The chairman of the Senate Banking Committee, a Connecticut Democrat, today unveiled a plan to take most oversight of banks away from the Federal Reserve and gives it to a new bank regulator.

Sen. Christopher Dodd announces his proposals for financial regulations on Tuesday. (Associated Press)

By a 2-to-1 margin, economists said the U.S. shouldn’t adopt a system where financial regulation is separate from the central bank. The results come from the Journal’s November forecasting survey, the full results of which will be released Thursday. “The Fed needs more, not less, access to the actual working of financial markets to set policy appropriately, and preserving their regulatory role is one way of them gaining that information,” said Diane Swonk of Mesirow Financial. The Fed sees it similarly.

Other economists pointed to failures in the U.K., which has a system that separates the Bank of England from the nation’s regulator, the Financial Services Authority. “The U.K. banking crisis has been much worse than the U.S.,” according to Stephen Stanley, chief economist at RBS Securities.

The minority of economists who supported the plan said that the current system risks politicization of the Fed, and some highlighted regulatory failures leading up to the financial crisis. “The central bank did poorly on regulation under [former Fed Chairman Alan] Greenspan and [current Fed Chairman Ben] Bernanke,” said Allen Sinai of Decision Economics.

At a press conference, Sen. Dodd, who is up for reelection in 2010, said, “I really want the Federal Reserve to get back to its core enterprises, in a sense, to do what it’s designed to do — monetary policy, dealing obviously with the lender of last resort, the payment system. Those are what they are designed to do. We saw over the last number of years when they took on consumer protection responsibility and regulation of bank holding companies it was an abysmal failure. The idea that we are going to go back and expand those roles and functions at the expense of losing the vitality and core functions that they are designed to perform, I think is going in the wrong direction.”

Dodd added: “It’s not designed to basically punish the Federal Reserve, but rather to enhance their role and their independence, by the way. I feel very strongly about the central ingredient in the Fed’s strength and that is its independence. You start loading up the Fed with additional responsibilities, and that independence could be threatened.”

Bernanke

Mr. Bernanke’s current term expires at the end of January.

At a press conference to discuss his legislation overhauling financial-market rules, which takes away power from the central bank, Sen. Dodd said Mr. Bernanke was someone he had “great admiration for” and thinks “is doing a terrific job.”

Asked by a reporter after the press conference if he thought Mr. Bernanke would be confirmed by Christmas, Mr. Dodd replied, “I think so.”

Mr. Bernanke was nominated for the new term by President Obama several months ago. Hearings are expected in early December. Mr. Bernanke must be confirmed by Mr. Dodd’s panel before facing a full vote on the Senate floor.

Yellen

The strength and durability of the expansion is in question. Some of the rebound is due to temporary government programs and a swing in inventory investment that will not provide an ongoing source of growth. Financial conditions have improved markedly in some respects, but many financial institutions are still hobbled with bad loans. The outlook for consumer spending is in doubt because households remain burdened with debt, and they have taken enormous hits to their wealth from declines in house and stock prices in recent years…

As the impetus from government programs and inventories diminishes in the quarters ahead, private final demand will have to fill the breach. The danger is that demand may grow at too anemic a pace to support vigorous expansion.

First, it may take quite a while for financial institutions to heal to the point that normal credit flows are restored. The credit crunch hasn’t entirely gone away…

Second, households have been pummeled and prospects for consumer spending are cloudy. Consumers have surprised us in the past with their free-spending ways and it’s not out of the question that they will do so again. But I wouldn’t count on them leading a strong recovery…

Weakness in the labor market is another factor that may keep the recovery sluggish for quite some time… The U.S. experienced so-called jobless recoveries following the previous two recessions in 1991 and 2001, when job creation remained weak for several years following the business cycle trough. In both cases, output growth was less robust than in the typical recovery and, unfortunately, things seem to be shaping up similarly this time around…

When we turn to commercial real estate, the prospects are worrisome. Commercial property didn’t turn down until well after housing did. The sector’s problems appear to stem in large part from the effects of the recession and the credit crunch, rather than the type of building boom and lax underwriting standards that tripped up housing. Still, there are some parallels between the two sectors. As in the residential market, commercial real estate values posted enormous price gains, with office values roughly doubling from the end of the 2001 recession to the peak. Since then, values have plunged an estimated 35 to 40 percent and vacancy rates are rising for office, retail, warehouse, and other income-producing properties…

