Federal Reserve…policy.

Interesting developments are afoot with regards to Federal Reserve policy;

From the Financial Times,

Fed looks to extend debate on liquidity
By Krishna Guha in Washington

Federal Reserve policymakers will discuss paying interest on bank reserves in a closed door meeting on Wednesday. Such a move could in theory allow the Fed to expand its liquidity support operations without limit.

The discussion will take place alongside the Fed’s regular meeting on monetary policy, at which officials are expected to agree to cut rates another quarter point (25 basis points) to 2 per cent and hint at a possible pause in June.

Under a law passed in 2006, the US central bank will gain the authority to pay interest on reserves in 2011.

The meeting on Wednesday is based on that timeframe and will not be followed by any announcements.

However, the meeting could spark an internal debate as to whether the Fed should consider asking Congress to bring forward this authority to help it deal with the current credit crisis.

Many experts think that would be a good idea. Vincent Reinhart, former chief monetary economist at the Fed, said paying interest on reserves would allow the Fed to “expand their liabilities to support more asset purchases”.

A number of other central banks already have the authority to pay interest on reserves, as well as the authority to lend banks money.

In normal times they can use these deposit and lending rates to put a corridor around the main policy rate, and prevent it from being buffeted too far away from the level they aim to set.

But at times of financial market stress, the ability to pay interest on reserves takes on added significance. Currently, the Fed cannot expand or contract its balance sheet without altering the overall supply of reserves and changing its main policy rate, the Fed funds rate.

All it can do is change the composition of its balance sheet – absorbing more duration risk, liquidity risk or credit risk from the private sector.

But if the Fed was able to pay interest on deposits, it could use that rate to put a floor under the Fed funds rate.

That would free the US central bank to conduct liquidity operations that were larger than the size of its current balance sheet – roughly $800bn.

“The point…would be to allow the Fed to expand its balance sheet without having to drive the fed funds rate to zero in the process,” said Goldman Sachs.

 

Legislation for The Federal Reserve

WASHINGTON (Reuters) - The U.S. Treasury Department will propose on Monday that the Federal Reserve be given sweeping new powers that would make it chief regulator with authority to require actions to ensure market stability.

An executive summary of the proposals published by the New York Times, which Treasury Secretary Henry Paulson will make public on Monday when he unveils a blueprint for regulatory overhaul, says it is vital to fix “regulatory gaps and redundancies” exposed by an ongoing subprime mortgage crisis.

Lax regulation has been widely blamed for permitting a flood of inadequately documented loans to be made during the boom years of a U.S. housing market that has since soured and now threatens to drag the economy into a deep recession.

The proposals say a “market stability regulator” is needed and the Fed best fits that role, suggesting the central bank could use its control over interest rates as well as its ability to provide market liquidity to fulfill its functions.

It proposes that the Fed be given broad authority to require information from all participants in financial markets and a right to collaborate with other regulators in writing the rules that companies and institutions must follow.

NEW FED POWERS

If the Fed finds that the actions of some market participants pose risks for the overall financial system or the economy, “the Federal Reserve should have authority to require corrective action to address current risks or to constrain future risk-taking,” the summary said.

Among other recommendations, Treasury suggests merging the Securities and Exchange Commission, the U.S. markets watchdog, with the Commodity Futures Trading Commission that oversees the activities of the futures market.

It also recommends getting rid of a Depression-era charter for thrifts that was intended to make it easier to obtain mortgage loans, saying it is no longer necessary. That would mean closing up the Office of Thrift Supervision and transferring its duties to the Office of the Comptroller of the Currency that oversees national banks.

It urges setting up a “Mortgage Origination Commission” made up of regulatory agency representatives that would be able to set licensing standards for mortgage brokers.

Brokers were blamed for steering many Americans into mortgage loans that carried low initial “teaser” rates that lasted only a few years before resetting at higher levels with consequently costlier monthly payments.

New York Democratic Sen. Charles Schumer, who chairs the congressional Joint Economic Committee, said in a statement on Friday night that Paulson was “on the money when he calls for a more unified regulatory structure.”

Fed Chairman Ben Bernanke is scheduled to testify next Wednesday about the economy’s condition and will face questioning about the U.S. central bank’s willingness to step up as a super-regulator.

Treasury said it has been working on its proposals since March last year, well before calls for an overhaul began to intensify in the wake of the subprime mortgage crisis that began to wreak havoc last summer on financial markets.

Paulson had signaled some of the direction the proposals would take earlier this week when he said that since the Fed had taken the exceptional step of permitting investment banks access to its discount window for loans — the first time it has done so for any financial entities besides commercial banks since the 1930s — it should have some authority over the investment banks.

ACCESS BRINGS RULES

“Certainly any regular access to the discount window should involve the same type of regulation and supervision,” he said in a speech to the U.S. Chamber of Commerce.

Another proposal would provide an option for insurance companies to obtain a charter to do business under federal regulation, though it says the current state-based system would continue for any that did not get a federal charter.

Most of the financial services industry in the United States is regulated by federal authorities except insurance, which the states supervise. For years, big insurance companies, however, have been calling for an optional federal charter.

The chairman of the House Financial Services Committee, Democratic Rep. Barney Frank, last week said Congress should seriously consider giving a federal agency the power to monitor all risk in the financial system and act when necessary, regardless of its corporate form.

Frank suggested one possibility would be to empower the fed as “Financial Services Risk Regulator,” an idea that Treasury’s proposals appear to broadly embrace.

Many analysts and some Treasury officials have said they don’t expect recommendations made during the current administration to become law but hope it will be used a springboard for the next resident of the White House.