Updated from Thursday, Jan. 7NEW YORK ( TheStreet) -- Like it or not, the case for auditing the Federal Reserve just got a whole lot better. That observation was made Thursday by CNBC commentator Larry Kudlow, who started his career as a Fed economist and served as a high-level economic and fiscal advisor to President Reagan, and it does seem Kudlow's political instincts are on target here. Kudlow made his remark during an on-air discussion of revelations that outside attorneys for the New York Fed persuaded AIG ( AIG) not to disclose that it was paying banks 100 cents on the dollar on credit default swaps they bought from the giant insurer. E-mails posted on The New York Times's DealBook blog show AIG originally drafted a regulatory filing disclosing that the swaps would be paid in full, a disclosure that was crossed out by attorneys at Davis, Polk & Wardwell, who were advising the New York Fed. Not even on the table at the time was disclosing the names of the banks, which we later found out were led by Goldman Sachs ( GS), Societe Generale and Deutsche Bank ( DB). The Securities and Exchange Commission pushed for that disclosure, we now know thanks to a Bloomberg report, though the press got there first. The SEC has dropped the ball repeatedly in recent years but nonetheless has a tradition of disclosing information that contrasts with the Fed's institutional preference for secrecy. A proposal to audit the Fed, an effort led by Congressman Ron Paul (R., Texas), is already included in the massive financial services reform package that passed the House of Representatives on Dec. 11, but the legislation still needs to pass the Senate and get signed by President Obama.
Opponents of the proposed audit rarely seem to address it directly. Instead, they argue that decisions such as setting interest rates should be free from political intervention. That is true, but I am not clear how we get there from a mere audit. I suppose it's the slippery slope argument: once Congress starts meddling, it will be hard to get them out. That may be so, but the Fed needs to do a better job of proving it deserves the public's trust. What possible legitimate reason could there be for keeping it quiet that AIG's counterparties were paid in full? "People close to the New York Fed," gave CNBC's Mary Thompson a bunch of reasons for why they wanted the information kept quiet. The sources said the Fed wanted to stop a run on AIG and also maintain an edge in managing the insurer's positions. Then there's my favorite: that the information was withheld "in the interest of accuracy." That last one sounds so lame it almost kills the first two explanations, which are halfway decent. But why isn't anyone on the record? More amateur spy games to combat the original amateur spy games ain't helping your cause, guys. Shares of AIG closed Thursday down 56 cents, or 1.9%, at $28.58. -- Written by Dan Freed in New York.