Reform of the Federal Reserve

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See also AIG, Federal Reserve, Federal Reserve Bank of New York, Federal Reserve bibliography, Federal Reserve Act, primary dealers, and repo.


Federal Reserve balance sheet assets

Goldman Sachs' Chief U.S. Economist, Jan Hatzius suggests that the Federal Reserve balance sheet could grow to $4 trillion depending on the direction of inflation and whether the economy moves back to a "low trend growth pace". (At about 7 minutes)

Fed’s strategy reduces U.S. bailout to $11.6 trillion

"The Federal Reserve decided to keep pumping $1.25 trillion of new money into the mortgage market to focus on rescuing the U.S. economy as the financial system revives and banks ask for less help.

The Fed is allowing some of the 10 support programs it created or expanded after the credit crisis began in August 2007 to expire or shrink. That caused the first decline in the amount of money the U.S. has committed on behalf of taxpayers to end the recession, according to data compiled by Bloomberg.

The central bank has purchased $694 billion of mortgage- backed securities since January and plans to spend $556 billion more by April 2010 to keep interest rates down. The debt-buying is the biggest program in the Fed’s arsenal.

“The first thing the Fed had to do was stop the bleeding in the banking system,” said Richard Yamarone, director of economic research at Argus Research Corp. in New York. “Now that that seems to have been accomplished, they’re focusing on the economy by buying mortgage-backed securities.”

The purchases were scheduled to stop at the end of December. The Federal Open Market Committee decided on Sept. 23 to continue the program through the first quarter of next year and slow the pace of buying to “promote a smooth transition in markets,” the committee said in a statement. It also said the economy has “picked up.”

The debt-buying pushed the average 30-year mortgage interest rate this week to 5.04 percent, its lowest since May, according to McLean, Virginia-based Freddie Mac. The debt is guaranteed by Freddie Mac and the other government-sponsored home-loan financiers, Fannie Mae and Ginnie Mae, both based in Washington.

The U.S. has lent, spent or guaranteed $11.6 trillion to bolster banks and fight the longest recession in 70 years, according to data compiled by Bloomberg.

That’s a 9.4 percent decline since March 31, when Bloomberg last calculated the total at $12.8 trillion.

The tally “ignores the fact that virtually all commitments are backed by assets,” Andrew S. Williams, a Treasury Department spokesman who had the same role at the Federal Reserve Bank of New York until earlier this year, said in an e- mail. “The Federal Reserve’s current ‘outlays’ are largely in the form of secured loans. The aggregate value of the collateral backing those loans exceeds the loan value. These are not ‘outlays.’”

Spokesmen Calvin A. Mitchell of the New York Fed and David Skidmore of the Fed in Washington declined to comment.

The Fed has refused to identify the collateral backing its loans. Bloomberg News parent Bloomberg LP, the New York-based company majority-owned by Mayor Michael Bloomberg, sued the central bank in November to force it to provide the information. U.S. District Judge Loretta A. Preska gave the Fed until Sept. 30 to appeal her decision requiring more disclosure about the financial institutions that have benefited....

...Among the U.S. programs that have expired is the Treasury guarantee of money market mutual fund deposits, instituted a year ago to stem an investor run the week after Lehman Brothers Holdings Inc.’s collapse. The department said it collected $1.2 billion in fees from funds before the effort concluded on Sept. 18 and never paid out a claim.

The $3 billion “cash for clunkers,” which gave people rebates for trading in gas-guzzling vehicles, ended in August after 700,000 vehicles were sold, according to the U.S. Department of Transportation.

The Fed’s Money Market Investor Funding Facility, or MMIFF, is slated to be closed on Oct. 30, and four other Fed programs with a total limit of $2.5 trillion are scheduled to expire in February. Others have been cut back.

The central bank said Sept. 24 it will reduce the Term Securities Lending Facility to $50 billion from $75 billion and the Term Auction Facility, once $900 billion, will shrink to $50 billion. Support for commercial paper, short-term loans that corporations and banks use to pay everyday expenses, has fallen to $1.2 trillion as the market fell from a one-year peak of $1.8 trillion in January.

Banks have repaid about $70.6 billion of the $204.6 billion in direct aid extended through the Capital Purchase Program of the Troubled Asset Relief Program, or TARP. Congress created the $700 billion fund last October.

The $70.6 billion includes $25 billion from New York-based JPMorgan Chase, one of the biggest recipients, and $28 million from Novato, California-based Bank of Marin Bancorp, one of the smallest, according to the Treasury and regulatory filings.

“Because financial conditions have started to improve, Treasury has already begun the process of exiting from some emergency programs,” the TARP administrator, Herb Allison, told the Senate Banking Committee Sept. 24. “It will, however, be some time before all CPP participants have fully extinguished their obligations to the taxpayers.”

The Federal Deposit Insurance Corp. said its Temporary Liquidity Guarantee Program has generated more than $9 billion in fees.

The combined commitments of the Fed and government agencies are 57 percent higher than on Nov. 24, when Bloomberg’s first tally was $7.4 trillion.

“We’re not self-sustaining yet,” William O’Donnell, head of Treasury strategy for RBS Securities Inc. in Stamford, Connecticut, said in an interview.

                                 --- Amounts (Billions)---
                                   Limit         Current
Total                            $11,563.65     $3,025.27
Federal Reserve Total            $5,870.65     $1,590.11
 Primary Credit Discount           $110.74        $28.51
 Secondary Credit                    $1.00         $0.58
 Primary dealer and others         $147.00         $0.00
 ABCP Liquidity                    $145.89         $0.08
 AIG Credit                         $60.00        $38.81
 Commercial Paper program        $1,200.00        $42.44
 Maiden Lane (Bear Stearns assets)  $29.50        $26.19
 Maiden Lane II  (AIG assets)       $22.50        $14.66
 Maiden Lane III (AIG assets)       $30.00        $20.55
 Term Securities Lending            $75.00         $0.00
 Term Auction Facility             $375.00       $196.02
 Securities lending overnight       $10.42         $9.25
 Term Asset-Backed Loans (TALF)  $1,000.00        $41.88
 Currency Swaps/Other Assets       $606.00        $59.12
 GSE Debt Purchases                $200.00       $129.21
 GSE Mortgage-Backed Securities  $1,250.00       $693.60
 Citigroup Bailout Fed Portion     $220.40         $0.00
 Bank of America Bailout            $87.20         $0.00
 Commitment to Buy Treasuries      $300.00       $289.22
Treasury Total                    $2,909.50     $1,075.91
 TARP                              $700.00       $372.43
 Tax Break for Banks                $29.00        $29.00
 Stimulus Package (Bush)           $168.00       $168.00
 Stimulus II (Obama)               $787.00       $303.60
 Treasury Exchange Stabilization    $50.00         $0.00
 Student Loan Purchases             $60.00         $0.00
 Citigroup Bailout Treasury          $5.00         $0.00
 Bank of America Bailout Treasury    $7.50         $0.00
 Support for Fannie/Freddie        $400.00       $200.00
 Line of Credit for FDIC           $500.00         $0.00
 Treasury Commitment to TALF       $100.00         $0.00
 Treasury Commitment to PPIP       $100.00         $0.00
 Cash for Clunkers                   $3.00         $2.88
FDIC Total                        $2,477.50       $356.00
 Public-Private Investment (PPIP)$1,000.00          0.00
 Temporary Liquidity Guarantees* $1,400.00       $301.00
 Guaranteeing GE Debt               $65.00        $55.00
 Citigroup Bailout, FDIC Share      $10.00         $0.00
 Bank of America Bailout, FDIC Share $2.50         $0.00
HUD Total                           $306.00         $3.25
 Hope for Homeowners (FHA)         $300.00         $3.20
 Neighborhood Stabilization (FHA)    $6.00         $0.05
 * The program has generated $9.3 billion in income, according to the agency.


  • ABCP -- Asset-backed commercial paper
  • AIG -- American International Group Inc.
  • FDIC -- Federal Deposit Insurance Corp.
  • FHA -- Federal Housing Administration, a division of HUD
  • GE -- General Electric Co.
  • GSE -- Government-sponsored enterprises (Fannie Mae, Freddie Mac and Ginnie Mae)
  • HUD -- U.S. Department of Housing and Urban Development
  • TARP -- Troubled Asset Relief Program

Breakout of TARP funds:

                                 --- Amounts (Billions)---
                                    Outlay      Returned
Total                              $447.76        $75.33
Capital Purchase Program           $204.55        $70.56
General Motors, Chrysler            $79.97         $2.14
American International Group        $69.84         $0.00
Making Home Affordable Program      $23.40         $1.13
Targeted Investment Bank of America $20.00         $0.00
Targeted Investment Citigroup       $20.00         $0.00
Term Asset-Backed Loan (TALF)       $20.00         $0.00
Citigroup Bailout                    $5.00         $0.00
Auto Suppliers                       $5.00         $1.50

Record level of excess reserves at the Fed

Excess reserves held by banks at the Federal Reserve are back on the rise, hitting their highest level last week since May 2009.

Kyle Bass of Hayman Advisors, who made money on the subprime crisis, now puts those reserves into pictorial context (H/T The Pragmatic Capitalist):

As can be seen they stand at$855bn versus just $2bn a year ago.

As Bass notes, this is a build-up to unprecedented levels for a post-World War II United States. And the reserves are there largely because banks are either unwilling or unable to lend due to fears of further losses or a general lack of creditworthy borrowers.

Bass’ point, though, is that the threat to actual money supply will only occur when banks suddenly decide to deploy those reserves. Under the fractional lending system, if this were to happen, it would increase money supply not just by $855bn but by a multiple thereof — usually around seven times. In which case, the scenario implies an increase in the money supply of approximately $6,000bn.

Of course, the Federal Reserve has signalled it believes its exit strategy will be able to soak up that extra money supply without a problem, for instance, by selling its Treasury and Agency holdings off. But according to Bass, there may be some very painful consequences linked to such a strategy.

As he observes:

Consider for a moment what that would entail - the Federal Reserve sellings its holdings of Treasuries and Agency securities into the market. These sales would put significant upward pressure on rates, which could be very damaging to what will likely be a fragile recovery. Since the onset of the Agency purchase program, the Federal Reserve has purchased more than 100% of the net issuance of both Agency debt and Agency MBS. Imagine what will happen when the only buyer in the market place becomes a seller, especially if China is no longer interested in buying any Agency securities.

What’s more, he adds, you must consider that sales of agency securities by foreign official institutions are increasingly supporting their purchases of Treasuries. Or as he puts it:

In other worse the Federal Reserve Agency purchase program is, indirectly, funding a Treasury purchase program.

In which case even more pressure might be put on yields, sending them to the sort of levels that could very well be indigestible to popular governments.

Federal Reserve earned $45 billion in 2009

"The Fed will return about $45 billion to the U.S. Treasury for 2009, according to calculations by The Washington Post based on public documents. That reflects the highest earnings in the 96-year history of the central bank. The Fed, unlike most government agencies, funds itself from its own operations and returns its profits to the Treasury.

The numbers are good news for the federal budget and a sign that the Fed has been successful, at least so far, in protecting taxpayers as it intervenes in the economy -- though there remains a risk of significant losses in the future if the Fed sells some of its investments or loses money on its stakes in bailed-out firms.

This turn of events comes as the banks that benefited from the Fed's actions are under the microscope. Starting at the end of the week, major banks are expected to announce significant earnings and employee bonuses. Anger in Washington is at such a high boil that the Obama administration will probably propose a fee on financial firms to recoup the cost of their bailout, officials confirmed Monday.

As it happens, the Fed's earnings for the year will dwarf those of the large banks, easily topping the expected profits of Bank of America, Goldman Sachs and J.P. Morgan Chase combined.

Much of the higher earnings came about because of the Fed's aggressive program of buying bonds, aiming to push interest rates down across the economy and thus stimulate growth. By the end of 2009, the Fed owned $1.8 trillion in U.S. government debt and mortgage-related securities, up from $497 billion a year earlier. The interest income on those investments was a major source of Fed profits -- though that income comes with risks, as the central bank could lose money if it later sells those securities to reduce the money supply.

The Fed also made money on its emergency loans to banks and other firms and on special programs to prop up lending, such as one that supports credit cards, auto loans, and other consumer and business lending. Those programs impose interest and fees on participants, with the aim of ensuring that the Fed does not lose money.

And while the central bank in its most recent financial report had recorded a $3.8 billion decline in the value of loans it made in bailing out the investment bank Bear Stearns and the insurer American International Group, the Fed also logged $4.7 billion in interest payments from those loans. Further losses -- or gains -- on the two bailouts are possible as time goes by. The Fed also charges fees for operating the plumbing of the financial system, such as clearing checks and electronic payments between banks."

President to nominate three new board members

For those unfamiliar with the latest batch of doves, here you go:

Janet Yellen

Dr. Yellen is professor emeritus at the University of California at Berkeley where she was the Eugene E. and Catherine M. Trefethen Professor of Business and Professor of Economics and has been a faculty member since 1980.Dr. Yellen earlier took leave from Berkeley for five years starting August 1994 when she served as a member of the Board of Governors of the Federal Reserve System through February 1997, and then left the Fed to become chair of the Council of Economic Advisers through August 1999. She also chaired the Economic Policy Committee of the Organization for Economic Cooperation and Development from 1997 to 1999.Dr. Yellen is a member of both the Council on Foreign Relations and the American Academy of Arts and Sciences and a research associate of the National Bureau of Economic Research. She also serves on the board of directors of the Pacific Council on International Policy, and in the recent past, she served as president of the Western Economic Association, vice president of the American Economic Association and was a Fellow of the Yale Corporation.Dr. Yellen graduated summa cum laude from Brown University with a degree in economics in 1967, and received her Ph.D. in Economics from Yale University in 1971. She received the Wilbur Cross Medal from Yale in 1997, an honorary doctor of laws degree from Brown in 1998, and an honorary doctor of humane letters from Bard College in 2000. An assistant professor at Harvard University from 1971 to 1976, Dr. Yellen served as an economist with the Federal Reserve's Board of Governors in 1977 and 1978, and on the faculty of the London School of Economics and Political Science from 1978 to 1980.

