An institutional flaw at the heart of the federal reserve

Published: Friday, June 22 2012 12:00 a.m. MDT

Our take: The ever brilliant Simon Johnson argues for why the governance rules of the New York Federal Reserve that helped launch the central bank 100 years ago no longer work in a world of too-big-to-fail banks.

This is partly an anachronistic holdover from the original Federal Reserve Act of 1913 – and reflects the political milieu of that time, in which bankers had to be persuaded to accept a central bank . . . But it is also an all-too-accurate reflection of where we stand today with regard to global mega-banks and the large, nontransparent and highly dangerous subsidies they extract from the rest of society by being too big to fail.

The people who run global mega-banks get the upside when things go well – they are paid based on their return on equity unadjusted for risk, so they prefer a lot of debt piled on top of very little equity. When things go badly, the downside is someone else’s problem – in the first instance, typically, the Federal Reserve’s.

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