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Why Reshaping the Federal Reserve is Today an Absolute Must

By : Ziad K. Abdelnour| 15 July 2010
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Regardless of one’s opinion on Ben Bernanke, there is no denying the extraordinary impact he has had on the Federal Reserve since taking over as Chairman in 2006.

A case can be made that the very nature and scope of the Fed has changed under Bernanke’s stewardship. Originally envisioned as a politically neutral institution meant to contain systemic risks and head off banking panics, the Federal Reserve has taken a considerably more “hands-on” role in the economy of late.

It began in March 2008 with the fire sale of Bear Stearns to J.P. Morgan Chase – a maneuver largely engineered by Bernanke in conjunction with then-Treasury Secretary Hank Paulson. The Fed’s response to the recession continued with a $182 billion rescue of troubled financial services firm AIG, characterized by the Huffington Post as a, “…backdoor bailout” due to a lack of transparency about its execution.

Wikipedia also reveals troubling testimony from Kentucky Senator Jim Bunning, who said on CNBC that “he had seen documents which show Bernanke overruled recommendations from his staff in bailing out AIG.” Even more significant than how AIG’s bailout was executed, however, is the pretext it created for future bailouts and government takeovers – including the TAARP program. Furthermore, the Fed’s initial responses to the recession were hardly the last of its politically consequential changes. It is a fact that Chairman Bernanke had, “…led the biggest expansion of the central bank’s power in its 95-year history.”

In a relatively short period of time, the Federal Reserve has morphed from a supposedly independent entity to one which actively takes sides in shaping economic outcomes of particular firms and industries. It has become, more than ever before, a political institution.

As alluded earlier, the political power of the Federal Reserve has increased substantially during Bernanke’s tenure at the helm.

It began in earnest at the outset of the fall 2008 financial meltdown, when Bernanke took a lead role in the government’s bailouts of Bear Stearns and AIG. As a longtime scholar of the Great Depression, Bernanke was well aware of the systemic risks posed by the failure of such integral financial institutions. However, much suspicion has arisen regarding the clandestine exercise of its power.

A number of concerned reporters had to file a Freedom of Information Act request in summer 2009 after the Fed, “…refused to name the financial firms it lent to or disclose the amounts or the assets put up as collateral under 11 programs” instituted to ameliorate the financial crisis. While the Federal Reserve argued that revealing the recipients would harm their competitive positions, Manhattan Chief U.S. District Judge Loretta Preska ruled instead that the Fed had, “…improperly withheld agency records” and ordered it to overturn hundreds of pages of reports requested by the reporters. Among the facts that came to light around the time of this ruling were how “…The Fed’s balance sheet about doubled after lending standards were relaxed” following the collapse of Lehman Brothers. This marked a quiet but foundational change in the scope of the Fed’s activities.

Prior to 2009, the Federal Reserve was not permitted to purchase non-government securities or to hold them as assets. However, during Bernanke’s aggressive new campaign to relieve banks of toxic assets, “…Fed assets rose 2.3 percent to $2.06 trillion” by the week ending August 19, 2009 – an increase up made almost entirely of private, mortgage-backed securities. Regardless of the merits or demerits of the Fed owning these particular securities, what matters from an institutional standpoint is that the Fed can now own private securities – a major departure from long-standing precedent.

Nor was purchasing non-government securities the only power Bernanke sought to bestow upon the Federal Reserve. In March 2009, Brady Dennis of the Washington Post reported that Bernanke had ,”…pressured Congress to give the federal government unprecedented new power” to take over distressed financial firms deemed to be essential to the overall financial system. Citing the, “…1930s-style global financial and economic meltdown, with catastrophic implications for production, income and jobs” that could have followed a failed AIG, Bernanke argued passionately for permitting the federal government to seize insurers and financial services firms, “…the way that the Federal Deposit Insurance Corp. can take over banks.”