Sarah Bloom Raskin

Sarah Bloom Raskin was appointed on August 28, 2007 as Maryland's Commissioner of Financial Regulation. Prior to her appointment, Ms. Raskin accumulated extensive experience in the financial industry from a range of perspectives in policy, regulatory and legal roles. Immediately prior to joining the Office of Financial Regulation, Mrs. Raskin served as Managing Director at Promontory Financial Group. Mrs. Raskin was also Banking Counsel to the Senate Banking Committee (the U.S. Senate Committee on Banking, Housing and Urban Affairs) and has worked at the Federal Reserve Bank of New York and the Joint Economic Committee of Congress. Sarah is a 1986 graduate of Harvard Law School. Sarah also graduated from Amherst College in 1983, where she graduated magna cum laude in Economics, and Phi Beta Kappa. She is a recipient of the James R. Nelson Award in Economics.

Peter Diamond

Peter Arthur Diamond (born April 29, 1940) is an American economist known for his analysis of U.S. Social Security policy and his work as an advisor to the Advisory Council on Social Security in the late 1980s and 1990s. Diamond earned a bachelor's degree in mathematics from Yale University in 1960 and defended a Ph.D. at the Massachusetts Institute of Technology in 1963. He was an assistant professor at the University of California, Berkeley from 1964-65 and an acting associate professor there before joining the MIT faculty as an associate professor in 1966. Diamond was promoted to full professor in 1970, served as head of the Department of Economics in 1985-86 and was named an Institute Professor in 1997. Diamond was in 1968 elected a fellow and served as President of the Econometric Society. In 2003, he served as president of the American Economic Association. He is a member of the National Academy of Sciences and a Fellow of the American Academy of Arts and Sciences. Fellow of the American Academy of Arts and Sciences (1978), and Member of the National Academy of Sciences (1984), and is a Founding Member of the National Academy of Social Insurance(1988). Diamond was the 2008 recipient of the Robert M. Ball Award for Outstanding Achievements in Social Insurance, awarded by NASI. In March, 2010, Diamond was mentioned as a possible Barack Obama nominee to the Federal Reserve Board. Diamond wrote a book on Social Security with Peter R. Orszag, President Obama's director of the Office of Management and Budget, titled Saving Social security: a balanced approach (2004,-5, Brookings Institution Press). An earlier paper from Brookings Institution introduced their ideas.

Fed receives more power in Dodd-Frank

After fending off most challenges to its independence and winning new powers to oversee big financial firms, the Federal Reserve has emerged from a bruising debate on the overhaul of U.S. financial rules as perhaps the pre-eminent regulator in the sector. But that could only bring it added blame if things go wrong again.

Just a few months ago, amid populist anger at the Fed for failing to prevent the financial crisis of 2008 and bailing out Wall Street, Congress was talking of stripping the central bank of its supervisory oversight of banks or forcing it to submit to congressional audit of its interest-rate decisions.

Instead, the new law gives the Fed more power and a better tool box to help prevent financial crises. It will become the primary regulator for large, complex financial firms of all kinds, such as American International Group, the insurer which built a massive derivatives portfolio that regulators didn't see until it was too late.

This isn't the first time Congress has expanded the Fed's role. After the Great Depression, it passed the Employment Act in 1946, charging the Fed with averting the huge unemployment seen in the 1930s. After the double-digit inflation of the 1970s, the Fed was formally given a dual mandate of promoting both price stability and maximum sustainable employment. In the wake of the latest financial crisis, the Fed is effectively being told to add the maintenance of financial stability to its responsibilities.

The risks, however, are that the Fed still won't be able to prevent another crisis, and that it will be an even clearer target for blame if that occurs. "The bill has good intentions, but I'm worried about its implementation. If I were the Fed, I'd be seriously worried about being left holding the bag," said Anil Kashyap, a professor at the University of Chicago's Booth School of Business.

The Fed, of course, still shares responsibility for overseeing the financial system with the Federal Deposit Insurance Corp., the Securities and Exchange Commission and other agencies with which it sits on the new Financial Stability Council. And in a change, the new law requires the Fed to get the Treasury's go-ahead before using its extraordinary authority to lend to almost anyone, and limits loans to sectors of the economy rather than individual firms, such as Bear Stearns or AIG.

But the Fed's role is in most respects expanded by the legislation. The central bank will decide whether the council should vote on breaking up big companies if they threaten the stability of the entire financial system. It also will be able to force big financial companies—not just firms legally organized as banks—to boost their capital and liquidity. It will have the power to scrutinize the largest hedge funds.

All this could suck the Fed into political controversies. A decision to break up a big bank because of its size likely would subject the Fed to conflicting pressures from lobbyists and politicians. "It could give a lot of people reason to interfere," says Thomas Cooley, professor at the New York University Stern School of Business.

The Fed's role in the rescue of AIG and Bear Stearns, and its acquiescence in letting Lehman Brothers fail, led the public to question the Fed's powers and prompted Congress to consider curtailing its powers.

One threat came from legislation sponsored by long-time Fed critic Ron Paul (R., Texas), author of the best-selling book "End the Fed," who sought to expand the authority of the congressional Government Accountability Office to audit the Fed. The new law expands the GAO's auditing authority but avoids nearly all provisions that alarmed the Fed.

In the end, the Fed's emergency lending during the 2008 crisis will face a one-time audit to be published by Dec. 2010 and it will be required—with a two-year lag—to reveal which banks borrow from its discount window. With lobbying from several presidents of the 12 regional Federal Reserve Banks, the Fed also fought off proposals to remove it from supervision of the large number of smaller banks.

Senate reform of the Fed

Sanders amendment to audit the Fed passes 96-0

UPDATE - 12:10 p.m. - The amendment to open the Fed to a one-time audit of its lending between December 1, 2007 and the present passed 96-0.

Judd Gregg (R-N.H.), the Federal Reserve's most outspoken defender, came out in support of an amendment by Sen. Bernie Sanders (I-Vt.) to force transparency on the Federal Reserve. Gregg's surprising support gives the amendment a major boost.

The Sanders amendment began as a reflection of language passed by the House and cosponsored by Reps. Ron Paul (R-Texas) and Alan Grayson (D-Fla.) that would authorize a broad audit of the Fed. In negotiations with Banking Committee Chairman Chris Dodd (D-Conn.) and officials from the Fed, Sanders scaled back his audit and restricted it to a one-time look at lending activity from December 1, 2007 until the present -- information that the Fed has so far fought to keep from disclosing. It goes further in some respects than the Paul-Grayson measure, in that it mandates the disclosure of recipients of Fed largesse. (Background on the compromise here.)

Even a year ago, it would have been unthinkable to have Judd Gregg and Ron Paul agree on anything having to do with the Fed other than its street address. The momentum behind a Fed audit is an indication of surging populist sentiment and a financial industry on the defensive.

A deal was struck in the Senate today regarding an audit of the Federal Reserve.

Senator Dodd worked out a compromise with Senator Sanders, and Dodd will now become a co-sponsor of the bill.

The bill would:

Require the non-partisan General Accountability Office to conduct an independent audit of the Board of Governors of the Federal Reserve System that does not interfere with monetary policy, to let the American people know the names of the recipients of over $2,000,000,000,000 in taxpayer assistance from the Federal Reserve System, and for other purposes.

And the bill provides:

Notwithstanding any other provision of law, the Board of Governors shall publish on its website, not later than December 1, 2010, with respect to all loans and other financial assistance it has provided during the period beginning on December 1, 2007 and ending on the date of enactment of this Act under the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Term Asset-Backed Securities Loan Facility, the Primary Dealer Credit Facility, the Commercial Paper Funding Facility, the Term Securities Lending Facility, the Term Auction Facility, Maiden Lane, Maiden Lane II, Maiden Lane III, the agency Mortgage-Backed Securities program, foreign currency liquidity swap lines, and any other program created as a result of the third undesignated paragraph of section 13 of the Federal Reserve Act.

Bernanke reconfirmation

See Bernanke reconfirmation.

Bernanke confirmed by Senate for second term at Fed

Ben S. Bernanke was confirmed by the U.S. Senate today for a second term as chairman of the Federal Reserve.

The Senate voted 70 to 30 to confirm the 56-year-old former Princeton University professor. Stocks pared losses as the Senate moved closer to a vote.

Bernanke overcame opposition from lawmakers who said he failed to head off the worst financial crisis since the Great Depression and then overstepped his authority by participating in rescues of firms including New York-based insurer American International Group Inc. and Citigroup Inc.

“If you’re the scorekeeper of our recovery, it looks like it can be summarized in the two-word phrase: Banks win,” said Democrat Sheldon Whitehouse of Rhode Island.

Supporters, including some who criticized his record on bank supervision, credited Bernanke with averting a deeper recession by slashing interest rates and pumping $1 trillion into the economy.

“Nobody was more important in preventing the collapse of the financial system and rescuing the economy from what looked like imminent freefall than Chairman Bernanke,” said Senator Charles Schumer, a Democrat from New York.

Rejecting Bernanke would “exacerbate economic uncertainty in an economy that needs confidence and stability, not volatility,” said Senator Robert Menendez, a Democrat from New Jersey.

The Standard & Poor’s 500 index fell 1.2 percent to 1,084.53 at 4:06 p.m. after Qualcomm Inc. lowered its sales forecast and speculation mounted Greece won’t be able to finance its debt. The index tumbled as much as 1.7 percent earlier.

  • Vote tally for the Bernanke reconfirmation, New York Times

Bernanke and Fed presidents lobby to keep power

Federal Reserve Chairman Ben S. Bernanke renewed his push to keep bank-supervision authority as some senators expressed support and others wavered.

Bernanke told the Senate Banking Committee that it would be a “grave mistake” to remove the Fed’s authority to oversee banks, as the panel’s chairman, Christopher Dodd, has proposed.

Democrat Evan Bayh of Indiana and Republicans Judd Gregg of New Hampshire and Mike Johanns of Nebraska, on Capitol Hill yesterday for a committee hearing with Bernanke, said they support Bernanke’s position. Rhode Island’s Jack Reed suggested the Fed may lose at least some of its authority.

“I don’t think it’s going to maintain its current role completely,” Reed, a Democrat, told reporters after the hearing.

There’s an “emerging consensus” on the panel to move the Fed’s regulation of smaller banks to the Federal Deposit Insurance Corp. At the same time, there is a “real substantive question” about the Fed’s role in overseeing large firms and its position on a council of regulators that would monitor risks to the financial system, Reed said.

Bernanke, 56, has said moving the powers to another agency would make it tougher for the central bank to act as the lender of last resort and conduct interest-rate policy. Dodd, a Connecticut Democrat, has said the Fed did an “abysmal” job supervising banks before the financial crisis.

Treasury Secretary Timothy F. Geithner told financial- industry trade group leaders yesterday he wanted to preserve the Fed’s power to oversee banks, Edward Yingling, the president of the American Bankers Association said in a telephone interview after attending the meeting.

Talking to Congress

“The industry representatives indicated they would be talking to Congress about that issue” to sway them to support the Fed, Yingling said. “The Senate seems to be going the opposite way.”

Fed officials have used letters, congressional testimony and talks with lawmakers to make the case that retaining supervision powers is essential to preventing a repeat of the financial crisis that prompted an estimated $1.7 trillion in writedowns and credit losses globally and led to government bailouts of firms including American International Group Inc. and Citigroup Inc.

Bernanke last month sent an 11-page letter to senators saying stripping the authority could harm the Fed’s ability to conduct monetary policy and provide emergency aid to lenders. The Fed “has substantial knowledge of financial markets, payment systems, economics, and a wide range of areas other than just bank supervision,” Bernanke told senators yesterday.

Meeting With Bennet

Two hours after Bernanke finished testifying, Kansas City Fed President Thomas Hoenig, the longest-serving Fed policy maker, met privately on Capitol Hill with Senator Michael Bennet, a Colorado Democrat on the banking panel, whose state is in Hoenig’s region.

In an interview after the 15-minute meeting, Bennet, 45, said he wasn’t immediately persuaded by Hoenig, even with his “long history” at the Fed.

“The Fed comes to this with an imperfect track record, which I think is widely acknowledged,” said Bennet, a former Denver schools superintendent who is running for election this year after being appointed in 2009 to fill a vacancy.

“The more important question for me is, what are we going to do to make sure we’re never in a position again” where the government may have to bail out a financial firm, he said.

Asked if that could be better accomplished with or without the Fed retaining supervisory powers, Bennet said: “I could see ways in which it could be accomplished in either case.”

Leading Efforts

Hoenig, 63, sent a letter last week to Bennet and 13 other senators saying proposed laws in the Senate wouldn’t improve financial regulation. Hoenig and Richmond Fed President Jeffrey Lacker of Richmond, chairman of the Fed’s Conference of Presidents, are leading efforts among some presidents to make the case to Congress.

The Fed Board of Governors delegates supervision to the 12 regional banks, which oversee more than 6,000 U.S. bank holding companies and state-chartered banks.

Bernanke fights to keep bank powers in Senate letter

Federal Reserve Chairman Ben S. Bernanke told senators a proposal to strip the central bank of its authority to supervise banks could harm its ability to conduct monetary policy and provide emergency aid to lenders.

The Fed’s role as supervisor provides information that helps officials decide when to change interest rates, the central bank said in an 11-page paper that makes the case to retain its examination powers. The document and a cover letter from Bernanke were sent yesterday to members of the Senate Banking Committee and released by the Fed today.

Christopher Dodd, the panel’s chairman, proposes stripping the Fed of those duties, calling its performance before the financial crisis an “abysmal failure.” Bernanke and the Obama administration are opposed. In his cover letter, Bernanke said the document shows how the Fed’s oversight role helps it “better perform its critical functions as a central bank.”

The Fed said in the paper that it is “seriously engaged” in efforts to correct “significant shortcomings” in oversight of banks whose risky investments were blamed in part for sparking the crisis.

