Two weeks ago, Bloomberg released a significant story on the actions of the Federal Reserve as the lender of last resort during the crisis and the extent of that lending. The article, an homage to the late great reporter Mark Pittman, revealed lending and guarantees of roughly $8 trillion, and estimated government-granted profit garnered by the big banks of $13 billion.
More disturbing were inconsistent statements by Bernanke publicly claiming he was lending only to sound institutions when the Fed’s internal assessments of those same banks showed otherwise. This article prompted a remarkable back-and-forth between Bloomberg and the Fed, in which neither side backed down while coming close to calling the other a liar. Bloomberg essentially argued that the Fed gave ill-gotten profits to money center banks through facilities set up to flood the system with liquidity. The Fed responded that it charged “penalty” rates to these banks, that it was fulfilling a well recognized function of central banks by serving as the lender of last resort.
I side with Bloomberg, and I’ll explain why.
American money is a political commodity, backed by nothing except the willingness of collective holders of that money to believe in the American system of wealth production and trade. Steve Waldman noted to me over email that the idea that there is a “penalty rate” in a liquidity crisis is absurd, since one can see a liquidity crisis as a period in which lending ceases. Other correspondents patiently explained to me that the Fed did a good job in its lender of last resort function, that it heroically unfroze credit. Indeed, 71% of investors prefer Bernanke’s Fed to the European Central Bank.
The problem with the Fed’s argument comes down to trust – and the institution that is asking us to trust it has aggressively fought every effort to obtain public disclosure and misled Congress about the state of the banks it was regulating. I have sympathy for the Fed’s predicament – it couldn’t say Citigroup was insolvent, but at the same time, the New York Fed did not have to, say, take the downside of $220 billion of that bank’s bad assets, with no upside and no resource (see page 20 of this SIGTARP report). That Citi didn’t use this specific facility is not important – once investors realized that Citi is now version 2.0 of Government Sponsored Entity, it didn’t have to. These banks now have lower costs of funding than smaller banks, which is an annual subsidy of between $6B and $34B. And this doesn’t include these banks’ increased liquidity, which very obviously matters when you see a company like MF Global go down despite very likely putting on very similar bets as others (who are too big to fail) have. Economist Ed Kane, for one, has estimated the value of the de facto guarantee as over $300 billion annually.
Even more than this assistance, it is important to put something on the record about the Federal Reserve’s politics. From 2009 onward, the Fed fought bitterly and fought dirty to prevent any disclosure whatsoever. I’ve never told this story before, about the Fed’s nasty and dishonorable lobbying campaign against a Fed audit.
But first, it’s important to understand the Fed’s enormous influence on Capitol Hill. While you and I see banks and public officials as self-interested actors, most political policy makers simply do not question the credibility of insiders in the political process. If Bernanke says something, to most members of Congress and staffers, that means it’s true. This is perhaps a holdover from Alan Greenspan’s time as “the oracle”, or perhaps it says something deeper about the psychology of those in power. Regardless, it’s how staffers and members tended to absorb information. The few that questioned the credibility of those in authority did so furtively because it was remote from the consensus position.
The Chairman of the Financial Services Committee during Dodd-Frank negotiations was Barney Frank. Sometimes, he made skeptical noises, but for the most part he accepted that the Federal Reserve was the adult in the room. He hired staffers from the Fed, listened to the Fed, and respected the Fed’s role. He often seemed to dislike hearings with Fed officials because he thought the hearings were a waste of their time. And if you watch how most members interact with officials, it’s not an entirely unreasonable posture. These hearings drone on for hours, with very few moments where a member fluently confronts the official with something relevant. More often, a Congressman with a somewhat limited sense of how banking works is reading a question prepared by a staffer, and then has to go off to do some fundraising work (which is unfortunately the real job of most junior members). This is not a criticism of the intelligence of any of these members of Congress – they simply don’t have time to learn the policy substance on top of the already time consuming tasks of doing politics, fundraising, Congressional procedure, daily votes, constituent services, and multiple committee assignments. But it meant that Frank didn’t believe much productivity came out of these back-and-forths.
