So, Bernie Sanders, Ron Paul, and Alan Grayson finally got the FED to drop some documents that show all the things it was up to during the financial crisis that dated to around 2007. I actually have no problem with that. That kind of information is useful and I think it’s good to have it after the fact.
If you’d like to know how much data and what it’s about, FT Alphaville has a pretty good site up that explains the types of data that have shown up. It’s an amazing amount of detail on $ 3.3 trillion worth of bailout funding. What’s really interesting is the list of collateral. The actual names of organizations running to the window during the time period is there, but really not all that surprising. You can find the details on that at another post on FT Alphaville. As was expected, BOA is most definitely the top hog.
If you read the link to the WSJ above, you can see what both Bernie Sanders and the FED think about all of this.
“After years of stonewalling by the Fed, the American people are finally learning the incredible and jaw-dropping details of the Fed’s multitrillion-dollar bailout of Wall Street and corporate America,” Mr. Sanders said in a statement Wednesday afternoon. “As a result of this disclosure, other members of Congress and I will be taking a very extensive look at all aspects of how the Federal Reserve functions.”
The Fed has kept key deliberations closely guarded. It has taken steps to boost transparency, but has kept certain details secret, such as the names of banks that borrow at its discount window. Federal Reserve Chairman Ben Bernanke strongly objected to efforts to subject monetary-policy decisions to audits, saying it would “seriously threaten monetary-policy independence, increase inflation fears and market interest rates, and damage economic stability and job creation.”
Matt Stoller (Policy Adviser to the now gone-pecan Congressman Grayson) has an incredibly long winded, hyperbole-ridden, populist rant against the FED that’s been published by Yves at Naked Capitalism and by New Deal 2.0. He must’ve just popped out of cartoon bunny land because there’s a lot of cyber ink over there “full of sound and fury, signifying nothing”. It’s attracting the usual attention of economic dilettantes and Paultards. It also has a bunch of paragraphs somewhat deferential to the P woman to whom he just about throws the title of “The Great Commoner”. (Isn’t that a somewhat surprising action for some one who advises a Democratic Congressman?) The bases of Matt Stoller’s arguments are not economics, data or theory because he dismisses all of that as being captured by the FED. Instead, he holds up a pop culture book on the subject.
In 1989, Bill Greider published a remarkable book called “The Secrets of the Temple: How the Federal Reserve Runs the Country” in which he described how Fed officials were the real decision makers in the American political order. Shielded by the argument of ‘political independence’, most politicians wouldn’t and still won’t dare interfere with the workings of our economic structure, even though the Constitution clearly mandates that the monetary system is the province of Congress. The dramatic and overt coordination of this ‘independent’ central bank with the executive branch and the banking sector, and its flouting of Congressional and public scrutiny, have removed its institutional legitimacy.
To dismiss academic research in area is simply self-serving. Every economist of every flavor comes up with data from all over the world that demonstrates a chaotic economy results from a central bank that is overtly influenced by politics and not independent.
The FED is simply a central bank which is the bank of bankers. It’s not supposed to be some arm of the political parties. It doesn’t clear as many checks as it used to, but it’s FED WIRE is still the major financial transaction wire system for banks. It gets coin and currency from the Treasury and it fills orders for them from banks. It also ensures that banks meet the regulatory obligations. It’s part of the trade off of getting insured by the FDIC. They have capital requirements, they have requirements on their organizational structure and investments, and they do truth-in-lending. Most of what the FED does outside of this is audit banks.
It’s really not some mysterious fraternity that they can’t get into. My work with the FED was very mundane. My staff gathered up orders for Treasury bills and bonds each Tuesday and sent them and tax payments where they would be applied. My other staff paid the electric bills and watched to make certain our branch budget was in line with other branches. I have never worked for a bunch of stuffier people than when I worked for the FED. I was even told to wear nude hosiery, short heels, and a suited skirt. Granted, I was not in NY where all the action is, but really, even bank visitations and teaching bankers how to watch their reserve accounts and use FED WIRE is not a glamor profession. It also pays diddly.
