Author: WSJ.com: Real Time Economics

The following is the full text of the FOMC’s statement following its March rate-setting meeting.

Information received since the Federal Open Market Committee met in January suggests that economic activity has continued to strengthen and that the labor market is stabilizing. Household spending is expanding at a moderate rate but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly. However, investment in nonresidential structures is declining, housing starts have been flat at a depressed level, and employers remain reluctant to add to payrolls. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve has been purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt; those purchases are nearing completion, and the remaining transactions will be executed by the end of this month. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

In light of improved functioning of financial markets, the Federal Reserve has been closing the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities and on March 31 for loans backed by all other types of collateral.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability.




The Fed’s balance sheet expanded in the latest week, with rising to $2.265 trillion from $2.262 trillion. With direct bank lending continuing to decline and central bank liquidity swaps returning to zero, the bulk of the increase came from the Fed’s purchases of long-term securities. More than $23 billion in new purchases of mortgage-backed securities was added to the balance sheet. The Fed expects to wind down these purchase by the end of the month.

In an effort to track the Fed’s actions, Real Time Economics has created an interactive graphic that will mark the expansion of the central bank’s balance sheet. The chart will be updated as often as possible with the latest data released by the Fed.

In an effort to simplify the composition of the balance sheet, some elements have been consolidated. Portfolios holding assets from the Bear Stearns and AIG rescues have been put into one category, as have facilities aimed at supporting commercial paper and money markets. The direct bank lending group includes term auction credit, as well as loans extended through the discount window and similar programs.

Central bank liquidity swaps refer to Fed programs with foreign central banks that allow the institutions to lend out foreign currency to their local banks. Repurchase agreements are short-term temporary purchases of securities from banks, which are looking for liquidity and agree to repurchase them on a specified date at a specified price.

Click and drag your mouse to zoom in on the chart. Clicking the check mark on categories can add or remove elements from the balance sheet.

A roundup of economic news from around the Web.

• Hayek: On Freakonomics, Justin Wolfers has some fun with government intervention being used to force the teaching of free marketeer Friedrich von Hayek. “Hayek just doesn’t belong with Smith, Marx, Keynes, or Friedman. In fact, it seems that despite having enjoyed a much longer period to accumulate citations, he is still much less widely cited than Larry Summers. Sure, Hayek was an insightful economist. But insisting that high schools teach Hayek is a clear statement of ideology, not of economic science. The message from the Texas Board of Education seems to be: If you can’t win in the marketplace of ideas, turn to government institutions to prop you up. I don’t think Hayek would approve.” William Easterly comes to Hayek’s defense on his blog. “Although Wolfers doesn’t do this, many readers of his blog will fall for that classic trick, the Reverse Ideological Rejection: because ideologues like Hayek, therefore I should (ideologically) reject Hayek. This is in the same class as “Hitler liked Wagner’s Ring, therefore I should hate Wagner’s Ring.” It’s sad that Hayek has been the victim of so many violations of the intellectual freedom for which he was one of the most eloquent and courageous spokesmen ever.”
• Bank and Criminality: Simon Johnson of the Baseline Scenario looks at potential criminal actions during the global debt-fueled boom. “In any case, it is time to close the loophole that effectively allows deception regarding securities sold into the United States. Rule 144A should be abolished — US residents (individuals and institutions) should only be allowed to buy securities that are properly registered with the SEC. If other countries are willing to have their people buy fraudulent securities, that is their problem. This is no longer acceptable in the United States.”
• Deficits: Writing for her Economist Mom blog, Diane Lim Rogers looks at Virginia’s deficit cutting measures and compares it to the federal situation. “The Virginia example may provide a little window into what the federal government would look like if Congressman Paul Ryan, newly named to the fiscal commission and the author of a plan to balance the budget entirely on the spending side, got his way. What Virginia will be cutting looks like a lot more than just “waste, fraud, and abuse.” But I guess I’m supposed to be happy about my taxes staying low, and people like me who (at the moment) have good jobs and income and health aren’t supposed to think that “there but for the grace of God go I” when we see our fellow citizens losing their safety net just as they’re falling.”

Compiled by Phil Izzo

The Federal Reserve funds itself, making money on the buying and selling and holding of U.S. government and mortgage-backed securities, among other things. After paying its expenses, any profits go to the U.S. Treasury. It prizes this independence from the congressional appropriations process.

It seems the Senate Banking Committee has discovered the advantages of what one might call off-balance-sheet financing. In the latest version of the financial-regulatory bill unveiled by Chairman Chris Dodd on Monday, the committee shifts the budgets of all financial consumer-protection activities from half a dozen federal agencies to the Fed –- and then makes explicit that the Fed would have little say over what the new consumer bureau, to be headed by a presidential appointee, would do.

Then there’s a new Office of Financial Research to be established inside the Treasury to advise a new council of regulators. The Treasury budget, of course, is appropriated by Congress, but not this office.

The Fed would foot the bill for the next two years, then the Treasury secretary is to assess the largest financial institutions to cover the costs. “To the extent that the assessments…do not fully cover the total expenses of the office, the [Federal Reserve] Board of Governors shall provide to the office an amount sufficient to cover the difference,” the Dodd bill says.

Canada’s top finance official visited New York Monday, delivering a triumphant message that flagged the relative health of his nation’s economy and public and private finances.

In his remarks, Canada Minister of Finance Jim Flaherty also emphasized what his nation considers prudent financial reform, arguing taxes on capital and on financial transactions are wrong and would not be implemented in his country.

The official spoke at an event held by the Canadian Association of New York. His stance was notable for its confidence, when considered against the caution seen in the words of other world financial leaders, who are in many cases facing huge and difficult to address government budget deficits, along with sluggish growth.

In his remarks, Flaherty said in Canada, “relatively speaking, we have sound fiscal strength” and that this among other factors is a “competitive advantage” for the nation on the global economic stage. He said “we think the economic recovery is showing good signs, but it is still fragile,” and because of this “we are going to continue to run a deficit and stimulate the economy.”

But even with the still tender state of Canada’s economy the conservative finance minister said balanced budgets are “very close,” and will likely happen around 2014 or 2015, amid a steady reduction in government red ink.

Flaherty noted the recent rise in energy and commodity prices had “created some pressures” on the Canadian dollar, but he added “that’s to be expected.”

The finance chief also said in Canada’s economy, “quite frankly, there’s no evidence of a bubble” in housing prices, and government actions have already been taken to counter any unwarranted speculative activity. Looking ahead the official projected “good demand” for Canadian new home production.

The finance minister’s confidence in Canada’s economy extended southward. Flaherty called recent economic data out of the U.S. “encouraging” and flagged what he sees as a “restoration” of business confidence across North America.

In his remarks Flaherty reiterated his opposition to any forms of tax increases, and he argued that based on the relative resilience of Canada’s banking system over the course of the crisis, his nation’s way of watching over banks warrants global attention.

To that end, Flaherty argued in favor of limiting borrowing levels, or leverage, at financial institution. Regulation needs to make sure financial institutions bear the cost of their own failures, he argued.

Consistent with his opposition to higher taxes, Flaherty fretted about certain developments in the global conversation about reform.

“I think the ideas that are being promoted by some in Europe, capital taxes and taxes on financial transactions, are mistaken, and Canada will not follow that course. I expect the United States will also not follow that course,” he said.

