It’s no secret that the Fed is having a hard time controlling inflation. While it is failing at its primary duty, the Democrats are busy crafting executive orders, passing bills and proposing new legislation that will expand the list of goals the Fed must prioritize.
As it stumbles to meet its current mandates to maintain price stability, maximum employment and financial stability, Congress and the administration are asking it to also control greenhouse gas emissions, promote equal employment, income, wealth and affordable credit outcomes across racial and ethnic groups, and proposing that the Fed be required to issue a new central bank digital currency. This insanity must stop. The Fed already has too many conflicting mandates without adding new highly politicized ones. The Fed should focus on price stability.
In October 2021, dutifully complying with a May executive order, the Financial Stability Oversight Council (FSOC) issued a report claiming that climate change poses a systemic risk to the financial system. To counteract this risk, the FSOC proposed that its members, including the Federal Reserve System, “incorporate climate-related financial risk into their regulatory and supervisory activities.” The FSOC’s primary regulatory tool for accomplishing this is a, “scenario analysis conducted by regulators to measure risk across a broad set of institutions.”
Scenario analysis is a purely hypothetical modeling exercise where institutions have to simulate their profits and losses assuming some calamitous event occurs in the future. Financial regulators would specify the fictitious calamitous event as they do today in the stress test exercises the Fed imposes annually on large bank holding companies.
In the case of climate-change risk assessment, the scenario would involve a so-called transitional risk event where some unknown climate-change scare causes Congress to pass new laws negatively impacting greenhouse gas-intensive firms, or consumers to abandon activities that use fossil fuels. In these fictional scenarios, the impact of imaginary events inflicts severe distress on greenhouse gas-intensive firms, elevating their default risk. This purely conjectural default risk will trigger higher capital requirements and other regulatory restrictions for the financial institutions that own their debt or equity resulting in a higher cost and more limited access to capital for greenhouse-intensive firms.
Hypothetical scenario analysis was the basis for the FSOC’s global systemically important institution designation of Metlife, Inc. in 2014. The designation subjected Metlife to the Dodd-Franck Act’s enhanced prudential regulatory standards that applied to the largest U.S. bank holding companies. Metlife fought the designation in court and won arguing that the FSOC hypothetical scenario analysis had no basis in history or fact. As such, it was a violation of the arbitrary and capricious standard imposed by the Administrative Procedures Act. Climate-change scenario analysis will be based on scenarios that are purely imaginary with no basis in history and should be ruled illegal if courts follow the Metlife precedent.
On June 21, the House passed H.R. 2543, the Federal Reserve Racial and Economic Equity Act. The act requires that the Federal Reserve,” must carry out its duties in a manner that supports the elimination of racial and ethnic disparities in employment, income, wealth, and access to affordable credit.” The law applies to the Fed’s conduct of monetary policy, supervision and regulation of banks, thrifts, financial institution holding companies, systemically important financial institutions and financial market utilities designated by the FSOC. The Fed must report to Congress periodically on the steps it has taken and on its pending plans to achieve these new mandates.
The Fed should be tasked with promoting equal opportunity for all but a mandate…
Read More: Price stability is more than enough for the Fed — no new mandates