“Elimination of the Federal Reserve’s role in supervision would severely undermine the Federal Reserve’s ability to obtain in a timely way and to evaluate the information it needs to conduct its central banking functions effectively,” the paper said.

Bank Collateral

Such information helps the Fed “assess independently and rapidly” the conditions of banks and the collateral they pledge when borrowing from the Fed’s discount window. In addition, getting data from another agency, even if employees were “willing and able to help,” could slow the Fed’s decision- making process, the central bank said.

In the cover letter addressed to Dodd and ranking Republican Richard Shelby of Alabama, Bernanke said some senators had asked for the Fed’s views on its role in supervision and regulation.

The paper discusses how the Fed’s expertise and information in setting monetary policy “enable it to make a unique contribution to an effective regulatory regime, especially in the context of a more systemic approach to consolidated oversight,” Bernanke said.

The document in part reflects public statements from Bernanke and other officials in recent months, responding to lawmakers’ criticism of the central bank for lax oversight on banks and subprime mortgages.

Managing Risks

Regulators failed to insist financial firms manage risks effectively, the Fed said. The central bank said it’s “engaged in an intensive self-examination of its supervisory functions” aimed at addressing weaknesses and improving oversight of individual firms and the broader system. The Fed cited steps such as starting “enhanced quantitative surveillance” of large banks.

The Fed tied supervisory information to monetary policy, saying the decisions to exit from close-to-zero interest rates and the record expansion of credit “will require particularly careful assessments of developments at financial institutions and in financial markets, and their resulting implications for the real economy.”

“Information from the supervisory process will help policy makers to assess overall credit conditions and the stability of the financial sector, and so to time appropriately the shift to reduced policy accommodation,” the paper said.

Big bank oversight to stay with Fed

"Banks with more than $100bn of assets will be overseen by the US Federal Reserve under a regulatory reform plan that represents a partial victory for the central bank after months of attacks in Congress.

Chris Dodd, the Senate banking committee chairman, had proposed hiving off all bank supervision to a single regulator but is set to propose this week that the 23 largest institutions stay under the Fed’s oversight, according to people familiar with the plans.

At issue over the weekend was the regulation of several hundred state chartered institutions that also want to remain under the Fed’s supervision.

While attention has been focused on an argument between Democrats and Republicans over the powers and location of new consumer protection functions, which may also be housed within the Fed, other elements of regulatory reform – deemed more important by many institutions and policymakers – are close to fruition.

A new “resolution” regime to deal with failing, but systemically important, institutions would allow the government to wind up a company quickly to avoid contagion spreading through the financial system.

But in a concession to Republican fears about giving government too much power over business, a bankruptcy judge would provide checks and balances.

The regime is designed to prevent a repeat of the costly bail-out of AIG or the damaging bankruptcy of Lehman Brothers.

But Democrats have had to come up with a complex system that incorporates a role for the judiciary to meet Republican concerns, while also limiting the time and scope of a judge’s intervention to prevent an unruly process that infects the entire financial system.

The Fed’s retention of authority over the biggest banks is partly a result of demands by Tim Geithner, Treasury secretary and former president of the New York Fed, who has told senators that only the central bank is qualified to oversee the core of the system.

But it also comes after a mobilisation of regional Fed presidents, unprecedented since the second world war, said people involved with the reform in the Senate.

“Until, frankly, chairman [Ben] Bernanke was confirmed I think the Fed’s hands were kind of tied,” said a banking industry figure who has held discussions with one of those Fed presidents. “Now he is chairman for the next four years ... the Fed has been able to be more aggressive in fighting for its authority.”

Senate panel nears agreement on role of Fed

"...But there is broad agreement among committee members to curb the Fed after it intervened repeatedly in the financial crisis to help troubled firms like insurer AIG.

Committee members have charged the Fed with lax regulation, failing to prevent the economic crisis, and misusing billions of dollars in taxpayer funds to prop up financial firms.

Members agree the Fed should be confined to monetary policy and being lender of last resort. So it should not be directly supervising banks, the two people said.

The sources requested anonymity because the bill is in flux and has not been made public.

Under such an arrangement, the Fed would be stripped of its duties to directly examine and supervise bank holding companies such as Citigroup Inc, Goldman Sachs, Morgan Stanley and Bank of America, the sources said.

A House of Representatives regulatory reform bill approved on Dec. 11 does not strip the Fed of its supervisory powers.

House Financial Services Committee Chairman Barney Frank has advocated ending the Fed’s consumer protection role, but has been adamant it needs to keep bank regulation powers.

Both Senate and House bills would have to be reconciled into a single measure before legislation could be sent by Congress to President Barack Obama to sign into law. That could happen in April or May, policy analysts said..."

Restructuring the Fed bank presidents

"Federal Reserve regional bank presidents and U.S. lawmakers intensified a clash over giving Congress a greater say in appointing the central bank officials, who are now named in part by private-sector banks.

St. Louis Fed President James Bullard said yesterday proposed legislation to subject some officials to Senate confirmation is a “blatant politicization” of the Fed. Separately, seven House Democrats called for an “exploration of possible changes” in how the Fed is governed, saying there’s an “inherent conflict” in the way presidents are named.

Proposed legislation in the Senate risks higher inflation if there’s too much political pressure on the Fed to keep interest rates low while the economy rebounds, some former Fed officials say. Lawmakers say private-sector banks have too much influence at the Fed, and that the regional Fed bank presidents focus too much on inflation at the expense of job growth.

“This is going to be a big battle,” said former Fed Governor Lyle Gramley, now a senior economic adviser to New York-based Soleil Securities Corp. “The danger is the new arrangement will politicize the Fed to the point that they don’t do what’s necessary” when the central bank needs to raise interest rates, he said.

The powers and autonomy of the 12 regional Fed presidents are under threat on several fronts in Congress.

Under a draft bill released Nov. 10 by Senate Banking Committee Chairman Christopher Dodd, directors at each regional bank would be chosen by the Fed’s Senate-confirmed governors, and each board chairman would be subject to White House appointment and Senate approval. Currently, two-thirds of directors are chosen by private-sector banks and one-third by the Fed’s Washington-based governors.

Vote on Policy

The boards of directors of each Fed bank select the president, who votes on monetary policy and is approved by Fed governors in Washington.

Dodd, who will begin debate on his financial-overhaul legislation today, also proposed stripping bank-supervision authority from the Fed and its regional banks and called the Fed’s regulation an “abysmal failure.”

The House Financial Services Committee voted on Nov. 17 to amend legislation to limit powers of the regional Fed presidents, so they wouldn’t share the decision-making power awarded the Fed board to oversee financial stability.

“I doubt very much that by a year from now Fed presidents are going to have as big a role as they now have,” Financial Services Committee Chairman Barney Frank told reporters after the vote. Frank said the presidents are “private citizens” who shouldn’t have “governmental powers.” He has said the presidents too often vote in favor of higher interest rates.

Political Appointees

Bullard, 48, the St. Louis Fed’s president since April 2008, said after a speech yesterday that the Fed is ultimately controlled by political appointees as it stands and that the private sector’s input is “invaluable.” Congress has “backed off these kinds of ideas” before and decided to “protect Fed independence,” Bullard said.

“We don’t want to put all the power into Washington and New York,” Bullard said. “That’s just the opposite of what this crisis is teaching us. So you want the input from around the country, and I think it’s really important for informing monetary policy.”

Richmond Fed President Jeffrey Lacker said Nov. 17 that the mix of private and public influence has “helped us keep focused on long-run objectives.”

“I wouldn’t want to see the reserve bank governance mechanism politicized in any way,” Lacker, 54, told reporters after a speech in Richmond, Virginia. Asked if Dodd’s plan would politicize the process, Lacker said: “I think it could.”

Cummings Letter

Yesterday, in a letter to Dodd and Frank, Representative Elijah Cummings cited a report this week by a Treasury Department overseer that the New York Fed failed to save taxpayers money on payments in connection with the bailout of American International Group Inc.

“There should be a comprehensive congressional review of the Federal Reserve System and an exploration of possible changes in its governance model,” Cummings and other lawmakers said in the letter.

Another former Fed official, Alice Rivlin, said she didn’t object to “modernizing” the process of choosing directors of regional Fed banks.

“The way the board members of the regional banks are chosen is really an anachronism” dating to the 1913 law that created the central bank, Rivlin, a former Fed vice chairman, said in a Bloomberg Radio interview. “I don’t see any great danger in modernizing it.”

Fed losing support on bank oversight

"... Meanwhile, Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee, is set to unveil legislation next week that would strip the Fed of much, if not all, of its bank oversight responsibilities.

Both lawmakers also plan to endow a council of regulators with more authority to address risks to the financial system than the administration had originally envisioned, though Frank said in an interview that the Fed would maintain a key role in addressing these threats.

"What you're seeing is a series of political compromises that preserves our ability to re-regulate the system to prevent another round of taxpayer bailouts, but yields to the reality that the Fed is very unpopular," said one Democratic aide. The aide recounted a wonkish joke making the rounds on Capitol Hill: "If the Fed were running for reelection, it would go home to spend more time with its family."

The legislative developments could upend the administration's vision of how Washington should regulate Wall Street in the wake of the financial crisis. Administration officials and some regulators are particularly concerned over the effort to eliminate the Fed's current responsibility for overseeing bank-holding companies, according to sources familiar with their thinking. Frank said he hopes to preserve this Fed power but that the prospect is more tenuous in the Senate.

Administration officials acknowledged that the final package of regulatory reforms enacted by Congress are likely to look markedly different from what was initially proposed in June.

Sen. Mark Warner (D-Va.) announced on the Senate floor Friday that he will introduce legislation next week to establish a systemic risk oversight council "that can spot gaps or opportunities for firms to avoid regulation, and that will not be consumed by other day-to-day responsibilities or protecting its own regulatory turf."

Warner said it would be a mistake to give the Fed that role because "it has obviously failed in that task," and because "its monetary policy responsibilities present potential conflicts, and it has proven incapable of properly regulating large institutions."

He said a strong council would create checks and balances, preventing the emergence of an all-powerful central bank. Warner said he envisions a council comprised of the Treasury secretary, Fed chairman and the heads of the major financial regulatory agencies, along with two independent members, including a council chairman appointed by the president..."

Audit the Federal Reserve

S. 604 - Federal Reserve Sunshine Act of 2009

Federal Reserve Sunshine Act of 2009

A bill to amend title 31, United States Code, to reform the manner in which the Board of Governors of the Federal Reserve System is audited by the Comptroller General of the United States and the manner in which such audits are reported, and for other purposes. link for the bill

Current co-sponsors (August 21, 2009)

  • John Barrasso [R-WY]
  • Robert Bennett [R-UT]
  • Barbara Boxer [D, CA]
  • Samuel Brownback [R-KS]
  • Richard Burr [R-NC]
  • Benjamin Cardin [D-MD]
  • Saxby Chambliss [R-GA]
  • Thomas Coburn [R-OK]
  • Thad Cochran [R, MS]
  • John Cornyn [R-TX]
  • Michael Crapo [R-ID]
  • Jim DeMint [R-SC]
  • Bryon Dorgan [D-ND]
  • Russell Feingold [D-WI]
  • Lindsey Graham [R-SC]
  • Charles Grassley [R-IA]
  • Thomas Harkin [D-IA]
  • Orrin Hatch [R-UT]
  • Kay Hutchison [R-TX]
  • James Inhofe [R-OK]
  • John Isakson [R-GA]
  • Patrick Leahy [D, VT]
  • Blanche Lincoln [D-AR]
  • John McCain [R-AZ]
  • Lisa Murkowski [R-AK]
  • James Risch [R-ID]
  • John Thune [R, SD]
  • David Vitter [R-LA]
  • Jim Webb [D-VA]
  • Roger Wicker [R, MS]

Merkley, Corker introduce legislation to audit the Fed

"...The Federal Reserve Accountability Act would require the GAO to audit all remaining emergency lending programs not already subject to audit. To protect against the risk that disclosure of the participation of particular institutions could disrupt markets, the GAO would be required to redact the names of the specific institutions. Names would, however, be made available one year after each emergency program is no longer used. In addition, to encourage greater accessibility for the average taxpayer, the Fed would be required to place these GAO audits along with additional audit materials on its website under a new “Audit” section. "

Draft of the legislation.

DeMint amendment fails

Source: Washington (Reuters) Monday July 6, 2009 -

"The U.S. Federal Reserve, facing growing pressure as it tries to heal the ailing economy, dodged a bullet on Monday when the U.S. Senate cast aside a new effort to increase scrutiny of the central bank.

On procedural grounds, the Senate blocked a bid to permit the U.S. comptroller general, who heads the investigative arm of Congress known as the Government Accountability Office, to audit the Federal Reserve system and issue a report.

Republican Senator Jim DeMint, who has been pushing for greater transparency at the Fed, failed to get the provision attached to the must-pass annual spending bill that includes funding for the GAO for the upcoming 2010 fiscal year.

The audit would have included details about the Fed's discount window operations, funding facilities, open market operations and agreements with foreign central banks and governments, DeMint said on the Senate floor.

"The Federal Reserve will create and disburse trillions of dollars in response to our current financial crisis," DeMint said. "Americans across the nation, regardless of their opinion on the bailout, want to know where the money has gone.

"Allowing the Fed to operate our nation's monetary system in almost complete secrecy leads to abuse, inflation and a lower quality of life," he said.

Democrats who control the Senate blocked the South Carolina Republican's amendment on the grounds that it violated rules prohibiting legislation attached to spending bills.

Fed officials were not immediately available to comment.

The move comes as some lawmakers have increasingly become wary of the Fed's actions, particularly for its handling of the real estate market and the meltdown of major financial institutions like investment bank Bear Stearns and insurance giant American International Group.

A non-binding provision in the fiscal 2010 budget blueprint Congress approved in April called on the Fed to provide more information about collateral posted against Bear Stearns and AIG loans.

That measure also sought a study evaluating the appropriate number and costs of the regional Fed banks."

Treasury Secretary supports Congress inquiry into Fed governance

"U.S. Treasury Secretary Timothy Geithner broke ranks with his former central bank colleagues and said he would support moves by Congress to take a look at how regional Federal Reserve bank presidents are appointed.

