The Fed and Rick Scott
Senator Rick Scott has attacked the Fed. Reader can decide — truth, fiction, or political hyperbole? We supply relevant facts.
Happy Birthday America, where freedom of speech is still allowed (we hope).
In a message sent to Florida residents over last weekend, Senator Rick Scott attacked the Federal Reserve and asserted that “Under Jay Powell's gross mismanagement, the Federal Reserve is riddled with fraud, waste, and abuse, all at the expense of American taxpayers.” He supported his claims with misleading errors in the data and evidence cited and argued for his proposed bill to enhance Congressional oversight of the Federal Reserve. His claims are so egregiously wrong that they warrant examination. Scott is miseducating Florida voters with regard to what the Fed does in an attempt to undermine its independence.
Scott has introduced legislation, which every senator can do. He wants Congress to curb the Fed’s independence and authority. He is not alone. President Trump would very much like to help Jerome Powell steer monetary policy. The Wall Street Journal offers a primer on the evolving relationship between the Fed and the executive branch, and on the question of whether a president can fire a Fed chair. Interested readers may want to spend six minutes watching:
“Can President Trump Fire Fed Chair Jerome Powell?” | WSJ,
Using congressional legislation to exert greater authority over Fed policy is a second option for an administration that would like to see lower interest rates despite the risk of higher inflation.
Is Scott’s bill justified? Readers must judge that for themselves. But he has posted falsehoods, and Fed analyst Bob Eisenbeis and I team up this morning to correct the record, so that we can all base our opinions of Scott’s bill on facts and not misrepresentations. Bob has had a distinguished Fed career and served under five Fed chairs. He served as chief monetary economist at Cumberland Advisors until his recent retirement. Bob and I have been members and colleagues in the National Business Economics Issues Council (NBEIC) for decades.
We will append a link to Scott’s piece at the end of this commentary, and readers may evaluate it for themselves. But first, let’s sort some facts.
Scott alleges waste, fraud and abuse based upon evidence that the Fed has accrued over $1 trillion in portfolio losses while giving the staff raises. Let’s start with the question of pay raises. No, the Federal Reserve Board of Governors did not give themselves massive pay raises. Congress sets the salaries of the Board Chairman and other Board members. Board members are considered government employees, and their salaries are set according to federal government’s pay scale for executive branch positions.
The portfolio losses Scott points to are not, in fact, operating losses. The Federal Reserve (Fed) did report significant unrealized book value losses on its portfolio from 2022–2024. These flow from emergency lending and the expansion of the Fed’s portfolio of assets as it responded first to the financial crisis in 2008 and later to the COVID pandemic. The portfolio increased from about $800 billion before the 2008 crisis to slightly less than $9 trillion. The declines in portfolio value are due primarily to the increase in interest rates in 2022–2023, which decreased the market value of the Fed's bond portfolio. However, those valuations did not reflect actual losses. These are not operating losses; and as the NY Fed reports, they had no impact on Fed reported earnings nor on remittances to the Treasury. Scott overlooks the fact that the Fed also has unrealized gains in its portfolio, reflecting its gold holdings of over $480 billion. While these unrealized losses Scott points to do represent a substantial decline in the value of the Fed's assets, they will not result in a loss if securities are held to maturity and not sold.
Scott rants about the size of the Fed’s balance sheet, but he ignores the fact that the Fed’s balance sheet is its current size because of the Fed’s responses to the financial crisis in 2008 and its subsequent responses to the COVID pandemic. The balance sheet response in the form of quantitative easing was a policy attempt to avoid a collapse of the economy, and it worked to prevent two serious crises from becoming financial system catastrophes. He also ignores the fact that the Fed has been in the process of reducing its balance sheet through a selective runoff of Treasury securities and MBS over the last two or three years.
Scott rants against the payment of interest to banks, but those payments are a tool of both monetary policy and financial stability. The rate on bank reserves is a tool that permits the Fed to lower the incentive of banks to create money in the form of new bank loans, thereby serving as a complementary tool to the Fed’s target federal funds rate. Again, Scott implies that this is a gift to banks rather than a policy tool. The Fed has reported operating losses for 2023 and 2024 amounting to $117.2 billion and $74.7 billion, but these are not due to mismanagement but rather to the fact that interest paid on reserves to member banks and its reverse repo operations (a financial crisis program) exceeded revenue on existing government securities holdings. In 2008 the Fed gained authority to pay interest on bank reserves as an additional tool for monetary policy to fight inflation as the Fed expanded its balance sheet by creating emergency lending facilities. This policy had long been advocated by Nobel Prize winner Milton Friedman as an important policy tool.
