The battleground is the hearts and minds — and fears — of the seven people who make up the board of governors of the Federal Reserve System. The critical contest will be about bank capital and how large financial institutions should fund themselves. The fog of war has masked the terrain, so that even well-informed bank lobbyists don’t realize they have wandered into a potentially disadvantageous position.

It remains to be seen whether the Fed can make the most of this real opportunity for reform. Too many governors still seem encumbered by a flawed mental model of how mega banks work.

Read more at Bloomberg.

Those minutes included these words: “Many participants also expressed some concerns about potential costs and risks arising from further asset purchases.” Many?

“The FOMC has indicated that it will continue purchases until it observes a substantial improvement in the outlook for the labor market,” he said, making it clear that no such improvement has been seen. He also asserted that “the benefits of asset purchases, and of policy accommodation more generally, are clear: Monetary policy is providing important support to the recovery.”

Mr. Bernanke acknowledged that “highly accommodative monetary policy also has several potential costs and risks,” but he immediately and emphatically debunked them. Basically, he didn’t give an inch.

Read more at the Wall Street Journal

Unfortunately, when it came to discussing how to bring down this subsidy – and addressing the problem of “too big to fail” financial institutions – Mr. Bernanke’s answers were disappointing.

Mr. Bernanke was pressed hard on these topics by Senator Elizabeth Warren, a Massachusetts Democrat – you can watch a clip of their exchange. The concerns that Senator Warren expressed are shared by some across the aisle – including Senator David Vitter, a Louisiana Republican, who said at the hearing, “There is growing bipartisan concern across the whole political spectrum about the fact — I believe it’s a fact — that ‘too big to fail’ is alive and well.”

At the hearing, Mr. Bernanke readily conceded that there is a “too big to fail” subsidy, in the form of cheaper funds than big banks would otherwise receive, because market participants think the government provides some downside protection, i.e., implicit insurance that limits losses. Even after the Dodd-Frank financial reform legislation, the extent of implicit creditor protection remains high.

Read more at the New York Times.

Although they are arguing about the details, both President Obama and the Republican Congress have committed to another $1.5 trillion of deficit reduction over the next decade, just about guaranteeing a prolonged period of high unemployment, an under-performing economy, and flat or declining wages for most working people.

Consider this thoughtful speech by the Fed’s vice chairman, Janet Yellen, delivered last week at an event jointly sponsored by the AFL-CIO (!) and the German Social Democratic (!) Friedrich Ebert Foundation, titled “A Trans-Atlantic Agenda for Shared Prosperity.” It was light years more progressive than the sort of fiscal summits that the White House has blessed.

In the speech, Yellen began by reminding the audience that the Fed’s mandate is a society of high employment, not just low inflation, and she made several important points that seem to have eluded President Obama — all of which are implicit rebukes to the Administration’s fiscally deflationary approach to the recovery. Compared to all other postwar downturns, she said, “The Great Recession stands out both for the magnitude of the job losses that attended the downturn and for the weak recovery in employment that occurred after the recession ended.”

How come? First, Yellen reports, bad fiscal policy. In every other postwar recession, government helped the recovery along by increasing spending or cutting taxes, or both. But in this recession, the government has been more concerned to rein in deficits.

Read more at the Huffington Post.

The answer is Peggy Noonan, the prominent conservative commentator, writing recently in The Wall Street Journal.

As Timothy F. Geithner prepares to leave the Treasury Department, most assessments focus on how his policies affected the economy. But his lasting legacy may be more political, contributing to the creation of an issue that can now be seized either by the right or the left. What should be done about the too-big-to-fail category of financial institutions?

Mr. Geithner came to Treasury in the middle of a severe financial crisis, a set of problems that he helped to create and then worked hard to prevent from worsening. As president of the Federal Reserve Bank of New York, starting in 2003, he watched over – and failed to defuse – the buildup of systemic risk. In fact, the New York Fed was relatively on the side of allowing large, seemingly sophisticated financial institutions to fund themselves with more debt relative to their thin levels of equity.