“I think it is very appropriate, and I would be completely supportive of the Congress taking a look at that broader governance structure” of regional Fed banks, Geithner said yesterday in an interview for Bloomberg Television’s “Political Capital With Al Hunt,” airing this weekend.

“You do not want to have any public institution in the position where its judgments, the judgments of their executives, are viewed through the prism of concern they are subject to influence of the financial community,” Geithner said. While that was “never the case,” he added, limiting such concerns would help protect the Fed, he said.

Federal Reserve spokeswoman Michelle Smith wasn’t immediately available for comment.

The Treasury Secretary commented a day after Federal Reserve Chairman Ben S. Bernanke defended the regional structure of the central bank as Congress considers the biggest overhaul of Fed powers since the 1930s. Lawmakers say private-sector banks have too much influence at the Fed, and that the regional bank presidents focus too much on inflation at the expense of job growth.

‘Incestuous Relationships’

Senate Banking Committee Chairman Christopher Dodd told Bernanke Dec. 3 that the regional Fed board structure leads to conflicts of interest and an “incestuous financial relationship” detrimental to the Fed.

The remarks came at a hearing on Bernanke’s nomination to a second four-year term. Bernanke told Dodd that Fed directors are chosen from “a wide representative cross-section” of community leaders.

House reform efforts

Rep. Barney Frank (D-Mass.) on Wednesday indicated he doesn’t expect changes on the House floor to a measure that would increase scrutiny of the Federal Reserve.

Frank, the chairman of the Financial Services Committee, opposes the measure sponsored by Rep. Ron Paul (R-Texas), but told reporters that he does not see language being changed on the House floor.

Ron Paul may take House subcommittee chair

"...One important indicator will be who is chosen to lead the House subcommittee that oversees the Fed when Republicans take control of the House of Representatives in January. First in line for the job is Representative Ron Paul of Texas, the libertarian renegade Republican, frequent presidential candidate, and outspoken critic of the Federal Reserve who wrote the best-selling polemic, “End the Fed.’’

Were he to assume the chairmanship, Paul would represent an altogether different type of critic: he really means what he says. But he’s no lock for the job. His views on monetary policy, and his disinclination to defer to the GOP leadership, have twice before led his own party to ignore his seniority and deny him control of this subcommittee, in 2003 and 2005. One acid test of whether the Republican Party is serious about trying to aggressively influence monetary policy and thwart QE2 is if it finally lets Paul loose on the chairmanship.

Paul expects it will. “I’m assuming that I’ll get it,’’ he said. “I’ve had no indication at all that I won’t.’’..."

House Committee votes to broaden oversight of the Fed

"In a display of populist anger toward the Federal Reserve, a House panel voted on Thursday to let Congress carry out sweeping new oversights of the central bank’s policy decisions and operations.

The House Financial Services Committee approved a measure proposed by Representative Ron Paul of Texas that would allow Congress to order audits of all the Fed’s lending programs as well as of its basic decisions to set monetary policy by raising or lowering interest rates.

If the measure becomes law, it would expose the Federal Reserve to far more political pressure than it has faced for decades. Fed officials have adamantly opposed the measure, saying it would undermine the central bank’s political independence and gravely threaten its credibility as a bulwark against inflation.

The vote on Thursday occurred despite the opposition of Representative Barney Frank, Democrat of Massachusetts, who had wanted to shield the Fed’s decisions on monetary policy from political pressures.

Mr. Paul, a libertarian Republican who has called for abolishing the Fed entirely, has introduced a version of his bill in every session of Congress since the early 1980s and never made any progress. But the Fed’s trillion-dollar efforts to bail out major banks and rescue the financial system provoked a popular firestorm that ignited both right-wing Republicans and left-wing Democrats.

Mr. Paul’s amendment would instruct the Government Accountability Office, the investigative arm of Congress, to carry out audits of all the Fed’s operations. Those include an array of emergency lending programs, bailouts of giant financial institutions, dealings with foreign central banks and the central bank’s efforts to drive down interest rates by intervening in bond markets.

Mr. Frank had already agreed that the G.A.O. should be authorized to audit all of the Fed’s rescue programs, but he had wanted to wall off the Fed’s more basic job of setting interest rates to steer the economy.

Mr. Paul’s bill would abolish a longstanding exemption that shielded the Fed from Congressional audits of its monetary policy. Supporters of the Fed’s independence have argued the shield provided crucial insulation from political pressure, which would make it much harder for Fed officials to take unpopular action aimed at heading off inflation.

The Watt amendment

The Watt amendment for "to be reported H.R. 3996

"A bipartisan effort to force transparency on the Federal Reserve is suddenly in jeopardy after a House Financial Services Committee member introduced an amendment that would let the multi-trillion dollar organization continue throwing tax dollars around in secret.

Rep. Mel Watt, a Democrat from North Carolina, has introduced an amendment intended as an alternative to the measure to audit the Federal Reserve introduced by Reps. Ron Paul (R-Texas) and Alan Grayson's (D-Fla.) . But instead of increasing transparency, as the amendment claims to do, Watt's measure would instead make the institution more opaque.

The measure could come for a vote anytime this week. Read the amendment here.

Watt pitched his amendment in a letter to colleagues circulated Tuesday. "While my amendment will certainly fall short of demands by those intent on destroying the independence (if not the existence) of the Fed, the critics of my amendment will have to concede...that my amendment will provide transparency of the Fed's financial operations that will be completely unprecedented," he wrote.

In fact, the critics are conceding no such thing. "The Watt Amendment, as written today, actually places new restrictions on the little authority that exists, such as it is, for independent auditing of the Fed," Grayson said. "It keeps in place all existing restrictions and adds four more. So I don't see why anybody would reasonably think that it creates unprecedented authority to audit the Fed."

The devil, as always, is in the details. While Watt's amendment talks a big game about opening up the Fed to a complete audit, all of the new powers granted must be carried out "each case in accordance with subsections (b) and (e)."

Those subsections of the current law delineate the many restrictions that an auditor confronts when seeking to audit the Fed. Watt's measure not only leaves those in place but requires all audits to abide by them.

And in addition to the current restrictions in place, it creates new ones. An auditor could not look at loans or liquidity arrangements the Fed enters into, the terms of those arrangements, or the effect of those loans and other liquidity deals on "reserves, the balance sheet or financial condition of a Federal reserve bank or the Federal Reserve System."

The Fed has expanded its balance sheet drastically over the last year, entering into exotic swap arrangements and otherwise pumping trillions of dollars into the economy. How it has done so and who has been on the receiving end would remain secret under Watt's bill.

By contrast, the Paul-Grayson amendment is patterned after Paul's bill H.R. 1207, which has broad bipartisan support. It has more than 310 cosponsors in a chamber with 435 members.

Paul's measure would repeal the provisions that Watt's leaves in place. If every member who cosponsored Paul's bill votes for it in committee this week, it would have the votes to pass. Watt's amendment is an effort to peel off votes.

Paul spokesman Jesse Benton said that Watt's proposal falls far short of the transparency that the multi-trillion dollar organization needs.

"The new exemptions are described as limited but they are extremely broad," Grayson said. They're so broad, in fact, that there would be very little left for an auditor to look into. What could an auditor check up on?

"Count the pencils on the desks," Grayson speculated. "Perhaps check on proper Metro card usage."

Consumer groups, unions support the Paul-Grayson amendment

Dear Chairman Frank, Ranking Member Bachus, and Members of the Committee,

As members of Americans for Financial Reform, a coalition of nearly 200 consumer, employee, investor, community and civil rights groups, we write you today to convey our strong support for the amendment to H.R. 3996, the Financial Stability Improvement Act of 2009, offered by Representatives Ron Paul and Alan Grayson.

This amendment subjects the Federal Reserve to an audit by the General Accountability Office within one year of enactment. This audit would shed light on questions the Fed has so far refused to answer, including the names of financial institutions that have received special loans and the conditions under which those loans were made. To shield policy discussions from political influence, the amendment exempts transcripts or minutes of meetings of the Board of Governors or of the Federal Open Market Committee. It also provides for delayed release of audit information dealing with individual market actions.

In responding to the financial crisis, the Federal Reserve has committed more than $1 trillion to aid troubled financial institutions through loans and asset purchases – without any of the restrictions on such things as executive compensation that came with funding from the Treasury under the Troubled Asset Relief Program (TARP).

Also, unlike the Treasury, which has posted all TARP transactions on its website, the Fed has kept most of the transactions secret.

In creating the Federal Reserve nearly 100 years ago, the Congress envisioned a central bank free from political pressure. But the structure that may have once ensured independence now appears to put the Fed much closer to the financial industry than the American people, who deserve to know who the beneficiaries are.

We strongly support transparency at the Federal Reserve and the Paul-Grayson Amendment.

  • Americans for Financial Reform
  • A New Way Forward
  • Accountable America
  • Campaign for America’s Future

SIGTARP report on the AIG counterparty payments

"The Federal Reserve Bank of New York crippled its own attempts to negotiate haircuts with American International Group's (AIG) credit default swap (CDS) counterparties late last year, effectively turning the AIG rescue into a 'backdoor bailout' of several major banks, according to a US government report published yesterday.

Neil Barofsky, the special inspector general for the US Troubled Asset Relief Program (Sigtarp), blamed New York Fed president, Tim Geithner (now Treasury secretary) for failing to negotiate aggressively with AIG's counterparties in November 2008. The New York Fed decided to treat all major counterparties equally - effectively giving a veto over haircuts to any of the counterparties, especially foreign banks such as Société Générale and Calyon, which were both legally prevented from agreeing to voluntary haircuts and less vulnerable to suasion from the Fed and other US regulators. In the end, of nine major counterparties only UBS suggested it would be open to a 2% haircut, and only if all other counterparties also agreed.

The Fed should have been ready to offer different terms to US banks, Barofsky said, especially since many had already received billions of dollars of aid from the US government, and should have used its leverage as their primary regulator to encourage them to accept haircuts. As it was, the Fed ended up with "a negotiating strategy with the counterparties that even then-FRBNY president Geithner acknowledged had little likelihood of success," Barofsky wrote.

The telephone negotiations, according to Barofsky's report, were similar to a game of chicken. For example, Goldman Sachs, which ultimately received a total of $14 billion, told the Fed that if AIG were permitted to default, Goldman would not be harmed, as it had sufficient third-party protection to make whole its losses, and there was therefore no reason for Goldman to agree to a haircut as part of the effort to avoid a default. But, Barofsky argues, this was disingenuous - the turbulence caused by an AIG default would have weakened third-party protection and would certainly have made it difficult for Goldman to liquidate the CDS's underlying assets. Goldman Sachs and the other counterparties also benefited from a calculation that the Fed would certainly not permit an AIG default in any case. The Fed, for its part, was unwilling even to hint that AIG would be permitted to default, for fear of the consequences this suggestion would have on the market in general.

Barofsky also criticised the initial decision to keep the names of the counterparties and the amounts they received secret, with Federal Reserve Board vice-chairman Donald Kohn arguing that releasing the names would "undermine the stability of the company". Although the names were eventually released in March 2009, with no noticeable adverse effects, they should never have been kept secret at all, Barofsky said. The government's argument "simply does not withstand scrutiny...The lesson that should be learned - one that has been made apparent time after time in the government's response to the financial crisis - is that the default position, wherever government funds are deployed in a crisis to support markets or institutions, should be that the public is entitled to know what is being done with the government's funds."

In its response to the report, the New York Fed said that "it would not have been appropriate to use our supervisory authority to obtain concessions", especially if this meant treating foreign banks more generously than US banks; the government's existing commitment to saving AIG left the Fed with very little negotiating leverage with the counterparties, it added.

The report comes the month after another critical Sigtarp report on the New York Fed's relationship with AIG. In October, Barosky said the Fed had failed to recognise the significance of oversight of compensation at the insurer, calling the Treasury's oversight of the same issue "haphazard" in an interview published this month in Risk.

Reform legislation "gutted" Paul says

Representative Ron Paul, the Texas Republican who has called for an end to the Federal Reserve, said legislation he introduced to audit monetary policy has been “gutted” while moving toward a possible vote in the Democratic-controlled House.

The bill, with 308 co-sponsors, has been stripped of provisions that would remove Fed exemptions from audits of transactions with foreign central banks, monetary policy deliberations, transactions made under the direction of the Federal Open Market Committee and communications between the Board, the reserve banks and staff, Paul said today.

“There’s nothing left, it’s been gutted,” he said in a telephone interview. “This is not a partisan issue. People all over the country want to know what the Fed is up to, and this legislation was supposed to help them do that.”

The Fed, led by Chairman Ben S. Bernanke, has come under greater congressional scrutiny while attempting to end the financial crisis by bailing out financial firms and more than doubling its balance sheet to $2.16 trillion in the past year. The central bank is also buying $1.25 trillion of securities tied to home loans.

Paul, a member of the House Financial Services Committee, said Mel Watt, a Democrat from North Carolina, has eliminated “just about everything” while preparing the legislation for formal consideration. Watt is chairman of the panel’s domestic monetary policy and technology subcommittee.

Keith Kelly, a spokesman for Watt, declined to comment and said Watt wasn’t immediately available for an interview. Watt’s district includes Charlotte, headquarters of Bank of America Corp., the biggest U.S. lender.

Paul said he intends to introduce an amendment to the bill when it comes to the House floor for a vote restoring the legislation’s original language.

Representative Barney Frank, a Democrat from Massachusetts and chairman of the committee, said in interview that he intends to ensure legislation would provide a time lag between FOMC actions and the reporting of them.

Such a provision would “lessen the market impact,” he said on Oct. 20. “The importance is to see that there are no abuses and to judge what they did.”

The legislation will probably be included in a broader Democratic package of financial-regulation changes in the House, Frank said.

H.R. 1207 - Ron Paul's bill to audit the Fed

Federal Reserve Transparency Act of 2009 link for the bill

To amend title 31, United States Code, to reform the manner in which the Board of Governors of the Federal Reserve System is audited by the Comptroller General of the United States and the manner in which such audits are reported, and for other purposes.

