By Joseph N. DiStefano

Inquirer Staff Writer

August 24, 2008

Anyone who's still under the Greenspan-era Wall Street illusion that the Federal Reserve runs this country should look at what happened when Fed Chairman Ben Bernanke tried to brush off a Pennsylvania congressman earlier this year.

On March 17, U.S. Rep. Paul E. Kanjorski, backed by members of both parties, sent Bernanke a letter asking him to bail out student lenders, and to let the Fed accept student loans as collateral for Fed financing, as it did with home loans.

Kanjorksi figured: If the Fed could take special steps to keep Bear Stearns & Co. and its damaged home-loan bonds from blowing up all over Wall Street, why not help the Pennsylvania Higher Education Assistance Agency and other troubled lenders keep kids in school?

On March 31, Bernanke said no. Bailing out student lenders "that do not pose a significant risk of systemic financial crisis" would contradict Congress' own priorities from earlier times, he wrote.

Blocked, Kanjorski did an end run around the Fed. The congressman from Nanticoke heads the influential House Financial Services subcommittee. In just a month, he and his colleagues passed a law setting up a new student loan financing authority - across town in the Department of Education.

On May 2, just before Kanjorski's bill passed, Bernanke bent, allowing the Fed to accept student loans as collateral alongside home loans.

"The regulators realized we were going to move, and that they'd get embarrassed, and they decided they'd better change their positions," Kanjorski told me. "It was a proud moment."

Kanjorski's approach raises big questions: Who's really in charge of financial policy? Is the Fed really independent, if Congress can push it aside to help constituents? Should it be?

Philadelphia Fed President Charles I. Plosser has warned that radical acts like the Bear Stearns rescue, which go beyond the agency's old mission as traffic cop for business and consumer lenders, demand careful, long-term policies that encourage prudent lending and discourage dangerous loans like the ones defaulting in Las Vegas, Florida and California, jamming financial markets around the world.

On Friday, Bernanke asked Congress for "a clear [legal] framework" granting new powers that would strengthen the Fed's powers over banks and non-bank financial companies.

It's a plea for long-term thinking and permanent rules. "Sometimes what we intend to be stopgap turns out permanent," acknowledged Kanjorski.

But he's not apologizing for Congress' firefighting approach: "We're interested in stabilizing the market. That means stabilizing real estate prices, and going where the free flow of capital funds has failed to develop substitute methodologies. Then, when we get the entire system working again, over the next 12 months, we're going to go into a very thorough examination of how we got there and what has to be changed. We're not anywhere near that right now."

It used to be, Kanjorski added, that policymakers worried some banks "were too big to fail. Now, it's 'are they too interconnected to fail?'"

That was Bear Stearns' danger: Not that traders and bankers would lose their jobs, but that loan-backed securities held by Bear would lose all value, bankrupting the company's bank and government clients. "They were small enough to fail, but they had $12 trillion [in securities bets with clients]," Kanjorski said. "Nobody knew what would happen if that started to unravel. That's a whole new concept."

"It's important for Congress to draw lines, rather than dealing with this on an ad hoc basis. It will be really interesting to see if the Fed accepts that notion," said Fed watcher Tom Schlesinger, of the Financial Markets Center, which has criticized the Fed for making policy in secret.

Schlesinger said Congress became deferential to the Fed during the bull-market 1990s. "But the Fed is a creature of Congress," he added. "Congress has always had the authority to step in and provide guarantees or bailouts for sectors it deems crucial. That's the key to what Kanjorski was getting at.

"Once the dust settles, there is going to be some new understanding of the law that guides the Federal Reserve."