Frank gaveled members down hard when they went over their allotted 5 minutes with Fed officials. And while Barney talked a good game about Fed transparency, going so far as to actually talk of his agreement with Ron Paul on Fed transparency on Reddit (see minute 2:30), it was clear that his priorities were elsewhere. When the time came, he actually voted against a Fed audit in committee, and I suspect he would have removed the provision from the overall bill if there had not been so much public heat on the issue. It’s not that he was adamantly against Fed transparency, it was just worth sacrificing for other political priorities. Here’s what he said immediately after the Fed audit amendment passed.
“It’s going to be seen as weakening the independence of monetary policy with consequent negative implications,” Barney Frank, the Massachusetts Democrat who chairs the committee, told reporters after the vote. “People are going to be worried about the impact on the dollar, on the interest rate.”
Of course, it had no measurable impact, and certainly, banks are still clamoring to borrow from the Fed. But the pattern, of promising crackdowns while delivering little, is consistently. While year, Barney introduced a bill to make the powerful President of the New York Fed a Presidential appointment instead of hired by banks on the Reserve Bank board, he actually killed such a provision during the conference negotiations over the final Dodd-Frank bill (when it would have mattered and structurally changed the Fed in a critical manner). This is just part of the posturing that goes on around policy reform – being loud against powerful interests when the vote isn’t being held, and then using that posture as a negotiating chip to get something else you think is important when the game is on the line. Part of why people call Barney brilliant –and he is brilliant – is because he is an utter master at such policy maneuvering, and this policy maneuvering is an essential part of legislating. It just sucks to be working on the priority that gets traded away.
Aside from Barney’s personal faith in the Federal Reserve, the institutional links among the central banking system and financial policy-makers are immensely strong. When the Financial Services Committee needed extra staff, they grabbed people from the Fed to come in and help. When Congressional staff left the Hill, many of them went to various parts of the Fed. In fact, the most aggressive people in favor of Fed secrecy during the eventual Fed audit fight were staff-level.
Barney supported the Federal Reserve, but he showed some skepticism. And I believe part of his reluctance to challenge the Fed was reasonable and based in committee politics – he knew he needed to carry votes to pass bills, and the Fed’s opposition would make his job much harder. So posturing can be useful in politics. Chris Dodd, though, has no such excuse of managing the politics; he simply did not have the expertise or confidence to challenge the Fed. In 2009, Grayson grew worried about the Federal Reserve’s use of a half a trillion dollars of currency swap lines with foreign central banks in 2008, an issue that has now been resurrected in the wake of the Euro-zone crisis.) Grayson actually got an amendment with Ron Paul through the House requiring the Treasury Secretary grant permission before the Fed could open said swap lines. In the conference committee, one of Dodd’s staffers took it out at the behest of the Fed. This staffer told us on the phone that there was simply no way any central bank would ever default. And thus, the Fed can now lend unlimited dollars to foreign banks through the ECB without any checks from the executive or legislative branch.
But perhaps the best way to illustrate the political strength of the Fed is to show how in small ways, it could and did move the ball at the behest of large banks, for no particularly good reason. There was a provision in early drafts of Dodd-Frank to allow big banks to open new branches without having to ask permission from state regulators (see this Ryan Grim story “Senate Bill Contains A Gift For Big Banks”) . No Congressman formally asked for this provision, so I was told, it just sort of wound up in the draft bill -which is a good argument against thousand page bills). I remember when small Florida banks asked Grayson to pull it out, and I went to House side staffers and asked them to remove the provision. They did. But then it popped up again in random amendments, and manager’s amendments (this is an obscure procedural move spearheaded by the Chairman of a committee). On the Senate-side, it was also in the draft bill – someone asked Dodd about the provision, and he didn’t even know it was there! He had it removed. But then it popped up again, and of course, it was included in the final draft of the bill. I later learned that the Fed was probably behind the amendment, and thus inserted it anywhere and everywhere they could.
So that was and is the strength of the Fed. Even if you didn’t believe them, it was very hard to find an alternative who had the skills, the information, and the lawyers to write law on central banking reform, and push it through. It’s why I turned to the financial blogs as a new class of information mediators to educate me on our financial architecture – these were vocal end-users in the capital markets who could for the first time talk back.