The Los Angeles Times likewise spoke of, “…the increased power of the complex and mysterious Fed” in October 2009. Despite, “…more than two-thirds of the House of Representatives” lending their legislative support to, “…a bill that would subject the central bank to increased congressional oversight through expanded audits”, Bernanke was intransigent in defending the, “…major new role” he and the Obama Administration had in mind for the Fed – specifically, “…supervising large financial institutions that pose a risk to the entire economy.” Such a role means the Fed would cease being merely an entity concerned with setting interest rates and become, essentially, an all-purpose financial regulatory agency.

That said, politicians from both ends of the political spectrum have begun mobilizing against the greater concentration of power in Federal Reserve hands. In addition to the aforementioned House bill, the LA Times notes that, “…a key senator” was pushing to …”strip the Fed of its authority to regulate banks” due to its lax oversight in the years and months leading up to the meltdown. Jaret Seiberg, a financial policy analyst with Concept Capital’s Washington Research Group, also opined that the Fed was encountering “…unprecedented opposition on Capitol Hill” in its quest for greater regulatory powers. What the Fed does have is the unwavering support of President Obama, who recently granted Bernanke a second term as Chairman.

One of the foundational purposes of the Federal Reserve was promoting overall financial stability.

We at Blackhawk hold that the Fed (under Bernanke’s leadership) has actually increased the likelihood of moral hazard and financial irresponsibility.

As far back as October 2008, SeekingAlpha.com published a reader e-mail about the lack of a bailout for Lehman Brothers – a decision Bernanke was instrumental in making. The e-mail pointed out that, “…a lack of a Lehman bailout only reduces moral hazard if investors think it is a preview of future actions.” But because the non-bailout was roundly questioned and considered a mistake, it actually, “…makes a bailout for the next major financial institution more likely.” In other words, because most analysts and experts outside of the Federal Reserve and Treasury Department believed bailing out Lehman was necessary to avert systemic failure, the decision not to do so actually made moral hazard more likely. Sure enough, SeekingAlpha notes, “…no further failures could be allowed” after Lehman went under, and, “…indeed, one of the main functions of the TARP bill was to make government bailouts much easier.”

The non-bailout of Lehman Brothers was not the only way in which the Federal Reserve enhanced the risks of moral hazard. In January 2010, ZeroHedge.com revealed that Goldman Sachs was actually willing to, “…tear up AIG’s derivative contracts”, and essentially, “…take a haircut” on the losses incurred by doing so. Had this been done, the need for a federal bailout of AIG would have been greatly diminished, if not completely eliminated. As ZeroHedge astutely observes, the Federal Reserve Bank of New York ,”…not only did not save US taxpayers’ money, but in fact ended up costing money” because they, “…funded the marginal difference between par and whatever discount would have been applicable to the contract tear down” that Goldman Sachs proposed a month prior. Admittedly, the full details of this story have yet to emerge, as have the long-term consequences of the various bailouts and non-bailouts. What is known currently is that Ben Bernanke, in his role as Fed Chairman, put the central bank in a position to actually enhance the very risks of moral hazard that it is institutionally mandated to discourage.

Bottom Line:

We fully back Congressman Ron Paul’s proposal for a full audit of the Fed’s activities – opposed by Bernanke on the grounds that it would be, “…highly destructive to the stability of the financial system, the dollar and our national economic situation.”

Though Bernanke argues that an audit would interfere with its monetary policy decisions….decisions about what toxic assets should be accepted by the Fed as collateral, how such assets should be valued, and who bailout funds should be given to are wholly separate from the Fed’s core monetary policy decision: raising or lowering interest rates.

Funneling hundreds of billions to foreign nations and foreign banks, accepting worthless junk from the “too big to fails”, marking it at unrealistic valuations, and doing the other things which the Fed has been doing recently are not core monetary functions. Congress never authorized these actions when they passed the Federal Reserve Act.

Therefore, it is critical that the Fed’s actions be made transparent and subject to the light of day.

Once again, the Fed over the course of this crisis has demonstrated that its influence goes far beyond the issue of monetary policy.

In monetary policy—controlling the supply of money—the Fed is constrained by reasonably well-understood policy levers that have a macro impact, and its decisions are rather evident in short order. Now, in contrast, the Fed is engaging in fiscal policy—spending money—and in fact has become the single largest fiscal actor in the U.S. economy, dispensing hundreds of billions of dollars to private parties. In doing so, the Fed is picking winners and losers. Why Goldman but not Lehman? Why guarantee the debt of some companies but not others?