His opposition could seal the doom of the proposal in light of the fact that many financial leaders believe the arc of financial regulatory reform must be harmonized across borders. If one nation were to tax financial transactions, it’s likely investors will gravitate to markets free of the tax, thereby blunting the tax and harming only the government imposing it.

Flaherty said there had also been good demand for recent government bond offerings.

Sen. Christopher Dodd (D., Conn.) unveiled a sweeping financial-regulation bill Monday. The following is the fact sheet for the legislation provided by Senate Banking Committee.

Two years ago today, Bear Stearns was collapsing. In the time since, Americans have faced the worst financial crisis since the Great Depression. Millions have lost their jobs, businesses have failed, housing prices have dropped, and savings were wiped out.

The failures that led to this crisis require bold action. We must restore responsibility and accountability in our financial system to give Americans confidence that there is a system in place that works for and protects them. We must create a sound foundation to grow the economy and create jobs.

HIGHLIGHTS OF THE NEW BILL

Consumer Protections with Authority and Independence: Creates a new independent watchdog, housed at the Federal Reserve, with the authority to ensure American consumers get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, and protect them from hidden fees, abusive terms, and deceptive practices.

Ends Too Big to Fail: Ends the possibility that taxpayers will be asked to write a check to bail out financial firms that threaten the economy by: creating a safe way to liquidate failed financial firms; imposing tough new capital and leverage requirements that make it undesirable to get too big; updating the Fed’s authority to allow system-wide support but no longer prop up individual firms; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.

Advanced Warning System: Creates a council to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the economy.

Transparency & Accountability for Exotic Instruments: Eliminates loopholes that allow risky and abusive practices to go on unnoticed and unregulated – including loopholes for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders.

Federal Bank Supervision: Streamlines bank supervision to create clarity and accountability. Protects the dual banking system that supports community banks.

Executive Compensation and Corporate Governance: Provides shareholders with a say on pay and corporate affairs with a non-binding vote on executive compensation.

Protects Investors: Provides tough new rules for transparency and accountability for credit rating agencies to protect investors and businesses.

Enforces Regulations on the Books: Strengthens oversight and empowers regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefit special interests at the expense of American families and businesses.

STRONG CONSUMER FINANCIAL PROTECTION WATCHDOG
The new independent Consumer Financial Protection Bureau will have the sole job of protecting American consumers from unfair, deceptive and abusive financial products and practices and will ensure people get the clear information they need on loans and other financial products from credit card companies, mortgage brokers, banks and others.

American consumers already have protections against faulty appliances, contaminated food, and dangerous toys. With the creation of the Consumer Financial Protection Bureau, they’ll finally have a watchdog to oversee financial products, giving Americans confidence that there is a system in place that works for them – not just big banks on Wall Street.

Why Change Is Needed: The economic crisis was driven by an across-the-board failure to protect consumers. When no one office has consumer protections as its top priority, consumer protections don’t get the attention they need. The result has been unfair and deceptive practices being allowed to spread unchallenged, nearly bringing down the entire financial system.

The Consumer Financial Protection Bureau

• Independent Head: Led by an independent director appointed by the President and confirmed by the Senate.
• Independent Budget: Dedicated budget paid by the Federal Reserve Board.
• Independent Rule Writing: Able to autonomously write rules for consumer protections governing all entities – banks and non-banks – offering consumer financial services or products.
• Examination and Enforcement: Authority to examine and enforce regulations for banks and credit unions with assets of over $10 billion and all mortgage-related businesses (lenders, servicers, mortgage brokers, and foreclosure scam operators) and large non-bank financial companies, such as large payday lenders, debt collectors, and consumer reporting agencies. Banks with assets of $10 billion or less will be examined by the appropriate bank regulator.
• Consumer Protections: Consolidates and strengthens consumer protection responsibilities currently handled by the Office of the Comptroller of the Currency, Office of Thrift Supervision, Federal Deposit Insurance Corporation, Federal Reserve, National Credit Union Administration, and Federal Trade Commission.
• Able to Act Fast: With this bureau on the lookout for bad deals and schemes, consumers won’t have to wait for Congress to pass a law to be protected from bad business practices.
• Educates: Creates a new Office of Financial Literacy.
• Consumer Hotline: Creates a national consumer complaint hotline so consumers will have, for the first time, a single toll-free number to report problems with financial products and services.
• Accountability: Makes one office accountable for consumer protections. With many agencies sharing responsibility, it’s hard to know who is responsible for what, and easy for emerging problems that haven’t historically fallen under anyone’s purview, to fall through the cracks.
• Works with Bank Regulators: Coordinates with other regulators when examining banks to prevent undue regulatory burden. Consults with regulators before a proposal is issued and regulators could appeal regulations if they believe would put the safety and soundness of the banking system or the stability of the financial system at risk.

LOOKING OUT FOR THE NEXT BIG PROBLEM: ADDRESSING SYSTEMIC RISKS

The Financial Stability Oversight Council

The newly created Financial Stability Oversight Council will focus on identifying, monitoring and addressing systemic risks posed by large, complex financial firms as well as products and activities that spread risk across firms. It will make recommendations to regulators for increasingly stringent rules on companies that grow large and complex enough to pose a threat to the financial stability of the United States.

Why Change Is Needed: The economic crisis introduced a new term to our national vocabulary – systemic risk. In July, Federal Reserve Governor Daniel Tarullo, testified that “Financial institutions are systemically important if the failure of the firm to meet its obligations to creditors and customers would have significant adverse consequences for the financial system and the broader economy.”

In short, in an interconnected global economy, it’s easy for some people’s problems to become everybody’s problems. The failures that brought down giant financial institutions last year also devastated the economic security of millions of Americans who did nothing wrong – their jobs, homes, retirement security, gone overnight.

The Financial Stability Oversight Council

• Expert Members: A 9 member council of federal financial regulators and an independent member will be Chaired by the Treasury Secretary and made up of regulators including: Federal Reserve Board, SEC, CFTC, OCC, FDIC, FHFA, the new Consumer Financial Protection Bureau. The council will have the sole job to identify and respond to emerging risks throughout the financial system.
• Tough to Get Too Big: Makes recommendations to the Federal Reserve for increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity, with significant requirements on companies that pose risks to the financial system.
• Regulates Nonbank Financial Companies: Authorized to require, with a 2/3 vote, nonbank financial companies that would pose a risk to the financial stability of the US if they failed be regulated by the Federal Reserve. With this provision the next AIG would be regulated by the Federal Reserve.
• Break Up Large, Complex Companies: Able to approve, with a 2/3 vote, a Federal Reserve decision to require a large, complex company, to divest some of its holdings if it poses a grave threat to the financial stability of the United States – but only as a last resort.
• Technical Expertise: Creates a new Office of Financial Research within Treasury to be staffed with a highly sophisticated staff of economists, accountants, lawyers, former supervisors, and other specialists to support the council’s work by collecting financial data and conducting economic analysis.
• Make Risks Transparent: Through the Office of Financial Research and member agencies the council will collect and analyze data to identify and monitor emerging risks to the economy and make this information public in periodic reports and testimony to Congress every year.
• Oversight of Important Market Utilities: Identifies systemically important clearing, payments, and settlements systems to be regulated by the Federal Reserve.
• No Evasion: Large bank holding companies that have received TARP funds will not be able to avoid Federal Reserve supervision by simply dropping their banks. (the Hotel California Provision)

ENDING TOO BIG TO FAIL BAILOUTS

Preventing another crisis where American taxpayers are forced to bail out financial firms requires strengthening big financial companies to better withstand stress, putting a price on excessive growth or complexity that poses risks to the financial system, and creating a way to shutdown big financial firms that fail without threatening the economy.

