Incompetence Threatens Federal Reserve Independence
Presidents almost always want lower interest rates—no matter the state of the economy.
That’s why Congress, through the Banking Act of 1935, created an independent Board of Governors at the Federal Reserve.
The Supreme Court has imposed a high bar for President Trump to remove Governors, preserving central bank independence.
But what Congress giveth it can taketh away, and Americans increasingly favor radical solutions. For example, many Democrats want to pack the Supreme Court.
If the Fed doesn’t competently manage its affairs, bank regulatory responsibilities and monetary policy, it could lose its independence.
President Trump has taken aim at cost overruns for the $2.4 billion renovation of the Fed’s headquarters.
The Fed Inspector General’s report found no criminal wrongdoing, but it uncovered incompetence in the management of the project.
The Fed signed a “construction manager at risk contract” that explicitly required a price ceiling. But four years after construction began and 18 months after the Fed Board approved the final design, the Fed still hadn’t obtained a “guaranteed maximum price.”
Among the worst overruns were $694 million for mechanical, electrical and plumbing work. Those came in $500 million overestimate
Most contracts were awarded after receiving one or two bids—not the customary three.
This makes former Chairman Jerome Powell vulnerable to pressure from Trump to relinquish his board seat. That would make room for a new Governor, like the former Fed Governor Stephen Miran, selected to vote as the president likes.
The Fed’s bank regulation has been sloppy, too.
The Silicon Valley Bank collapsed in 2023 when the Fed pushed up interest rates.
It took large unrealized losses on long-dated Treasuries. Those losses would have disappeared if the securities were held to maturity, but depositors panicked and a run on the bank closed its doors.
Then Vice Chair for bank supervision Michael Barr’s investigation put most of the blame on the bank’s executives, while a second investigation at the behest of the new Vice Chair more accurately places the blame on poor regulatory supervision.
A competent bank examiner understanding the consequences of interest rate changes on bond valuations would have flagged SVB’s vulnerability.
The latter shines a harsh light on the Fed’s competence.
Barr remains a Governor and is now another potential target for pressure to resign.
From 2021 to 2025, five Fed District Bank presidents or Governors faced scandals regarding their personal investing activities.
More recently fintech lender Enova International, under pressure from 20 Democratic state attorneys general and consumer activists, ended efforts to obtain a bank charter by merging with Grasshopper Bank.
That combination would have benefited consumers by expanding the range of borrowing choices for those with low credit ratings.
Mob rule from the left shouldn’t dictate federal bank chartering and merger policies.
As law school Professor Todd Zywicki recently concluded, this is a serious warning to Federal Reserve Chairman Kevin Warsh and the Comptroller of the Currency Jonathan Gould to clarify federal regulatory standards for mergers to account for innovative fintech service providers.
Warsh has done well to strike five independent task forces to examine how the institution does business, but the focu,s is predominantly on monetary policy making and tools.
To his credit he wants a long look at the data and policy frameworks the Fed uses to combat inflation.
For good reasons, the Fed places a lot of weight on business and household expectations for inflation.
Businesses set prices in part based on how much they believe competitors will be adjusting their prices.
Households adjust purchases, such as for big-ticket durable goods, and posture in wage negotiations based on anticipated inflation.
Similarly, creditors adjust the interest rates they require to make loans and purchase bonds.
Unlike the prices, we can’t observe expectations directly.
To measure these, analysts conduct surveys—simply ask people how much inflation they expect over a given time period—and build models that apply economic theory and information about business and household behavior.
The latter include observations in bond markets such as the spreads between Treasury Inflation-Protected Securities and ordinary Treasuries. Economists like the latter because those provide a direct observation of bond investors’ sentiments.
The Fed tries to combine all these approaches into a complex Index of Common Inflation Expectations, but it has been consistently wrong.
In the wake of accelerating inflation from COVID, ICIE has remained below 2.35% and averaged 2.22%.
Whereas surveys simply asking consumers where they think prices are headed, such as those by the University of Michigan, have more accurately anticipated inflation.
We can only wonder why Warsh has not taken away his economists’ computers.
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Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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