Fannie, Freddie, Ben, and the Dollar

As banking and financial stocks lead the overall indexes down into bear-market territory, Fed head Ben Bernanke and Treasury man Henry Paulson are testifying today before Barney Frank’s House Financial Services Committee on ways and means to reform all manner of bank and securities dealer supervision and regulation. This includes Fannie and Freddie, whose shares continue to plummet as investors doubt their solvency.

On this issue of Fannie and Freddie, which have become the central banks of housing, the matter boils down to this: Will it be an expansion of private capital or government capital to bail them out? The Wall Street Journal editorializes today on the need for government capital. I would prefer, at least at this point, that private capital do the job. There’s no question that these quasi- government agencies are in fact “too big to fail.” But before Congress gives them even more power to make more loans, somebody has got to resolve the question of how to bolster their balance sheets. And there really are just two choices: public or private money. Meanwhile, the Democratic idea that transaction-loan fees from Fannie and Freddie expansion should be siphoned off to finance the $300 billion FHA bailout bill is one hell of a bad idea.

Now, on the broader question of new financial regulation to backstop the banking system, it is noteworthy that as Paulson and Bernanke talked this morning the gold price jumped up $15. Is this a coincidence? I doubt it. Think of it this way: If the Fed becomes the financial-system stabilizer of last resort, as Bernanke suggested in a speech a few days ago, and if the Fed takes on yet another responsibility as the regulator of Wall Street investment banks, how will this agency be able to maintain price stability and a dependable dollar?

In other words, the Federal Reserve is already hobbled by a so-called dual mandate of maintaining low unemployment and low inflation. They haven’t done very well on this lately, as both targets have been rising rather than falling, while the dollar has been sinking in recent years. Now, if two more mandates are tacked on to the Fed’s mission, something is going to be sacrificed. And that something is likely to be price stability and a dependable dollar.

The gold price is signaling precisely this fear. Yesterday’s New York Sun editorial on this, undoubtedly penned by my friend Seth Lipsky, calls the Fed moves toward financial stabilizer and Wall Street regulator a “big power grab.” Well, maybe so. But if we keep heaping more and more responsibility on the Fed, then the original intent of that agency, which is to protect the value of the currency and keep prices stable, is assuredly going to fall by the wayside. That’s why Congress and the president and Mr. Paulson should think very hard on this whole idea that the Fed is the supreme being of economic central planning. I don’t think this is a good idea.