Why Change Is Needed: As long as giant financial firms (and their creditors) believe the government will prop them up if they get into trouble, they only have incentive to get larger and take bigger risks, believing they will reap any rewards and leave taxpayers to foot the bill if things go wrong. Since the crisis began, a number of financial institutions previously considered “too big to fail” have only grown bigger by acquiring failing companies, leaving our country with the same vulnerabilities that led to last year’s bailouts.

Limiting Large, Complex Financial Companies and Preventing Future Bailouts

• Discourage Excessive Growth & Complexity: The Financial Stability Oversight Council will monitor systemic risk and make recommendations to the Federal Reserve for increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity, with significant requirements on companies that pose risks to the financial system.
• Volcker Rule: Requires regulators to implement regulations for banks, their affiliates and bank holding companies, to prohibit proprietary trading, investment in and sponsorship of hedge funds and private equity funds, and to limit relationships with hedge funds and private equity funds. Nonbank financial institutions supervised by the Federal Reserve will also have restrictions on their proprietary trading and hedge fund and private equity investments. Regulations will be developed after a study by the Financial Stability Oversight Council and based on their recommendations.
• Extends Regulation: The Council will have the ability to require nonbank financial companies that pose a risk to the financial stability of the United States to submit to supervision by the Federal Reserve.
• Funeral Plans: Requires large, complex companies to periodically submit plans for their rapid and orderly shutdown should the company go under. Companies will be hit with higher capital requirements and restrictions on growth and activity, as well as divestment, if they fail to submit acceptable plans. Plans will help regulators understand the structure of the companies they oversee and serve as a roadmap for shutting them down if the company fails. Significant costs for failing to produce a credible plan create incentives for firms to rationalize structures or operations that cannot be unwound easily.
• Orderly Shutdown: Creates an orderly liquidation mechanism for the FDIC to unwind failing systemically significant financial companies. Shareholders and unsecured creditors will bear losses and management will be removed.
• Liquidation Procedure: Requires Treasury, FDIC and the Federal Reserve all agree to put a company into the orderly liquidation process. A panel of 3 bankruptcy judges must convene and agree – within 24 hours – that a company is insolvent.
• Costs to Financial Firms, Not Taxpayers: Charges the largest financial firms $50 billion for an upfront fund, built up over time, that will be used if needed for any liquidation. Industry, not the taxpayers, will take a hit for liquidating large, interconnected financial companies. Allows FDIC to borrow from the Treasury only for working capital that it expects to be repaid from the assets of the company being liquidated. The government will be first in line for repayment.
• Limits & Disclosure for Federal Reserve Lending: Updates the Federal Reserve’s 13(3) lender of last resort authority to allow system-wide support for healthy institutions or systemically important market utilities with sufficient collateral to protect taxpayers from loss during a major destabilizing event, but not to prop up individual institutions. The Board must begin reporting within 7 days of extending loans, periodically thereafter, and disclose borrowers, collateral, amounts borrowed unless doing so would defeat the purpose of the support. Disclosure may be delayed 12 months if itwould compromise the program or financial stability.
• Bankruptcy: Most large financial companies are expected to be resolved through the normal bankruptcy process.
• Limits on Debt Guarantees: To provide protection against bank runs, the FDIC can guarantee debt of solvent insured banks and thrifts and their holding companies only if the meet a series of serious checks: the Board and the Council determine that there is a threat to financial stability; the Treasury Secretary approves terms and conditions and determines a cap on overall guarantee amounts; the President must activate an expedited process for Congressional review of the amount and use of the guarantees; and fees are set to cover all expected costs and losses are recouped from users of the program.

IMPROVING BANK REGULATION
The bill will streamline bank supervision with clear lines of responsibility, reducing arbitrage, and improve consistency and accountability. For the first time there will be clear lines of responsibility among bank regulators.

Why Change Is Needed: Today, we have a convoluted system of bank regulators created by historical accident. There are 4 federal banking agencies that oversee large systemically significant and small local national and state banks and federal and state thrifts.

Experts agree that no one would have designed a system that looked like this. For over 60 years, administrations of both parties, members of Congress across the political spectrum, commissions and scholars have proposed streamlining this irrational system.

• Clear Lines of Responsibility: Replaces confusing regulation riddled with dangerous loopholes, with clear lines of responsibility.
• FDIC: will regulate state banks and thrifts of all sizes and bank holding companies of state banks with assets below $50 billion.
• OCC: will regulate national banks and federal thrifts of all sizes and the holding companies of national banks and federal thrifts with assets below $50 billion. The Office of Thrift Savings is eliminated, existing thrifts will be grandfathered in, but no new charters for federal thrifts.
• Federal Reserve: will regulate bank and thrift holding companies with assets of over $50 billion, where the Fed’s capital market experience will enhance its supervision. As a consolidated supervisor, the Federal Reserve can see risks whether they lie in the bank holding company or its subsidiaries. They will be responsible for finding risk throughout the system. The Vice Chair of the Federal Reserve will be responsible for supervision and will report semi-annually to Congress.
• Dual Banking System: Preserves the dual banking system, leaving in place the state banking system that governs most of our nation’s community banks.

CREATING TRANSPARENCY AND ACCOUNTABILTY FOR DERIVATIVES

Today’s bill largely reflects the November draft. Senators Jack Reed (D-RI) and Judd Gregg (R-NH) are working on a substitute amendment to this title that may be offered at full committee.

Under today’s proposal, common sense safeguards will protect taxpayers against the need for future bailouts and buffer the financial system from excessive risk-taking. Over-the-counter derivatives will be regulated by the SEC and the CFTC, more will be cleared through centralized clearing houses and traded on exchanges, un-cleared swaps will be subject to margin requirements and swap dealers and major swap participants will be subject to capital requirements, and all trades will be reported so that regulators can monitor risks in this large, complex market.

Why Change Is Needed: The over-the-counter derivatives market has exploded– from $91 trillion in 1998 to $592 trillion in 2008. During the financial crisis, concerns about the ability of companies to make good on these contracts and the lack of transparency about what risks existed caused credit markets to freeze. Investors were afraid to trade as Bear Stearns, AIG, and Lehman Brothers failed because any new transaction could expose them to more risk.

Over-the-counter derivatives are supposed to be contracts that protect businesses from risks, but they became a way for traders to make enormous bets with no regulatory oversight or rules and therefore exacerbated risks. Because the derivatives market was considered too big and too interconnected to fail, taxpayers had to foot the bill for Wall Street’s bad bets. Those bad bets linked thousands of traders, creating a web in which one default threatened to produce a chain of corporate and economic failures worldwide. These interconnected trades, coupled with the lack of transparency about who held what, made unwinding the “too big to fail” institutions more costly to taxpayers.

