Curious Op-Ed Piece by a Board Member of Federal Reserve

Why now? Inquiring mind wants to know.

Kevin M. Warsh is a 39-year-old former VP of Morgan Stanley and a current member of the Board of Governors of the Federal Reserve. He wrote an op-ed piece for Wall Street Journal, which was posted on September 24 for September 25 publication.

It is hard to believe he is 39 years old, for he writes as enigmatically as 83-year-old Alan Greenspan speaks (or used to speak).

The Fed's Job Is Only Half Over
(Kevin M. Warsh, 9/25/09 Wall Street Journal)

"Recent media stories have chronicled in great detail the events of the last couple of years. A pair of conclusions might be fairly drawn from these early drafts of history. One is that the financial-market turmoil of the last year proved to be of significant consequence to the economy. The second is that the Federal Reserve distinguished itself from historical analogues by taking extraordinary actions to address risks to the economy. Commentators, however, tend to disagree as to whether the extraordinary actions undertaken were to the good or the detriment of the U.S. economy in the long-run."

With this not so attention-grabbing opening, he drools on about how the Federal Reserve has done a good job but that this is no time to "declare victory". And I'm thinking "OK, what is your point?"

Then, he delivers, sort of, one of the points [emphasis is mine]:

"It is unwise to prejudge the Federal Reserve's policy strategy—or to declare the victor or the vanquished—by the split time, however notable it might be. We are at a critical transition period, of still unknown duration, and we must prepare diligently for an uneven road race ahead. If policy is not implemented with skill and force and some sense of proportionality, the success of the overall endeavor could suffer."

He seems to me to be saying, in crude language, "Don't ask questions. Leave it us, or you will suffer a consequence of your meddling."

Then he mentions "policy makers". At first, I thought he means legislators. But as I read the article, I now think he means "policy makers" at the Federal Reserve, because he starts to talk in first person.

"It also means that policy makers should acknowledge the heightened costs of policy error. The stakes are high, in part, because the policy accommodation that requires timely removal as the economy rebounds is substantial. And our policy judgments will ultimately prove worthy of the accolades, and tender the ultimate rejoinder to our critics, if we rise to meet this heightened responsibility. I am confident we will."

Tender the ultimate rejoinder to our critics? (He talks like Edward IV or his brother Richard III, last king of the House of York.) Is he challenging the supporters of H.R. 1207 (audit the Fed), which is slated to be introduced in the House Financial Services Committee on September 25?

A curious part comes in the last three paragraphs:

"In this environment, market participants and policy makers alike should steer clear of ironclad policy prescriptions. Nonetheless, I would hazard the view that prudent risk management indicates that policy likely will need to begin normalization before it is obvious that it is necessary, possibly with greater force than is customary, and taking proper account of the policies being instituted by other authorities."

Is he saying that the Fed will drain the liquidity sooner and faster than it becomes necessary? Even if that could threaten the market crash and economic crash? (Maybe that's why he, in the preceding paragraphs, cites history full of unintended and unfortunate policy errors?)

""Whatever it takes" is said by some to be the maxim that marked the battle of the last year. But, it cannot be an asymmetric mantra, trotted out only during times of deep economic and financial distress, and discarded when the cycle turns. If "whatever it takes" was appropriate to arrest the panic, the refrain might turn out to be equally necessary at a stage during the recovery to ensure the Federal Reserve's institutional credibility. The asymmetric application of policy ultimately could cause the innovative policy approaches introduced in the past couple of years to lose their standing as valuable additions in the arsenal of central bankers."

This to me is the most curious remark. The Fed would do "whatever it takes" at a recovery stage "to ensure the Federal Reserve's institutional credibility". The Fed would do it, not that it is necessary or it would help the recovery, but to ensure its credibility. Also the next sentence is interesting. He seems to be saying that if the Fed doesn't do "whatever it takes" in the recovery stage, it would lose those valuable weapons - various lending programs, buying securities that are not allowed by the Fed's charter (i.e. agency bonds and MBS), owning stakes in a private business (AIG), creating SIVs (Maiden Lane LLCs), "whatever it took".

"For those of us at the Federal Reserve, the task ahead involves longer days, but, in all likelihood, fewer weekends. While the undertaking is as challenging as any we faced in the preceding period, it is exceptionally well suited to the Federal Reserve's comparative advantages of deliberation, dispassion, and a determination to make judgments based on the long-term interests of the U.S. economy."

In 1913 when the Federal Reserve System was born, one ounce of gold was US$18.92. Today, one ounce of gold is $996. US dollar's purchasing power as measured by gold has dropped 95% since the Fed came into being. And that is the long-term interest of the U.S. economy?

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