Busch: Throttling Back The Fed

Chairman of the U.S. House of Representatives Financial Services Committee Rep. Barney Frank said he plans legislation to restrict the Federal Reserve's emergency lending powers and subject the central bank to a "complete audit" according to Reuters . "In addition, he said the House would move to rein in the authority that allows the Fed to lend to a wide range of non-bank firms in "unusual and exigent circumstances."While I generally don't make a habit of it, I have to agree with Rep. Frank on this issue. Congress is finally waking up to the enormous power and money the Fed has at its disposal without oversight.

Ben Bernanke and the Federal Reserve expanded the use of "unusual and exigent" (Section 13(3) of the Federal Reserve Act) to the extreme to lend to almost anyone under these circumstances. It's created the impression that the Fed is not only the lender of first resort, but of any resort to do whatever it takes to stabilize the financial system. Under the law, it is a long stretch for the central bank to make these decisions. As for the argument that quick decisions have to be made when a crisis hits, I argue that the quick decision to lend to an investment bank, then to create an SIV, then to effectively tell a bank what price they should pay in a takeover is not salient in supporting rapid decision making.

But don't just take it from me. Here's what Vince Reinhart (senior Fed staffer) said at the time, "the worst policy mistake in a generation."Or Richmond Fed President Jeffrey Lacker who said it created a "moral hazard" and that markets would expect the Fed to be there anytime something bad happened.

The decisions made without following the legal structure that had been established for the central bank did something worse: it created uncertainty. To me and others, this led to a misperception that Lehman Brothers would be bailed out. When they weren't, the uncertainty led to a financial panic.

Frank said the audit and emergency lending provisions would be incorporated in broader legislation to revamp U.S. financial regulation that would likely pass the House in October. (RTRS) So far, this bill has been slow to get down as Congress has focused on health care. With the anniversary of the "Panic of 08", let's hope Congress recognizes the need to act.

________________________

v align="left">

Andrew Busch
Andrew Busch

</</p>

Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece andreach him here and you can follow him on Twitter athttp://twitter.com/abusch .