Bringing Transparency and Accountability to the Derivatives Market

• Closes Regulatory Gaps: Provides the SEC and CFTC with authority to regulate over-the-counter derivatives so that irresponsible practices and excessive risk-taking can no longer escape regulatory oversight. Uses the Administration’s outline for a joint rulemaking process with the Financial Stability Oversight Council stepping in if the two agencies can’t agree.
• Central Clearing and Exchange Trading: Requires central clearing and exchange trading for derivatives that can be cleared and provides a role for both regulators and clearing houses to determine which contracts should be cleared. Requires the SEC and the CFTC to pre-approve contracts before clearing houses can clear them.
• Safeguards for Un-Cleared Trades: Requires margin for un-cleared trades in order to offset the greater risk they pose to the financial system and encourage more trading to take place in transparent, regulated markets. Swap dealers and major swap participants will be subject to capital requirements.
• Market Transparency: Requires data collection and publication through clearing houses or swap repositories to improve market transparency and provide regulators important tools for monitoring and responding to risks.

HEDGE FUNDS
Hedge funds that manage over $100 million will be required to register with the SEC as investment advisers and to disclose financial data needed to monitor systemic risk and protect investors.

Why Change Is Needed: Hedge funds are responsible for huge transfers of capital and risk, but some operate outside the framework of the financial regulatory system, even as they have become increasingly interwoven with the rest of the country’s financial markets.

No regulator is currently able to collect information on the size and nature of these firms or calculate the risks they pose to the broader economy. The SEC is currently unable to examine unregistered hedge funds’ books and records.

Raising Standards and Regulating Hedge Funds

• Fills Regulatory Gaps: Ends the “shadow” financial system in which hedge funds operate by requiring that they provide regulators with critical information.
• Register with the SEC: Requires hedge funds to register with the SEC as investment advisers and provide information about their trades and portfolios necessary to assess systemic risk. This data will be shared with the systemic risk regulator and the SEC will report to Congress annually on how it uses this data to protect investors and market integrity.
• Greater State Supervision: Raises the assets threshold for federal regulation of investment advisers from $25 million to $100 million, a move expected to increase the number of advisors under state supervision by 28%. States have proven to be strong regulators in this area and subjecting more entities to state supervision will allow the SEC to focus its resources on newly registered hedge funds.

INSURANCE
Office of National Insurance: Creates a new office within the Treasury Department to monitor the insurance industry, coordinate international insurance issues, and requires a study on ways to modernize insurance regulation and provide Congress with recommendations.

Streamlines the regulation of surplus lines insurance and reinsurance through state-based reforms.

Growth of 2.5% is looking a whole lot stronger than 5.9%.

After Friday’s reports on retail sales and inventories, real gross domestic product looks on track to grow between 2.0% and 2.5% this quarter. That is quite a few notches down from the 5.9% rate posted in the fourth quarter, but the mix suggests a much stronger economy.

Demand is now leading the way, instead of inventories. And even modestly rising demand creates a more sustainable recovery because increased spending starts the virtuous cycle of more orders, production and hiring, leading to more spending.

The 0.3% gain in February total retail sales was a pleasant surprise since economists expected sales down by 0.3% because of falling vehicle sales and bad weather.

Core sales — a measure that goes directly into GDP calculations and which exclude autos, building materials, and gasoline — jumped 0.9%. Alan Levenson, chief economist at T. Rowe Price, says the uptrend in core sales suggests real consumer spending is growing close to 2.5% this quarter, better than the 2% rate he was expecting before the February retail data were released.

Since consumer spending accounts for 70% of GDP, the sector sets the tone for overall growth (what may bring economic growth closer to 2% is the expected drop in state and local government outlays.).

The consumer sector’s importance was much less pronounced in the fourth quarter, but that was because the inventory sector had taken the spotlight. Inventories contributed 3.88 percentage points of the 5.7% jump in GDP last quarter.

That contribution isn’t being repeated this quarter.

Business inventories were unchanged in January, instead of the 0.1% gain which had been projected. Inventories would have to jump by more than 1% in both February and March in order for the inventory sector to contribute another 4 points to GDP. History shows inventories don’t turn around that quickly.

Without the push from inventories, final demand will have to account for this quarter’s growth. The February data indicate consumers are back, and that’s a good thing.

Businesses, especially small firms, have said the lack of demand has made them hesitant about expanding and hiring. Businesses also won’t begin restocking inventories until they think orders will keep coming in.

And what about February’s record snowfalls along the East Coast? There seems to have been little impact.

Snowbound consumers didn’t shop online. Internet sales were flat. And Rosalind Wells, chief economist at the National Retail Federation, says the blizzards might have helped sales because “cabin fever” pushed consumers out for some fresh air and shopping once the weather cleared up.

To be sure, the household sector is not out of the woods yet. The Reuters/University of Michigan index of consumer sentiment, already low, unexpectedly weakened in early March.

The biggest stumbling block remains high unemployment. But sustained increases in demand should push businesses to start adding workers again. And job growth should chase the consumer blues away and keep cash registers ringing.

A roundup of economic news from around the Web.

• China: At the New York Times, Paul Krugman says that the U.S. has no reason to fear China. “What you have to ask is, What would happen if China tried to sell a large share of its U.S. assets? Would interest rates soar? Short-term U.S. interest rates wouldn’t change: they’re being kept near zero by the Fed, which won’t raise rates until the unemployment rate comes down. Long-term rates might rise slightly, but they’re mainly determined by market expectations of future short-term rates. Also, the Fed could offset any interest-rate impact of a Chinese pullback by expanding its own purchases of long-term bonds. It’s true that if China dumped its U.S. assets the value of the dollar would fall against other major currencies, such as the euro. But that would be a good thing for the United States, since it would make our goods more competitive and reduce our trade deficit. On the other hand, it would be a bad thing for China, which would suffer large losses on its dollar holdings. In short, right now America has China over a barrel, not the other way around. So we have no reason to fear China.” Separately, Bruce Bartlett broadly agrees in this article at Forbes.
• Economic Forecasts: Writing for Project Syndicate, Robert Shiller looks at the trouble with economic forecasts. “The problem for macroeconomics is that the types of causes mentioned for the current crisis are difficult to systematize. The mathematical models that macroeconomists have may resemble weather models in some respects, but their structural integrity is not guaranteed by anything like a solid, immutable theory. The most important new book about the origins of the economic crisis, Carmen Reinhart’s and Kenneth Rogoff’s This Time Is Different, is essentially a summary of lessons learned from virtually every financial crisis in every country in recorded history. But the book is almost entirely non-theoretical. It merely documents recurrent patterns. Unfortunately, in 800 years of financial history, there is only one example of a really massive worldwide contraction, namely the Great Depression of the 1930’s. So it is hard to know exactly what to expect in the current contraction based on the Reinhart-Rogoff analysis. This leaves us trying to use patterns from past, dissimilar crises to try to infer the likely prognosis for the current crisis. As a result, we simply do not know if the recovery will be solid or disappointing.”
• Married Women and Risk: On voxeu, Graziella Bertocchi, Marianna Brunetti and Costanza Torricelli ask if married women are more risk averse. “Does marriage make people less averse to risk? This column argues that this is the case for women, but not for men. But married women’s different attitude towards risk has fallen over time as the prevalence of marriage in society has faded. For women who work, marriage makes no difference.”

Compiled by Phil Izzo

Sen. Bob Corker (R., Tenn.) spoke with the Wall Street Journal about the bill Senate Banking Committee Chairman Christopher Dodd (D., Conn.) plans to introduce Monday to overhaul financial market regulation. Messrs. Corker and Dodd tried to strike a bipartisan compromise on the package until Mr. Dodd abruptly said last week they likely wouldn’t be able to introduce a joint bill because of time constraints.

WSJ: What’s happened in the last 48 hours?

