Author: L. Randall Wray
Along with Presidential candidate Ron Paul, Denis Kucinich and Bernie Sanders are harshly criticizing the Fed and demanding Congressional action.
Very reasonable analysts including Chris Whalen at The Institutional Risk Analysis are outraged at the Fed’s deliberate obfuscation and possibly illegal activities. It is not just what the Fed did to bail-out the banks, nor its QE 1, QE 2, and almost inevitable Q 3 that raises hackles. And it is not just that the Fed abhors transparency and sees itself as accountable to no one.
It looks like the Fed continues to leak information about its monetary policy actions to insiders—something that concerned Henry B. Gonzalez as House Banking Committee Chair back in 1993. He called for an audit of the Fed—and eventually forced Chairman Greenspan to open the “secrets of the temple” a bit. And while it appears that a huge number of favorite insiders are privy to the most intimate details of the Fed, Chairman Bernanke doesn’t believe the Congress has any right to know anything the Fed doesn’t want to tell it.
Last year, Senator Sanders finally pushed through an amendment requiring an audit of the Fed’s bail-out activities (it passed the Senate 96-0!)—a partial victory. But the Fed continues to operate mostly behind closed doors insisting that its independence gives it impunity to do whatever it damn well pleases while answering to no one.
I’m going to write on a lot of the details in later posts. Here I want to focus on President Andrew Jackson’s veto of legislation to renew the charter of the Second Bank of the United States in 1832. There is an excellent piece (“Ignorance is Confidence: Fedtalk or Newspeak? Andrew Jackson on Repealing a Central Bank”, February 14, 2011) from The Institutional Risk Analyst that briefly looks at today’s Fed in light of Jackson’s veto, and it includes a copy of Jackson’s speech. The speech is fascinating for two reasons. First, it demonstrates that the intelligence of either voters or our leaders has diminished remarkably over the years (my bet is both). I cannot imagine a leader in America today who would or could give such an address before Congress.
Second, the speech makes it clear that “Old Hickory” got a bad rap. I’d always thought he was on the wrong side of the debate, that he’d kept America in the dark ages by forestalling the creation of a central bank. Surely the US needed one? Our much more checkered financial history—littered with financial crises and a depression every generation—must have been caused in part by our failure to “modernize”? We finally created the Fed in 1913, ending the cycle of speculative booms and busts. Right?
Well, maybe not. After the Global Financial Crisis that began in 2007, and the $29 trillion dollar Fed scandalous bailout, and the $2 trillion Quantitative Diarrhea, and the coming financial crisis (starting next week or the week after next), perhaps it is time to revisit Andy Jackson.
The basis of his objection to the US Bank was its “exclusive privilege of banking under the authority of the General Government, a monopoly of its favor and support” which accorded to its owners some $17 million as the “present value of the monopoly”. Those owners consisted of an elite aristocracy of Americans and foreigners. Jackson argued that it would be far more just if Congress were to “create and sell twenty-eight millions of stock, incorporating the purchasers with all the powers and privileges secured in this act”—that is, sell the stock to the American people. “If our Government must sell monopolies, it would seem to be its duty to take nothing less than their full value”.
He also recognized that the set-up ensured a net transfer of wealth from the West to the Eastern aristocrats. Further, “Of the twenty-five directors of this bank five are chosen by the Government and twenty by the citizen stockholders” (of whom a third were foreigners). Thus, “The entire control of the institution would necessarily fall into the hands of a few citizen stockholders, and the ease with which the object would be accomplished would be a temptation to designing men to secure that control in their own hands…There is danger that a president and directors would then be able to elect themselves from year to year…It is easy to conceive that great evils to our country and its institutions might flow from such a concentration of power in the hands of a few men irresponsible to the people.” (I do love the phrase “designing men”—worthy of a Veblen or a Galbraith.)
