Did The Fed "Pull A Homer"?

In an early episode of The Simpsons, “Homer Defined,” Homer saves the nuclear plant from meltdown by randomly pushing a button on the control panel. Soon “to pull a Homer,” meaning to “succeed despite idiocy," becomes a popular catchphrase.

Is that what happened last week? Did Jerome Powell and the Federal Reserve inadvertently “pull a Homer” by helping to create a bank panic that actually might accelerate their desire to slow down the economy? That might not have been their intention, but it sure looks like it.

At least it does to former White House adviser and Goldman Sachs President Gary Cohn (although he didn’t reference The Simpsons).

"We're almost getting to a point right now where he's outsourcing monetary policy," Cohn told CNBC, referring to Powell. “I don't believe they [the banks] are going to loan money, or as much money, and therefore we're going to see a natural contraction in the economy.”

Minneapolis Fed president Neel Kashkari said basically the same thing on CBS’s Face the Nation Sunday.

"It definitely brings us closer [to recession]," Kashkari said. "What's unclear for us is how much of these banking stresses are leading to a widespread credit crunch. That credit crunch ... would then slow down the economy.”

Now, I sincerely doubt that the Fed deliberately phonied up a banking panic in order to put the brakes on the economy.

Just the same, though, it certainly did play a major role in creating one not just through monetary policy — by raising interest rates so high and so fast — but also through neglect.

Just as it did in the road leading up to the global financial crisis, the Fed allowed problems at several banks it regulated to reach the point that generated an electronic run on deposits and the banks’ eventual failure. 

While the details are certainly different, the current episode does harken back to the 2007 mortgage and real estate market meltdowns, which was largely due to regulators — led by the Fed — allowing banks and other lenders to approve mortgage loans for the asking without nary a hint of underwriting for years before it dawned on them to act. By then the mountain of debt had gotten so big and so combustible that the entire global economy was shaken for more than a decade.

Hopefully the current bank panic will remain just that — a panic, and not a full-blown crisis. But we really need to look at how the Fed goes about its business, and something clearly needs fixing.

The Fed is being asked to do two very important things – run monetary policy and regulate large banks — neither of which it seems capable of doing very well, unless it involves throwing massive amounts of money at problems it itself created or ignored.

The system in Canada provides a sharp contrast. There, the Bank of Canada, the country’s central bank, formulates and executes monetary policy, while the Office of the Superintendent of Financial Institutions (OSFI) regulates deposit-taking banks, insurance companies, and private pension plans, among others. Granted, OSFI has a much easier job of regulating about 400, mostly small, banks compared to thousands in the U.S., but it is very strict when it comes to regulation. When was the last time you heard of a banking crisis in Canada?

Yet some people in Washington don’t believe the Fed has enough on its plate. They want the Fed to be a major player in battling climate change and economic inequality, too.

While some of the problems at SVB, First Republic and others were certainly the result of poor management, the root problem appears to be Fed monetary policy that kept interest rates too low for too long.

The banks, like many others, loaded up on supposedly super-safe government bonds with super low interest rates that rapidly sank in value as the Fed raised interest rates. When the deposit runs began, the banks had to start selling off their bond holdings to meet massive withdrawal demands, forcing them to realize huge losses on their portfolios, triggering Fed and Treasury intervention.

While the Fed can probably be forgiven for not imagining a deposit run like this, it should have been perceptive enough to know that a problem was lurking in the banks’ bond portfolios, sitting as they were on possible massive losses if they were forced to sell them before maturity, which turned out to be the case.

“The question we were all asking ourselves over that first week was, ‘How did this happen?’” Fed Chair Jerome Powell said last week. Maybe the Fed’s bank examiners should have known.

If this whole episode does manage to get the Fed where it wants the economy to be without further raising interest rates — i.e., in recession — it certainly doesn’t put the Fed in a positive light.

We might as well have Homer Simpson run the Fed.

George Yacik
INO.com Contributor

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.