Monetary Policy is done by the Open Market Committee and carried out by the NY FED. No one any place else knows remotely what is done. That’s because if any one in the market or near the market knew, it would be like the ultimate insider trading. Would you really want YOUR congressman or Senator trusted with the ultimate INSIDER trading? When the FED buys and sells bonds and bills, it does it through a number of brokers who get the job through a bidding process. None of them can see the bigger picture. None of them can discern patterns any more than I could by transmitting bond and bill sales of the public every Tuesday. It’s that way because you don’t want any one making big time money knowing which way the market moves.
So, almost every country has designed their central bank to look like our FED; that includes the Europeans. Independence is valued above just about everything because as I’ve said, all the research shows that if you have a politically managed FED, you get a really bad economy. Here’s an example from South Africa today of worries about central bank independence.
“During the year there has been a focus on issues relating to monetary policy independence in response to the letter from the Minister of Finance clarifying the mandate of the Bank, as well as the recent New Growth Path document, in which reference was made to a looser monetary policy stance,” Gill Marcus said.
There were perceptions that these documents had undermined the independence of the SARB, and there had been a tendency to over-interpret monetary policy actions in terms of these discussions.
“For example, when the repo rate was reduced at the previous meeting, some analysts argued that because there was no economic rationale for this move, it therefore must have been politically inspired.
“A few days later, when the disappointing growth figures were announced, these analysts conceded that our decision was vindicated on economic grounds,” Marcus said.
There is plenty of information about the FED should you want to delve into it. It produces a lot of research and a lot of information. It just doesn’t share its immediate monetary policy targets, goals and actions with any one because that’s basically enabling insider trading. It also doesn’t let congress tell it how to run things, but it follows the laws set forth by Congress to achieve the goals it was given. That would be:
Monetary policy has two basic goals: to promote “maximum” sustainable output and employment and to promote “stable” prices. These goals are prescribed in a 1977 amendment to the Federal Reserve Act.
The FED has no role in the stock markets and could not do anything to prevent or cause bubbles there. So, any one that tries to say the FED caused any stock market bubble is out there in la la land. The FED can provide liquidity to credit markets through its open market activities and its activities to influence the FED FUNDS rate. It only directly controls the rate at which it lends to financial institutions; the discount rate. The FED FUNDS rate is a market established rate and reflects the price of loans between financial institutions. In some cases, it is a substitute for loans from the FED.
Even if the Fed suspected that a bubble had developed, it’s not clear how monetary policy should respond. Raising the funds rate by a quarter, a half, or even a full percentage point probably wouldn’t make people slow down their investments in the stock market when individual stock prices are doubling or tripling and even broad stock market indexes are going up by 20% or 30% a year. It’s likely that raising the funds rate enough to burst the bubble would do significant harm to the economy. For instance, some have argued that the Fed may have worsened he Great Depression by trying to deflate the stock market bubble of the late 1920s.
I’m beginning to think I should do more pieces on what the FED is and what the FED is not because of the disturbingly ignorant comments on that thread at Naked Capitalism. Part of the Fed’s problem is that it puts out a lot of information but it really doesn’t do much in terms of prime time explanations. Well, unless you watch the twice a year briefing by the Chair on CSPAN, then you may get an idea of it. However, that speech almost puts me to sleep and the stupid Congress questions just make me made.
So, any way, I just wanted to give you some information on this drop of data and let you know that most of the economists who know things are still pouring over it. I’m going to be pouring over it too, so I’ll try to keep you informed. All these discussions that are early to the media don’t appear to be coming from Financial Economists. They appear to be all politically motivated. Wait until some one who knows speaks up before you start forming any opinions.
