Crisis of Credibility: The Federal Reserve’s mounting trading scandals
How personal trades by prominent Fed members encumbers monetary policy decisions
Originally posted on my Power and Markets Substack, please feel free to share and subscribe to my newsletter to get these articles in your inbox!
The Federal Reserve System is the central bank of the United States. Its primary responsibility is conducting the nation’s monetary policy-controlling interest rates to manage desired policy outcomes within the economy. The Fed’s decisions impact every American and markets globally. This is why if we are to have a central bank, the credibility must be iron-clad. Recent events have thrown that into question entirely.
Over the past few weeks we have been informed of rather distasteful practices by Federal Reserve Board members. Recent disclosure forms released indicate several Fed officials were trading within their personal brokerage accounts ahead of policy decisions. Given they are tasked with the most market-moving tools imaginable-literally controlling the supply of money and credit-this severely impacts the Fed’s reputation going forward.
Up until today, October 18, 2021, three senior Federal Reserve officials were identified as front-running transactions with insider information. Dallas Fed President Robert Kaplan and Boston Fed President Eric Rosengren are retiring early from their positions having cashed in on lucrative trades. The Fed Vice Chair Richard Clarida is also under scrutiny for his personal enrichment by timely rebalancing his portfolio. Clarida rotated his holdings from conservative bonds into riskier stock funds one day before the Federal Reserve slashed interest rates. As Warren Buffett quipped, interest rates are like gravity to assets. When rates go down, stock prices increase as you are discounting future cash flows at a lower rate. Knowing the Fed is going to cut interest rates is certainly valuable information for anyone buying stocks ahead of time.
Another bombshell dropped this morning and it isn’t good. The Federal Reserve Board Chairman Jerome Powell sold between $1-$5 million worth of stock from his personal account within the same week of stimulus discussions. Powell unloaded shares on October 1, 2020, knowing that transcripts of his recent Open Market Committee meetings would be disclosed on October 7. Within those meeting minutes, the Fed would warn:
“Participants continued to see the uncertainty surrounding the economic outlook as very elevated, with the path of the economy highly dependent on the course of the virus; on how individuals, businesses, and public officials responded to it; and on the effectiveness of public health measures to address it. Participants cited several downside risks that could threaten the recovery.”
Why this is concerning is the impact on monetary policy decisions. If these Fed officials are able to hold assets they ultimately can swing the values of, then they personally gain from their own policy decisions. The obvious built-in incentive is to adopt strategies that may not serve the public’s interests.
None of this is a good look for the Federal Reserve. Over the past few years, many of our institutions are under intense criticism for breaching the public trust. One of the last bastions of faith is the stability of the U.S. Dollar. Behavior and actions by Fed officials such as this it erodes confidence in its decisions.
What Americans may be facing is a significant overhaul of the Federal Reserve members. This entertains substantial political risks as the Fed is designed to be independent from politics, although we know better than that. Chairman Powell’s term expires in February 2022 coinciding with the midterm election cycle. Democrats seem eager to find his replacement, and the Fed has done little to ensure confidence in its current leadership. Where that lands us may be a Federal Reserve makeup more politically aligned with the number of current members potentially leaving. The devil we know may be preferable to the unknown alternatives vying for these coveted seats.
Originally published at https://powerandmarkets.substack.com on October 18, 2021.