His words near the end of the speech are worth quoting even though they go beyond the specific issues at hand:
“If we can not at once, in justice to interest vested under improvident legislation, make our Government what it ought to be we can at least take a stand against all new grants of monopolies and exclusive privileges, against any prostitution of our Government to the advancement of the few at the expense of the many, and in favor of compromise and gradual reform in our code of laws and system of political economy. I have now done my duty to my country. If sustained by my fellow citizens, I shall be grateful and happy; if not, I shall find in the motives which impel me ample grounds for contentment and peace.” (Can you just imagine a Bush or even an Obama uttering anything like this? Railing against prostitution of our Government Sachs to Wall Street?)
And with that, Old Hickory forestalled the creation of the central bank monopoly for eight decades.
To be sure, the Fed’s set-up was somewhat different. It is owned by its member banks, not by individuals. Its Board of Governors is chosen by the President but private banks elect the Board of Directors of each Fed Bank, which then choose the Presidents (who must be approved by the BOG). Five of these Presidents sit on the Federal Open Market Committee, which sets monetary policy. A US Appeals Court ruled that the Federal Reserve Banks are “independent, privately owned and locally controlled corporations”. While the Fed is not operated for profit, it generates a huge revenue flow that finances its far-flung operations across the country (most of them wrong-headed, but that is a topic for another day). The banks that own the Fed get a maximum return of 6%, with the rest of the profits going to the Treasury; in 2010, the Federal Reserve made a profit of $82 billion and transferred $79 billion to Uncle Sam.
So this is not quite the blatant monopoly power that the US Bank was handing over to a handful of rich white guys. But there are at least three problems with the arrangements that would raise the ire of Andy Jackson.
First, the Fed continues to operate mostly in secret—usually only dribbling out information that it decides to disclose. While one can concede that some deliberations need to be done in secret (discussing details of a bank examination, for example, since disclosure would generate a run on a troubled bank), there is no reason to conceal ANY information after the fact. Yet the Fed continues to claim that it is not subject to “freedom of information” laws.
Second, the Fed allows favored insiders to sit-in on its deliberations. This apparently includes local businessmen as well as reporters and foreigners. I’m not sure because the Fed does not release lists of attendees. That then raises two further issues: it is a well-known secret that insiders trade on the information and it means that the veil of secrecy really only prevents American voters and taxpayers from knowing what their central bank is up to.
And, third, the Fed’s activities—especially those undertaken in the aftermath of the crisis—expose it to possible losses. I am not worried about the potential reduction of the portion of profits it pays to Treasury. While that could be a minor political issue (and is almost certain to happen in the next couple of years), the bigger problem would be massive losses on its portfolio of toxic waste assets and loans to bailed-out banks.
Over the course of the bail-out the Fed provided a cumulative total of $29 trillion of funds to troubled banks. (My Graduate Research Assistants Andy Felkerson and Nicola Matthews are finishing up their study of the Fed’s data, so the results to demonstrate this figure will be released soon.) To be sure, that is the total since the bail-out began; the amount outstanding at any point in time was much less—on the order of $2-4 trillion—since banks would borrow funds and then repay them. Still, the Fed was lending against just about any trash banks had, so the potential for losses was significant.
Further, the Fed also bought a lot of the trash. We do not know what, if any, losses the Fed has already absorbed, much less what it could incur over the life of the toxic waste. It is probable that the Fed is engaged in the same “extend and pretend” accounting that is rampant among the banks. And the Fed has apparently been pushing some of the trash onto the GSEs (Fannie and Freddie)—which still puts Uncle Sam on the hook. So there is still an unknown but reasonably high probability for big losses. Are we going to let the Fed go bankrupt? Will we ask its member banks to kick in more capital? Or will the Treasury be asked to cover the losses? I think we know the answer.
I must admit that I’ve long been skeptical of Jackson’s followers, who insist we’d be better off without a central bank. Surely we need someone to set the overnight interest rate, we need check clearing, and we need a lender of last resort. But maybe it’s time to think about an alternative to the Fed.
Why don’t we all do that over the next few weeks.