My dad was a small town Ford dealer (Council Bluffs, IA). Dad was fortunate enough to have a very rich mentor that put him into the dealer development program when I wasn’t even walking and so we moved to what I still believe is the middle of no where and put down roots. I don’t know if you’ve got much experience in a small town, but the local car dealers are actually pretty big businesses for them. My dad headed up blood drives and the United Way. He belonged to the Chamber of Commerce. When Dad was younger he volunteered for everything. As he got older, he wrote a lot of checks. He helped my Mom establish a Victorian house museum that still is world-renown. He always bought tons of tickets to the college world series to hand out to every one who walked in the door. He sponsored little league teams and bought advertising in the local newspapers and TV stations. His 50-100 employees were with dad for as long as I can remember. Not only the mechanics and the office folks stayed with Dad, but also the car salesmen. They were my family too. When dad retired in the 1980s after surviving those horrible energy crisis years, I came to look back on how central the car business is to small town America. Actually, Dad also sold a lot of trucks because we lived in farm country.
I’m thinking more and more about this as well as having a lot of discussions with Dad on the unwinding of the great American car companies. In a way, it feels like the unwinding of small America cities and a way of living. Chrysler and GM are dumping dealers all over the country. Most of the surviving dealerships are not going to look like the way dealerships developed when cars and the car industry were the most American of all business. I’m sure it’s going to be much more efficient and I am certain that each of the US automakers over franchised, but still, there is something about a small town car dealership that is not going to be replaceable. In many towns, it is one of the biggest employers and also a huge source of charitable donations.
It is odd that the first two articles that grabbed me this morning as I drunk my coffee were two contrasting views on the wind down of Chrysler. The first one was all about the finance and the bankruptcy and is on Salon. It’s called “Who is Screwing with the bankruptcy laws”. The second was on the front page of the business section of the NY Times. It goes to directly to the heart of the dealer closings and is entitled “Chrysler Francisees Make Case Against Closure”. Both show exactly how ugly the Chrysler bankruptcy has become.
I’m sitting here watching the kids get their costumes together for the big day of celebration called Fat Tuesday. That’s the day when you pull out all the stops because you know lean days (no meat, no alcohol, no fun) starts tomorrow. I guess I must be in hyper-metaphorical mode because it’s really striking me this year as a good fable. Tonight at midnight, the Krewe of Klean will take to the streets of the French Quarter to shovel all the leftovers into the dump trucks. The police will ride their horses down Bourbon street and announce that the Party’s over. They arrest anyone who want the party to continue at that point. You can either spend Ash Wednesday doing penitence in your bed or the Parish Prison.
When I first got out of graduate school I went to work at a small bank. I was soon lured to the biggest Savings and Loan in the middle of the country. I’d been working on loan pricing models and arranging bank income statements into an exercise called spread management and asset-liability matching. Big time company working for a big time CEO!
I have to admit, the only person that I really knew that was a CEO was my dad and he was great. His employees loved him. He gave them wonderful benefits and when they had sick children or they were gravely ill, he gave them time off with pay. His office manager was openly gay. His mechanics and body technicians were a diverse group for small town Iowa. Most of them worked for my dad the entire 30 years and loved him as much as I did. From the time he bought it when I was one, until he retired when I was in my 30s, the entire employee base was my extended family. So, I entered the business world thinking this was the model for management and boy, was I wrong.
As the economy continues its slide towards recession, we now have a pork-laden rescue of many of the folks both responsible for the recession as well as the crisis. TARP may unfreeze the credit markets, but until we responsibly regulate the financial markets that are now shoveling troubled assets onto taxpayers and until we support the prices of their underlying assets (that would be folks’ homes), we will not solve the problem.
I focused recently on the lax lending standards that helped to create the housing bubble (fueled also by the Fed who kept interest rates too low, too long after 2001). It was the red meat thrown into the piranha pool. Let’s talk about what the piranhas did with the red meat once they had it.
Let me mention first that we’ve nearly been here before when Long-Term Capital Management (LTCM) came close to collapse in September 1998 at the time when Russia had difficult repaying its debt. The Fed rescued the fund and showed that some guys are just “too-big-to-fail”. The Fed wanted to stop possible contagion coming from the failure from spreading to commercial banks. Studies at the time showed that losses to investment banks during this type of contagion could be huge (including one done by my Financial Intermediaries Seminar prof). They noticed that investment banks would be far more vulnerable to losses than depository institutes. This small crisis that most folks probably don’t even remember was the canary in the coal mine.