"Rep. Barney Frank endorses measure to audit the Federal Reserve that has won hundreds of co-sponsors on both sides of the aisle since it was introduced in late February by Rep. Ron Paul.

Rep. Barney Frank, the chairman of the House Financial Services Committee, has endorsed a bill calling for an audit of the Federal Reserve.

The support from the powerful Massachusetts Democrat comes after the measure, introduced in late February by Rep. Ron Paul, has won hundreds of co-sponsors on both sides of the aisle.

Frank's office had previously declined to comment on the bill, which had been idling in his committee for months, but the congressman publicly backed it when pressed on the issue at a recent town hall meeting held during Congress' month-long summer recess.

"We will subject them to a complete audit," Frank said, explaining that he has been working with Paul, a Texas Republican, on the bill and expects it to pass as part of a broader financial regulatory overhaul in October.

Frank said he and Paul are working to make sure the audit does not appear as if it would influence policy.

"We don't want to have the audit appear as if it is influencing monetary policy, because that would be inflationary," Frank said.

He said the audit would make public a list of what the Federal Reserve "buys and sells" but that such information would be released several months after the fact, so as not to affect the markets.

Paul tried to push a similar bill back in 1983, but it died. He suggested earlier in the year that the renewed concern about excessive federal spending and loose monetary policy is driving the wave of support to his proposal this time around.

"I think it's the financial crisis obviously that's drawing so much attention to it, and people want to know more about the Federal Reserve," Paul told, warning about the consequences of continuing to give the body more authority. "If they give them a lot more power and there's no more transparency, that'll be a disaster. "

The bill would call for the comptroller general in the Government Accountability Office to audit the Fed and report those findings to Congress. The first audit would be ordered by the end of 2010.

The GAO's ability to conduct such audits now is severely restricted. "

Click here to see the video of Frank discussing the Fed audit.

"The financial-overhaul plan before Congress leaves the Federal Reserve in the business of lending to everyone from General Electric Co. to investors in student loans. That makes it harder for Chairman Ben S. Bernanke to keep Congress from second-guessing what he does.

Bernanke is trying to deflect a bill, co-sponsored by 276 members of the House of Representatives, that would require audits of central bank operations, including monetary policy decisions, by the Government Accountability Office. Audits wouldn’t be “consistent with independence,” Bernanke said at a Kansas City town hall meeting July 26. “I don’t think the American people want Congress running monetary policy.”

Unless the Fed retreats from unlimited lending, Bernanke can expect such a result, said Marvin Goodfriend, an economist at Carnegie Mellon University in Pittsburgh. The more the Fed invades the domain of Congress by supplying credit to businesses and markets outside the banking system, the more Congress will seek a hand in monetary policy, said Goodfriend, a former adviser to the Richmond Fed.

“Central bank independence is incompatible over time with all but limited, temporary last-resort lending” to banks, Goodfriend said in an interview. The Fed’s role in emergency lending “needs to be clarified before the next crisis,” he said.

Congress may demand more say over the Fed’s credit policies. Democratic Representative Paul Kanjorski of Pennsylvania is gathering signatures for a letter asking Bernanke to extend the Term Asset-Backed Securities Loan Facility.

The TALF, an emergency program that lends to investors to purchase securities backed by consumer and business loans, is set to expire Dec. 31. Bernanke told the Senate Banking Committee July 22 that it would be “difficult” to justify extending the TALF if markets return to normal operations..."

"... Voter concern that the Fed overstepped its authority prompted a majority of House lawmakers to co-sponsor a bill allowing for audits by the Government Accountability Office of the central bank’s monetary policy and other operations. Bernanke opposes the measure, which was introduced by Representative Ron Paul of Texas, a Republican.

Asked yesterday about the audit bill, Bernanke said it could result in lawmakers issuing subpoenas over potential decisions to raise interest rates. “I don’t think the American people want Congress running monetary policy,” he said.

The central bank chairman said independence from political interference in setting interest rates produces “much better results” for the economy. “We are very, very sensitive to this issue,” Bernanke said at the forum.

Participating in yesterday’s meeting was an “enormously smart decision” for Bernanke, said Gregory Hess, an economics professor at Claremont McKenna College in California and a member of the Shadow Open Market Committee, a group of economists that critiques the Fed.

‘Big Questions’

“People still have big questions, which are, how did we get in this mess, how do we get out of this mess, how are we going to make sure this mess never happens again?” Hess said. “It’s a time where he can really leverage his ability to communicate.”

Bernanke appeared on the CBS program “60 Minutes” in March, his first televised interview since becoming Fed chairman in 2006.

His comments are scheduled to air in three segments this week as part of “The NewsHour with Jim Lehrer” on U.S. stations affiliated with PBS, the Public Broadcasting Service."

"Rep. Ron Paul usually stands far outside the mainstream in Congress, particularly in his campaign to kill the Federal Reserve. But the Texas Republican now has the bulk of his colleagues standing alongside him in a fight against the central bank’s autonomy.

His bill to audit the Fed, just three pages long, has 274 co-sponsors — every House Republican and almost 100 Democrats — and counting. “People are upset,” he says. “People are demanding more transparency of the Fed, and they’re supporting me on this.”

The longtime Fed critic would prefer an economy without a central bank, where the market sets interest rates and troubled firms are left to sink. He blames the Fed for the past century’s financial bubbles and worries about its ability to monetize debt to finance government spending, even though Fed officials insist they’d never allow it.

Mr. Paul sees transparency as a first step in making the public more aware of the Fed’s ability to electronically print money to support the banking system. The revelations from an audit will “expose to the American people exactly how the Federal Reserve operates,” he says. “Because when they fully understand how they operate, what they do, how they manipulate monetary policy and interest rates, they will finally figure out that it’s the Fed that has caused all the mischief.”

Most of the lawmakers who have signed on as co-sponsors of the legislation don’t share Mr. Paul’s anti-Fed stance. They say Congress has an oversight role and needs a full accounting of how much money the Fed has lent — and to whom."

House Oversight Committee review of AIG

The House Oversight and Reform Committee is conducting extensive oversight of the transactions between the US Treasury, Federal Reserve Bank of New York and AIG.

House Oversight Committee review of Stephen Friedman stock sales

Senior Federal Reserve officials had “serious misgivings” about allowing the former chairman of the Federal Reserve Bank of New York’s board to serve while owning shares of Goldman Sachs Group Inc., a House chairman said.

The Fed officials argued against allowing Stephen Friedman to stay on as chairman while simultaneously investing in Goldman Sachs before the central bank waived its conflict of interest policy in January 2009, House Oversight and Government Reform Committee Chairman Edolphus Towns said in a statement today.

“Senior officials had misgivings about granting the waiver but were overruled,” Towns, a New York Democrat, and Representative Stephen Lynch, a Massachusetts Democrat, said in the statement.

The Oversight Committee will schedule a hearing “to learn more from Mr. Friedman and senior Fed officials about how he was permitted to make windfall profits by trading stock in a company he had a role in regulating,” the lawmakers said.

After Goldman Sachs opted to become a Fed-supervised bank in September 2008, the Fed approved a waiver for Friedman to remain chairman of the New York Fed’s board.

Friedman bought additional stock in Goldman Sachs after receiving the waiver, drawing criticism from members of Congress including Towns and Senator Richard Shelby of Alabama, the senior Republican on the Senate Banking Committee. Friedman resigned the Fed post in May 2009, citing the distraction caused by the controversy.

The Fed changed its policies in November to bar non-bankers serving as directors of a regional Fed bank from being board members or employees of a company that owns or is part of a bank, thrift or credit union.

To contact the reporter on this story: Jeff Plungis in Washington at

House Oversight Committee review of Bank of America

The House Oversight and Reform Committee is conducting extensive oversight of the transactions between the US Treasury, Federal Reserve Bank of New York and Bank of America.

House Financial Services Committee Hearing Sept. 25

9 a.m., Friday, September 25, 2009, 2128 Rayburn House Office Building

Witness List & Prepared Testimony:

Today, the House Committee on Financial Services held a hearing, which would grant the Government Accountability Office (GAO) expanded authority to audit the Federal Reserve. Chairman Barney Frank (D-MA) opened the hearing by briefly describing the economic crisis over the past year, including the Federal Reserve’s involvement in stabilizing the financial market. Members of the Committee, including Representatives Stephen F. Lynch (D-MA) and Jeb Hensarling (R-TX) also made introductory comments, noting the need to increase transparency at the Federal Reserve and to differentiate between emergency funding and serial institutional bailouts. Testifying before the Committee were the following witnesses: • Scott G. Alvarez, General Counsel, Board of Governors of the Federal Reserve System • Thomas E. Woods, Jr., Ludwig von Mises Institute

Since 1978, when the Federal Banking Agency Audit Act was enacted, the Board of Governors of the Federal Reserve System, the individual Federal Reserve Banks, and the Federal Open Market Committee have been subject to GAO audits. Under current law, certain Federal Reserve matters are expressly excluded from GAO audit: "Audits of the Federal Reserve Board and Federal reserve banks may not include -

  1. transactions for or with a foreign central bank, government of a foreign country, or nonprivate international financing organization;
  2. deliberations, decisions, or actions on monetary policy matters, including discount window operations, reserves of member banks, securities credit, interest on deposits, and open market operations;
  3. transactions made under the direction of the Federal Open Market Committee; or
  4. a part of a discussion or communication among or between members of the Board of Governors and officers and employees of the Federal Reserve System related to clauses (1)-(3) of this subsection."

Proposed H.R. 1207 would repeal all of these exclusions.

Mr. Alvarez explained why granting the GAO broad new authority to audit the monetary policy and related activities of the Federal Reserve would be contrary to the public interest. Mr. Alvarez defended the Federal Reserve’s commitment to protecting the public interest, noting that monetary policies, to be most effective, must be as free as possible from political influence, and asserted that the Federal Reserve is “not as secretive as [it is] thought to be.” He stated that the Federal Reserve is accountable to both the Congress and the public, noting that the GAO already audits the Federal Reserve and that such audits also serve as a policy guide and provide recommendations with respect to policies. He further noted that the GAO had conducted 14 audits of the Federal Reserve to date and that an additional 14 GAO audits remain pending.

Committee members asked Mr. Alvarez why the identity of firms accessing discount window loans at the Federal Reserve remains confidential. Mr. Alvarez explained the Federal Reserve’s concern that if the names of borrowers are disclosed in a GAO audit, as proposed in H.R. 1207, borrowing institutions would be viewed by the public as troubled institutions, potentially triggering a deposit run and accelerating failure, notwithstanding the fact that the Federal Reserve makes the discount window available to both troubled and healthy institutions.

Another Committee member requested details of what circumstances warrant the authorization of loans pursuant to Section 13(3) of the Federal Reserve Act . Mr. Alvarez stated that institutions will only receive Section 13(3) funding in unusual and exigent circumstances and upon a determination that no other credit is available to the institution. Mr. Alvarez reviewed additional measures recently adopted by the Federal Reserve to increase accountability, including additional public disclosures about the composition of and changes in the Federal Reserve’s balance sheet, heightened disclosure of policy programs and financial activities on the Fed’s website, Congressional reports on each outstanding liquidity facility authorized under Section 13(3) and public disclosure of significant contractual obligations entered into to assist in the management and administration of the programs established to address the financial crisis.

In response to a question by a Committee member, Mr. Alvarez asserted that he did not believe enhanced GAO audits would have prevented the financial crisis and concluded that the adoption of H.R. 1207 would “increase inflation fears and market interest rates and, ultimately, damage economic stability and job growth.”

Mr. Woods defended H.R. 1207, stating that “taxpayers—involuntary investors in this case—have a right to know who received loans, in what amounts, for which collateral, and why specific loans were made.” He asserted that, without a full audit of the Federal Reserve, inflation cannot be effectively fought and interest rates cannot be effectively monitored. Mr. Woods noted that the current financial crisis is a historic moment and challenged the Federal Reserve’s defensiveness, arguing that “if you’re not doing anything wrong, you have nothing to worry about.”

From Mr. Woods' testimony:

"There is no good reason for Americans not to know the recipients of the Fed’s emergency lending facilities. There is no good reason for them to be kept in the dark about the Fed’s arrangements with foreign central banks. These things affect the quality of the money that our system obliges the American public to accept.

The Fed’s arguments against the bill are unlikely to persuade, and will undoubtedly strike the average American as little more than special pleading. Perhaps the most frequent of the claims is that a genuine audit would jeopardize the alleged independence of the Fed. Congress could come to influence or even dictate monetary policy.

This is a red herring. The bill is not designed to empower politicians to increase the money supply, choose interest-rate targets, or adopt any of the rest of the Fed’s central planning apparatus, all of which is better left to the free market than to the Fed or Congress. It seeks nothing more than to open the Fed’s books to public scrutiny. Congress has a moral and legal obligation to oversee institutions it brings into existence. The convoluted scenarios by which merely opening the books will lead to an inflationary catastrophe at the hands of Congress are difficult to take seriously.

At the same time, as we hear this objection repeated time and again, we might wonder just how independent the Fed really is, what with its chairman up for reappointment by the president every four years. Have these critics never heard of the political business cycle? Fed chairmen have been known to ingratiate themselves into the president’s favor close to election time by means of loose monetary policy and the false (and temporary) prosperity it brings about. Let us not insult Americans’ intelligence by pretending this phenomenon does not exist...

If there is any truth to the idea of Fed independence, it lay in precisely this: the Fed may reward favored friends and constituencies with trillions of dollars in various kinds of assistance, while keeping the public completely in the dark. If that is the independence we’re talking about, no self-respecting American would hesitate for a moment to challenge it.

A related argument warns that the legislation threatens to politicize lender-of-last-resort decisions. Again, this is untrue. But even if it were true, how would that represent a departure from current practice? I hope we are not asking Americans to believe that the decisions to bail out various financial institutions over the past two years, and in particular to allow them to become depository institutions overnight that they might qualify for assistance, were made on the basis of a pure devotion to the common good and were not political at all. Most Americans, not unreasonably, seem convinced of another thesis: that Goldman Sachs, for instance, might be just a little bit more politically well connected than the rest of us...