The story of how I became involved with the Fed audit fight starts with a semi-random event. I connected with Grayson in the fall of 2008, when a Democratic landslide seemed imminent; he hired me to work on policy. My title was “Senior Policy Advisor”, a Lake Wobegon-ish line used on the Hill to designate catch-all advisor (there are no “Junior Policy Advisor” titles). Soon after, in the beginning of the session, he got put on the Financial Services Committee, because that’s where Democratic leadership put a lot of freshmen in swing districts. We had no other policy staffers yet, which caused some chatter of the “did you hear the only person they have working on policy is a BLOGGER?!?!” variety. Still, despite my handicap of having written stuff on the internet, I ended up covering the Financial Services Committee in my issue portfolio.
Our specific fight with the Fed started in January, 2009, when I put a stack of blog posts and Bloomberg articles on the trillion dollar expansion of the Fed’s balance sheet in front of Grayson to prep him for a hearing with Fed Vice Chair Don Kohn. It was Grayson’s second Congressional hearing. And what I didn’t know, and what Kohn was about to find out, was that Grayson was basically the best cross-examiner in Congress and fluent in central banking parlance and international investing. Members get just five minutes to ask questions, and when the witnesses are important, they can’t ask for more time. As I noted before, Barney was especially aggressive about preventing members from getting more time, especially when the witnesses were from the Fed and the questions were probing.
But Grayson made his time count. Kohn never saw it coming – Grayson asked him which banks received the $1.2 trillion in spending from the Fed. The scene was electric, and fortunately, it’s preserved on Youtube. Grayson would ask a question, and when Kohn didn’t answer, simply repeat the question. Who got the money? Did Credit Suisse get the money? Citigroup? Etc. The droning contrast of Kohn’s evasive answers, combined with Grayson’s clear questions, was an entertaining metaphor for the power of a cold and enormous bureaucracy up against a scrappy iconoclast. As Kohn got tripped up, and confused spending and lending, bored observers in the committee room woke up and note. One experienced journalist told me that Kohn is a master of these hearings, and it was shocking to see him embarrassed by a random freshman legislator The video went viral, because Grayson was the only member who had theatrically focused on what Mark Pittman of Bloomberg reported, a remarkable and unprecedented expansion of the Fed’s balance sheet. And Grayson was fun about it. After the hearing, banks began calling our office, afraid that we knew something about their relationship with the Fed. We didn’t, which they quickly realized. But it turns out they had good reason to worry, since they were in fact borrowing trillions.
Soon thereafter, I met Pittman, and a whole suite of people on the right and the left skeptical of the Fed’s behavior (including Yves Smith, Bob Ivry, Barry Ritholz, Walker Todd, Chris Whalen, Josh Rosner, Jane D’Arista, Bill Greider, Karl Denninger, Dean Baker, Simon Johnson, and lots of others, including over email Tyler Durden). The financial blogs formed a sort of shadow financial elite, making counter-arguments against the standard establishment norms peddled by centrist, conservative, and liberal Fed defenders. These people became increasingly influential over the course of several years, which is an important reason the financial reform bill became stronger over the course of 2009-2010, unlike most bills which get chipped away at by special interests.
During the next year and a half, heat on the Fed ratcheted up as the AIG counterparties story came out (due to Darryl Issa), and as Bloomberg and many others (like Elijah Cummings) began digging into what was going on during the crisis. Grayson continued with a remarkable use of YouTube and Congressional hearings, including one hearing with the Fed’s inspector general that now has over 4 million views. Bernanke had a rough confirmation ride in 2009, because of the focus and heat on the Fed from this newly interested public. As the confirmation vote neared, blogger Mike Stark kicked off the mania around Bernanke’s hearings when he asked Dodd whether the confirmation was a certainty (as Dodd had implied a few months earlier). Dodd said his confirmation wasn’t a certainty, which led to furious lobbying by the White House, some market panic, and ultimately a record 30 no votes on Bernanke, “the weakest endorsement ever extended to a chairman in the Fed’s 96-year history.”
