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Sunday, November 12, 2006

Do We Need Independent Fed-Like Committees to Reform Health Care and Retirement Policy?

This is a review of the history leading up to the creation of the Federal Reserve system followed by an idea to overcome the political stalemate preventing reform of health care and pension policy. The idea is to follow the Fed model and put the reform decisions in the hands of politically independent policy experts. Here's the the Fed history and the proposal followed by extensive comments on each:

How last century's money wars may lead to healthcare, pension reform, by H.W. Brands, Commentary, LA Times: Pity Ben Bernanke. As chairman of the Federal Reserve, his every utterance (or cough or sneeze) is analyzed for clues as to the future direction of interest rates. The weight of the American economy is laid on his shoulders...

But matters could be worse. Trying as Bernanke's job ... might sometimes be, it is nothing like the task his more distant predecessors faced. The modern Fed was born nearly a century ago of a grand compromise that terminated one of the longest-running and most bitter struggles in American political history: the fight over the money question.

From the 1780s until 1913, the money question roiled American public life — spawning political parties and candidates, sparking legislative fisticuffs and convention brawls, prompting boardroom conspiracies and White House scandals. It fell into two parts. What constituted money? And who controlled it? Was money gold, silver, paper currency or bank notes? Should the private sector control the money supply, the way it controlled the supply of wheat, corn and steel? Or should the public sector, which typically controlled water supplies and police services? ...

The money question ... provided the first battleground between Alexander Hamilton's Federalists and Thomas Jefferson's Republicans, with Hamilton urging creation of a federally chartered but privately controlled bank to oversee and manage the American money supply, and Jefferson opposing Hamilton's bank as unconstitutional and elitist.

Hamilton won, and Congress created the Bank of the United States; but Jefferson's heirs had their revenge when they refused to renew the bank's 20-year charter in 1811.

The War of 1812, however, convinced even the Republicans that the country needed a central bank, and a second Bank of the United States was established in 1816. This version lasted long enough to arouse the ire of Andrew Jackson, who objected to it on Jeffersonian constitutional grounds, on populist suspicion of banks and bankers generally and on a visceral distrust of Nicholas Biddle, the second bank's director.

Biddle had collaborated with Jackson's enemies in Congress and manipulated the money supply to embarrass the president. Old Hickory thereupon declared war on the bank, vetoing its recharter bill and withdrawing the federal government's deposits. The "bank war" escalated as Biddle deliberately engineered a financial panic, proving Jackson's point that money was too vital to the people's welfare to be left to the bankers. Jackson won the war — but lost the peace when the nation's financial system melted down in the panic of 1837, confirming Biddle's contention that money was too complex to be left to the politicians.

The California Gold Rush of 1849 injected a flood of yellow liquidity into the American money supply, but at the cost of driving silver out of circulation. The Gold Rush also aggravated the crisis between North and South, and after the country descended into civil war in 1861, the opposing governments — Union and Confederate — resorted to paper currency to sustain their war efforts. Union paper helped defeat the Confederacy... In the aftermath of the war, a cabal of speculators led by Jay Gould and Jim Fisk attempted to corner the gold market, bribing officials of the Grant administration and nearly wrecking the financial system in the Black Friday debacle of Sept. 24, 1869.

From then until the second decade of the 20th century, the United States suffered a series of booms and busts. The panic of 1873 burst a bubble of railroad speculation; the panic of 1893 produced a run on the Treasury's gold reserves that threatened to bankrupt the federal government. President Cleveland was forced to call in the country's arch-capitalist, J.P. Morgan, who arranged a private bailout of the public sector — and then refused to tell Congress how much money he made on the deal. Morgan was every populist's image of a bloated banker, and his performance helped persuade the Democrats (and the Populist Party, separately) to nominate William Jennings Bryan for president in 1896 on a platform pledging to return silver to circulation (thereby drastically expanding the money supply) and curb the power of the bankers.

Bryan lost to the gold-hugging William McKinley, but the money question persisted into the new century. Another panic, in 1907, required another rescue by Morgan, which triggered another congressional investigation, in which Morgan again refused to open his account books... But by this time, the Progressive tide was rising, and in 1913, Congress, determined to answer the money question once and for all, approved the Federal Reserve Act...

The act established the Federal Reserve system, which represented a compromise between the private sector and the public sector — between the demands of the bankers and holdover Hamiltonians for capitalist control of the money system, and of the Populists, Progressives and remnant Jeffersonians for democratic control. The ... Federal Reserve system was designed to be institutionally independent of both the business and the political classes.

By comparison with what went before, the Fed proved remarkably successful in managing the American money supply. The Great Depression of the 1930s was a stumble, but it was hardly the fault of the Fed alone... And from World War II to the present, the Fed has sustained steady, long-term growth while sparing the American people the financial panics that wracked the country with sunspot frequency during the 19th century.