If our monetary system were really as strong, robust, and beyond criticism as its cheerleaders claim, why does it need to rely so heavily on public ignorance? How can it be a sound banking system that depends on keeping the public in the dark about the condition of its financial institutions?

Let me also make clear that supporters of this legislation are strongly opposed to a watered-down version of the bill – which, incidentally, would only increase public suspicion that someone is hiding something.

If the Federal Reserve Transparency Act passes and the audit takes place, the American people will have achieved a great victory. If the legislation fails, more and more Americans will begin to wonder what the Fed could be so anxious to keep hidden, and the pressure for transparency will simply intensify. A recent poll finds 75 percent of Americans already in favor of auditing the Fed. The writing is on the wall.

The Federal Reserve may as well get used to the idea that the audit is coming. That would be a far more sensible approach than the counterproductive and condescending one it has adopted thus far, in which the peons who populate the country are urged to quit pestering their betters with all these impertinent questions. The Fed should take to heart the words of consolation the American people are given whenever a new government surveillance program is uncovered: if you’re not doing anything wrong, you have nothing to worry about.

The superstitious reverence that Americans have been taught to have for the Federal Reserve is unworthy of the dignity of a free people. The Fed enjoys a government-granted monopoly on the creation of legal-tender money. It is not an unreasonable imposition for Americans to demand to know about the activities of such an institution. It is common sense."

Representative Grayson questions General Counsel Alvarez about the Federal Reserve participation in the equities and futures markets.

House Financial Services hearing July 9

House Financial Services Committee Thursday July 9: "Regulatory Restructuring: Balancing the Independence of the Federal Reserve in Monetary Policy with Systemic Risk Regulation" (Domestic Monetary Policy/Technology Subcomm 1:30 p.m.)

Witness List & Prepared Testimony:

  • Mr. Donald L. Kohn, Vice Chairman, Board of Governors of the Federal Reserve
  • Dr. Frederic Mishkin , Alfred Lerner Professor of Banking and Financial Institutions, Graduate School of Business, Columbia University
  • Dr. Laurence Meyer, Vice Chairman, Macroeconomic Advisers
  • Dr. James K. Galbraith, Lloyd M. Bentsen Jr. Chair in Government/ Business Relations and Professor of Government, LBJ School of Public Affairs, University of Texas
  • Dr. Richard Berner, Chief Economist, Morgan Stanley
  • Dr. John B. Taylor, Mary and Robert Raymond Professor of Economics, Stanford University
  • Dr. Allan Meltzer, The Allan H. Meltzer University Professor of Political Economy, Tepper School of Business, Carnegie Mellon University

Fed rejects Geithner request for study of governance, structure

"The Federal Reserve Board has rejected a request by U.S. Treasury Secretary Timothy Geithner for a public review of the central bank’s structure and governance, three people familiar with the matter said.

The Obama administration proposed on June 17 a financial- regulatory overhaul including a “comprehensive review” of the Fed’s “ability to accomplish its existing and proposed functions” and the role of its regional banks. The Fed was to lead the study and enlist the Treasury and “a wide range of external experts.”

Some top central bank officials, after agreeing to the review, saw a potential threat to Fed independence after the Treasury released the proposal, two of the people said. The Obama plan said the Treasury would consider recommendations from the review and “propose any changes to the Fed’s governance and structure.”

“It is not obvious at all why that is a Treasury responsibility or even appropriate why the Treasury would undertake that kind of study,” said Robert Eisenbeis, chief monetary economist at Cumberland Advisors Inc. in Vineland, New Jersey, and a former Atlanta Fed research director. “The Fed was created by Congress and it is not part of the executive branch.”

U.S. lawmakers have also called for a review of the Fed’s power and structure, saying Fed Chairman Ben S. Bernanke overstepped his authority as he bailed out creditors of Bear Stearns Cos. and American International Group Inc. while battling a crisis that led to $1.62 trillion in writedowns and losses at financial firms.

While the report requested by the Treasury hasn’t been formally scrapped, no work has been done on the project, which was due Oct. 1, the people said. Treasury spokesman Andrew Williams declined to comment, as did Fed spokeswoman Michelle Smith."

Volcker criticizes Obama plan to expand Fed’s role

"Paul Volcker, a former Federal Reserve chairman and now a outside economic adviser to President Barack Obama, criticized the administration’s plan to give the Fed authority to supervise “systemically important” financial firms.

“I don’t know what systemically important institutions are,” Volcker said. “But I’m sure that if you picked them out, people will assume they’re going to be saved, that they’re too big to fail.”

Volcker’s remarks appeared in the form of a “conversation” with Gary Stern, who retired last month as president of the Fed Bank of Minneapolis, and published in “The Region,” the bank’s quarterly bulletin. Volcker, 81, is chairman of the Economic Recovery Advisory Board, a body created by Obama in February to recommend responses to the crisis.

Obama’s plan to give the Fed powers to monitor risks to the financial system is aimed at avoiding a repeat of the financial meltdown that led to $1.6 trillion of bank losses and writedowns and triggered a global recession. The Obama plan would label banks including Bank of America Corp. and Citigroup Inc. as “systemically important” and subject them to capital and liquidity requirements and stricter oversight.

Jen Psaki, a White House spokeswoman, declined to comment on Volcker’s remarks."

Kohn identifies areas of study for the Fed

Donald Kohn, Fed Vice Chairman lists 4 homework tasks for policymakers:

"The events of the past few years have raised many questions for central bankers. Although prompt and innovative actions by the Federal Reserve and other central banks helped prevent a severe economic downturn from turning into something even worse, our experience also highlighted a number of areas we need to study further to see whether we can improve the conduct of monetary policy. I’ve titled my presentation “Homework Assignments” because I don’t think the answers are clear, though I will venture some tentative thoughts. I have four assignments on my list; I could easily have more. And others would have yet a different list. I recognize that the complexity of these questions could keep us profitably engaged for a whole semester, but let’s see if I can outline some of the challenges and possible responses in an evening."

The fours tasks are:

  • Liquidity facilities – Fed started number of liquidity facilities in this crisis and as crisis has eased, has closed most of them as well. The question is what should be the design if liquidity facilities going forward? Should these facilities become permanent tools in Fed’s kit? If not, then how should Fed be using them in future?
  • Fed’s asset purchases – Fed purchased Treasuries, mortgage backed assets and agency debt etc. What is the impact of these purchases on the economy and fin markets? A related aspect is to understand the impact of large volumes of bank reserves which Fed has created to buy assets. Ideally these reserves should go into increasing money supply and credit. But this has not happened.
  • Should Fed use interest rates to dampen asset bubbles/financial instability? This is the evergreen question. Parallelly, do low interest rates lead to asset bubbles?
  • Should we have higher inflation targets? This was suggested by IMF’s economists lately and has been criticised by most central bankers. Kohn does not agree to this proposal and says it will lead to higher inflation expectations. He also looks at the idea of price index targeting as an alternative. He likes the concept but finds it difficult to implement and communicate.

New York District Court and the Federal Reserve

See New York District Court and the Federal Reserve.

Proposals embodied in the Presidents Plan

Expand Federal Power to Regulate Nonbank Financial Firms that Pose Systemic Risk

  • Create a new Financial Services Oversight Council chaired by Treasury with the "authority to gather information from any financial firm" and the responsibility for "referring emerging risks to the attention of regulators with the authority to respond."
  • Authorize the Federal Reserve to identify, supervise, and regulate "any financial firm whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed" (referred to as "Tier 1 Financial Holding Companies").
  • Impose stricter capital, liquidity, and risk management standards on Tier 1 Financial Holding Companies than those applicable to other financial firms.
  • Charge the Federal Reserve with overseeing systemically important payment, clearing, and settlement systems.
  • Eliminate the SEC's Supervised Investment Bank Holding Company consolidated supervision program, and subject investment banking firms that seek consolidated supervision to regulation by the Federal Reserve.
  • Authorize Treasury to employ a new special resolution regime—modeled after the FDIC's regime for insured depository institutions—to administer the resolution of failing bank holding companies and Tier 1 Financial Holding Companies.
  • Amend Section 13(3) of the Federal Reserve Act to require Treasury approval for any extensions of credit by the Federal Reserve in "unusual and exigent circumstances."
  • Close "loopholes ... for thrift holding companies, industrial loan companies, credit card banks, trust companies, and grandfathered 'nonbank' banks" and subject them to supervision and regulation by the Federal Reserve.
  • Conduct a "fundamental reassessment" of current regulatory capital requirements for banks and bank holding companies, with a report due by December 31, 2009.
  • Require banking agencies to promulgate regulations that require originators or sponsors of securitizations to retain a financial interest in the credit risk of the securitized exposure.

Source: Jones, Day

Federal Reserve independence

Please see Federal Reserve independence.

"Bergman: Martin, you used the words "dubious legal authority" for the Federal Reserve's lending. Walker's done a lot of work in that area and Section 13(3) of the Federal Reserve Act. Walker, could you describe the origin of Section 13(3) and its relevance to this crisis?

Todd: Most of the actions the Fed has taken since the spring of 2008 have been said to be under the authority of Section 13(3) of the Federal Reserve Act. That's an emergency powers section that was plugged in first around 1932. It gave the Federal Reserve Board of Governors the power in "unusual and exigent circumstances" to make loans directly to individuals, partnerships, and corporations--not just to banks or other financial institutions. It required a positive vote of five members of the board to invoke this authority. It was rarely used during the 1930s because the Reconstruction Finance Corporation was created and made the great bulk of all the loans that this statute was originally contemplated to do. That Section 13(3) authority, in fact, was not used after 1936.

Until 1991. In the dark of night during the Senate markup of the FDIC Improvements Act, lobbyists for the investment banks saw to it that Sen. Christopher Dodd introduced an amendment that would waive the statute's technical collateral requirements, because the statute required collateral of the type eligible for discount at the Federal Reserve--which was short-term trade-related obligations and certain government securities. By and large, investment banks did not hold that kind of collateral, but they had lots of stocks and bonds and other things that were not eligible for discount.

So the collateral requirement was changed to any collateral satisfactory to the Federal Reserve Bank, and that meant that investment banks could borrow at the Fed for a change. Now, I opposed that change, and I identified it in an article that was published by the Cleveland Federal Reserve Bank in its Economic Review in the third quarter of 1993. The publication of the article created an internal firestorm. The Board of Governors really came down on me hard for having published it. Years later, we find out why. They wanted to use that power if they had a big enough emergency--as they thought they did once Bear Stearns went down--to make a bailout loan to an investment bank.

This stands the entire Federal Reserve Act on its head. The exceptional rule--the emergency power--has now become the regular way of doing things and the quantitatively dominant method of extending credit for the Fed. It's very bad from a number of perspectives, not the least of which is institutional structure, because it means that the narrow and insular views of the Board of Governors together with the New York Federal Reserve Bank, the entity that's making these loans, are the only views listened to in deciding when and how an emergency loan is being made. Basically, the credit gets booked and then the other Reserve Banks are required to eat a pro-rata share of these loans through loss-sharing agreements and the like.

It's a process that needs to be stopped. They need to channel all of this out into something like a newly created RFC. The only other alternative would be to just explicitly require the Treasury to take these loans off the books of the Fed, to recapitalize them and refund them with Treasury debt issues.

Kane: What do you think is going to be the long-term effect on the Federal Reserve as an institution? It has exercised discretion it was never given. The independence of monetary policy was always the central principle underlying its responsibilities and discretion. By putting bankers and brokers first in the line out of all other members of society, do you think that the Federal Reserve can retain its independence going forward?

Todd: Martin, do you want to respond to that?

Mayer: I have been very disturbed about the way this thing has worked in terms of body language. [Fed chairman from 1951 to 1970] Bill Martin was very reluctant to go to the White House for lunch with Lyndon Johnson because he thought that he was not part of the executive branch, which indeed the Fed is not, remember? The Constitution gives Congress the power to coin money and regulate the value thereof. [House Banking Committee chairman from 1965 to 1975] Wright Patman used to say, "We farmed it out to the open market committee of the Federal Reserve." The basic source of the Fed's real authority is in the Congress, not the executive branch.

It was always Bill Martin's feeling--and it was certainly the feeling of [Fed chairman from 1979 to 1987] Paul Volcker--that they were not part of the executive branch. They didn't take dictation from the president of the United States, and indeed, Lyndon Johnson blew his stack about Martin once raising interest rates, but Johnson couldn't do a thing about it.

I think all of this has been lost. The Fed has sacrificed under Ben Bernanke, as it had under [Fed chairman from 1970 to 1978] Arthur Burns, quite a lot of its independence. There should be a law that prevents academics from becoming chairmen of the Fed."

Fed official questions Fed Res as systemic regulator

Source: Revamp Could Hurt Central Bank, Warns Head of Philadelphia Fed WSJ, July 28, 2009

"Charles Plosser, president of the Federal Reserve Bank of Philadelphia, expressed reservations about the Obama administration's plans for rewriting the nation's financial regulations, saying it could leave the Fed with an ill-defined role as bank regulator and make it less effective at its main job of fighting inflation.

Mr. Plosser is one of 12 Federal Reserve regional bank presidents who have a say in Fed decisions about interest rates and bank supervision. His comments were among the most skeptical yet from a Fed official on the Obama plan. "You don't want an institution that is so heavy into other things that it fails to do its appropriate role on the monetary policy piece," Mr. Plosser said in an interview Monday, emphasizing the primacy of the Fed's job in promoting price stability.

Mr. Plosser expressed some discomfort with the plan to designate the Fed as the overarching protector of financial stability. "I would feel more comfortable with this if I had a clearer statement of what it is we're expected to accomplish," he said. "I want that authority defined in a way that protects the independence of monetary policy." Mr. Plosser's concerns are notable because they come from within the Federal Reserve system."

Financing the deficit

"...In our comments, we focused on the lack of an objective basis for many new securities and derivatives, and asked why it is that virtually no one in the regulatory community, even now, who is willing to call these "innovative" securities what they are, namely unsafe and unsound. If you are going to pollute the marketplace with securities that are entirely subjective and thus entirely speculative, then effective bank supervision becomes impossible.