This was a major conceptual mistake for which there still has not been a full accounting. In fact, blank denial continues to be the reaction from the relevant officials.

Mr. Geithner was also in the hot seat as more explicit government support for large financial institutions began in earnest in early 2008. The New York Fed brokered the sale of failing Bear Stearns to relatively healthy JPMorgan Chase, with the Fed providing substantial downside insurance to JPMorgan, against potential losses from assets they were acquiring.

Read more at the New York Times.

The implication is that Congress should relax and not push any additional changes, such as capping the size of our largest banks in a meaningful way or forcing them to simplify their legal structures. If regulators lack support on Capitol Hill, they won’t try as hard.

On Nov. 15, resistance to this industry view came from a surprising place: a speech by William Dudley, the president of the Federal Reserve Bank of New York. That institution isn’t usually associated with strong pro-reform positions, yet Dudley was unexpectedly forceful on three points.

First, he made clear that too big to fail remains with us. Some very large financial institutions receive implicit government subsidies in the form of downside protection (or at least the market’s perception that such protection exists). This insurance is free of charge and allows them to borrow more cheaply, and presumably encourages them to become even larger. Now, whenever someone questions the existence of these dangerous subsidies, I will cite Dudley’s speech.

Read more at Bloomberg.

His 1989 book Market Volatility (MIT Press) is a mathematical and behavioral analysis of price fluctuations in speculative markets. His 1993 book Macro Markets: Creating Institutions for Managing Society’s Largest Economic Risks (Oxford University Press) proposes a variety of new risk-management contracts, such as futures contracts in national incomes or securities based on real estate that would permit the management of risks to standards of living. His book Irrational Exuberance (Princeton 2000, Broadway Books 2001, 2nd edition Princeton 2005) is an analysis and explication of speculative bubbles, with special reference to the stock market and real estate. His book The New Financial Order: Risk in the 21st Century (Princeton University Press, 2003) is an analysis of an expanding role of finance, insurance, and public finance in our future. His book Subprime Solution: How the Global Financial Crisis Happened and What to Do about It, published in September 2008 by Princeton University Press, offers an analysis of the housing and economic crisis and a plan of action against it. He co-authored, with George A. Akerlof, Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism published in March 2009 by Princeton University Press. He co-authored with Randall Kroszner Reforming U.S. Financial Markets: Reflections before and beyond Dodd-Frank published in March 2011 by MIT Press.

Dr. Roubini has extensive policy experience as well as broad academic credentials. From 1998 to 2000, he served as the senior economist for international affairs on the White House Council of Economic Advisors and then as the senior advisor to the undersecretary for international affairs at the U.S. Treasury Department, helping to resolve the Asian and global financial crises. The International Monetary Fund, World Bank and numerous other prominent public and private institutions have drawn upon his consulting expertise.

He has published over 70 theoretical, empirical and policy papers on international macroeconomic issues and coauthored the books “Political Cycles: Theory and Evidence” (MIT Press, 1997) and “Bailouts or Bail-ins? Responding to Financial Crises in Emerging Markets” (Institute for International Economics, 2004) and “Crisis Economics: A Crash Course in the Future of Finance” (Penguin Press, 2010).

Dr. Roubini’s views on global economic issues are widely cited by the media, and he is a frequent commentator on various business news programs. He has been the subject of extended profiles in the New York Times Magazine and other leading current-affairs publications. The Financial Times has provided extensive coverage of Dr. Roubini’s perspectives.

“To the extent that a growing systemic footprint increases perceptions of at least some residual too-big-to-fail quality in such a firm, notwithstanding the panoply of measures in Dodd- Frank and our regulations, there may be funding advantages for the firm, which reinforces the impulse to grow,” he said in a speech at the University of Pennsylvania Law School. “There is, then, a case to be made for specifying an upper bound.”