The Fed has enormous discretion in its decisions. It is entirely appropriate to demand that they be carried out with greater transparency and be subject to greater oversight.

To take it one step further, we believe that the very structure of the Federal Reserve system is so fraught with conflicts that it is “corrupt” and undermines democracy.

If the World Bank had seen a governance structure that corresponds to our Federal Reserve system, we would have been yelling and screaming and saying that country does not deserve any assistance, this is a corrupt governing structure.

In fact, if another country had presented a plan to reform its financial system, and included a regulatory regime that copied the makeup of the Federal Reserve system – “it would have been a big signal that something is wrong.”

Further, the Fed banks have clear conflicts of interest, since the banks are largely governed by a board of directors that includes officers of the very banks they’re supposed to be overseeing:

So, these are the guys who appointed the guy who bailed them out … How is that not a conflict of interest?

Why is this so very important?

Well, the reason you talk about governance is because in a democracy you want people to have confidence … This is a structure that will undermine confidence in a democracy. Indeed, by all objective measures, the Fed has performed horribly.

We really see at least 4 reasons to demand full transparency of the Federal Reserve, and a change in the Fed’s structure:

First … how effective a regulator can the Federal Reserve be if it is unwilling to strive for good public policy through its regulatory powers?

Second, there is an inherent conflict in the manner in which regional reserve branch presidents are selected – in that representatives of the member banks select the regional president. It seems counterproductive, yet the banking system has provided case after case of regulated entities selecting their own regulator.

Third, the Federal Reserve has continually resisted efforts to engage in discussion on structural and governance reform at the System. Most recently, the Federal Reserve has rejected a White House request that it conducts a public review of its structure and operations. Despite a request from the administration that provided ample opportunity for the Federal Reserve to have input into its own reforms, the central bank has simply refused. It is because of this attitude that I argue that real financial regulatory reform cannot occur without an examination into the structure of this entity.

Fourth, and most importantly, the Federal Reserve has shown a repeated unwillingness to accept efforts to improve transparency for the System.

It is high time to wake up and realize this is not the middle ages anymore as this whole Fed dictatorship seems to be a return to the mindset of the middle ages where only the clergy were allowed to read and interpret the bible and the laity were presumed incapable of comprehending the intricacies and subtle nuances of the faith and where the elites get wealthy during booms and they get wealthy during busts. Therefore, the boom-and-bust cycle benefits them enormously, as they can trade both ways.

And indeed there is a great deal of similarity between economics and fundamentalist version of religion in that both depend on the unquestioning faith of the masses that those pretty printed pieces of paper represent something real, albeit invisible.

But the advent of the printing press led people to take a closer look at the actual content of fundamentalist version of religion and it has been revealed not as a complex and sophisticated system but as a mish-mash of half-baked myths and legends often in contradiction with itself and used to enrich the church ….

The same is true of economics today.

The advent of blogs has fortunately led people to take a closer look at the actual content of economics and it has been revealed not as a complex and sophisticated system but as a mish-mash of half-baked theories and math often in contradiction with itself and used to enrich the bankers and conceal their fraud against the public.

The public now understands that when a private bank issues the public currency at interest, debt will always exceed the available money supply.

The public now understands that the Federal Reserve is no more Federal than Federal Express.

The public now understands that the Federal Reserve is a legalized counterfeiting operation, that creates the money they loan out of thin air!

The public now understands that the Federal Reserve system of banking, since its creation in 1913, has reduced the value of a dollar down to about four cents!

The public now understands that the Federal Reserve system is a pyramid scam that only works when ever larger populations of borrowers can be found, and that once an entire nation or planet has borrowed to the max, the system must crash (which is what is happening now).

Just as the fundamentalist priests, stripped of the arcane scriptures and rituals, stand exposed … so too the economists, stripped of their arcane equations and theories, stand exposed ….

This circus has got to stop …. Enough is enough.

Your feedback as always is greatly appreciated.

