http://www.huffingtonpost.com/2009/09/07/priceless-how-the-federal_n_278805.html
The Huffington Post
September 9, 2009
The Federal Reserve, through its extensive network of consultants,
visiting scholars, alumni and staff economists, so thoroughly dominates
the field of economics that real criticism of the central bank has
become a career liability for members of the profession, an
investigation by the Huffington Post has found.
This dominance helps explain how, even after the Fed failed to foresee
the greatest economic collapse since the Great Depression, the central
bank has largely escaped criticism from academic economists. In the
Fed's thrall, the economists missed it, too.
"The Fed has a lock on the economics world," says Joshua Rosner, a Wall
Street analyst who correctly called the meltdown. "There is no room for
other views, which I guess is why economists got it so wrong."
One critical way the Fed exerts control on academic economists is
through its relationships with the field's gatekeepers. For instance, at
the Journal of Monetary Economics, a must-publish venue for rising
economists, more than half of the editorial board members are currently
on the Fed payroll -- and the rest have been in the past.
The Fed failed to see the housing bubble as it happened, insisting that
the rise in housing prices was normal. In 2004, after "flipping" had
become a term cops and janitors were using to describe the way to get
rich in real estate, then-Federal Reserve Chairman Alan Greenspan said
that "a national severe price distortion [is] most unlikely." A year
later, current Chairman Ben Bernanke said that the boom "largely reflect
strong economic fundamentals."
The Fed also failed to sufficiently regulate major financial
institutions, with Greenspan -- and the dominant economists -- believing
that the banks would regulate themselves in their own self-interest.
Despite all this, Bernanke has been nominated for a second term by
President Obama.
In the field of economics, the chairman remains a much-heralded figure,
lauded for reaction to a crisis generated, in the first place, by the
Fed itself. Congress is even considering legislation to greatly expand
the powers of the Fed to systemically regulate the financial industry.
Story continues below
Paul Krugman, in Sunday's New York Times magazine, did his own autopsy
of economics, asking "How Did Economists Get It So Wrong?" Krugman
concludes that "[e]conomics, as a field, got in trouble because
economists were seduced by the vision of a perfect, frictionless market
system."
So who seduced them?
The Fed did it.
Three Decades of Domination
The Fed has been dominating the profession for about three decades. "For
the economics profession that came out of the [second world] war, the
Federal Reserve was not a very important place as far as they were
concerned, and their views on monetary policy were not framed by a
working relationship with the Federal Reserve. So I would date it to
maybe the mid-1970s," says University of Texas economics professor --
and Fed critic -- James Galbraith. "The generation that I grew up under,
which included both Milton Friedman on the right and Jim Tobin on the
left, were independent of the Fed. They sent students to the Fed and
they influenced the Fed, but there wasn't a culture of consulting, and
it wasn't the same vast network of professional economists working there."
But by 1993, when former Fed Chairman Greenspan provided the House
banking committee with a breakdown of the number of economists on
contract or employed by the Fed, he reported that 189 worked for the
board itself and another 171 for the various regional banks. Adding in
statisticians, support staff and "officers" -- who are generally also
economists -- the total number came to 730. And then there were the
contracts. Over a three-year period ending in October 1994, the Fed
awarded 305 contracts to 209 professors worth a total of $3 million.
Just how dominant is the Fed today?
The Federal Reserve's Board of Governors employs 220 PhD economists and
a host of researchers and support staff, according to a Fed spokeswoman.
The 12 regional banks employ scores more. (HuffPost placed calls to them
but was unable to get exact numbers.) The Fed also doles out millions of
dollars in contracts to economists for consulting assignments, papers,
presentations, workshops, and that plum gig known as a "visiting
scholarship." A Fed spokeswoman says that exact figures for the number
of economists contracted with weren't available. But, she says, the
Federal Reserve spent $389.2 million in 2008 on "monetary and economic
policy," money spent on analysis, research, data gathering, and studies
on market structure; $433 million is budgeted for 2009.
That's a lot of money for a relatively small number of economists.
