Is Fed wearing too many hats to do its main job?

WASHINGTON -- Even before President Barack Obama outlined his plans last month to revamp the financial regulatory system and expand the powers of the Federal Reserve, the global financial crisis had turned the autonomous central bank into a new institution.

The Fed has been in the forefront of efforts to combat the crisis, and that has made it a target for both criticism and worry. Concerns are growing with the unveiling of Obama's plan. The fear is that the Fed has taken on so many missions that it may not be as capable as before of doing its main one: ensuring a growing economy with low inflation.

It was the Fed that stepped up in September to rescue failed insurer American International Group. The Fed also stood alongside the Treasury Department in aggressively brokering the sale of investment banks Bear Stearns and Merrill Lynch, institutions it didn't even regulate at the time.

When credit markets seized up last year, the Fed stepped in to lend to corporate America, going well beyond its traditional role of lender of last resort to banks. The move provided needed credit and prevented the economic downturn from growing even worse.

Today the Fed is increasingly taking bundles of residential and commercial mortgages on its balance sheet to help unlock the financing of mortgages and ease the housing slump. That is yet another move outside its traditional activity.

The Fed's primary mission is to try to maintain full employment while ensuring that inflation is low. It does that through controlling the supply of money and credit available to the economy. That's "monetary policy." Yet the Fed's aggressive lending to fight the crisis has prompted fears that inflation will follow.

"There are already questions in monetary policy about their ability to unwind these facilities they've put in place and reduce their asset holdings," said Alan Levenson, the chief economist for investment manager T. Rowe Price in Baltimore. "What if you need to tighten rapidly to contain inflation? Are you really going to be able to sell $400 billion or $500 billion [of mortgage securities], even if it disrupts the mortgage market?"

For some former Fed board members, the expansion of the Fed's role in the economy is nothing short of breathtaking.

"I think that they've shifted more from being a bank of last resort to right now a bank of first resort, and they're in essence helping to finance and keep afloat more than their traditional commercial banks," said Susan Phillips, a Fed governor from 1991 to 1998.

"Am I uncomfortable? Yeah, sure. I see them doing things I wouldn't have imagined 20 years ago," said Phillips, now the dean of the George Washington University School of Business. "Having said that, I think we're in a very difficult situation, and I am very sympathetic to the need to keep the banking system afloat. I do think these are extraordinary times."

Others see the Fed's evolution as necessary but potentially dangerous, "because Congress can now see that the Fed can do these things," said Larry Kantor, the head of global research in New York for Barclays Capital, a global investment firm. "It kind of opens a Pandora's Box."

Kantor, a former Fed staffer, fears that lawmakers may try to politicize the Fed in the future by pressuring it to interfere in credit markets, such as to boost car and home sales or other forms of consumer credit.

If the Fed's response to the financial crisis has been creative, it also has sometimes stretched its statutory authority to the edge. Some veteran Fed watchers believe it has also blurred the line between independence and being an arm of the executive branch.

"I think by the nature of its close cooperation on what I would call credit policy with the Treasury and various government agencies, the Fed is at risk of compromising its independence," said Marvin Goodfriend, a finance professor at Carnegie Mellon University in Pittsburgh. "The Fed is at great risk of compromising its perceived independence on monetary policy."

Obama's proposal would further blur the question of the Fed's mission and independence. It would make the Fed a "systemic risk" regulator. The Fed would police a wide range of large financial institutions for any risks they might pose that could threaten the U.S. and global financial system.

Fed officials think their supervisory powers, which date back seven decades, haven't yet interfered with their ability to conduct monetary policy and don't expect them to now.

But enough questions are being raised that Treasury Secretary Timothy Geithner, testifying before the Senate Banking Committee last month, addressed the issue.

"Our plan is to give it a carefully designed, modest amount of additional authority," Geithner said. He later said the broad range of changes being proposed to the financial regulatory structure actually would reduce chances of an unbridled Fed and would limit its overall powers.

Some lawmakers weren't convinced. Many are concerned that the proposed new powers could leave the Fed overextended.

"To me, getting monetary policy right is a big job, and a crucial job," said Sen. David Vitter, R-La., during questioning of Geithner.

Meanwhile, a House Financial Services subcommittee announced that it would hold a hearing on the Fed's independence. That suggests that House lawmakers also are pondering just what the Fed's evolution means.