for Financial Reform, Jane has currently given Congressional testimony at financial services hearings. Jane has lectured at the Boston University School of Law, the University of Massachusetts at Amherst, the University of Utah and the New School University and writes and lectures internationally. Her publications include The Evolution of U.S. Finance, a two-volume history of U.S. monetary policy and financial regulation.