Sen. Corker: “There was no question in my mind that when things were as they were Thursday, that [Sen. Dodd] was going to move to the left with the bill to make sure that at least in committee he had almost all the Democrats. He obviously didn’t want to find himself jammed in committee which would have been very embarrassing…

“If he continued talking to me and moving over to the mdde of the road, he was losing Democrats…”

“There’s no question that Treasury is pushing left, and that’s what I would expect at this point. Hopefully we can have some amendments passed in committee to move it back in the middle of the road. We woke up on Friday moring, dusted ourselves off and are back at it. Our staff has been engaged…

“We’ve noticed throughout the weekend Treasury’s impact on the bill has moved it away from where we had been, no question.”

“It would be my guess that ‘enforcement’ has probably taken on a different sort of place in the consumer side.”

“At least the starting point is going to be much better this time. At least the bill will be amendmable this time. It will be in a place where you can make amendments. It’s still my goal to keep working in committee, we may not get there in committee because his time frame is so short…

“I hope we can get a bipartisan bill out of committee, but the timeframe is awfully short for that kind of thing to occur…

WSJ: Given the political climate, is a deal still possible?

Sen. Corker: “I don’t think there’s any qetison that Sen. Dodd wants a bipartisan bill. I don’t think ther’s any question, hopefully, in anybody’s mind that I’d like to see a bipartisan bill. I think Mark Warner would like to see one. I think Judd Gregg would like to see one. I think Richard Shelby would like to see one…

“If on the consumer piece, we can’t get to where there’s an appropriate relationship between the prudential regulator and new consumer agency, that’s obviously going to be problematic…

“There’s a lot of things that we haven’t even talked about that are important aspects of the bill. If you really look at what created our financial issues, there were a lot of loans made that couldn’t be paid back. The underwriting was terrible, and if we don’t address that somehow, which was the core issue in the beginning, we haven’t done a whole lot. Hopefully we will.”

“I continue to be very optimistic. One of the good things that’s happened since Thursday, one of the positive outcomes has been just the level of engagement now among lots of people.”

Where do you think the bill will be with respect to the “Volcker Rule”?

Sen. Corker: “I would bet, especially with the high level of Treasury involvement that we’ve seen over the weekend and that fact that they actually issued language a week and a half ago, I would be surprised if the Volcker Rule is not strongly addressed, pretty strongly addressed int eh text that comes out on Monday.”

WSJ: Will you offer amendments in the committee?

Sen. Corker: I know generally speaking that he bill is going to move to the left of where we had stopped. I’m going to offer amendments to try to get it back in the middle of the road and do so in a constructive way so we can get to place where we can hopefully get to an 80 vote bill. I don’t view that as anything but positive.”

Senate Banking Committee Chairman Christopher Dodd (D., Conn.) spoke with the Wall Street Journal on Sunday about the bill he plans to introduce Monday to rewrite financial market regulations. Mr. Dodd said the bill had been “well vetted, well thought out, and thoroughly explored. I’m not interested in setting up a regulatory structure that strangles anyone.” But he also vowed to push forward aggressively.

“The idea we can somehow delay this to some later date is just totally unrealistic and wrong, because the American public rightly deserves answers to how we can address this set of problems,” he said.

He said the bill would try to achieve three main things.

1)    “Plug up the gaps that created the problems in the first place.”

2)   “Limit the possibility of another economic crisis of this magnitude. We aren’t going to stop all future economic crises. That would be silly to suggest…” But the bill will set up “early warnings of problems as they emerge, to at least have some ability to step in to institutions or products that pose” major risks.

3)   “Create an architecture that makes credit available, capital available, to allow the U.S. to retain its world leadership.”

He said the bill would have four basic pillars.

1) “Never, ever, ever again should any financial institution become so large, so interconnected, so complex that they have the implicit guarantee the American taxpayer will bail them out if they get in trouble. The result will be bankruptcy or a resolution that will be so painful you never want to think about it as an option.”

2) “We are going to put in place a systemic risk council idea with the authority to be able to identify an bring in institutions that pose a systemic risks to the nation.” He said it would “provide a lookover…between institutions, even beyond the shores of this country.”

3) On the derivatives, the over the counter derivatives and hedge funds…we haven’t reached cloture yet (because Sens. Judd Gregg and Jack Reed haven’t hashed out their deal). I’ll make it abundantly clear when they reach agreement and we vet it properly, I will accept that work.” Mr. Dodd said the derivatives language he will include on Monday “is still a strong provision and has gotten a lot of good reviews from the industry itself.”

4) On the consumer area, I feel very strongly about it…” He said he’s told Republicans “We’re willing to work with you but you’ve got to come to the table with votes too.” His proposal for a new consumer protection division would have the “authority and independence, and I emphasize that second word to you, to address the abuses and fraud that went on that caused so many” problems.

To hear more from Mr. Dodd, tune into his press conference Monday.

House prices across the globe still have room to fall, but the U.S. may be in better shape than other developed nations, according to an International Monetary Fund research article.

In the article, Prakash Loungani notes that house prices in major economies declined an average of about 5% in inflation-adjusted terms from 2007 through 2009. But he looks at some key metrics to determine if the global correction has ended.

One measure is how much house prices have risen compared to rents, and another shows how much they jumped compared to incomes. In many countries those ratios are still far above long-term averages. Based on this and other data, Loungani concludes: “house prices in many countries still have room to fall.”

But the U.S. is hardly in the worst position in the developed world. In fact, it looks to be in pretty good shape. Compared to rents, houses aren’t too far from the average of the pre-boom years. Canada, Sweden and Spain are in much worse positions. Meanwhile the ratio of house prices to incomes is actually below the 1970-2000 average.

To be sure, housing, like politics, is all local. The U.S. has seen some bubble areas hit much harder than the rest of the country, which affects the average. The massive discounts on condos in Florida could be offsetting still expensive houses elsewhere in the country.

There’s also no guarantee that just because houses are running closer to the long-run averages that they will stay there. Germany and Japan have ratios far below the mean for 1970-2000, and they didn’t experience the bubbles that other countries saw in the 2000s.

The Obama administration is considering a Maryland regulator awarded “Consumer Advocate of the Year” and a Massachusetts economics professor known for his Social Security expertise to join Janet Yellen as nominees to the Federal Reserve Board.

Yellen, president of the Federal Reserve Bank of San Francisco, is on the administration’s short list to replace Federal Reserve Board Vice Chairman Donald Kohn, White House spokesman Robert Gibbs said Friday. Sarah Bloom Raskin, Maryland’s commissioner of financial regulation, and Massachusetts Institute of Technology economics professor Peter Diamond are “under strong consideration for additional vacancies” at the Fed, Gibbs said.

Raskin has been outspoken on protecting consumers, the need to preserve state laws from federal preemption, and not having the Fed or any other agency serve as a monolithic systemwide regulator.

Raskin, who last year was awarded the Maryland Consumer Advocate of the Year award from the Maryland Consumer Rights Coalition, has been sharply critical of the “deregulatory fervor” that encouraged abuses against consumers. Not enough people had the courage to raise red flags about predatory practices, she said when accepting the award last September.

“Speaking truth to power is never easy, especially when power is giving you a paycheck,” she said.

Diamond comes from a different background. A noted economist for much of his career, Diamond is known for his work on Social Security and retirement programs, as well as behavioral economics.