According to the American Economic Association, a total of only 487
economists list "monetary policy, central banking, and the supply of
money and credit," as either their primary or secondary specialty; 310
list "money and interest rates"; and 244 list "macroeconomic policy
formation [and] aspects of public finance and general policy." The
National Association of Business Economists tells HuffPost that 611 of
its roughly 2,400 members are part of their "Financial Roundtable," the
closest way they can approximate a focus on monetary policy and central
banking.
Robert Auerbach, a former investigator with the House banking committee,
spent years looking into the workings of the Fed and published much of
what he found in the 2008 book, "Deception
and Abuse at the Fed". A chapter in that book, excerpted here, provided
the impetus for this investigation.
Auerbach found that in 1992, roughly 968 members of the AEA designated
"domestic monetary and financial theory and institutions" as their
primary field, and 717 designated it as their secondary field. Combining
his numbers with the current ones from the AEA and NABE, it's fair to
conclude that there are something like 1,000 to 1,500 monetary
economists working across the country. Add up the 220 economist jobs at
the Board of Governors along with regional bank hires and contracted
economists, and the Fed employs or contracts with easily 500 economists
at any given time. Add in those who have previously worked for the Fed
-- or who hope to one day soon -- and you've accounted for a very
significant majority of the field.
Auerbach concludes that the "problems associated with the Fed's
employing or contracting with large numbers of economists" arise "when
these economists testify as witnesses at legislative hearings or as
experts at judicial proceedings, and when they publish their research
and views on Fed policies, including in Fed publications."
Gatekeepers On The Payroll
The Fed keeps many of the influential editors of prominent academic
journals on its payroll. It is common for a journal editor to review
submissions dealing with Fed policy while also taking the bank's money.
A HuffPost review of seven top journals found that 84 of the 190
editorial board members were affiliated with the Federal Reserve in one
way or another.
"Try to publish an article critical of the Fed with an editor who works
for the Fed," says Galbraith. And the journals, in turn, determine which
economists get tenure and what ideas are considered respectable.
The pharmaceutical industry has similarly worked to control key medical
journals, but that involves several companies. In the field of
economics, it's just the Fed.
Being on the Fed payroll isn't just about the money, either. A
relationship with the Fed carries prestige; invitations to Fed
conferences and offers of visiting scholarships with the bank signal a
rising star or an economist who has arrived.
Affiliations with the Fed have become the oxygen of academic life for
monetary economists. "It's very important, if you are tenure track and
don't have tenure, to show that you are valued by the Federal Reserve,"
says Jane D'Arista, a Fed critic and an economist with the Political
Economy Research Institute at the University of Massachusetts, Amherst.
Robert King, editor in chief of the Journal of Monetary Economics and a
visiting scholar at the Richmond Federal Reserve Bank, dismisses the
notion that his journal was influenced by its Fed connections. "I think
that the suggestion is a silly one, based on my own experience at
least," he wrote in an e-mail. (His full response is at the bottom.)
Galbraith, a Fed critic, has seen the Fed's influence on academia first
hand. He and co-authors Olivier Giovannoni and Ann Russo found that in
the year before a presidential election, there is a significantly
tighter monetary policy coming from the Fed if a Democrat is in office
and a significantly looser policy if a Republican is in office. The
effects are both statistically significant, allowing for controls, and
economically important.
They submitted a paper with their findings to the Review of Economics
and Statistics in 2008, but the paper was rejected. "The editor assigned
to it turned out to be a fellow at the Fed and that was after I
requested that it not be assigned to someone affiliated with the Fed,"
Galbraith says.
Publishing in top journals is, like in any discipline, the key to
getting tenure. Indeed, pursuing tenure ironically requires a kind of
fealty to the dominant economic ideology that is the precise opposite of
the purpose of tenure, which is to protect academics who present
oppositional perspectives.
And while most academic disciplines and top-tier journals are controlled
by some defining paradigm, in an academic field like poetry, that
situation can do no harm other than to, perhaps, a forest of trees.
Economics, unfortunately, collides with reality -- as it did with the
Fed's incorrect reading of the housing bubble and failure to regulate
financial institutions. Neither was a matter of incompetence, but both
resulted from the Fed's unchallenged assumptions about the way the
market worked.
