Fed gets political with market interventions, Volcker warns

Volcker Says Fed's Market Interventions Risk 'Political Battles'

By Craig Torres
Bloomberg News Service
Wednesday, May 14, 2008

http://www.bloomberg.com/apps/news?pid=20601087&sid=a0gtQpItabH0&refer=home

WASHINGTON -- Former Federal Reserve Chairman Paul Volcker says the central bank's interventions in securities markets have raised political questions, and warned that the Fed's independence is critical for setting interest rates.

"Recent events" have spurred a "significant question for central banking," Volcker said in prepared testimony to the congressional Joint Economic Committee in Washington today. "Intervention in a broad range of credit-market instruments may imply official support for a particular sector of the market or the economy."

The Fed has created three new instruments since December to alleviate credit strains, including direct loans to nonbanks for the first time since the Great Depression. Chairman Ben S. Bernanke and his colleagues also aided the takeover of Bear Stearns Cos. by JPMorgan Chase & Co. and took on mortgage and other securities as collateral from securities firms.

Fed policy makers' support for specific credit markets "throws them into political battles," Volcker warned in a brief interview before the hearing. In his testimony, he said that "independence is integral to the central responsibility of the Federal Reserve" for "the conduct of monetary policy."

Volcker, 80, served as Fed chairman from 1979 to 1987, and is credited with halting runaway inflation. He was succeeded by Alan Greenspan, who retired in January 2006.

Bernanke, 54, said yesterday that financial markets remain unsettled and the central bank will increase its auctions of cash to banks as needed.

While markets have improved, they remain "far from normal," Bernanke said in a speech to an Atlanta Fed conference at Sea Island, Georgia. "We stand ready to increase the size of the auctions if further warranted by financial developments."

The flight from risk since August has made financial institutions reluctant to lend to each other, driving up banks' borrowing costs.

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