This brings me to inflation, a topic that has been hotly debated. Some people worry about the long-term inflationary implications of sustained federal budget deficits. Others fear that economic slack and downward wage pressure are pushing inflation below rates that are consistent with price stability. I am in the second camp. Persistent large budget deficits may be harmful once the economy recovers because they are apt to boost interest rates and absorb private savings that would otherwise finance productive investments. But experience teaches us that budget deficits do not cause inflation in advanced economies with independent central banks that pursue appropriate monetary policies…

I believe that the more significant threat to price stability over the next several years stems from enormous slack in the economy that is pushing inflation lower. Today, inflation is already very low… And with slack likely to persist for years and wages barely rising, it seems probable that core inflation will move even lower over the next few years.

Here’s some quick takeaways from the “Restoring American Financial Stability Act of 2009” — more to come:

1) The bill would create the Financial Institutions Regulatory Administration, which would essentially handle all regulation of banks at the national level.

2) The bill would create a Consumer Financial Protection Agency.

3) The bill would create an Agency for Financial Stability, chaired by a White House appointee who is subject to Senate confirmation.

a. The board would this agency would include the Treasury Secretary, the Federal Reserve Chairman, the head of the Financial Institutions Regulatory Administration, head of the Consumer Financial Protection Agency, head of the Securities and Exchange Commission, head of the Federal Deposit Insurance Corp., head of the Commodity Futures Trading Commission, and an independent member picked by the White House.
b. This agency would identify systemic risks to the economy, promote market discipline, and respond to emerging risks.

c. It will have the power to require companies to face enhanced supervision.
d. It will also be able to write regulations setting risk-based capital, leverage, and liquidity requirements for larger companies.

Lockhart

I believe an economic recovery is under way. It probably started in the summer…

The situation is much improved, but there are sobering aspects of the economic picture. Let me cite two.

First, the economy has been supported and stimulated by several government programs. Appropriately, these programs are temporary. However, they are at various stages of removal or extension…

A second reason to strike a note of caution about the economic picture is that both the data and anecdotal descriptions of ground-level reality are quite mixed. Data on foreclosures, unemployment, personal income, and bank failures continue to disappoint. Also, nonresidential construction continues to decline, and state and local government budgets remain severely constrained…

Despite marked improvements in financial markets from a year ago and improved flow of private capital to banks in recent months, the banking system has not fully recovered — far from it. Bank credit losses are still climbing, and many banks are still capital constrained. It almost goes without saying that recovery of the banking system is crucial to the recovery of the overall economy…

While the [commercial real estate] problem is serious for parts of the banking industry, I don’t believe it poses a broad risk to the financial system. Compared with residential real estate, the size of the [commercial real estate] debt market is smaller, and the exposure is more concentrated in smaller banks.

However, I am concerned about the potential impact of CRE on the broader economy. Unlike residential real estate, there is not the same direct linkage from CRE to household wealth — and therefore consumption — caused by erosion of home equity. However, there could be an impact resulting from small banks’ impaired ability to support the small business sector — a sector I expect will be critically important to job creation…

It’s appropriate to be a bit tentative in the assessment of CRE risk to the financial system, however. In 2007, many underestimated the scale and contagion potential of the subprime residential mortgage-backed securities problem. With this experience in mind, my assessment should continue to be refined.