Thanks much for your consideration.

Comments

  1. Jennifer HedrickJennifer Hedrick

    This is a good posting, I was wondering if I could use this write-up on my website, I will link it back to your website though. If this is a problem please let me know and I will take it down right away

  2. Pingback: 5years After Our Last Crisis of 2008 – the Federal Reserve's program

  3. A. PetersonA. Peterson

    Ziad, As always a very insightful and provocative comment. As one of the leaders of the restructuring of Continental Illinois (in the 1980′s if your memory streches that far), when under the stewardship of Paul Volker as Chmn of the FED, and leadership of the late John Swearnigen (formerly of Standard Oil of Indiana and the Chase) we narrowly avoided the collapse of the US (and global) banking industry, I was able to see in action a FED without political agendas, working efficiently to provide the policy guidance, innovative and curageous approach to financial crisis management and checks and balances to avoid a global financial meltdown. Sadly, these important characteristics of the FED were not in evidence since the politicised FED under Greenspan, who in support of the Clinton Presidency allowed interest rates to be lowered to unreal levels, and allowed to remain there for far too long (initially to help fund the expensive Clinton’s and the Democratic Party’s welfare and social engineering programs, and later the expensive Bush Admin. war in Iraq). The cheap credit, besides helping fund the growing US government budget deficits, and “off book” financings, also helped finance the US “real-estate bubble”, as well as the Capital Markets Casino attitude that “all numbers win” and the only way for the markets is up… I agree that the Bernanke FED is in urgent need of change, both in policy formulation, structure, and freedom from undue political/ideological influences. But the blame for the sad current state of affairs should go, and stay squarely on the shoulders of Bernanke’s predecessor, Alan Greenspan

  4. Craig MeadCraig Mead

    “Men and women in taverns of pre-Revolutionary America were more politically aware than most politicians today, let alone the citizens who put them in office.” – a true statement and indication that all the ‘debates, discussions and even articles’ will lead no where. Americans are angry, but apathetic – a rare combination that comes from not knowing how to fix a problem. Afraid to organize because those that understand the nature of global government have good reason to shut up and remain invisible, while those rebel souls who speak out often do so for only a brief period…so what we have instead is a lot of crying “The theater is on fire” and nobody getting out of their chairs, let alone grabbing an extinguisher or making it out the door. We all know what happens in that event, right? I think “Kiss yer assets goodbye.” sums it up nicely.

  5. W. TimmermanW. Timmerman

    These discussions – and they should include Fanny & Freddie – harken back to those at the chartering and recharterting of the First & Second Banks of the United States. President Andrew Jackson believed that the power of such institutions could be dangerous and corrupting, which is why he fought so hard to deny the Second Bank an extention of its charter.

  6. Michael CohnMichael Cohn

    Well I am a practical LIBERTARIAN so I am predisposed to like Ron Paul and it is the interstate commerce clause that upsets me most. That being said, The failure of the LEHMAN BANKRUPTCY as a policy prescription may well sit with the way the Liquidation was handled by a UK receiver. Had there been some harmonization in wind down procedures that allowed for an orderly liquidation and netting of positions globally I feel a better outcome would have been possible. The challenge is that the financial system to the best of my knowledge has not fixed this co-ordination flaw and as such makes the correct path difficult to follow. I have no issue with FED Balance sheet purchases that are transparent as the market through FX valuation and bond market rates can regulate the same. I do think that there should be an improved governance mechanism in place for the selection of Regional FED Presidents at a minimum. I will admit to some trepidation to seeing such a public display several weeks OK of the FED CHAIRMAN and our PRESIDENT at a meeting to discuss the economy in such a public way.

  7. Craig MeadCraig Mead

    From mortgages to corporate stock, they’ve done a wonderful job of slowly vacuuming assets world-wide. Now few firms can fund anything of substance…the capital just isn’t there. Example: we have a wind farm – booming industry – operational, profitable site – needed $20M – couldn’t get anyone to fly to California to look at it. Example: another wind farm project pays $5M in year one for the first $500K invested (soil tests etc.) – couldn’t get anyone to look at that. This is not 2005 anymore

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