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Jan 27, 2010, 12.07 PM IST
For investors worried the Federal Reserve will lack the resolve to withdraw its unprecedented support to the financial system at just the right time, the world just got a little bit scarier.
The struggle to get enough Senate votes to back Ben Bernanke's nomination for a second term as Fed chairman puts an already corralled central bank under even greater pressure from lawmakers, raising fears that politics will sway Fed policy.
While few question the rate-setting Federal Open Market Committee's desire to keep inflation low and stable, some are concerned growing political encroachment into monetary affairs will weigh on policymakers' thinking.
"I believe the FOMC would try very hard, but it's almost impossible not to think about it," said Ann Owen, a former Fed economist who now teaches at Hamilton College in Clinton, New York. "What you don't want is the FOMC thinking about political repercussions of monetary policy."
The political jostling also strengthens the hand of lawmakers who would like to strip the Fed of its bank supervisory role.
Critics say the central bank opened itself up to just this sort of influence by supporting an excessively hands-off approach to regulating the nation's large banks.
Others argue that the Fed also was inviting congressional meddling when it resorted to highly unconventional policies to combat the worst financial crisis since the Great Depression. Some have construed programs such as the commitment to purchase $1.4 trillion of mortgage debt as tip-toeing into the realm of fiscal policy, since it allocates resources to a specific sector of the economy.
"I feared from the beginning that the Fed's extensive lending operations, instituted without congressional authorization, would embroil it in political disputes, such as over disclosure and who did and did not get assistance," said William Poole, former president of the St. Louis Federal Reserve Bank.
Many investors share Poole's dismay, citing the close cooperation between the U.S. Treasury and Fed in propping failing financial firms such as insurer AIG.
"The federal government and the Fed have been in bed for the past year and a half. The AIG imbroglio is evidence of that. So, I do believe that the line has been crossed, if the line ever existed in the first place," said Haag Sherman, managing director at Salient Partners in Houston, Texas.
Most recently, the political quid-pro-quo seemed to be getting more blatant.
Senate Majority Leader Harry Reid, for instance, justified his rather lukewarm support of Bernanke on the basis of assurances made by Bernanke to "redouble his efforts to ensure families can access the credit they need."
CONGRESS' POWER LOOMS
Not that anyone really expected the Fed to begin pushing rates higher in the immediate future. Indeed, a report on Monday showing the deepest ever one-month drop in existing home sales suggested the economic recovery is still too tentative for the central bank to begin its much-debated pullback of extraordinary measures.
The looming shadow of Congress is sure to make Fed officials uncomfortable at this week's two-day meeting.
"Before the Bernanke-Senate blow-up, there was a minor chance Tom Hoenig would dissent," said Michael Feroli, referring to the Kansas City Federal Reserve Bank's hawkish president. "In the current circumstances, no committee member would break ranks with an embattled chairman. We expect no dissents."
The potential erosion of the Fed's regulatory powers, while less immediate, are equally salient.
One of the biggest criticisms of the central bank is that it was either unwilling or unable to rein in loose lending in the mortgage sector. Worse, it actively encouraged the housing bubble, some analysts say, by vocally denying its existence.
The Fed argues that its supervisory function informs monetary policy by giving it a bird's eye view of the banking sector's health. Stripping away that role, officials say, would thwart the adequate conduct of monetary policy.
Yet that may be something the Fed simply has to give up in order to prevent a measure it dreads even more -- a proposal to open up its momentary decisions to direct audits, which was already approved by the US House of Representatives.
"The Fed has gotten a black eye that will take a long time to heal," said Dan Seiver, professor at San Diego State University.
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