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September 20, 1996
The credit markets drifted into paralysis this week, waiting for Tuesday's Fed meeting.
The drift went the wrong way, giving up half of last week's gains, and mortgages settled near 8.50% at "zero and zero" prices. Stronger economic data were the proximate cause of the damage: industrial production rose .5%, the trade deficit posted a big surprise, and housing starts rose to their highest level since March '94.
Seven of the twelve seats on the Fed's Open Market Committee (the "FOMC") are filled by Presidential appointees confirmed by Congress, including the chairman. The other six are occupied on a rotating basis by the presidents of the twelve regional Federal Reserve banks.
The regional presidents are nominated by commercial banks -- the dreaded private sector -- and not confirmed by Congress, which gets conspiracy theorists and Democrats all in a lather. The regional banks have also gotten the Fed into an unusual, public split.
Eight of the twelve banks have made a formal demand that the Fed raise rates by .50%. In the kabuki dance of central banking, the regional banks always "request" that the Fed take its action (about the way the Queen "asks" an election-winner to form a government), and the chairman always complies with the request.
This time, it seems that Mr. Greenspan stands opposed.
Why? The chairman has made his academic case all year long: a strong economy does not present inflation danger so long as there are corresponding gains in productivity, and he believes that there are.
However, there is another reason for him to override a regional majority: the election. Contrary to the favorite conspiracy theory, the Fed would never take or withhold necessary action to advance the interests of a particular candidate. However, the Fed does have one priority higher than its duty to manage markets and the economy: it must preserve its own independence and power.
All chairmen believe that if the Fed were to lose its independence, it would then lose its ability to manage the economy. In this Harding-Coolidge election, the worst possible event for Mr. Greenspan would be to raise rates, and thereby invite a debate about the independence and power of the Fed. Some candidates could be trusted to do so, but not these.
If the desperate one takes a shot at the Fed, the other, of limited conviction in all things (though he has had the wit to leave the Fed alone for four years) will be tempted to out-bash the other.
Good economic policy or not, the chairman isn't about to give these gentlemen an opportunity to one-up each other at the expense of the Fed.
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