Even the late Milton Friedman, whose monetary economic theories heavily
influenced Greenspan, was concerned about the stifled nature of the
debate. Friedman, in a 1993 letter to Auerbach that the author quotes in
his book, argued that the Fed practice was harming objectivity: "I
cannot disagree with you that having something like 500 economists is
extremely unhealthy. As you say, it is not conducive to independent,
objective research. You and I know there has been censorship of the
material published. Equally important, the location of the economists in
the Federal Reserve has had a significant influence on the kind of
research they do, biasing that research toward noncontroversial
technical papers on method as opposed to substantive papers on policy
and results," Friedman wrote.
Greenspan told Congress in October 2008 that he was in a state of
"shocked disbelief" and that the "whole intellectual edifice" had
"collapsed." House Committee on Oversight and Government Reform Chairman
Henry Waxman (D-Calif.) followed up: "In other words, you found that
your view of the world, your ideology, was not right, it was not working."
"Absolutely, precisely," Greenspan replied. "You know, that's precisely
the reason I was shocked, because I have been going for 40 years or more
with very considerable evidence that it was working exceptionally well."
But, if the intellectual edifice has collapsed, the intellectual
infrastructure remains in place. The same economists who provided
Greenspan his "very considerable evidence" are still running the
journals and still analyzing the world using the same models that were
incapable of seeing the credit boom and the coming collapse.
Rosner, the Wall Street analyst who foresaw the crash, says that the
Fed's ideological dominance of the journals hampered his attempt to warn
his colleagues about what was to come. Rosner wrote a strikingly
prescient paper in 2001 arguing that relaxed lending standards and other
factors would lead to a boom in housing prices over the next several
years, but that the growth would be highly susceptible to an economic
disruption because it was fundamentally unsound.
He expanded on those ideas over the next few years, connecting the dots
and concluding that the coming housing collapse would wreak havoc on the
collateralized debt obligation (CDO) and mortgage backed securities
(MBS) markets, which would have a ripple effect on the rest of the
economy. That, of course, is exactly what happened and it took the Fed
and the economics field completely by surprise.
"What you're doing is, actually, in order to get published, having to
whittle down or narrow what might otherwise be oppositional or
expansionary views," says Rosner. "The only way you can actually get in
a journal is by subscribing to the views of one of the journals."
When Rosner was casting his paper on CDOs and MBSs about, he knew he
needed an academic economist to co-author the paper for a journal to
consider it. Seven economists turned him down.
"You don't believe that markets are efficient?" he says they asked,
telling him the paper was "outside the bounds" of what could be
published. "I would say 'Markets are efficient when there's equal access
to information, but that doesn't exist,'" he recalls.
The CDO and MBS markets froze because, as the housing market crashed,
buyers didn't trust that they had reliable information about them --
precisely the case Rosner had been making.
He eventually found a co-author, Joseph Mason, an associate Professor of
Finance at Drexel University LeBow College of Business, a senior fellow
at the Wharton School, and a visiting scholar at the Federal Deposit
Insurance Corporation. But the pair could only land their papers with
the conservative Hudson Institute. In February 2007, they published a
paper called "How Resilient Are Mortgage Backed Securities to
Collateralized Debt Obligation Market Disruptions?" and in May posted
another, "How Misapplied Bond Ratings Cause Mortgage Backed Securities
and Collateralized Debt Obligation Market Disruptions."
Together, the two papers offer a better analysis of what led to the
crash than the economic journals have managed to put together - and they
were published by a non-PhD before the crisis.
Not As Simple As A Pay-Off
Economist Rob Johnson serves on the UN Commission of Experts on Finance
and International Monetary Reform and was a top economist on the Senate
banking committee under both a Democratic and Republican chairman. He
says that the consulting gigs shouldn't be looked at "like it's a
payoff, like money. I think it's more being one of, part of, a club --
being respected, invited to the conferences, have a hearing with the
chairman, having all the prestige dimensions, as much as a paycheck."
The Fed's hiring of so many economists can be looked at in several ways,
Johnson says, because the institution does, of course, need talented
analysts. "You can look at it from a telescope, either direction. One,
you can say well they're reaching out, they've got a big budget and what
they're doing, I'd say, is canvassing as broad a range of talent," he
says. "You might call that the 'healthy hypothesis.'"