Scott says that the Board does not have an independent inspector general and needs better oversight, but he ignores the fact that the Fed is a creature of Congress and is already subject to oversight. The Fed Chairman testifies twice a year before the Senate and House. In truth, the Board’s inspector general reports to both the Board of Governors and the director of the CFPB and has an independent reporting responsibility to Congress. Specifically, the inspector general must keep the Board, the CFPB, and Congress informed about any significant issues related to the administration of programs and operations of the agencies, any recommendations to address those issues, and the progress made by the agencies in implementing corrective action. The Board’s inspector general must also issue a semiannual report to Congress summarizing the Fed’s activities every six months. It is also clear that the Fed does consider the impacts of its actions on families (see https://www.federalreserve.gov/aboutthefed/fedexplained/monetary-policy.htm).
As an example of the Fed’s failure to provide oversight of bank safety, Rick Scott lists six banks that have failed. But the list fails to note that only two of the six – Heartland Tri-State Bank and Silicon Valley Bank – involved Fed oversight of banks, and a third was a national bank (subject to oversight by the OCC) and a subsidiary of a bank holding company (subject to Fed jurisdiction). Three of the listed banks – First Republic Bank, Signature Bank, and Republic First Bank – were the responsibility of state regulators and the FDIC.
Note that Scott provides no evidence to substantiate a claim of fraud or abuse.
Our take: Please note that the Fed doesn’t defend itself. It confines itself to explaining policy and fulfilling its statutory obligations. Our system allows for politicians to say whatever they wish, whenever they wish, in any form they wish. And they do. The Fed speakers use a formal setting (congressional testimony, speeches, research papers). Thus, there is an asymmetry. Critics that have unlimited free speech with ability to distort facts have legal permission to shoot arrows. Those critics don’t have “blackout periods.” Many folks in the world of finance and economics ignore their ongoing barks and barbs. And some will speak out to support the independence of the central bank. We are in that camp.
Powell’s critics want him to lead the Fed into an easing of policy action based on the critics’ estimates about tomorrow. The Powell Fed says that the FOMC wants to wait because of uncertainty about various factors, including the impacts of tariff policy. They want a low interest rate because it will reduce the deficit, and they don’t consider the funds rate as a policy tool to achieve the Fed’s statutory objectives. We agree with the Powell Fed. The tariff policy is an unknown as this is written.
Line up 100 economists, and you will get 101 different estimates about what is coming. We have ours, and it suggests that a business slowdown is already starting and that tariff policy as we know it will induce stagflation characteristics. To what extent? We don’t know. Inflation changes? We don’t know. Unemployment increase? We don’t know. One-time shift or an ongoing trend? We don’t know. And, in our opinion, nobody else knows either. Reason? As far as we can tell, the makers of the Trump 2.0 tariff policy don’t know. And they are constantly changing the rules of engagement. So, if the policymakers of the biggest tariff disruption in almost a century don’t know what the final scenario will look like, how can anyone expect the Fed to know and to act on a presumption or a forecast or a multi-scenario probability expectation?
Add to that the unknowns about the currency (US dollar) and the budget/deficit (an unresolved debate), and the uncertainty gets worse.
So, what’s the Fed to do?
Here’s our view:
Don’t make things worse with any surprise action.
Maintain a positive real interest rate, as the Fed is presently doing, until incoming data suggest that a different policy is needed. We see no reason for the Fed to move away from a 2.0% annual inflation rate target on the PCE. Two percent doubles inflation every 39 years. Just a half percent more — 2.5% annual inflation — doubles inflation in 31.5 years — 7.5 years earlier. Furthermore, 2.0% is consistent with what other central banks are targeting.
Maintain financial stability in the banking system and keep actively focused on worldwide stability in the global payments system involving the US dollar as the primary global reserve currency. Note the Fed is not responsible for the foreign-exchange-rate pricing of the dollar. That is the purview of the US Treasury, not the central bank. But a positive real rate that is maintained as a steady pattern helps the dollar to remain central to world finance when there are so many forces trying to undermine it.
For those detractors throwing barbs at the Fed, you are free to do so. Sometimes the Fed gets it wrong. But if you are honorable, you will also say that the Fed has to make each decision in real time and with incomplete information and that critics are free to say whatever they wish, but they do so after the fact. Monday morning quarterbacking is what that’s called.
We have provided a link to Scott’s hit piece for readers who would like to see his email blast to Floridians in PDF format. Readers can decide for themselves.
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