Both could add distinct expertise at an important time for the central bank, which is still dealing with the fallout from the financial crisis, how long it should keep interest rates at unusually low levels, and what its role will be under a new regulatory regime being considered by Congress.

Raskin, for one, could add a new dynamic to the Fed’s board on regulatory matters. A colorful speaker who likes to mix in quotations from poets and others in her speeches, Raskin has spoken at length about needed changes to the nation’s regulatory system in the wake of the recent financial crisis. Notably, in an April 29 speech last year, she suggested the Fed or any other regulator shouldn’t be given sole authority to monitor systemic risk.

“There is no single person, and no single agency that can be omniscient about risk,” Raskin said in the speech, warning of a “system with only one pair of eyes watching for risk.”

Additionally, Raskin’s nomination would put a vocal advocate of state regulation over federal preemption in a key policy-making position in Washington.

“I see great potential for the national government to embrace certain state financial regulatory policies,” she said in the speech last April. “Most importantly, let us not allow the failure of federal regulatory oversight and management to be used as an opportunity to erode or abolish state regulatory powers and policies.”

Diamond, meanwhile, could add an expert on key entitlement programs at a time when the future of Social Security remains in flux in Washington. He has authored a series of papers about pensions and social-security systems around the world, and already has a connection with top Washington policymakers: In July 2004 he and current Office of Management and Budget Director Peter Orszag co-authored a paper titled “A Summary of Saving Social Security: A Balanced Approach.”

In 1976, the Federal Reserve established its Consumer Advisory Council at the direction of Congress to advise the central bank on its responsibilities tied to consumer issues. Fed Chairman Ben Bernanke generally attends the council’s meetings in a Fed dining room three times a year, and even suggested to lawmakers last year that they could bolster the group as one way to improve the Fed’s performance on consumer protection.

But some members of the council, even as they plan for their next meeting later this month, don’t seem to think very highly of the Fed on this front.

Today, 19 current and former members of the group wrote to Senate Banking Committee Chairman Christopher Dodd (and the rest of the panel) urging him not to place a proposed Consumer Financial Protection Agency within the Fed in his proposed legislation. Nor do they want it in any other regulatory agency. “Consumers will be served only by having the CFPA as an independent agency where the primary responsibility is consumer protection,” they wrote.

The full text of the letter below:

Friday, March 12, 2010

Chairman Christopher Dodd
448 Russell Building
Washington, DC 20510

Cc: Senate Banking Committee

Dear Chairman Dodd,

We the undersigned current and former members of the Federal Reserve’s Consumer Advisory Council (CAC) are writing to express our support for a strong and independent Consumer Financial Protection Agency (CFPA), not housed within any other existing agency. Even an agency such as the Federal Reserve, which already has a Division of Consumer and Community Affairs, which includes the CAC and direct input from consumer, advocates, has competing priorities that undermine its ability to strongly enforce consumer protections.

Our service advising the Federal Reserve on consumer protection issues spans two decades. Those of us who are currently serving on the CAC are raising these concerns in that forum. Many of us have met with Federal Reserve Chairman Alan Greenspan and Chairman Ben Bernanke over the years to express our concerns about how consumers have been treated by financial institutions. Collectively, we raised concerns about unfair and deceptive mortgage lending, overdraft fees, credit card abuses and a host of other consumer lending abuses. We proposed ideas for consumer protections that we felt were necessary given what was happening in the capital and credit markets. The foreclosure crisis and the credit crunch bore out our concerns, but we take little comfort in being right.

However, given the validity of our concerns, we think it would be imprudent to give the Federal Reserve or any other existing agency primary consumer protection responsibilities. No agency, including the Federal Reserve, has a strong record in this regard. In 1994 Congress gave the Federal Reserve the power to outlaw unfair and deceptive practices in the mortgage market. The Federal Reserve waited until 2008 to issue their rule, long after the problem had become a crisis and after the market had collapsed. During that time, we and other consumer protection experts issued reams of comment and testimony calling on them to exercise their authority to protect consumers.

The Federal Reserve has its hands full with responsibilities relating to safety and soundness and monetary policy.  Consumers will be served only by having the CFPA as an independent agency where the primary responsibility is consumer protection.  We urge you reconsider your proposal for the CFPA to be within any other agency.

Sincerely,

John Taylor
President & CEO
National Community Reinvestment Coalition
Washington, DC

Stella Adams
Principal
SJ Adams Consulting
Durham, North Carolina

Malcolm M. Bush
Research Fellow
Chapin Hall, the University of Chicago.
Chicago, Illinois

Constance K. Chamberlin
President & CEO
HOME of Richmond
Richmond, VA

Kathleen Engel
Professor of Law
Suffolk University
Boston, MA

Thomas P. FitzGibbon, Jr.
Principal
BSI
Glenview, Illinois

Dwight Golann
Professor of Law, Former Chair of the CAC
Suffolk University
Boston, MA
Ken Harney
Syndicated Columnist
Washington Post Writers Group

Kirsten E. Keefe
Staff Attorney
Empire Justice Center
Albany, NY

Sarah Ludwig
Co-Director
Neighborhood Economic Development Advocacy Project (NEDAP)
New York, New York

Ruhi Maker
Senior Staff Attorney
Empire Justice Center
Albany, NY

Patricia McCoy
Director, Insurance Law Center and Connecticut Mutual Professor of Law
University of Connecticut School of Law
Hartford, Connecticut

Ronald L. Phillips, President
Coastal Enterprises, Inc.
Wiscasset, Maine

Dory Rand
Executive Director
Woodstock Institute
Chicago, Illinois

Hubert Van Tol
Director of Economic Justice
Pathstone
Rochester, NY

Alan White
Assistant Professor
Valparaiso University Law School
Valparaiso, Indiana

Marva E. Williams
Chicago, Illinois

Ted Wysocki
President & CEO
LEED Council
Chicago, IL

Robert Zdenek
Consultant
Common Bond
Westfield, New Jersey

Affiliations listed are for identification purposes only.

Former Federal Reserve Vice Chairman Alan Blinder said Friday he fears Congress will fail to act to revamp the financial regulatory system, calling it a “tragedy.”

“An astounding fact to me is we are still here in March 2010 and we’ve done nothing in the way of financial reform,” Blinder said in a speech at the Futures Industry Association. “I’m not very optimistic about getting good financial reform, which is a tragedy,” he later added.

Blinder’s comments came in reaction to a major setback Thursday when Senate Banking Chairman Christopher Dodd (D., Conn.) announced he plans to push ahead with a bill without support from Republicans. Senate Banking member Bob Corker (R., Tenn), which whom Dodd had been negotiating, said one of the snags in developing a bill came over how to craft new rules for over-the-counter derivatives and which transactions should be exempted. But he blamed pressures over the health care bill as the reason for the “pause” in the talks.

If Congress fails to move forward, Blinder said, it will be up to the regulators to step forward and take actions on their own even though they will still be limited on what they can do without additional authority.

Blinder spoke about several big issues that are on the table before Congress, saying he supports the creation of a systemic-risk regulator and thinks that role should go to the Fed.

He also endorsed the concept of the Volcker rule, which would place major restrictions on banks’ ability to own hedge funds and do proprietary trading, but questioned how such a concept might be implemented. He said the rule should only be applied to financial firms that have a “claim on the public purse.”

“I don’t want those institutions gambling with the taxpayers’ money,” Blinder said. “If you have no claim on the public purse, which still accounts for virtually every hedge fund… then I don’t worry about it.”