Meanwhile, the primary mortgage market was coming under the spell of the underwrite-nearly-everything mentality spurred on by Fannie and Freddie. We’ve mentioned that Fannie and Freddie also imply a government guarantee. Now, we have a situation where the Fed has shown its readiness to put the tax payer’s money behind anything it deems too big to fail. Both actions were like chumming the waters. Rising house prices were just more blood on the water. It was only time before the piranhas and sharks came to feed. They were being encouraged to ignore risk and that’s not a wise thing to do.
Five investment banks, including Goldman Sachs, approached the SEC with a proposal around 2004. They sought an exemption for their brokerage units from old depression-era regulations that limited the amount of debt they could incur. An exemption from this leverage rule would free up a heckuva lot of money to invest in some new-fangled investments: mortgage-backed securities, credit derivatives, and credit default swaps. They got permission. Enter the net capital rule that enabled the piranhas and the sharks. During the next few years, leverage ratios increased until for about every dollars worth of equity held by an investment bank, there was around $30 in debt.
Credit default swaps act like insurance. They are instruments intended to cover losses to banks and bondholders when companies fail to pay their debts. Since 2000, the market has boomed from about $900 billion to more than $45.5 trillion. This about twice the size of the entire U.S. stock market. The market for credit default swaps as well as the market for mortgage securities were left unregulated. Many folks have been worried about this market for some time.
The Comptroller of the Currency, a federal bank regulator warned that increased trade in swaps during 2007 was putting a strain on processing systems that were used to handle swaps. Swaps are essentially what brought down AIG. Back in the beginning of the year, AIG found that it had incorrectly valued some of the swaps and announced that mistake would cause the company to lose $6.3 billion more than they had estimated before.
Placing correct values on Swaps and Mortgage securities is very difficult. Big banks, insurance companies and hedge funds are among the financial institutions that trade these derivatives. CDS tend to be private agreements where buyers of the protection/insurance agrees to pay a premium to the seller over time. (Much like an insurance policy premium). The seller pays only if a particular crisis occurs. These contracts can also be bought and sold. Because the market is basically unregulated, no one quite knows when the swaps are sold and to whom they are sold. This can be a problem when the protection is required, say like when the Hurricane Katrina of asset bubbles bursts in the housing market. Just so you know, the largest players in this market are JP Morgan Chase, Citibank, and Bank of American. All WAY too big to fail, right?
Enter speculators as this market gets large. Speculators (read HEDGE FUNDS) have used these instruments to bet on a company or a bank’s failure. Funny thing is there is actually more value now out there in the derivatives than there is in the underlying assets. Remember, this is BEFORE the bubble bursts and brings the asset prices down even further. So credit default swaps are basically default insurance, although they can’t be named that. So what happens when every one needs to make a claim on their insurance and can’t exactly locate your contract and it probably resides with some one who is in worse shape than you? (Ah, let your imaginations run away with you, it’s bad.)
So, let’s get back to our Pirahanas and Sharks. They’re being encouraged to loosen up those lending standards by Fannie and Freddie AND they can buy insurance too if their bad loans go bad. How can you lose with a deal like that? It doesn’t appear that you can, does it? So what do you do? Continue underwriting loans for folks without income, folks without credit, folks that are even dead. (Yes, dead, I’m not making that up.)
I think you can see that what we have here is the perfect storm. So let me get back to what this bill doesn’t do. It DOESN’T stop the assets from continuing to go bad, at least in the housing end of things. It DOESN’T regulate any of the players in this market although the investment banks are now under the jurisdictions of bank holding companies and basically the FED. It DOESN’T deal with the leverage issue. It DOESN’T punish any one for lending bad loans even. No one is getting yelled at for encouraging this — not Fannie and Freddie, not the FED and not the SEC. Definitely not the congresscritters that enabled them either, at least not yet.
What we are witnessing is the creation of more TOO BIG TO FAIL critters AND we’re giving them more money to lend out and we have inadequate regulation. It’s time to take the chum out of the water, folks!