The secret of the Federal Reserve Act ... was the willingness, born of exhaustion, of the two opposing camps to turn the money question over to a partly capitalist, partly democratic agency — and thereafter to keep their hands off. It's a model that works and that might be applied to other vexing problems. The healthcare and pension questions, for example, have defied solution in much the way the money question did during the 19th century. On healthcare and pensions, both the private and public sectors have strong interests in the outcome — so strong as to prevent, thus far, any outcome besides a muddled extension of the status quo.

Reviewing the compromise that produced the Federal Reserve, modern reformers might well find the key to similarly happy, or at any rate acceptable, solutions. ..[T]he principle of a public-private compromise, followed by insulation from both the political and corporate spheres, would allow decisions to be made that can't be made in the current setting.

Whether the resulting agencies would achieve the success of the Fed is something only time would reveal. But, at the least, Ben Bernanke would have company.

While it is true that the Fed was initially structured to balance competing interests and share power, the system has evolved into an institution with centralized rather than shared power. The intent to share power and balance competing interests is evident in the structure of the Federal Reserve system. For example, individual banks are overseen by a board of nine part-time directors. These directors come in three types, three are type A and are bankers, and three are type B and represent the business community. Legislation prohibits type B board members from being bankers. In a further attempt to make the process democratic, type A and type B directors representing banking and business interests are elected by member banks within each of the twelve Federal Reserve districts. Type C directors are appointed by the Board of governors and are intended to represent the public interest.

Thus, the districts themselves provide geographic representation that is population based, while control of the district banks balances public, banking, and business interests. Initially, the district banks functioned as twelve cooperating banks and each district had considerable control of monetary conditions within the district. It was very much a shared power arrangement. As one example of the power district banks had, each bank had full control of the discount rate for its district (the discount rate was only tool available for controlling the money supply when the Fed was formed, open-market operations were not well understood until later and there was no provision for the Federal Reserve system to control reserve requirements, another way to affect the money supply).

The shared power arrangement within the Federal Reserve system changed after the Great Depression. As noted in the article above, "The Great Depression of the 1930s was a stumble." The problem, it seemed, was the democratic nature of the system. The deliberative, democratic nature of the institution prevented it from taking quick, decisive action when it was most needed. Furthermore, the Fed did not have the tools it needed to deal with system-wide disturbances rather than problems with individual banks (the discount window is well-suited to help individual banks, but not system wide disruptions; on the other hand, open-market operations can inject reserves system-wide and are much more useful in these circumstances).

It is much like the war powers act. We want, at times, power concentrated in the hands of an individual or a small group of individuals so that should a crisis occur, we can act quickly and ask questions later. If we have to wait for the House and  Senate to debate an action, and get the president to sign off, it may be too late. Better, then, in some cases to give the power to respond, say, to a nuclear attack to one or a few (hopefully trustworthy) people. There are risks, of course, to concentrating power so narrowly, but we are often willing to take that risk when quick action is essential to avoid catastrophic outcomes.

This is what happened after the Great Depression, power was in fact concentrated. For example, banks no longer control the discount rate in their districts. They can propose a change in the discount rate at an FOMC meeting. However, the Board of Governors must approve the rate and they will only approve one rate, the rate they decide, so that while the rates are formally set in the Districts, they are essentially set by the Board of Governors. When all such changes in the concentration of power over time from the districts to the Central Bank in Washington D.C. are considered, it is clear that the Fed has evolved from a very democratic, shared power arrangement at its inception to one where it functions, for all intents an purposes, as a single bank in Washington, D.C,. with twelve branches spread across the U.S..

For this reason, I have to disagree with the author's use of the Fed as a model of a private-democratic cooperation. It hasn't functioned that way for quite some time now.

But the main question is whether the Fed's independence provides a model for health care and pension reform by removing it from the political process. For monetary policy and the money supply, I think there are good reasons to have an independent Fed making the decisions. Political manipulation of the economy is too tempting and experience leads to the conclusion that lack of independence of the central bank leads to inferior outcomes, particularly with inflation, and sudden catastrophic outcomes are not out of the question.

But there needs to be a compelling reason to take any decision out of the hands of people accountable to the electorate - I hope the recent election taught us the power of the public will as expressed through the ballot box. To give control of health care and pension policy to an independent authority, as we have monetary policy, puts policy in the hands of twelve people accountable to nobody. If we don't like what they do, we can't vote them out. They are intentionally insulated from the political process and from accountability for their actions.

Is there a compelling reason to take the decision out of the hands of politicians and give it to a small group of people with the power to implement whatever policy they see fit (within bounds - the powers are legislative, not constitutional, and can always be taken away)? I don't think so, at least not yet. We have been able to legislate large social programs in the past, the social insurance programs of the 1930s and 1960s are examples, and I believe we can do so again. It won't be easy, of course, and maybe I'm wrong and in the end it simply cannot be done in the political arena. But I'm not ready to replace the democratic process with small groups of all powerful policy experts just yet.

    Posted by on Sunday, November 12, 2006 at 02:43 AM in Economics, Health Care, Monetary Policy | Permalink  TrackBack (0)  Comments (15)

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