The Federal Reserve Bank Needs New Tools

When I was a little boy, I loved those books where you took a pencil and connected the dots by following the numbers until a picture took form before your eyes. Understanding economics and monetary theory is very much like connecting the dots with a pencil in those books I loved as a child.

Understanding what money is and the forms it can take, as well as understanding that like a commodity money can go up in down in value, also known as purchasing power, and, to rent money, the interest rate that is paid by the borrower can change over time.

The concept of a central bank with power over the commercial banks orbiting around it, is the stuff that makes our economy so dynamic and gives it its strength. However, we know the world is not static, as there are always new innovations that can short circuit the best systems. Our central bank, The Fed, had its sights on growing the economy and did not realize that computers and a few bright guys could create a whole new sector of finance known as structured debt obligations. Once securitization came about, it was time for The Fed to reexamine the situation and ask itself if it had the necessary tools to continue to influence the growth rate of the money supply.

Securitization of mortgages did not exist when the first tools of monetary policy were put together. The world of finance changed, but The Fed did not anticipate how that change would affect their ability to run monetary policy. Securitization, the triple-A bond rating, and a world wide market for collaterized mortgage obligations (CMOs) changed the framework under which monetary policy could be effective.

The Federal Reserve Bank needs to control the issuance of the triple-A rating as a tool to influence monetary policy. The triple-A rating, in a world of the securitization of mortgages, can not remain in the hands of the private sector. The weights and measures of finance, the credit ratings by which billion$ of dollars are underwritten, must be in the hands of the Federal Reserve Bank.

There are a lot of people that will disagree with my opinion, but no one can disagree with the fact that with the securitization of mortgages, the Fed has lost influence over the monetary policy for which it is charged. Congress needs to step up to the plate and recognize that the financial playing field of the 21st century is far different than it was when Congress created the Fed. A Federal Reserve Bank without control over the triple-A rating and thus the issuance of CMOs, is a Fed lacking control of its own monetary policies.

Stay tuned.