The other hypothesis, he says, "is that they're essentially using
taxpayer money to wrap their arms around everybody that's a critic and
therefore muffle or silence the debate. And I would say that probably
both dimensions are operative, in reality."
To get a mainstream take, HuffPost called monetary economists at random
from the list as members of the AEA. "I think there is a pretty good
number of professors of economics who want a very limited use of
monetary policy and I don't think that that necessarily has a negative
impact on their careers," said Ahmed Ehsan, reached at the economics
department at James Madison University. "It's quite possible that if
they have some new ideas, that might be attractive to the Federal Reserve."
Ehsan, reflecting on his own career and those of his students, allowed
that there is, in fact, something to what the Fed critics are saying. "I
don't think [the Fed has too much influence], but then my area is
monetary economics and I know my own professors, who were really well
known when I was at Michigan State, my adviser, he ended up at the St.
Louis Fed," he recalls. "He did lots of work. He was a product of the
time...so there is some evidence, but it's not an overwhelming thing."
There's definitely prestige in spending a few years at the Fed that can
give a boost to an academic career, he added. "It's one of the better
career moves for lots of undergraduate students. It's very competitive."
Press officers for the Federal Reserve's board of governors provided
some background information for this article, but declined to make
anyone available to comment on its substance.
The Fed's Intolerance For Dissent
When dissent has arisen, the Fed has dealt with it like any other
institution that cherishes homogeneity.
Take the case of Alan Blinder. Though he's squarely within the
mainstream and considered one of the great economic minds of his
generation, he lasted a mere year and a half as vice chairman of the
Fed, leaving in January 1996.
Rob Johnson, who watched the Blinder ordeal, says Blinder made the
mistake of behaving as if the Fed was a place where competing ideas and
assumptions were debated. "Sociologically, what was happening was the
Fed staff was really afraid of Blinder. At some level, as an applied
empirical economist, Alan Blinder is really brilliant," says Johnson.
In closed-door meetings, Blinder did what so few do: challenged
assumptions. "The Fed staff would come out and their ritual is:
Greenspan has kind of told them what to conclude and they produce
studies in which they conclude this. And Blinder treated it more like an
open academic debate when he first got there and he'd come out and say,
'Well, that's not true. If you change this assumption and change this
assumption and use this kind of assumption you get a completely
different result.' And it just created a stir inside--it was sort of
like the whole pipeline of Greenspan-arriving-at-decisions was
disrupted."
It didn't sit well with Greenspan or his staff. "A lot of senior
staff...were pissed off about Blinder -- how should we say? -- not
playing by the customs that they were accustomed to," Johnson says.
And celebrity is no shield against Fed excommunication. Paul Krugman, in
fact, has gotten rough treatment. "I've been blackballed from the Fed
summer conference at Jackson Hole, which I used to be a regular at, ever
since I criticized him," Krugman said of Greenspan in a 2007 interview
with Pacifica Radio's Democracy Now! "Nobody really wants to cross him."
An invitation to the annual conference, or some other blessing from the
Fed, is a signal to the economic profession that you're a certified
member of the club. Even Krugman seems a bit burned by the slight. "And
two years ago," he said in 2007, "the conference was devoted to a field,
new economic geography, that I invented, and I wasn't invited."
Three years after the conference, Krugman won a Nobel Prize in 2008 for
his work in economic geography.
One Journal, In Detail
The Huffington Post reviewed the mastheads of the American Journal of
Economics, the Journal of Economic Perspectives, Journal of Economic
Literature, the American Economic Journal: Applied Economics, American
Economic Journal: Economic Policy, the Journal of Political Economy and
the Journal of Monetary Economics.
HuffPost interns Googled around looking for resumes and otherwise
searched for Fed connections for the 190 people on those mastheads. Of
the 84 that were affiliated with the Federal Reserve at one point in
their careers, 21 were on the Fed payroll even as they served as
gatekeepers at prominent journals.
At the Journal of Monetary Economics, every single member of the
editorial board is or has been affiliated with the Fed and 14 of the 26
board members are presently on the Fed payroll.