The fight over the Fed, at least on the House side, was largely within the Democratic Party. Ron Paul was able to persuade all of his Republican colleagues to support his Fed audit bill, and much of the opposition to Bernanke’s renomination came from conservative Senators. So the swing votes were moderate and conservative Democrats, as well as a few anti-establishment liberals. It was a motley combination, but I wouldn’t be doing the fight justice if I didn’t point out how important Ron Paul and his staff, Brad Sherman and his staff, Elijah Cummings and his staff, and Bernie Sanders and his staff were. But there was a robust outside campaign as well. The campaign for liberty made incessant calls. The AFL-CIO signed onto the bill after we had made a sufficiently strong case. One of the key organizers in the outside campaign, Jane Hamsher, brought a number of important liberal validators onto the campaign in last minute letters supporting the Fed audit. These were pivotal, as I’ll explain a bit later.
The campaign to spotlight the need for transparency on the Fed showed me something about legislating, which is the importance of oversight. Congress doesn’t pass good laws because a majority supports them, that’s just the technical piece of the puzzle. Congress passes good laws because someone has made an excellent public case that a problem needs to be solved, often using hearings and investigations to highlight the problem. Elizabeth Warren, for instance, built the political case for reining in the banks with her time at the Congressional Oversight Panel. One of the simplest ways to tell that Congress wasn’t serious about financial reform was that the commission they empowered to find the root of the financial crisis, the Financial Crisis Inquiry Commission, was mandated to come out with its report after Dodd-Frank passed. They weren’t marshaling public support, because they knew what they wanted to pass before making the public case for it.
As heat built up on the Fed, Rep. Grayson was going down to the floor every day for votes, collecting Democratic co-sponsors for the bill to audit the Fed (HR 1207). Ron Paul’s supporters were constantly calling members on the Financial Services Committee, which meant that staffers I interacted with were often getting those calls. They held me responsible for them. I was called in meetings of Democratic legislative assistants a “Larouchie”, and the bill to audit the Fed was referred to by one staffer as a “piece of shit”. Yet, despite the staff opposition, the number of sponsors continued to climb, first hitting 100, then 200, then a majority of the House (218), then 300.
Eventually, the heat was so heavy that the committee held a hearing on the bill. The question was no longer whether the bill would pass, but whether it could be attached to Dodd-Frank. Most bills are introduced as message pieces, and don’t go anywhere. The only way they actually move is by attaching them as amendments to larger bills that are going to pass, like annual spending bills or bills like Dodd-Frank that are Presidential priorities. So whether the Fed audit bill could be attached to Dodd-Frank was pivotal, because a majority is mostly meaningless if you can’t get a vote on it. So this was a question of jurisdiction; fortunately, the committee’s parliamentarian ruled that the Fed audit provision was germane to the overall financial reform bill.
The whole time, the Fed was defending itself by screaming in bureaucracy-speak “Federal Reserve independence” through every economist and validator it could. This was a way of preying on the insecurity of Congressmen, who are afraid of making governance mistakes and desperately want someone else to blame in case something goes wrong. In making the claim that it was above politics, the central bank turned its back on its own history, ignoring the time it was controlled by a very political Treasury Department and financed the winning of World War II. The period of the non-independent Fed, which ended in the early 1950s, saw an enormous flattening of income equality. The Fed knows this, but pretended that it did not. The idea of democratic accountability in the Federal Reserve system was simply unthinkable, a clear indication of how the public simply could not be trusted.
Senator Judd Gregg, who is now a senior advisor at Goldman Sachs now claiming that he was unaware of the extent of the Fed lending, led the charge on this point. He used the talking point that the public knowing which banks got trillions of dollars from the Fed was tantamount to iron-clad Congressional control of the Fed. It was an absurd argument, but it was what they had. Here’s Gregg.
A growing effort in the House to require periodic audits of the Federal Reserve is little more than “great PR,” one Republican senator stressed Friday.