• Bubble Risk: In the Financial Times, former Fed governor Frederic Mishkin says not all bubbles present a risk to the economy. “The second category of bubble, what I call the “pure irrational exuberance bubble”, is far less dangerous because it does not involve the cycle of leveraging against higher asset values. Without a credit boom, the bursting of the bubble does not cause the financial system to seize up and so does much less damage. For example, the bubble in technology stocks in the late 1990s was not fuelled by a feedback loop between bank lending and rising equity values; indeed, the bursting of the tech-stock bubble was not accompanied by a marked deterioration in bank balance sheets. This is one of the key reasons that the bursting of the bubble was followed by a relatively mild recession. Similarly, the bubble that burst in the stock market in 1987 did not put the financial system under great stress and the economy fared well in its aftermath.”
• Consumption: On Econbrowser, Menzie Chinn looks at per capita consumption. “Consumption (as well as disposable income) were higher [in the third quarter] than they were a year ago. Since we’re concerned with living standards, as opposed to economic activity, I thought it of interest to look at per capita consumption. Since population is available only on quarterly basis, I compare consumption per capita in 2009Q3 to that in 2008Q3. Per capita consumption is 0.3 percent (in log terms) below the level in 2008Q3. Moreover, per capita consumption is 6.5 percent below the 1967Q1-09Q3 trend (which grows at 2.9 percent per annum).Is that a disaster? Maybe not. But one wonders how much lower per capita consumption would have been in the absence of the actions undertaken by fiscal and monetary authorities around the world.”
• Larry Summers: William D. Cohan profiles Larry Summers in Vanity Fair. “Sheryl Sandberg, the chief operating officer of Facebook, was Summers’s chief of staff for four years at the Treasury Department and also worked for him at the World Bank. She, too, thinks Summers has been unfairly criticized over the years. “I think his directness is a huge asset,” she says. “You always know exactly where you stand with Larry. He pulls no punches. He does nothing behind your back. He literally tells you to your face, if you are working for him and if he thinks you did a great job, he says, ‘You did a great job.’ If he thinks you did a bad job, he says, ‘Try harder and let me help you try harder. I don’t think you quite understood what you needed to do here. Let me help you.’?” But not everyone in Summers’s high-powered circle thinks he is misunderstood. For instance, Tim Geithner, the Treasury secretary: “Larry has not had the jobs he’s had because he’s misunderstood. He’s had them because some of the best leaders in our country understand quite well how much he has to offer.””

Compiled by Phil Izzo

A parent’s job loss increases the probability that a child repeats a grade in school by roughly 15%, according to a new paper from two economics professors at the University of California, Davis.

“If we view grade repetition as a signal of academic difficulties, these short-run effects may be consistent with findings of longer-term negative outcomes in education and earnings,” write Ann Huff Stevens and Jessamyn Schaller. The effects are particularly large for families in which the parents have only a high school education or less, their study finds.

“This is in contrast to earlier work that has found only limited evidence of short-run effects of displacement on children’s academic outcomes,” they write. Their study may also explain why areas of the country prone to cyclical layoffs, such as those with a large factory base, have trouble improving their school systems.

The authors find that household earnings are reduced by about 15% in the year after a parent’s job loss, based on their analysis of data from the Survey of Income and Program Participation in 1996, 2001, and 2004, a program maintained by the Census Bureau.

In turn, while just over 7% of children without a parental layoff repeated grades by the third SIPP study, more than 9% of children who had a parent laid off repeated grades — resulting in about a 15% greater chance that children who experience a parent’s job loss will repeat a grade. The effect is twice as likely in boys than in girls, they find.

The findings come as the nation’s unemployment rate hit 10.2% in October –the first time it has crossed double-digits since 1982. A broader gauge of unemployment, including those who are working part-time for lack of full-time work, is at 17.5%. According to the Labor Department, about 15.7 million Americans are currently unemployed.

“More attention should be paid to the potential role of external factors in affecting school level outcomes,” they conclude. “Schools in areas with large concentrations of displaced workers…may face particular challenges in maintaining achievement standards during times of economic hardship.”

Called the Federal Budget Challenge, the Web site leads users through a series of policy choices ranging from health care to national defense to tax deductions. At each step along the way, a graph displays how their choices impact federal budget deficits over the next 10 years. Users can opt to receive a detailed explanation of each choice that offers arguments for and against each option.

“With the federal deficit soaring, the baby boomers beginning to retire and both houses of Congress debating the cost of health care, it is now more critical than ever that Americans understand the way our nation’s finances work,” said Robert L. Bixby, executive director of The Concord Coalition.

Added F. Noel Perry, founder of Next 10. “Our nation’s finances impact all of us and it’s our responsibility to understand how the federal budget works. This tool allows users to set their own priorities and make policy choices that reflect their values and vision for the future.”