After the top editor, King, comes senior associate editor Marianne
Baxter, who has written papers for the Chicago and Minneapolis banks and
was a visiting scholar at the Minneapolis bank in '84, '85, at the
Richmond bank in '97, and at the board itself in '87. She was an advisor
to the president of the New York bank from '02-'05. Tim Geithner, now
the Treasury Secretary, became president of the New York bank in '03.
The senior associate editors: Janice C Eberly was a Fed visiting-scholar
at Philadelphia ('94), Minneapolis ('97) and the board ('97). Martin
Eichenbaum has written several papers for the Fed and is a consultant to
the Chicago and Atlanta banks. Sergio Rebelo has written for and was
previously a consultant to the board. Stephen Williamson has written for
the Cleveland, Minneapolis and Richmond banks, he worked in the
Minneapolis bank's research department from '85-'87, he's on the
editorial board of the Federal Reserve Bank of St. Louis Review, is the
co-organizer of the '09 St. Louis Federal Reserve Bank annual economic
policy conference and the co-organizer of the same bank's '08 conference
on Money, Credit, and Policy, and has been a visiting scholar at the
Richmond bank ever since '98.
And then there are the associate editors. Klaus Adam is a visiting
scholar at the San Francisco bank. Yongsung Chang is a research
associate at the Cleveland bank and has been working with the Fed in one
position or another since '01. Mario Crucini was a visiting scholar at
the Federal Reserve Bank of New York in '08 and has been a senior fellow
at the Dallas bank since that year. Huberto Ennis is a senior economist
at the Federal Reserve Bank of Richmond, a position he's held since '00.
Jonathan Heathcote is a senior economist at the Minneapolis bank and has
been a visiting scholar three times dating back to '01.
Ricardo Lagos is a visiting scholar at the New York bank, a former
senior economist for the Minneapolis bank and a visiting scholar at that
bank and Cleveland's. In fact, he was a visiting scholar at both the
Cleveland and New York banks in '07 and '08. Edward Nelson was the
assistant vice president of the St Louis bank from '03-'09.
Esteban Rossi-Hansberg was a visiting scholar at the Philadelphia bank
from '05-'09 and similarly served at the Richmond, Minneapolis and New
York banks.
Pierre-Daniel Sarte is a senior economist at the Richmond bank, a
position he's held since '96. Frank Schorfheide has been a visiting
scholar at the Philadelphia bank since '03 and at the New York bank
since '07. He's done four such stints at the Atlanta bank and scholared
for the board in '03. Alexander Wolman has been a senior economist at
the Richmond bank since 1989.
Here is the complete response from King, the journal's editor in chief:
"I think that the suggestion is a silly one, based on my own experience
at least. In a 1988 article for AEI later republished in the Federal
Reserve Bank of Richmond Review, Marvin Goodfriend (then at FRB Richmond
and now at Carnegie Mellon) and I argued that it was very important for
the Fed to separate monetary policy decisions (setting of interest
rates) and banking policy decisions (loans to banks, via the discount
window and otherwise). We argued further that there was little positive
case for the Fed to be involved in the latter: broadbased liquidity
could always be provided by the former. We also argued that moral hazard
was a cost of banking intervention.
"Ben Bernanke understands this distinction well: he and other members of
the FOMC have read my perspective and sometimes use exactly this
distinction between monetary and banking policies. In difficult times,
Bernanke and his fellow FOMC members have chosen to involve the Fed in
major financial market interventions, well beyond the traditional
banking area, a position that attracts plenty of criticism and support.
JME and other economics major journals would certainly publish exciting
articles that fell between these two distinct perspectives: no
intervention and extensive intervention. An upcoming Carnegie-Rochester
conference, with its proceeding published in JME, will host a debate on
'The Future of Central Banking'.
"You may use only the entire quotation above or no quotation at all."
Auerbach, shown King's e-mail, says it's just this simple: "If you're on
the Fed payroll there's a conflict of interest."
Elyse Siegel, Julian Hattem, Jeff Muskus and Jenna Staul contributed to
this report
Ryan Grim is the author of This Is Your Country On Drugs: The Secret
History of Getting High in America
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