But to actually write regulations that place restrictions on proprietary trading would be tough, he added, because it might be too hard to determine which trading is considered proprietary.

A roundup of economic news from around the Web.

• Toxic Asset: NPR’s Planet Money purchased a toxic asset, and now we can all watch it die. “Our toxic asset has 2,000 mortgages, many of them in hard-hit states like California, Arizona and Florida. A lot of the people in our bond are really struggling. Almost half are behind on their mortgage payments, and 15 percent of the homes are already in foreclosure. At some point those homes will be taken over and sold for a loss. Every time that happens, the bond shrinks. Eventually, our part of the bond will disappear entirely. Until then, we get a little money every month from people paying off their mortgages. We just got a check for $141. If it goes to Thanksgiving, we could double our money. By the way, we bought the asset with our own money. Any proceeds will go to charity. If we lose money, we take the loss.”
• Cigarette Taxes: Writing for voxeu Deliana Kostova looks at the correlation between higher cigarette taxes and demand. “Do higher cigarette prices deter smoking? This column finds that policymakers in developing countries could reduce cigarette consumption by youths by raising taxes. A 10% increase in the price will reduce youth cigarette demand by 18.3%.”
• Consumer Satisfaction: Bryan Caplan on EconLog looks at how to measure consumer satisfaction. ” For the past few years, social scientists have been arguing over the One True Measure of consumer welfare. Most economists still cling to the Demonstrated Preference Standard: If A buys X, then X makes A better off by definition. Psychologists and psychologically-minded economists have been pushing the Happiness Standard: If A buy X and feels happier as a result, then and only then is A better off. I think both standards have some merit. But I’d like to suggest a middle way. I call it the Consumer Satisfaction Standard. According to this standard, if A buys X, and would do so if he had the chance to make the decision over again, then X makes A better off. The Consumer Satisfaction Standard is less tautologous than the Demonstrated Preference Standard; it allows for the possibility – which we often observe in real life – that a person will not be a satisfied customer. At the same time, if someone complains about X but keeps buying it, the Consumer Satisfaction Standard treats his grousing as empty verbiage.”

Compiled by Phil Izzo

Janet Yellen, president of the Federal Reserve Bank of San Francisco, is expected to be nominated by President Barack Obama as vice chair of the Federal Reserve Board. Ms. Yellen, 63 years old, has served as a Fed policy maker for almost a decade between her stints in Washington and San Francisco.

Dan Francisco Fed President Janet Yellen (Reuters)

Policy stance:
Ms. Yellen has been a reliable supporter of Fed Chairman Ben Bernanke’s policies. She is frequently cited by economists as one of the central bank’s most dovish policymakers, generally backing policies that would boost growth and reduce high unemployment. She has long been a counterweight to the Fed’s more hawkish regional bank presidents who tend to be more concerned about rising inflation. (The Fed’s dual mandate from Congress is to promote maximum sustainable employment and price stability.)

Voting record:
In her time as a Fed policy maker, Ms. Yellen has never cast a dissenting vote on policy — in either raising interest rates or lowering them. She has voted 36 times as a member of the Federal Open Market Committee, always with the majority, according to a tally by Wrightson-ICAP. Of the 12 current regional bank presidents, five have dissented at least once. Of current FOMC officials, only three have cast more votes on interest-rate policy in their careers: Vice Chairman Donald Kohn (63 votes), Kansas City Fed President Thomas Hoenig (60 votes) and Chairman Bernanke (56 votes), according to the Wrightson tally.

Policy experience:
Ms. Yellen has been president and chief executive officer of the San Francisco Fed since June 2004. She served as a Fed governor from August 1994 through February 1997. She left the Fed to become chair of the Council of Economic Advisers under President Bill Clinton through August 1999. In 1977 and 1978 she served as a staff economist on the Fed’s Board of Governors in the Division of International Finance (Trade and Financial Studies Section).

Academic background:
Ms. Yellen graduated from Brown University in 1967 with a degree in economics and received her doctorate in economics from Yale University four years later. She taught at Harvard from 1971 to 1976, then the London School of Economics from 1978 to 1980. She has been on the faculty at the University of California at Berkeley since 1980, most recently as a professor of business and professor of economics.

Research:
Ms. Yellen’s key research interests are unemployment and labor markets; monetary and fiscal policies; and international trade and investment policy. A respected scholar, she has written widely on income inequality and published numerous papers with her husband, George Akerlof, the Nobel prize-winning economist. (Among them: “An Analysis of Out-of-Wedlock Childbearing in the United States” in 1996 and “East Germany In From the Cold: The Economic Aftermath of Currency Union” in 1991.) In 2001, she published “The Fabulous Decade: Macroeconomic Lessons from the 1990s” with former Fed vice chair Alan Blinder.

In her own words:
Ms. Yellen, in her most recent speech, defended the Fed’s near-zero interest rate target. “Such accommodative policy is appropriate, in my view, because the economy is operating well below its potential and inflation is undesirably low. I believe this is not the time to be removing monetary stimulus.”

Calling government budget deficits unsustainable, a top Federal Reserve official on Thursday called on national leaders to start laying out plans that would allow a move back to more manageable spending levels.

New York Fed President William Dudley (Reuters)

“Just as there needs to be a credible exit strategy for monetary policy to anchor inflation expectations, there also needs to be a credible exit strategy from fiscal policy stimulus to anchor expectations about the risks of sovereign debt default,” Federal Reserve Bank of New York President William Dudley said Thursday.

Much like the very stimulative state of monetary policy, the “accommodative” levels of government spending have been “appropriate” and in many cases unavoidable, given the shifts in demand seen in national economies, the policy maker said. As for the U.S., “without substantial fiscal stimulus, the economy would have been even weaker and the unemployment rate considerably higher.”

But even as that’s the case, governments need to start thinking about and making public plans to get their respective fiscal houses back in order, the official said. Dudley, who is also vice-chairman of the interest rate setting Federal Open Market Committee, offered his comments in the text of a speech prepared for delivery before the Council of Society Business Economists Annual Dinner, in London.

Dudley made no comment about the outlook for the U.S. economy, or for monetary policy. But his call for forming plans to making government spending more sustainable came at a time where central bankers are also mulling how to unwind a set of policies designed to support a badly wounded economy, one that needed zero% interest rates and intensive interventions into markets.

Dudley’s case for government fiscal sustainability essentially argued national leaders need to make decisions now, so that markets don’t make the call later.

When it comes to things like U.S. government debt, “market participants appear to be quite tolerant of the current large fiscal imbalance.” But thinking this will continue is “a risky strategy because it fully exposes the economy to the vagaries of market sentiment and because shifts in such sentiment can have important consequences for both the deficit path and the economy,” Dudley warned.

To be sure, the central banker said he was not calling for some imminent shift in government spending patterns. “The economic recovery is still very fragile” and “premature fiscal retrenchment could jeopardize the recovery and push a convalescent economy into a double-dip recession,” he said. The official added any plan should be phased in slowly.

Much of the rest of the official’s speech centered on issues of financial regulatory overhaul and the need to rebalance world economies.

Dudley noted “the international consensus to harmonize standards globally appears fragile.” He added, “If each country acts to strengthen its financial system in an uncoordinated way, we will be left with a balkanized system, riddled with gaps that encourage regulatory arbitrage.”

