Controversy Stretches Back Decades
Since the Federal Reserve Act of 1913 created the Fed, scholars have argued the Fed itself as an entity is unconstitutional. Texas Republican Rep. Ron Paul and his newly elected son Rand have made similar arguments.
FOX Business' top legal analyst, Judge Andrew Napolitano, notes that “the Supreme Court has never ruled on the constitutionality of the Federal Reserve, believe it or not. But the lower federal courts that have addressed the issue have found it to be constitutional by employing the argument that Congress can enter into a contract with private entities to perform governmental services; and that is what it has done with the private bankers who own and operate and profit greatly from the Fed.”
Fox Business news director Ray Hennessey notes that in 1952, Rep. John Wright Patman of Texas, who was head of what was then called the House Committee on Banking and Currency, crystallized the argument, saying, “In the United States we have, in effect, two governments. We have the duly constituted Government. Then we have an independent, uncontrolled and uncoordinated government in the Federal Reserve System, operating the money powers which are reserved to Congress by the Constitution."
The U.S. central bank grudgingly bought U.S. debt during the Great Depression under pressure from Congress to battle deflation—a playbook Bernanke is following now.
Between 1926 and 1929, the Fed bought $1.7 billion in US debt, but then ramped that up from $729 million to $1.8 billion in 1933, averaging $2.4 billion in purchases every year after that until 1941.
While these moves helped lower interest costs corporate debt “and appeared to arrest the decline in prices and economic activity,” Bernanke said. “Fed officials remained ambivalent about their policy of monetary expansion. Some viewed the Depression as the necessary purging of financial excesses built up during the 1920s..slowing the economic collapse by easing monetary policy only delayed the inevitable adjustment.”
The Fed also bought U.S. debt in the 1940s to keep interest rates low after World War II, a move some economists say helped usher in the post-war economic boom.
And back in the 1970s, it was Congress that pressured the Fed into adding Fannie Mae and Freddie Mac securities to its portfolio in order to help develop the market for those mortgage-backed securities. That was unpopular with the Fed at the time too.
Bernanke Uncomfortable
Fed chairman Bernanke himself said he was nervous about such extracurricular moves by any central bank in a 1999 speech, where he discussed the Bank of Japan’s monetary easing to help fix the country’s banking collapse that led to its lost decade of the ‘90s, now two decades running.
Bernanke said that if the BOJ outright bought nonperforming bank loans, such purchases would be “correctly viewed as an end run around the authority of the legislature, and so are better left in the realm of theoretical curiosities.”
But the Fed effectively did make such a monetary gift to Fannie Mae and Freddie Mac when it bought its rotten mortgage-backed securities, notes John Hussman of Hussman Funds.
Hussman says: “It is doubtful that when Congress drafted the Federal Reserve Act to allow the use of mortgage-backed securities, it ever dreamed that the Fed would purchase these securities outright when the issuer was insolvent. Until this issue is clarified in legislation, Bernanke will continue to see it as “perfectly sensible” for the Fed to make ‘money financed gifts’ that substitute his own personal discretion for those of a democracy.”
Quantitative easing simply lets the Fed to not just buy Treasuries, but also other assets that may not be allowed by the Constitution, Hussman says.
“Creating government liabilities to acquire goods and assets, unless those assets are other government liabilities, is fiscal policy, pure and simple” and “that fiscal authority is enumerated by the Constitution as the sole right of Congress,” Hussman notes.
And “nowhere in the Federal Reserve Act did Congress provide authority for the Fed to create subsidiary corporate entities as it did with the Maiden Lane vehicles,” to take on rotten assets from Bear Stearns and AIG, says Chad Emerson of the William & Mary Business Law Review. “The Fed cannot simply establish off-the-books shadow companies to avoid its restrictions under the Act. The legislative power of Congress cannot be circumvented by merely creating a LLC.”
When Bernanke Acted
Bernanke first raised the idea of purchasing Treasuries in a Dec. 1, 2008 speech, which the Federal Open Market Committee later reaffirmed in a statement on Jan. 28, 2009. But when the Bank of England later that year succeeded in dropping long-term rates by buying U.K. gilts, that’s when the Fed took notice. The 10-year gilt yield slid to the lowest level in at least 20 years after the BOE’s purchases began.
But Great Britain became abstemious with its deficit spending. The U.S. has not.