Reps. Ron Paul (R-Texas) and Alan Grayson’s (D-Fla.) effort to subject much of the Fed’s records, communications and decisions to public scrutiny survived a key committee vote this week, and it now over 300 supporters in the House. But Sen. Judd Gregg (R-N.H.) told CNBC Friday morning that the amendment was little more than “pandering [to] populism.”
“For the Congress to get into monetary policy, it’s just absolutely inexcusable,” he said. “We can’t handle fiscal policy, but now we want to manage monetary policy?
One of the great strengths of our nation is an independent Fed, and this idea that’s coming out of the House, which is populist fervor … is absolutely wrong, and it would do fundamental damage to our system of monetary policy.” “They’re all absolutely wrong, there’s no question about it, and [it's] because they want to get reelected,” a frustrated Gregg added. “It’s great PR; you go home and beat up the Fed.”
This was a key part of the attack, that this was populism run amuck, and that Congress wanted to control monetary policy like it does fiscal policy. Aside from the fact that monetary policy is very clearly in the Constitution as a Congressional responsibility, and that the Fed constantly argues it is a creature of Congress, this was simply not what the bill did. It was a disclosure bill, pure and simple, which is why people on the right and the left could side together on it. Economists joined in to the “Fed independence” chorus, but their credibility was damaged by a remarkable article written by Ryan Grim on how the Federal Reserve funded most monetary policy research (which Congressional investigator Robert Auerbach had noted in the 1990s). In fact, one of the key letters used by the main committee opponent of a Fed audit, Congressman Mel Watt, was discredited when Grim figured out that the economist organizers of the letter were or had been on the payroll of the Fed. The Fed also argued it was already audited; what the Fed meant, of course, is that its emergency lending facilities and discount window were audited by accountants that reported to the Federal Reserve. It was audited by itself, in other words. Former Fed Vice Chair Alan Blinder made this dishonorable point in the Washington Post, a seat of the anti-populist fervor.
The overall question it raises sounds fair: After all, why should the Fed be immune from audit? In fact, it is not. The Fed already gets its books examined regularly.
By the time the vote happened, we had won the argument for Federal Reserve transparency. But we were far from winning the fight. And this is where the Fed got dirty. Congressman Mel Watt, who was the Chairman of the subcommittee in charge of monetary policy, introduced an amendment that was in all likelihood written by the Fed, purporting to increase Federal Reserve transparency. Watt, a Democrat from North Carolina, had this to say.
“The Fed currently has no political capital,” conceded Representative Mel Watt, a Democrat who opposed the Paul-Grayson provision. “Everybody would like to beat up on the Fed and call them the bad guy,” Watt said. “(But) are we going to so substantially castrate the Fed so it cannot do what it was set up to do?”
Most of Watt’s amendment listed various parts of the Fed that would be opened up to audit, like the bank supervision pieces. But several pages were confusing; they referenced parts of the code in ways that seemed designed to make it hard to understand the gist of what it actually meant, along with phrases that grammatically worked against each other.
When it gets down to crunch time, as a staffer going up against a big force of lots of lawyers, you get really tired and cut corners. One obstacle in legislating is that it is really hard to tell what bills do, because they have multiple provisions like “In Section 203, delete “do” and replace with “shall”. You have to constantly reference pieces of the code and compare changes, which gets confusing. It’s like doing “track changes”, but on paper and with multiple versions. This is a problem software could easily solve and I’ve heard that agencies and (probably the Fed) have such software. But I didn’t. So the Fed thought we would do nothing more than cursory reading of Watt’s amendment, and rely on their validators who told us the amendment would increase transparency. And this is where Grayson showed legislative genius. We were exhausted, but he got all the difference pieces of the law, and spent a few hours deciphering exactly what this amendment meant. And he figured out that not only did the amendment not open up the Fed facilities to independent inspection, it actually increased the secrecy of the Fed. If you want the gory details, here’s Grayson’s argument during the markup.
