Is the Fed Overstepping Its Bounds?

Richmond Fed President Jeffrey Lacker says the Fed is helping housing too much.

Federal Reserve Chairman Ben Bernanke, left, and Richmond Federal Reserve President Jeffrey Lacker, right.
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In 2012, Fed watchers got used to eight words: "Voting against the action was Jeffrey M. Lacker."

This phrase appeared near the end of every statement from the Federal Open Market Committee this year. At all eight 2012 committee meetings, Richmond Fed President Jeffrey Lacker was the sole dissenter. Now, after this week's December meeting, Lacker is not only sounding common inflation alarms but also leveling another charge: the Fed is overstepping its bounds.

"Deliberately tilting the flow of credit to one particular economic sector is an inappropriate role for the Federal Reserve," he wrote in a Friday statement explaining his most recent dissent.

He's talking about the Fed's purchases of mortgage-backed securities — bonds that are essentially claims on money that comes from mortgages on millions of Americans' homes. With QE3, the third round of quantitative easing announced in September, the central bank began to buy $40 billion of the securities each month.

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The Fed's goal is to lower interest rates and boost the housing market. As Federal Reserve Chair Ben Bernanke put it in a November speech, MBS purchases are designed to "mitigate some of the headwinds" facing housing, making it easier for the sector to flourish.

However, Lacker points to a statement made by the Fed and the Treasury in 2009, during the height of the financial crisis, in which the two agreed the central bank should approach credit markets broadly, without targeting particular sectors or borrowers. Trying to improve particular economic areas is a fiscal concern, they agreed, and not a central bank concern.

Not only is Lacker in the minority; Lacker is the minority on the current committee, albeit a vocal one. He has voiced concerns that the Fed is going too far before, after the September and October Fed meetings. But is he right?

Lacker has the 2009 statement to back him up, but the Fed has another authority to point to, says one analyst.

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"The Fed's got a dual mandate to promote inflation and promote full employment. I think the Board of Governors thinks it's fully within their purview to pursue these policies that help all segments," of the economy says John Canally, vice president and economist at LPL Financial. "You could argue, yes, that it directly impacts housing, but certainly if you could say that housing was impacted directly, you could think of another 100 industries that are helped because housing's better."

Helping 100 industries would mean a boost for employment, something that is very much within the central bank's purview. Housing has in the past been considered a driving force in boosting the economy, and the recent turnaround in housing has boosted optimism about the current recovery, even amid the many obstacles facing it.

There are also broader concerns the Fed has simply done too much in terms of easing. The Federal Reserve's unprecedented asset buys are intended to stimulate the economy, but they have also more than tripled the size of the Fed's balance sheet. Undoing all of that could be fantastically difficult for the Fed's board of governors.

"One problem is that how are you going to unwind this liquidity," asks James Johannes, director of the Puelicher Center for Banking Education at the University of Wisconsin-Madison. "And what form will that unwinding take? And what will the repercussions be?"

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While there is the argument that the Fed can simply sell off some of the nearly $3 trillion in assets it holds, Johannes is skeptical about exactly how simple that would be.

"Who really knows what the implication of that will be? I don't think we've been at this point before," says Johannes.

Though Lacker may continue to voice his hawkish opinions, December's statement could be his last dissent for some time. Federal Reserve Bank presidents rotate on and off of the FOMC, and Richmond will not be back on the committee until 2015.