Fed Role Protecting Consumers Debated

Fed Vice Chairman Donald Kohn said the agency has performed better at protecting consumers recently.
Fed Vice Chairman Donald Kohn said the agency has performed better at protecting consumers recently. (By Brendan Hoffman -- Bloomberg News)
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By Neil Irwin
Washington Post Staff Writer
Friday, July 10, 2009

Some economists with ties to the Federal Reserve are recommending that the central bank be stripped of its powers to protect consumers, in contrast to the positions of Chairman Ben S. Bernanke and other Fed leaders.

The Obama administration has proposed creating a new regulator to oversee financial products offered to consumers, which would take on responsibilities currently held by the central bank.

"The consumer protection regulator is not at the core of what the Federal Reserve does," former Fed governor Frederic S. Mishkin told a House Financial Services subcommittee yesterday. Protecting consumers against exploitative lending arrangements "uses a very different skill set" from managing risks to the overall economy, said Mishkin, a Columbia University economist.

Former Fed governor Laurence H. Meyer, vice chairman of research firm Macroeconomic Advisers, said that "if something is to be given up, the most obvious choice is consumer protection and community affairs," which he added "are not seen around the world as core responsibilities of central banks."

Many Democrats in Congress are furious that the Fed did not use its powers to protect consumers during the boom years of mortgage and credit card lending in the middle of this decade.

The Fed has acted more vigorously to protect consumers in the last two years, with new rules governing mortgages and credit cards that have generally won praise from consumer advocates.

Testifying yesterday, Fed Vice Chairman Donald L. Kohn said the agency has some unique skills that make it well-positioned to protect consumers, given its regulators' deep insights into banks and its interest in watching out for overall economic stability.

"I think in the last couple of years we have stepped up to the plate on high-cost mortgages, on consumer credit," said Kohn, echoing an argument that Bernanke has made. Kohn acknowledged that in years past the Fed "did not see the abuses, as widespread as they were, and we were slow to react to them."

Some Fed leaders argue that the central bank is particularly well-positioned to protect consumers because it bases decisions on rigorous analysis. Its status also enables it to attract high-quality staff. There is no way to know how much institutional credibility and power a newly created agency would have.

"Consumer protection isn't the core function of a central bank, so in that sense you can take it out," said Marvin Goodfriend, an economist at Carnegie Mellon University and former Fed staffer. "On the other hand, you don't want a consumer protection regulator to do things that create economic inefficiency. So this is an issue on which reasonable people can disagree."

One key argument for stripping the Fed of its powers to protect consumers is that senior leaders of the bank are at risk of being spread so thin they cannot devote sufficient attention to consumer issues.

Rep. Keith Ellison (D-Minn.) asked Kohn whether the Fed is looking into potentially unfair practices by banks in assessing overdraft fees. "I'm not sure, congressman," replied Kohn.

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