Tim Duy writes about the loss of political capital for the Federal Reserve.

The Fed earns accolades from academics for its handling of the crisis, in particular since the Lehman failure. Fair enough; I have few quibbles with policy since last fall. But what about the years before Lehman, when the crisis was building? Where was the Fed then? Did they abdicate regulatory responsibility? How did banks develop such incredible exposure to off-balance sheet SIV’s? How could the Fed ignore increasingly predatory lending in the mortgage market? What exactly was Timothy Geithner, then president of the all important New York Fed, regulating and supervising? Clearly not Citibank.

To be sure, there were plenty of other regulatory failures along the way, but the Fed – an independent Fed – should have been in a much better position to raise regulatory and supervisory roadblocks during the debt build-up compared to other, more politically susceptible agencies. The Fed’s independence should have allowed it to be a leader, not a follower. Ideological objections to regulation, apparently, prevented the Fed from looking for problems in their own backyard. Rapid debt creation was justified as a response to asset appreciation, with little concern that the connection might just be a bit more self-reinforcing.

The resulting crisis left the Fed struggling to keep the ship afloat – and in that struggle the Fed stepped too deep into the realm of fiscal policy in an effort to keep the trains running on time. But that mission creep was simply incompatible with the Fed’s desire for secrecy. This was all to predictable: Like it or not, you cannot commit literally billions of dollars of taxpayer money and in the process secretly funnel money through AIG to the investment banking community without expecting just a little blowback. The last I checked, this was still a democracy.

He concludes that Americans could hardly be blamed for losing faith in the Fed.

This is particularly acute when you see the Fed response to rising unemployment. It was enough that the Fed missed a giant housing bubble and resisted regulation of Wall Street. That today, the unemployment rate is clearly the biggest problem facing the economy, and the Fed is unprepared to do anything about it because they fear a threat of inflation – which we should probably want at this stage – just strips them of any credibility as a central banker with an explicit mission to deal with employment.

Central bankers are more concerned with chasing phantoms on Wall Street – tamping down dubious threats of high interest rates or hyperinflation – than providing any substantive support to working people, which it is in their power to do. Such muteness does not display that vaunted “independence” of the Fed, but a severe dependence on the beliefs and concerns of the banking industry. They may not be directly intervening to scare the public with fears of the deficit and runaway interest rates and interest payments, but they are by their silence doing effectively the same thing.

I don’t think Ben Bernanke will be taken out before he wins another term. But the recent move to audit the Fed is a natural response to policymakers who see nothing from the Federal Reserve but a secretive organization hell-bent on shoveling cash out the door to whatever financial giant asks them for some. That’s not a failure of Congress, but the Fed itself. They’ve made their own case for losing their independence.