The Fed wanted to frame this as a Goldilocks choice. Congress could do nothing, which was clearly unacceptable and too cold a response. Congress could adopt the Ron Paul – Alan Grayson Fed audit, which was fringe and way too hot a response. Or it could adopt Mel Watt’s bill, which was just the right temperature. Congresscritters like compromise, especially when that compromise is supported by the Fed, and in the five minutes they had to consider this amendment, they might have gone for Watt’s bill. This would have made it harder for Bloomberg to win its FOIA request lawsuit, and obviously shielded the Fed from disclosing what it disclosed. And the Fed was able to frame the Watt bill as a compromise among the old media outlets with whom it was friendly. Normally, this would have won the fight. But we were able to get new media outlets to focus on the substance of the amendment, and show that it shielded the Fed from Congress. In 1970s, the last time the Fed was under threat of an audit, the Fed had played this same trick. But this time, advocates on the internet were watching carefully.
The day of the committee vote, we found that on the empty chair of every member was a letter signed by Alan Greenspan and Paul Volcker opposing the Paul-Grayson Federal Reserve audit. This was against the committee rules, so we had the letters removed. And Grayson was circulating our own letter calling the Watt amendment a vote “for secret bailouts”. This made the choice crystal clear for members, and the Fed didn’t want members to have a clear choice. They wanted it muddled.
This was the result.
In a surprising display of political rebellion, about half the Democrats present and all the Republicans voted for Mr. Paul’s bill instead of a compromise measure drafted by Representative Mel Watt, Democrat of North Carolina.
The House vote was in 2009, and the path to the ultimate audit went on into the next year. Socialist Bernie Sanders carried it in the Senate, along with hard-right Senators like Jim Demint and skeptical ranking member Richard Shelby. It was changed on the floor of the Senate, and in the conference committee, though Grayson did insist on putting in a provision in the final Dodd-Frank ensuring that the bill did not interfere with the Bloomberg FOIA lawsuit. Sanders got a report from the GAO on the Fed’s governance structure. In terms of how the Fed was brought to heel, that House vote was a crushing moment. The Fed simply did not lose fights like this, ever. It was also the most significant non-establishment bipartisan initiative in that entire Congress. In spite of yapping from Republican and Democratic establishment players, the populist left and populist right really did join to defeat the establishment, and force the Fed and the banking industry to disclose what they were doing.
The claims the Fed made about why it needed secrecy ran the gamut; it argued that it couldn’t operate effectively if banks knew they would be exposed to the public. It argued that internal Fed officials would be afraid to air their opinion if they thought there would be oversight. In fact, the 2006-2010 transcripts of the Federal Reserve Open Market Committee are still secret, so we still do not know what the Fed was deliberating while the later stage bubble was inflating and the system was crashing. In 2010, Rep. Issa said he’d look into this before he took the gavel of the Government Reform Committee, but so far hasn’t. But ultimately, the Fed relied on the fake belief that a government agency can be dispassionate and responsive only to angels, that political independence is a meaningful concept. It isn’t. The idea that the Fed must be independent or above politics is just a dishonorable way to argue against democratic accountability.
Obviously the Federal Reserve is responsive to someone or some group; that group is the bankers and their allies who serve on the boards of the Reserve banks (such as Eric Schneiderman opponent Kathryn Wylde, who was just re-upped as Vice-Chair of the New York Fed). And the numerous economists who made the argument for “independence” did so because many of them were protecting the insular and unethical world of economists spotlighted so beautifully in Inside Job. Finally, when all its arguments were exhausted, it relied on devious legislative trickery intended to mislead Congress by putting forward a bill ostensibly to increase Federal Reserve transparency that in fact did the opposite. This time, for once, the Fed lost.
I had a great deal of fun in this fight, because ultimately, this was a fight for democracy. And since we won this fight, the Federal Reserve has become a bit better on transparency, and recognizes that it is operating in a different information ecosystem. We’ve since learned of bitter disputes between the New York Fed and the Federal Reserve Board, which are teased at in this GAO report. And fundamentally, questioning the Federal Reserve, which is the heart of the monetary system, has been legitimized. We know that the creation and lending of trillions of dollars is a completely reasonable topic to be debated and shaped by the public, that the system will not crash as the high priests at the Fed tell us it will when we question those in authority. And this is a good thing. It’s a good thing for the public. It’s a good thing for democracy. And I bet it’s a good thing for the operations of the Federal Reserve system.