No word whether President Barack Obama has played the game.

By increasing exports to rapidly growing countries like China and India, the U.S. could put a dent in joblessness and foster long-term economic growth without stressing the federal budget. But overhauling export policy is part of a White House approach that is in the early stages of execution.

Obama officials want to change outdated U.S. export controls, make it easier for foreign executives to travel to the U.S. and strengthen protections of intellectual property. One difficulty they face is making it easier for companies shipping products overseas to obtain necessary financing and credit from banks. And firms still face intellectual property rights and foreign-exchange issues.

Some, including the U.S. Chamber of Commerce, complain that as long as a trio of stalled free trade agreements remain unratified, the administration is shunning the most direct way to quickly lift exports. Its stance on trade agreements with Colombia, South Korea and Panama is still unclear.

“We need these agreements to make these guys as open to us as we are to them,” said Frank Vargo, vice president of international economic affairs at the National Association of Manufacturers.

Obama, who embarks this week on a nine-day swing through four Asian countries, opposed the Colombia and South Korea agreements during his presidential campaign, signaling he wants to rework them to address lingering trade concerns.

“All we are asking is for our own auto companies to be able to compete on a level playing field in the Korean market,” U.S. Trade Representative Ron Kirk said last week.

A new study by the U.S.-Korea Business Council found that if the U.S.-Korea pact isn’t implemented and the European Union seals its own trade pact with South Korea, the U.S. could suffer a net loss of nearly 350,000 jobs and $35 billion in export sales.

Despite signs of economic growth, the U.S. continues to struggle with high unemployment and a record, $1.4 trillion budget deficit. Obama’s push for more export-driven growth is a welcome message for critics who are worried the U.S. could fall prey to protectionist sentiment.

Last week, Obama sought to ease these concerns by saying a “goal of this administration is to break out of what I think has been a debilitating gridlock on trade policy.”

Fewer than 1% of U.S. companies export, and most send products to only one country.

“We don’t have to move that needle very far to make a real difference,” said Kirk.

NAM’s Vargo said he’s confident the White House means business on trade as a tool for boosting the U.S. economy. “They see that exports are absolutely going to be a part of it,” Vargo said.

Vargo said an overhaul of export controls is long overdue. The National Security Council has worked with the Commerce, Defense and State Departments to redesign a system meant to keep sensitive technology out of the hands of enemies. Export controls, for example, may still hinder business with countries that were once adversarial but are now emerging trading partners.

Obama’s economic team is considering ways to boost exports. During a meeting of the President’s Economic Recovery Advisory Board last week, General Electric Chief Executive Jeffrey Immelt noted that, currently, just 7% of U.S. gross domestic product is exports. That pales in comparison to countries such as Germany, where exports make up almost 40% of GDP, Immelt said.

The president’s response: If Germany can do it, the U.S. should be able to as well. –Henry J. Pulizzi and Maya Jackson Randall

Among the ingredients: Don’t rush to exit. Do be clear about plans to reduce government debt over time. Central banks can raise interest rates before they unwind unconventional monetary policies. Coordination among countries — although not synchronization — is important.

The principles:

Principle 1.
The timing of exits should depend on the state of the economy and the financial system, and should err on the side of further supporting demand and financial repair.

Principle 2.
With some exceptions, fiscal consolidation should be a top policy priority. Monetary policy can adjust more flexibly when normalization is needed.

Principle 3.
Fiscal exit strategies should be transparent, comprehensive, and communicated clearly now, with the goal of lowering public debt to prudent levels within a clearly-specified timeframe.

Principle 4.
Stronger primary balances should be the key driving force of fiscal adjustment, beginning with actions to ensure that crisis-related fiscal stimulus measures remain temporary.

Principle 5.
Unconventional monetary policy does not necessarily have to be unwound before conventional monetary policy is tightened.

Principle 6.
Economic conditions, the stability of financial markets, and market-based mechanisms should determine when and how financial policy support is removed.

Principle 7.
Making exit policies consistent will improve outcomes for all countries. Coordination does not necessarily imply synchronization, but lack of policy coordination could create adverse spillovers.