She is a Research Scholar at the Levy Economics Institute of Bard College. Dr. Kelton has a B.S. in Business Finance and a B.A. in Economics, both from California State University, Sacramento(1995). After finishing her undergraduate degrees, she completed an M.Phil in Economics at Cambridge University, England(1997). She then spent a year at The Levy Economics Institute on a fellowship she won through Christ’s College, Cambridge.

While at the Levy Institute, she wrote a number of papers that became part of her Ph.D. dissertation at the New School for Social Research (April 2001), titled Public Policy and Government Finance: A Comparative Analysis Under Different Monetary Systems. She is creator and editor of New Economic Perspectives, a top-ranked economics blog, and has been featured in: Common Dreams, Business Insider, Truthdig, Counter Punch, Wall St. Pit, Credit Writedowns, and many more.

At the most recent meeting of its policy-setting Open Market Committee, Aug. 7, the Fed declined to lower interest rates further, under pressure from inflation hawks. The vote to keep rates at their present level was only 7-3, with the dissenters favoring tighter money.

But raising interest rates now or any time in the near future would be insane, since the underlying economy remains very weak. Any increase on food prices will reflect heat waves, factory farming, and of course global climate change — not the price pressures of a recovery.

If you think the Fed would not be so crazy as to tighten money because of a drought, think again. In the 1970s, inflation was the result of price spikes in key sectors — energy, food, health care, and housing. It was emphatically not the result of macroeconomic overheating, the classic reason for the Fed to damp down the economy with higher interest rates.

Read more at The Huffington Post.

At the most recent meeting of its policy-setting Open Market Committee, Aug. 7, the Fed declined to lower interest rates further, under pressure from inflation hawks. The vote to keep rates at their present level was only 7-3, with the dissenters favoring tighter money.

But raising interest rates now or any time in the near future would be insane, since the underlying economy remains very weak. Any increase on food prices will reflect heat waves, factory farming, and of course global climate change — not the price pressures of a recovery.

If you think the Fed would not be so crazy as to tighten money because of a drought, think again. In the 1970s, inflation was the result of price spikes in key sectors — energy, food, health care, and housing. It was emphatically not the result of macroeconomic overheating, the classic reason for the Fed to damp down the economy with higher interest rates.

Read more at The Huffington Post

Last month, Federal Reserve Board Chairman Ben Bernanke gave testimony before Congress in which he said that he had become aware of evidence that banks in the UK were rigging the Libor – the inter-bank lending rate and one of the primary benchmarks for short-term interest rates – in the autumn of 2008. According to Bernanke, he called this to the attention of Mervyn King, the head of the Bank of England. Apparently Mervyn King did nothing, since the rigging continued, but Bernanke told Congress there was nothing more that he could do.

Read more at AlJazeera.

Consider the new U.S. unemployment announcement. If you are a college graduate, there is no employment crisis. 72.7 percent of the college-educated population age-25 and over is working. The unemployment rate is 4.1 percent. Incomes are good.

If you have less than a high-school diploma, however, you are barely scrapping by. Only 40.4 percent of those without a high-school diploma have a job. Their unemployment rate is 12.7 percent. Incomes are too low to make ends meet.

There are two Americas: the college-educated crowd that may have taken a hit in their retirement accounts, but who are generally doing well. Then there are the rest, around 60 percent of the population, who are increasingly dropping out of the middle class. Nearly one-half of American households are now classified as low-income, within twice the poverty line.

Read more at Huffington Post.

I’d have to disagree with that assessment. The household survey is far more erratic than the establishment survey. For example, it shows a jump of 422,000 jobs in May. Anyone remember that boom? Last June it reported a drop of 423,000. In August and September the household survey showed a combined gain of 657,000 jobs at a time when many news accounts were debating the likelihood of a double-dip recession.

Read more at Business Insider.