Bernanke Embrace May Turn as Fed Seeks More Powers

By Scott Lanman

July 14 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke picked a good time to ask Congress for the biggest expansion of his office's powers since the Great Depression. He has to make the most of an opportunity that may prove fleeting.

Bernanke, who testifies before Congress this week, has stored up goodwill with lawmakers after reducing interest rates at the most aggressive pace in two decades and acting to prevent a financial-market meltdown.

``The chairman has done a good job at crisis management,'' says Representative Carolyn Maloney of New York. ``I like the moves he's made,'' says Representative Mel Watt of North Carolina. Both are Democratic members of the House Financial Services Committee, which will question Bernanke July 16 after he delivers his semi-annual report on the economy to Congress.

The favorable reviews on Capitol Hill will serve Bernanke, 54, well as Congress considers his bid to expand his authority over the financial-services industry, a debate that will probably continue into early 2009. The longer it lasts, the more he may find his popularity strained whenever he has to start taking the rate cuts back.

The chairman already faces pressure from some regional Fed- bank presidents to start raising the cost of credit to curb expectations of higher inflation. Such a move would test both his political skills and the Fed's independence, requiring him to justify higher rates to the same lawmakers he's asking for authority to help prevent future financial crises.

Bad Position

``From a political standpoint for the Fed, that's a bad position to be in,'' says Jay Bryson, global economist at Wachovia Corp. in Charlotte, North Carolina, who formerly worked at the Fed in Washington. ``You're going to have senators and congressmen breathing down their necks.''

While Watt, 62, and Maloney, 60, give Bernanke high marks for helping to keep the economy out of a recession and stepping in to prevent the bankruptcy of Bear Stearns Cos., both say it's much too soon to be talking about higher interest rates. Their support matters because the committee they sit on would decide on any expansion of the Fed's regulatory powers.

Although those powers and changes in interest rates ``are unconnected on a policy level, they could be connected politically,'' says Senator Michael Crapo, an Idaho Republican who sits on the Banking Committee, which will be the first to hear Bernanke's report in a session tomorrow. Raising rates may lead some politicians to try ``to stop efforts'' to expand the Fed's authority, he says.

Inflation Mandate

Bernanke's appearances this week on Capitol Hill provide him with the chance to separate the Fed's approach to financial markets from its mandate to keep a lid on inflation, says Dean Maki, chief U.S. economist at Barclays Capital in New York.

``There can be a fuzzy line between them at times,'' says Maki, a former Fed researcher.

Bernanke's decision in March to allow investment banks to borrow from the Fed on terms similar to those it extends to commercial banks has opened a discussion about how to legislate oversight of the securities firms, with bills likely to be debated next year.

Yesterday, Bernanke decided to open the Fed's lending window to Fannie Mae and Freddie Mac, government sponsored companies that are the biggest buyers of mortgage securities. The Fed board's action was part of a broader effort led by Treasury Secretary Henry Paulson, who asked Congress for authority to buy unlimited stakes in and lend to the companies, aiming to stem a collapse in confidence.

A Single Regulator

Last week, Bernanke told the Financial Services Committee that Congress should give a single federal regulator enhanced jurisdiction to set standards for the capital, liquidity and risk management of investment banks.

While he didn't say the regulator should be the Fed, Bernanke did tell the committee that if the central bank is given responsibility for the ``overall stability of financial markets,'' it needs additional authority to examine institutions and collect information on those markets.

``Holding the Fed more formally accountable for promoting financial stability makes sense only if the institution's powers are consistent with its responsibilities,'' Bernanke said in a July 8 speech.

To accomplish that mission, the Fed needs the ``ability to look at financial firms as a whole,'' as well as the ``authority to set expectations and require corrective actions as warranted in cases in which firms' actions have potential implications for financial stability,'' he said.

Skepticism Among Lawmakers

Some lawmakers are skeptical of granting Bernanke any more authority. Senator Jim Bunning, a Kentucky Republican, says he ``wouldn't give the Fed an inch more of power.'' Individual senators can block bills from coming to a vote.

Democratic Representative Barney Frank of Massachusetts, who chairs the Financial Services Committee, may be more accommodating. ``There's an increasing consensus that there should be new powers given to the Federal Reserve to regulate some of the activities of investment banks and hedge funds,'' he says.

The tradeoff for such authority would be heightened scrutiny by lawmakers. ``If we grant additional powers to the Fed or to other regulatory bodies, I certainly hope that that will provide more reliable information to the Congress,'' says Representative Brad Miller, a North Carolina Democrat.

Regional Fed Presidents

Frank, 68, is also demanding scrutiny of the role regional Fed presidents play in setting monetary policy. While Bernanke has yet to advocate increasing borrowing costs, some Fed-bank presidents who sit on the central bank's policy committee are agitating to do so.

Dallas Fed President Richard Fisher dissented from the Fed's June 25 decision to leave the benchmark rate at 2 percent, the first pause after seven cuts totaling 3.25 percentage points. Fisher sought an increase. Last week, Richmond Fed President Jeffrey Lacker said in a speech that the Fed should consider raising rates to limit inflation.

Frank said in an interview July 9 that he plans to probe how the 12 regional Fed presidents are appointed and their role in setting interest rates.

``There's a real question whether or not they should have as much governmental power as they do,'' Frank said. Still, he said, ``we're not talking about compromising'' the Fed's independence on monetary policy.

Political Interference

Political interference with that policy has been rare since the early 1990s, when some lawmakers pushed unsuccessfully to pass legislation that would have taken interest-rate votes away from Fed bank presidents, and then-Treasury Secretary Nicholas Brady was criticizing the Fed for not lowering rates fast enough.

Now, a potential rate increase looms for the first time since Democrats won control of Congress in the 2006 elections, taking over from Republicans, who had been in charge for most of the previous 12 years. Traders see a 69 percent probability of higher rates before Americans vote Nov. 4 on electing a new president, the entire House of Representatives and one-third of the Senate.

That prospect isn't sitting well with some lawmakers after the first half's 438,000 job cuts, soaring home foreclosures and plunging housing prices.

``It would be counterproductive to be talking about raising interest rates right now,'' says Watt. Maloney says ``it's hard to see how the Fed can start raising rates in the face of widespread job losses, declining consumer confidence and weak growth.''

`Difficult Medicine'

Crapo says interest-rate increases are ``probably going to happen'' and he wouldn't necessarily object. ``It's difficult medicine to take, but I think it's the medicine that's going to be applied, and it probably is called for.''

For Bernanke, accomplishing his goals on regulatory powers without compromising on monetary policy may help keep the central bank independent from political pressure by lawmakers, something his predecessor, Alan Greenspan, has flagged as a major risk.

``An independent Federal Reserve is important in good times,'' says James Leach, who formerly chaired the House Financial Services Committee and now directs the Institute of Politics at Harvard University's Kennedy School of Government. ``It's imperative in challenging times.''

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net