We also suggested that regulators must come up with their own metrics for measuring bank safety and soundness and stop the discredited practice of imitating the internal systems of the banks which we are supposed to regulate! Regulation, after all, assumes that regulators are actually able to measure something objectively and use these observations to ensure that banks are operating within the law. The current Basel II framework is a bad joke in this regard and we suspect that it will be replaced with a regime that looks very much like the description by Charles Goodhart.

While the members of our panel suggested various ways to restore balance and even virtue to the regulatory process, we suggested that Washington does not need another oversight agency or more platonic guardians. Rather, we need to address the problem where it truly resides, first with the debt issuance of our profligate government and second with the accommodative monetary policy of our central bank. As one participant noted, there is no longer any distinction between fiscal and monetary policy in the US.

Though there were many insightful and interesting comments made at the two-day conference in the FRB Chicago, the one thing that we heard virtually no one say is that the current financial crisis stems from irresponsible monetary and fiscal policies. Many participants talked about the role of "global capital flows" in fueling the crisis, but none made the basic statement that having printed this money to pay for imports and fund domestic deficit spending, the US was bound to see the dollars eventually come home in the form of a credit bubble.

Since the October 1987 financial crisis, the Federal Reserve System has not denied the Street either liquidity or collateral. The objective goal of policy, it seems, has been to keep the ability of Congress to issue debt intact all the while keeping the casino part of the banking system operating at full steam regardless of the impact on inflation and, more important, investor behavior. Seen in this light, the proliferation of hedge funds and OTC securities is the natural response of investors to inflationary fiscal and monetary policies in Washington, a city where income and the proceeds of borrowing are seen as being equivalent.

Today the amount of debt and fiat money issued by the US government is threatening not only the solvency of private financial institutions and companies, but the stability of the entire global economy. Yet virtually no observers make the connection between the reality of secular inflation in the US and the bad outcomes in the financial markets, and in the global economy, where trade flows continue to shrink. Indeed, if members of Congress ever wanted a reason not to give the Fed more power as a regulator of financial institutions, they should start with an investigation of the Fed's conduct of monetary policy, not bank regulation. Just imagine how the US economy would look several decades from now were the Congress to give the Fed hegemony over bank supervision via the rubric of "systemic risk" even as the central bank continues its reckless policies with respect to monetary policy and its accommodation of US debt issuance.

Systemic risk, it seems, is not the result of bad regulatory policies, but the natural outcome of a system where income from productive economic activities is being increasingly supplemented with debt and inflation. Our political leaders say that such policies are meant to help the American people, but we've heard such empty justifications before. Call the policies of borrow and spend and print the "crimes of patriots," a powerful metaphor used by author Jonathan Kwitny to describe the bad acts of the CIA in the banking world decades ago. Since then, the money game and the role of government in our financial markets has only grown larger.

If the American people want to get the US financial system under control, then the first areas of investigation, we submit, must be fiscal and monetary policies. And if Americans do not soon get control over the habit of borrow and spend practiced by the Congress and facilitated by the Fed, then end result must be a populist backlash against Washington and incumbents in politics and the corporate world. As Congressman Ron Paul (R-TX) writes in his latest book, End the Fed: "Nothing good can come from the Federal Reserve… It's immoral, unconstitutional, impractical, promotes bad economics, and undermines liberty."

"The U.S. relies on foreign investors to finance the federal budget deficit. About 51 percent of the $6.45 trillion in marketable Treasuries are held outside the U.S., up from 35 percent in 2000, according to data compiled by the government.

Concern that international investors would pull back from American financial assets have grown as the U.S. Dollar Index weakened 9.4 percent since February after President Barack Obama and Fed Chairman Ben S. Bernanke committed $12.8 trillion to thaw frozen credit markets and snap the longest U.S. economic slump since the 1930s.

New York-based Goldman Sachs, another primary dealer, estimates that the U.S. may borrow a record $3.25 trillion this fiscal year ending Sept. 30, almost four times the $892 billion in 2008, to finance the budget deficit.

‘Expected to Explode’

“The debt is expected to explode, as we all know,” said John Spinello, chief technical strategist in New York at primary dealer Jefferies Group Inc. “Will they maintain that 50 percent share? We don’t know.”

People’s Bank of China Governor Zhou Xiaochuan said the nation won’t change its currency reserve policy suddenly, speaking to reporters at a central bankers’ meeting yesterday in Basel, Switzerland.

The dollar fell against most of its major counterparts on June 26 after China repeated its call for a supranational currency “delinked” from sovereign nations. The People’s Bank of China said the International Monetary Fund should manage more of members’ foreign-exchange reserves.

“To prevent the deficiencies in the main reserve currency, there’s a need to create a new currency that’s delinked from the economies of the issuers,” the People’s Bank said in its 2008 review. China is the biggest foreign holder of Treasuries, with $763.5 billion as of April."

Fed alleged to support Wall Street

Source: Wall Street profits from trades with Fed Financial Times, August 2, 2009

"Wall Street banks are reaping outsized profits by trading with the Federal Reserve, raising questions about whether the central bank is driving hard enough bargains in its dealings with private sector counterparties, officials and industry executives say.

The Fed has emerged as one of Wall Street’s biggest customers during the financial crisis, buying massive amounts of securities to help stabilise the markets. In some cases, such as the market for mortgage-backed securities, the Fed buys more bonds than any other party.

However, the Fed is not a typical market player. In the interests of transparency, it often announces its intention to buy particular securities in advance. A former Fed official said this strategy enables banks to sell these securities to the Fed at an inflated price.

The resulting profits represent a relatively hidden form of support for banks, and Wall Street has geared up to take advantage. Barclays, for example, e-mails clients with news on the Fed’s balance sheet, detailing the share of the market in particular securities held by the Fed.

“You can make big money trading with the government,” said an executive at one leading investment management firm. “The government is a huge buyer and seller and Wall Street has all the pricing power.”

A former official of the US Treasury and the Fed said the situation had reached the point that “everyone games them. Their transparency hurts them. Everyone picks their pocket.”

Fed actions over BofA questioned

Source: 17 members ask for Fed probe over BofA role The July 10, 2009

"Seventeen House members from both parties are calling on the Obama administration to investigate the Federal Reserve over its role in Bank of America's acquisition of Merrill Lynch at the height of the financial crisis.

The deal has caused significant controversy on Capitol Hill, where Democrats and Republicans on the House Oversight Committee have held several hearings with former Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and Bank of America CEO Kenneth Lewis...

The House members behind the letter are: Chris Carney (D-Pa.), Alan Grayson (D-Fla), Marcy Kaptur (D-Ohio), Scott Garrett (R-N.J.), Tom Price (R-Ga.), Walter Jones (R-N.C.), John Duncan (R-Tenn.), Ron Paul (R-Texas), Thaddeus McCotter (R-Mich.), Marsha Blackburn (R-Tenn.), Michael Burgess (R-Texas), Adrian Smith (R-Neb.), Michele Bachmann (R-Minn.), Louie Gohmert (R-Texas), Dan Burton (R-Ind.), Patrick McHenry (R-N.C.) and Bill Posey (R-Fla)."

Fed plans repo markets revamp

Source: (FT, 06-21-09)

"The US Federal Reserve is considering dramatic changes to the giant repurchase – or repo – markets where banks around the world raise overnight dollar loans.

The plans include creating a utility to replace the Wall Street banks that handle transactions, people familiar with the matter say.

The Fed’s deliberations are partly motivated by concerns that the structure of the US overnight repurchase market may have exacerbated the financial turmoil that accompanied the failure of Lehman Brothers in September last year.

Fed officials plan to meet next month with market participants to discuss reforms.

People familiar with the Fed’s thinking say it is looking into the creation of a mechanism to replace the clearing banks – the biggest of which are JPMorgan Chase and Bank of New York Mellon – that serve as intermediaries between borrowers and lenders."

The Fed and TBTF

Source: White paper sets out skilful compromises FT, 06-17-09

"Perhaps the most vulnerable element of Wednesday’s overhaul is the proposal to give the Fed new powers over institutions that are considered too big to fail. Given that the Fed is held responsible for stoking the asset bubble in the first place, many lawmakers, including Democrats, see this as the regulatory equivalent of rewarding failure. They point to the Fed’s role in creating easy money over the past few years and then failing to save Lehman Brothers at what is dated as the beginning of the meltdown last September.

“I share the concern that there are tensions between the Federal Reserve’s responsibilities for the conduct of monetary policy and its responsibilities for bank supervision,” said Mark Warner, the Democratic senator for Virginia, who sits on the Senate banking committee. “Too much economic power in one place puts our system of government at risk. Our founding fathers opposed concentrations of power, economic or otherwise, and favoured a system of checks and balances.”

Republicans are even more strident in their opposition to a more powerful Fed. “The vast expansion of the Fed’s balance sheet in recent months arguably represents a far more significant source of ‘systemic risk’ to our nation’s economy than the failure of any specific financial institution,” said the Republican congressional leadership in a recent statement."

Source: Obama Fed plans draw more questions The, 6-18-09

"Senate lawmakers from both parties raised questions on Thursday about one of the main elements of President Obama’s proposal to restructure the financial system: granting more power to the Federal Reserve.

Treasury Secretary Timothy Geithner defended the proposal and the Fed's role as a “systemic risk regulator” at a Senate Banking Committee hearing.

But committee Chairman Chris Dodd (D-Conn.) continues to have questions about granting the central bank authority to oversee “systemic risk.” Meanwhile, Sen. Richard Shelby (R-Ala.) took aim at the Fed for failing to regulate lending practices among large firms at the center of the financial crisis. Shelby questioned the administration's plan to vest more power in an agency that traditionally has tried to maintain its independence in setting monetary policy.

“I do not believe that we can reasonably expect the Fed or any agency," Shelby said, to "effectively play so many roles."

Fed considering money market reverse repo scheme

The U.S. Federal Reserve is studying the idea of borrowing from money market mutual funds as part of eventual steps to withdraw stimulus, the Financial Times reported on Thursday.

The Fed would borrow from the funds via reverse repurchase agreements involving some of the huge portfolio of mortgage-backed securities and U.S. Treasuries that it acquired as it fought the financial crisis, the newspaper reported, without citing any sources.

This would drain liquidity from the financial system, helping to avoid a burst of inflation as the economy recovered.

The FT said Fed officials had in recent days held discussions with market participants on how it might implement such a scheme.

The Fed is considering whether to conduct a pilot scheme, but worries such a test might be seen as a signal that the central bank was about to drain liquidity on a large scale, the newspaper said. In the near term, a big drain remains unlikely, it added.

The central bank held interest rates at close to zero on Wednesday and upgraded its assessment of the U.S. economy, saying growth had returned after a deep recession. The Fed also said it would slow its purchases of mortgage debt to extend that program's life until the end of March, in a move toward withdrawing the central bank's extraordinary support for the economy and markets during the contraction.

The idea of the Fed using reverse repos to help unwind policy is not new; Fed chairman Ben Bernanke identified them as a potential means of soaking up liquidity in July. But the market had previously expected the repos to be done with primary dealers, including former Wall Street investment banks.

The central bank is now considering dealing with money market funds because it does not think the primary dealers have the balance sheet capacity to provide more than about $100 billion, the Financial Times said.

Money market mutual funds have about $2.5 trillion under management so they could plausibly provide between $400 billion and $500 billion, it said.

The newspaper added that the Fed did not think it would need to drain liquidity all the way to where it was before the crisis, because it was confident it could raise interest rates even with a much larger amount of reserves in the system than existed before the crisis.

The Fed as derivative seller?

Source: Should the Fed Get Into the CDS Business? WSJ, August 21, 2009

"Exotic financial instruments known as credit default swaps played a central role in the crisis that brought the U.S. economy to its knees last year. Ricardo Caballero and Pablo Kurlat, two M.I.T. economists, have an audacious response: The Federal Reserve itself should get into the credit default swap business to prevent the next crisis.

Their proposal will be debated today at the Fed’s annual Jackson Hole, Wyo., symposium by the world’s leading central bankers and economists. Harvard’s Kenneth Rogoff, former chief International Monetary Fund economist, will present a critique.

A credit default swap is an insurance policy for financial storms. A firm selling a swap — a hedge fund, an insurance company, a big bank — promises the buyer that it will be repaid if an underlying debt defaults.

Use of these instruments soared during the credit boom earlier this decade. Many investors and banks went beyond using them as insurance protection against defaults and instead used them to make bets on the ups and downs of firms and markets. Many sellers of the protection also gravely misjudged the risk they were insuring. When American International Group Inc.’s financial services unit fell deep into the hole on mortgage-related CDS promises, it collapsed and helped sink the global financial system.

The two professors say the underlying idea — selling insurance against extreme financial risk — should be in the Fed’s arsenal to manage financial crises."

Parallels of the '97 Asian & US subprime crisis

Asia: A Perspective on the Subprime Crisis IMF, June 2008, Khor Hoe Ee and Kee Rui Xiong

"The catchphrases may be different, but there are many similarities between the 1997 Asian financial crisis and today's

Crisis anniversaries are usually occasions to draw lessons from the past—and the 10th anniversary of the Asian financial crisis last year was no different. Numerous conferences analyzed events of a decade earlier and studied ways to prevent a similar crisis.

But the conferences had barely ended when a new crisis erupted. The epicenter of the crisis had changed—from Asia to the United States and Europe. And the buzzwords had, too. Securitization, subprime mortgages, and collateralized debt obligations (CDOs) seem radically different from the currency pegs, excessive corporate borrowing, and foreign debt that dominated the Asian financial crisis. But the underlying causes of both episodes are similar. Each was triggered by investor panic in the face of uncertainty over the security and valuation of assets, and each featured a liquidity run and rising insolvency in the banking system.

How can policymakers better identify precrisis warning signals? And how can they pinpoint the recurring problems that, if tackled during tranquil times, could mitigate the risk and cushion the impact of future crises? This article explores the subprime and Asian crises to see what lessons can be learned and discusses the factors behind Asia's resilience, thus far, to the current crisis.

