The Federal Reserve was already under pressure to control inflation, protect the job market, avoid a recession and prevent a repeat of multiple scandals involving stock trades by officials. Then the banking crisis hit.
The whiplash of the past two weeks has ratcheted up the political pressure on the central bank, which usually prides itself on its independence from elected officials. Many members of Congress are pinning this month’s bank meltdown on the Fed, despite a bipartisan vote in 2018 to ease regulations on midsize institutions like Silicon Valley Bank. Meanwhile, a vacancy for the Fed’s No. 2 job could tee up a testy confirmation fight in the Senate. All the added scrutiny comes as the Fed is already on shaky ground over its fight to wrestle inflation down to normal levels — and assure Washington and the nation that it is steering the economy in the right direction.
“Raising rates is unpopular,” said Adam Posen, president of the Peterson Institute for International Economics. “But then it should be harder to defend your behavior and your reputation when you have so visibly messed up supervision. There’s no two ways about it.”
The Fed’s effectiveness relies on its reputation for independence from politics. Central bankers make some of the most consequential decisions about the economy’s future, and they must resist demands from whoever is in the White House or Congress, focusing instead on the long-term benefit of the economy.
That’s especially the case with monetary policy, through which Fed officials use interest rates to juice or slow the economy. Facing dangerously high inflation, officials spent the last year hoisting rates at the fastest pace in decades, and those moves could cause a recession this year or next — on President Biden’s watch, heading into an election.
Donald Kohn, the Fed’s vice chair from 2006 to 2010 who is now at the Brookings Institution, a liberal-leaning think tank, noted that the central bank’s independence can take a few forms. It stands alone on interest rate decisions. But on banking issues, the Fed often works alongside other financial regulators. That could leave some room for Congress to give the Fed a closer look on supervision without infringing on other parts of its mandate.
“Monetary policy independence and regulatory independence are on separate tracks, in some sense,” Kohn said. “When bad things happen, it’s not unusual to get Congress wondering whether oversight and accountability is adequate. I think it’s a conversation you need to have periodically.”
Since the pandemic, Republicans and Democrats have ping-ponged their attacks on the Fed. In early 2021, the Fed emerged as a key White House ally to go big on a stimulus package. Then, as prices took off later that year, Republicans lambasted the Fed for insisting that inflation would be temporary and holding off on rate hikes.
For much of 2022, Republicans sided with the Fed in its aggressive rate hike campaign. But in the weeks before the midterm elections, Democrats began warning the central bank against overdoing it and jeopardizing the job market, which is still growing at a remarkable clip.
The Fed also took heat from both sides of the aisle over trading and investment scandals that shook the public trust. And Republicans have slammed the Fed and some of its regional banks for devoting attention to climate change and economic inequality, which GOP lawmakers say aren’t part of the institution’s mandate.
“You will see Republicans saying the Fed needs to spend less time worried about racial equity and climate change [when] they can’t even regulate the banks they’re supposed to be regulating,” said Michael Strain, director of economic policy studies at the American Enterprise Institute, a conservative-leaning think tank.
Banking regulation is a key part of the Fed’s job, and questions are mounting over how SVB failed and triggered enough panic that government officials had to jump in with significant force. The Fed has launched its own probe, with answers to come by May 1. But many lawmakers and Fed watchers are skeptical that the central bank can investigate itself. On Friday, Republicans on the Senate Banking Committee sent a letter to Fed Chair Jerome H. Powell and the San Francisco Fed seeking records on SVB’s implosion.
In a news conference after the Fed raised rates again this week, Powell said it was clear “right away” that a review was necessary as officials asked themselves, “How did this happen?” Powell said that the Fed clearly needs to strengthen its supervision of the banking system, and that recommendations would probably come from its investigation.
He added that an outside probe was welcome and practically guaranteed.
“When a bank fails, there are investigations, and of course we welcome that,” Powell said.
It’s still early, but pressure on the Fed may fall into two camps, Strain said. The first revolves around whether lawmakers still have confidence in Powell, a Republican tapped for the Fed’s top job by Trump, then nominated for another term by Biden. He was confirmed both times with broad support in the Senate, and so far, people close to the Hill and administration said they don’t expect that support will erode much.
But the second area of pressure could bring more tangible changes to the Fed, Strain said, as lawmakers debate reining the central bank in. This week, Sens. Rick Scott (R-Fla.) and Elizabeth Warren (D-Mass.) — two lawmakers who rarely agree on much — unveiled legislation that would replace the Fed’s watchdog with an inspector general appointed by the president and confirmed by the Senate. Twelve senators, 10 Democrats and two Independents are also urging the Fed to impose tougher rules on banks with assets totaling $100 to $250 billion, a zone that saw a deregulatory push by Congress during the Trump administration. The Fed implemented those changes, with Powell’s support.
“Irresponsible and excessive risk taking by SVB and Signature executives should serve as a clear reminder that banks cannot be left to supervise themselves,” wrote the senators, led by Warren. “The Fed has a responsibility to ensure financial stability, and in order to fulfill that responsibility, it must ensure that all banks with potential systemic significance are subject to rigorous safety and soundness rules.”
Sen. Bernie Sanders (I-Vt.) has also introduced a proposal to block bank executives from serving on the boards of regional Fed banks. (The chief executive of SVB was on the board of directors at the San Francisco Fed until the bank’s collapse. The Fed says directors of reserve banks aren’t involved in banking supervision issues.)
Oversight will probably play a major role in next week’s congressional hearings. Michael Barr, the Fed’s banking cop who is also overseeing the internal investigation, is set to testify before the Senate Banking Committee and House Financial Services Committee on Tuesday and Wednesday, respectively, alongside Martin Gruenberg, chair of the Federal Deposit Insurance Corp., and Nellie Liang, undersecretary for domestic finance at the Treasury Department. Treasury, the FDIC and the Fed were all instrumental in this month’s emergency response.
Still, the Fed’s rare independence in Washington puts it in an unusual position. Wendy Edelberg, director of the Hamilton Project and a senior fellow in economic studies at the Brookings Institution, said that “in some ways, an institution can show how trustworthy it is when it responds to how it got something wrong.”
But maintaining independence also means staying focused when political pressure heats up.
“Regulation, and effective regulation, take a little bit of stamina, or a lot of stamina,” Edelberg said, “because you have to be willing to be the unpopular person.”