As many Fed officials have done, Dudley also argued against efforts to strip the central bank of its bank oversight powers. “The Federal Reserve is particularly well suited to this role,” one with the added benefits of aiding the central bank in its lender-of-last-resort role, and in its job of making monetary policy, Dudley said.

The official also said the longer-run growth outlook would be better if consumption patterns were higher in emerging economies, and lower in the U.S. over a long run period. He warned that current patterns, which see a massive outflow of dollars to nations like China, are problematic, saying “a number of countries have surely reached a point at which further reserve accumulation comes with more costs than benefits.”

Dudley also argued for more transparency across the financial system, particularly in things like the trading of derivative securities.

“If regulators had ready access to current OTC derivatives transaction information in trade repositories, I suspect that this would serve as a brake on the use of OTC derivatives that are used for more questionable purposes,” Dudley said.

The Federal Reserve’s latest flow of funds report offers a clue for those trying to understand why banks often don’t want to lend to businesses: By some measures, businesses’ finances are still deteriorating.

In the fourth quarter of 2009, nonfinancial corporate businesses’ net worth — what they have minus what they owe — declined 1.9%, notching its ninth straight quarter of contraction. The main driver of the drop is companies’ real-estate holdings, which tend to include things like land, warehouses and offices that have kept falling in value even as residential real estate has rebounded a bit.

One problem with the fall in net worth is that it can drive a wedge between the interests of a company’s owners and its creditors. With less to lose, the owners might be willing to take on more risk in the hopes of making big gains. The creditors, by contrast, are more likely to take a bigger loss if the owners’ bets go wrong. Consider, for example, a guy who bets $11 on a horse that pays double if it wins, $1 of his own money and $10 borrowed at 10% interest. In the best case, he makes $10; in the worst, he loses $1, with the creditors taking the rest of the hit.

Those odds can make bankers wary of lending to anyone, a problem noted long ago by economists Ben Bernanke and Mark Gertler, who developed a concept known as the “financial accelerator” to describe how such lending problems can aggravate economic downturns. If the latest data on bank lending are any indication, the accelerator could still be engaged: As of the end of 2009, total bank lending to businesses — known as commercial and industrial lending — was down 18% from a year earlier.

Sen. Bob Corker (R., Tenn.) on Thursday talked openly of the bipartisan compromise he nearly reached with Senate Banking Committee Chairman Christopher Dodd (D., Conn.) over new financial regulations.

On consumer protection:

“I think the consumer title that Chairman Dodd puts forth will be very much shaped by our discussions. My guess is he’ll probably veer it to a hair left to be candid  … but hopefully not. But where it was left, it was housed at the Fed, appointed by the president, confirmed by the Senate.”

“One of the things about the Fed, and since I can come real clean now…the thing about the Fed if you remember the President said that he wanted an independent source of funding. The way the Fed works, the Fed gives whatever surplus is left to the Treasury each year, and that was a way of solving that problem because in essence the consumer protection agency would have an independent source of funding.”

Mr. Corker said the consumer division within the Fed wouldn’t “report to the chairman. It was a lot different than people thought. Here’s where it’s been: Republicans, conservative Republicans I might add, have agreed to broad-scope rulemaking, and that’s never happened. And were talking about rulemaking where the shadow industry has to live by the same rules that the regulated market has. If I’m a consumer person, I’m saying that’s breaking ground. Where Republicans have drawn a line in the sand, and that line has been honored, we do not want (the consumer division) involved in enforcement. … In other words, if consumer issues exist, we want the OCC to implement, or the Fed to implement, or the FTC to implement. We don’t want rulemaking and enforcement combined.”

“There was a veto process. We made the first real offer on consumer a week ago Saturday. It was actually a real offer to try to get a deal done. There was a process through which rules would be made. It’s consultative. There is a veto process if the safety and soundness of the financial system or systemic risk is created, there’s a veto process by the regulators. …  We were down to issues that I promise you none of you ever dreamed of in your life.  … If there’s a conflict and there’s a judgment, then how does that all work out. It got down to judicial issues if you will. So that’s the sort of fine-tuning that we had gotten to on consumer. But again, the major concepts, actually agreed to.”

On rating agencies:

“We have at present a pretty painful clause for rating agencies, if you are one of the large ones in there. I know the House basically wrote them out of the code, and I’m not saying I’m opposed to that I might add. But on the credit rating side, we had a pretty big liability burden that was going to be placed on credit rating agencies, and I think (would have) caused them to pay a lot more attention to what they are doing.”

On derivatives:

“The issue that has kept (Sens. Jack Reed and Judd Gregg) from coming to closure, although they are this close, has been how much of an end-user exclusion should exist. I have not seen their language, nor has Chairman Dodd seen their language, I might add, because it’s not ready yet. …  I give Chairman Dodd some additional slack because I think he knows that it’s going to take probably a couple weeks to be honest for them to resolve their differences. … I probably felt a better way to do that is to leave that section out and add it as an amendment when it comes.”

As health care goes, so goes job growth?

Amid the worst labor market in more than a generation, it is surprising that discussions — pro and con — about overhauling health insurance tend to ignore one key issue: The current insurance system that relies on employer-provided policies and little portability threatens future job growth.

If left alone, the current system will curtail job creation in many ways, from raising the total cost of U.S. labor to hurting global competitiveness, besides dimming the entrepreneurial spirit. While it’s hard to pin down numbers, it’s safe to say that no change on health care will make it even tougher to bring down the unemployment rate, currently at 9.7%.

A study by Hewitt Associates forecasts that absent change, U.S. companies providing health insurance will face an annual bill of $28,530 per employee by 2019 — almost three times more than the $10,700 cost in 2009.

That leaves U.S. multinationals and exporters at a huge disadvantage because their foreign competitors in developed economies don’t provide health insurance to their workers. Instead, medical care is funded by the government.

As a report by the Business Roundtable said, “America’s businesses cannot win in the marketplace when bidding against global companies [that are] shouldering significantly lower health-care cost burdens.”

In other words, U.S. companies will lose sales, lessening the need for more U.S.-based labor.

Domestic demand will take a hit as well. Higher health-care bills means less money to give out in the form of cash wages. Slower income growth will hurt consumer spending. Small businesses, from restaurants to hair salons, depend on households as customers. Without increased sales, they have no need to take on extra staff.

At the same time, workers will have fewer career paths because of the possible loss of health insurance if they leave their current jobs. That will reduce earnings growth and the number of start-up companies that could create new jobs.

Workers with health problems (or with an ill dependent) often stay in a job because of the fear that a new insurance plan will not cover an existing condition. Economists have estimated this job-lock reduces voluntary turnover from 16% yearly to 12%. That means about 2 million workers stay in a job because of health insurance concerns.

Switching jobs expands income potential (since people most often take new jobs that pay more). Research shows that reducing job-lock by making health insurance portable could raise personal income by $30 billion a year. But if workers are stuck in jobs, the loss of potential income will hurt consumer spending growth.

Similarly, workers decide against becoming entrepreneurs because of the unavailability or high cost of individual insurance policies. Past research on male workers indicates that their worries about insurance stop about a quarter of possible entrepreneurs from going out on their own. Start-up businesses that survive and become small firms are the primary generators of jobs.

So whether you are for the Senate bill, the House proposals or prefer an entirely new approach, keep this in mind: Maintaining the status quo isn’t a viable option. The current insurance system will lead to many fewer jobs in the U.S. in the coming decades.