Early warning signals

A common backdrop to both crises was abundant liquidity and excessive, imprudent credit expansion. Prior to the Asian crisis, capital flows into the region surged (see Chart 1), leading to a sharp rise in bank lending and corporate borrowings. Foreign investors bought high-yielding Asian securities or U.S. dollar–denominated debt instruments assuming that Asian economies would continue to grow rapidly and currency pegs would hold indefinitely. Similarly, the current crisis was preceded by massive flows of capital into the United States to finance its current account deficits.

That abundant liquidity was intermediated by financial institutions into consumer credit and mortgages, which were converted into mortgage-backed securities (MBSs) and CDOs. The search for yield fueled demand for these structured products by investors, many of whom based their decisions solely on the strength of the AAA ratings afforded by credit rating agencies...."

Please see the IMF site for the complete paper.

Federal Reserve study of 40 systemic banking crises

Source: Financial Crises and Economic Activity Bank for International Settlements, Stephen G Cecchetti, Marion Kohler and Christian Upper, August 24, 2009

This paper studies the length, depth and output costs of a sample of 40 systemic banking crises in 35 countries since 1980 to assess the likely real impact of the current crisis.

Most, but not all, systemic banking crises in our sample coincide with a sharp contraction in output from which it takes several years to recover. The current financial crisis is unlike any others in terms of initial conditions, industrial and institutional structures, levels of development, degrees of openness, policy frameworks and external conditions.

Simply averaging outcomes of past crises to get a reading on the current one is therefore likely to be misleading regardless of the sample or subsample. With this in mind we go on to study the determinants of the output losses from past crises. Our findings suggest that the costs are higher when the banking crisis is accompanied by a currency crisis or when growth is low immediately before the onset of the crisis.

Furthermore, when it is accompanied by a sovereign debt default, a systemic banking crisis is less costly. The final part of the paper takes a longer-term view and study the impact of crises on potential output several years down the road. We find that many systemic banking crises have had lasting negative effects on the level of GDP. And even in those cases in which trend growth was higher after the crisis than it had been before, making up for the output loss resulting from the crisis itself took years.

  • Cecchetti is Economic Adviser at the Bank for International Settlements (BIS) and Head of its Monetary and Economic Department, Research Associate of the National Bureau of Economic Research, and Research Fellow at the Centre for Economic Policy Research; Kohler is Senior Economist at the BIS; and Upper is Head of the Financial Markets Unit of the BIS. This paper was prepared for the Federal Reserve Bank of Kansas City’s symposium at Jackson Hole, Wyoming, August 2009.

Banking or currency crisis?

The crisis problem is one of the dominant macroeconomic features of our age. Its prominence suggests questions like the following: Are crises growing more frequent? Are they becoming more disruptive? Are economies taking longer to recover? These are fundamentally historical questions, which can be answered only by comparing the present with the past.

To this end, this paper develops and analyzes a data base spanning 120 years of financial history. We find that crisis frequency since 1973 has been double that of the Bretton Woods and classical gold standard periods and is rivaled only by the crisis-ridden 1920s and 1930s. History thus confirms that there is something different and disturbing about our age.

However, there is little evidence that crises have grown longer or output losses have become larger. Crises may have grown more frequent, in other words, but they have not obviously grown more severe.

Our explanation for the growing frequency and chronic costs of crises focuses on the combination of capital mobility and the financial safety net, including the implicit insurance against exchange risk provided by an ex ante credible policy of pegging the exchange rate, which encourages banks and corporates to accumulate excessive foreign currency exposures. We also provide policy recommendations for restoring stability and growth.

The authors also look at three kinds of crisis- Banking, currency and twin crisis and each era has different findings:

  • Currency crisis hasve become more frequent post 1973 leading to higher overall number of crisis. However, we also had high number of currency crisis in Bretton Woods time despitye capital controls and fixed exchange rates
  • Banking crises were higher during the War period because of Great Depression. However, this era is not far behind. So, Bretton woods restrictions limited banking crisis but not currency crisis.
  • Moreover, in pre 1914 there were hardly any crisis of both kinds. This was an era of active financial and trade liberalisation. So we cannot really associate liberalisation with crisis. It is faulty policies which have led to expansion of financial safety net and moral hazard which have led to higher number of crisis.

Monetary policy errors

Economic histories in the United States and elsewhere are packed with examples in which the monetary authorities, with the overwhelming benefit of hindsight, may have misjudged the communication, timing or force of their exit strategies. In some cases, policymakers may have waited too long to remove easy-money policies. In other cases, policymakers may have acted too abruptly, normalizing policy before the economy was capable of self-sustaining growth.

Errors of each sort are neither uncommon nor unexpected in the normal conduct of monetary policy. During normal turns in the business cycle, the consequences of policy error to the broad economy tend to be meaningful. Forgone output. Higher unemployment. Threats to price stability. None of which are--or should be--acceptable to the Federal Reserve, or to the broader body politic. And the current environment is anything but normal. There are uncertainties regarding the trajectory of the economy recovering from a major financial crisis and a deep recession. Equally, there are uncertainties about the performance of the monetary transmission mechanism and the operation of the Federal Reserve's unconventional policy tools. A nimble, even-handed approach toward our risk-management challenges will prove necessary.

Monetary policy rules have for some time served as an alluring guide for policymakers, particularly at transition points when guidance is especially useful. In particular, the Taylor rule has proven to be informative in describing, if not prescribing, how a central bank might adjust its interest rate policy instrument in response to developments in inflation and macroeconomic activity.4 But, to make the outputs operational, we need reasonable conviction in the reliability of our estimates of current resource utilization and inflation or, for some alternative rules that have been proposed, forecasts of these model inputs.5 And it is these kinds of estimates that appear especially uncertain during this period of economic history, emblematic of the challenging task ahead. Policy rules and models alike tend to presume average historical responses, incorporating typical transmission effects and normal market functioning, which may not fairly capture the current state of play.

Nonetheless, policymakers strive to answer the following questions: How is the economy currently performing relative to its long-run potential, and is this likely to change in the next few months? Where is inflation now relative to its desired level, and what are the prospects for an acceleration or deceleration in prices in the near-term? Will changes in the federal funds rate interact with financial conditions and affect future real activity and inflation consistent with past practice? Or have these interactions changed, with implications for both the outlook and the conduct of policy?

It may be, for example, that potential output has fallen by virtue of the panic and its aftermath. If the resulting economy proves less adaptive, for example, the natural rate of unemployment may well threaten to move upward, implying tighter labor markets at higher unemployment rates, and lower potential output. These estimates are especially difficult to ascertain given the uncertain contour of the financial architecture and the greater-than-usual reallocation (and risk of misallocation) of labor and capital across sectors.

Of course, countervailing risks could cause a mark-up in economic potential that cannot be dismissed: Productivity gains may turn out to be larger and more enduring than we expect, and the remarkable resiliency of the U.S. economy could defy skeptics as it has done repeatedly in the post-World War II era.

Data in the past couple of months show continued improvement in real economic performance. In combination with the repair in financial markets, the outlook for gross domestic product (GDP) in the next few quarters appears better, improving the odds of a more enduring positive feedback loop arising from market developments and real activity.

Nonetheless, the medium-term risks to the outlook are still disquieting. Policies, broadly defined, that purport to bring stability to the macroeconomy could risk lowering output potential over the horizon.6 The uncertainty of the capital and labor reallocation process, a global trade environment in transition, and a shifting regulatory environment represent downside risks. The possibility that we fail to accurately gauge the resulting changes in economic and inflation prospects--by virtue of the remarkable, iterative changes in private sector practices and public policy prescriptions--is a foremost risk for policymakers. In this environment, we should maintain considerable humility about optimal policy.

Federal Reserve failed supervising two banks

The Federal Reserve Bank of Chicago failed to halt speculative real estate lending that led to losses at banks in Indiana and Michigan that were later closed, the central bank’s inspector general said.

Columbus, Indiana-based Irwin Union Bank and Trust almost tripled in size from 2000 to 2005 as it extended credit to subprime mortgage borrowers with insufficient collateral, Fed Inspector General Elizabeth Coleman said in a report. Chicago Fed supervisors missed “multiple opportunities between 2002 and 2009 to take additional and stronger supervisory actions,” the report said.

At Warren, Michigan-based Warren Bank, early supervisory action by the Chicago Fed could have reduced the cost of the ultimate failure, blamed on excessive concentration in commercial real estate, Coleman said in a separate report. Both banks were closed last year.

The findings, dated April 29 and posted on the Fed’s Web site, follow similar criticism last year of supervisory flaws at the Atlanta Fed. Senate Banking Committee Chairman Christopher Dodd is leading an effort to scale back the Fed’s supervision, saying the central bank failed to curtail risky lending practices that contributed to the collapse of the housing market. The measure is part of a proposed overhaul of financial regulation now under debate in the Senate.

Federal Reserve rebuffed pleas for oversight of mortgage originators

"...But during the years of the housing boom, the pleas failed to move the Fed, the sole federal regulator with authority over the businesses. Under a policy quietly formalized in 1998, the Fed refused to police lenders' compliance with federal laws protecting borrowers, despite repeated urging by consumer advocates across the country and even by other government agencies.

The hands-off policy, which the Fed reversed earlier this month, created a double standard. Banks and their subprime affiliates made loans under the same laws, but only the banks faced regular federal scrutiny. Under the policy, the Fed did not even investigate consumer complaints against the affiliates.

"In the prime market, where we need supervision less, we have lots of it. In the subprime market, where we badly need supervision, a majority of loans are made with very little supervision," former Fed Governor Edward M. Gramlich, a critic of the hands-off policy, wrote in 2007. "It is like a city with a murder law, but no cops on the beat."

Between 2004 and 2007, bank affiliates made more than 1.1 million subprime loans, around 13 percent of the national total, federal data show. Thousands ended in foreclosure, helping to spark the crisis and leaving borrowers and investors to deal with the consequences.

Congress now is weighing whether the Fed should be fired. The Obama administration has proposed shifting consumer protection duties away from the Fed and other banking regulators and into a new watchdog agency. That proposal, a central plank in the administration's plan to overhaul financial regulation, is opposed by the industry and faces a battle on Capitol Hill.

The Federal Reserve is best known as an economic shepherd, responsible for adjusting interest rates to keep prices steady and unemployment low. But since its creation, the Fed has held a second job as a banking regulator, one of four federal agencies responsible for keeping banks healthy and protecting their customers. Congress also authorized the Fed to write consumer protection rules enforced by all the agencies.

During the boom, however, the Fed left those powers largely unused. It imposed few new constraints on mortgage lending and pulled back from enforcing rules that did exist.

The Fed's performance was undercut by several factors, according to documents and more than two dozen interviews with current and former Fed governors and employees, government officials, industry executives and consumer advocates. It was crippled by the doubts of senior officials about the value of regulation, by a tendency to discount anecdotal evidence of problems and by its affinity for the financial industry...."

Crisis-related measures in the financial system and sovereign balance sheet risks

  • Measures to support the financial system have had a limited impact on fiscal deficits so far, but sovereign balance sheets have expanded and risk exposures have risen substantially. Moreover, interventions by institutions other than budgetary government—such as the central bank or sovereign wealth funds—have led to a blurring of policy roles.
  • This raises some key fiscal and financial management challenges, with consequences for sovereign creditworthiness. This relates especially to the management of off-balance sheet contingent risks that arise given the extensive use of guarantee facilities. Care is also needed to ensure that efforts to address the financial (and corporate) sectors’ balance sheet problems do not undermine the public sector balance sheet. Impairment of the public sector balance sheet would impede the policy flexibility needed to secure a durable economic recovery, the restoration of financial sector stability, and a return of monetary policy operations to a normal mode.
  • Proper management of financial assets and liabilities, at the sovereign level is, thus,

essential to protect fiscal solvency. Components include:

  1. specifying an asset-liability management strategy within a medium-term macroeconomic framework that defines a path for fiscal consolidation and restoring monetary policy channels; #to the extent consistent with financial stabilization goals, pursuing fiscal solvency by refraining from unrequited support (subsidies), maximizing recovery rates, minimizing the realization of contingent liabilities, and limiting quasi-fiscal operations;
  2. identifying and managing financial risks and resolving institutional deficiencies;
  3. upholding transparency and accounting standards; and
  4. specifying debt management strategies that are robust to the potential materialization of contingent liabilities and take account of the scale of balance sheet risks, including their impact on financing costs.

In particular, this implies preparing the ground for an orderly unwinding of the support measures. Besides necessary macroeconomic conditions, the timing of unwinding will also depend upon the existence of structural preconditions. Market confidence that conditions have begun to normalize is important and some agreed market indicators could be helpful. Ideally, a robust framework of sound financial regulation will have been specified. Sequencing will need to address arrangements for asset disposal, transfer of residual risks to the private sector, including from guarantee programs, and to repair balance sheets of central banks and relevant government entities.

The possible international ramifications of any unwinding will also need to be considered, as well as domestic coordination. These include the scope for coordination of policies and operational aspects during the unwinding phase. To enhance credibility, there may be scope for common methodologies to assess the state of financial systems, active exchange of international experience, and sending a clear signal that conditions are normalizing. Internationally coordinated approaches would also be needed to help minimize long-term distortions, opportunities for arbitrage across borders, and the use of measures that could be construed as being protectionist.

History of the Federal Reserve

Image:Cheap money.jpg

Source: THE BALANCE OF POWER, The Political Fight for an Independent Central Bank, 1790 - present Free online book

By Tim Todd, director of public information at the Federal Reserve Bank of Kansas City (Biography)

"Directors often question the nature of the role and relationships between the political elements of the Federal Reserve and its independence. This volume was created to help Federal Reserve Bank directors who are responsible for the governance of their Districts and the guardianship of the Federal Reserve System."

  • Come with Me to the FOMC Remarks by Federal Reserve Governor Laurence H. Meyer, The Gillis Lecture, Willamette University, Salem, Oregon, April 2, 1998

Dismantle the Federal Reserve


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