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July 31, 2001

The Fed: The Inside Story of How The World's Most Powerful Financial Institution Drives Markets

By Gregory Bresiger

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  • The Fed: The Inside Story of How The World's Most Powerful Financial Institution Drives Markets
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by Martin Mayer

(Free Press, New York, 350 pages) $27.50

Reviewed by Gregory Bresiger

Is Martin Mayer having some doubts about one of our most revered of institutions, the venerable Federal Reserve Board?

Martin Mayer has never been noted as a prominent critic of the idea of central banking - or as a friend of its philosophical nemesis, free banking, which is the libertarian concept that a bank should be allowed to fail; that it should be treated the same as any other badly run business.

Nevertheless, a close reading of this book raises many questions about the recent eulogizing of our central bank and its leaders. In the end, this book intimates that the Fed's policies could be a house of cards, ready to crumple at the first massive market shock and demand for liquidity.

Lender of Last Resort

Mayer argues that the Fed's role as the lender of last resort is becoming confused; that players in the fixed income and stock markets are wrongly looking to it as a safety net that will always save them from the destructive powers of the market.

This savior role will egg them on to making riskier choices because the Fed is viewed as a kind of benevolent parent, always there to protect them from disaster. But, as readers of the great classical and Austrian economists understand, markets are supposed to be destructive. In a market economy all plans can no more succeed than every team can win the World Series this year or any year. However, Mayer, pointing to the Fed's bailout actions, says market participants, including those running big hedge funds, are receiving confusing signals.

"The head of one of the largest hedge funds in the world," Mayer writes, "said to me shortly after the rescue of Long Term Capital Management that the episode had carried a clear message for him: If I get in trouble, the Fed will come and save me. I told him that if Alan Greenspan could hear him he would turn white as a sheet and resign. But he was sure he was right."

In this tidy little tome Mayer also accuses the Fed of a panoply of other sins over the last few decades. Among the Fed controversies outlined: operating in secret and deliberately trying to keep the public from understanding its policies, rigging monetary policy to help re-elect President Richard Nixon in 1972 and arrogating power from Congress by allowing banks to offer almost unlimited deposit insurance protection.

Mayer also suggests that the Fed may have been getting in over its head recently when it became the ultimate federal government financial regulator. This book contains more than its share of blundering and political shenanigans by our central bankers. Mayer notes that many banks failed in the 1980s because of the "implicit" or "explicit" protection of deposit insurance, which was inducing some banks to ease their credit restrictions and try more dicey investments than were previously in their conservative portfolios.

The Fed and its agencies, Mayer writes, also pulled an end run on Congress in the 1980s. But Mayer writes that this creation of Congress had become a problem child, according to one important Congressional leader.