Bloomberg vs. the Fed: Secrecy and Moral Hazard

By James Kwak

According to Reuters, the Federal Reserve recently got a stay of a federal district court’s order that the Fed must reveal details about which banks accessed its emergency loan programs during the financial crisis.

The arguments on each side are pretty straightforward. Bloomberg, the plaintiff, is arguing that the public has a right to know where their taxpayer money,* via the Federal Reserve, is going. The Fed is arguing that if it reveals the names, that could trigger a run on those banks, because customers will worry about their solvency; it is also arguing that revealing names now will make banks less willing to access emergency lending programs in the future, taking away an important tool in a financial crisis.

I find both of the Fed’s arguments weak.

I agree that immediate revelation of who is borrowing at the discount window (the Fed’s facility for lending to banks directly) could make creditors worry about a bank, triggering the modern version of a bank run. (Traditional bank runs shouldn’t happen because of FDIC insurance.)

But we’re talking about things that happened last year, and the government has done everything it can to convince the public that the banking system is sound again. Even if Citigroup borrowed at the discount window last September, the ample bailouts it has received since then should convince any jittery investors that Citigroup isn’t going anywhere.

That is also something that apparently Barney Frank and Ron Paul agree on – any Fed disclosure should be delayed by several months.

The second Fed argument is interesting. Basically it says that if banks need to be bailed out in time of crisis, we want the ability to bail them out in secret. This only weakens the incentives for bank managers to run their companies prudently. Knowing that the Fed will bail me out in times of trouble already creates moral hazard. Knowing that they will bail me out without even my shareholders ever knowing only increases the moral hazard. Where does this stop?

* I know you can argue about whether Fed lending counts as “taxpayer money,” since the Fed is arguably an independent entity. The argument on the other side is that when the Fed lends money to dodgy institutions, the ultimate downside risk is taken either by the taxpayer, or by anyone who has dollar-denominated assets that would be hurt by inflation.

Comments

[Moon Kil Woong:]

Your points are most succinct. Whereas people may feel that the governments actions help investors they do not. The actions during this crisis has diluted shareholders rights to get accurate, honest, and timely information from the executives running a company. Furthermore the government has sieilded these very same people from liability, responsibility, and full disclosure for years on end now.

In the end, this war has been a war on shareholders (otherwise known as owners) and the ultimate losers are shareholders and the market as a whole in the name of preventing some illusive "financial meltdown". The winners, the inept executives who were not fired, retained their wealth, and did not get criminal charges filed against them by their own shareholders.

When we speak about government intervention, lets skip over the nationalistic rhetoric and doomsday monologue and get right down to the crux of the seedy practices it is hiding. Your rights as shareholders are dropping to zero. When they do you can't call this capitalism anymore. In fact, you basically can't do anything unless you're in power.

Thus the broader victim at threat is not the economy but the free market and the free market has clearly lost.

Sep 01 05:47 AM

[conceptwizard:]

Now that we are talking the boiled down version of the Capitialism in a democratic sociiety, there is no place for a Federal privately owned central bank secretly controlling the destiny of everyones financal future.
It erodes the very fabric of what the "free" democracy of the USA stands for.
How can we be sure that they will do the right thing for the general public when we have no measure of counterwieghts and balances to keep them in check.
How can we have faith in the FED when they break their own mandates of "protecting employment" and the "value of the dollar" to protect themselves from harm first? After all the FED is owned by the banking cartel.
Many Presidents have said that the FED will be the downfall of America, and they have us well on our way.

Sep 01 06:51 AM

[Dave Wrixon:]

Unless the Fed comes clean, how can you dispell the conspiracy theorist?

But if the Fed actually were to come clean, how could it avoid confirming what most fear?

Sep 01 07:18 AM

[CautiousInv...:]

By expanding its balance sheet by over $1 trillion through direct purchases of agency debt, CMBS's, Maiden Lane (set-up to help JP Morgab to acquire the assets of Bear Stearns), securitized student loans and God knows what, the Fed has changed the nature of its charter and has compromised its presumptive independence.

Through these direct purchases of industy specific assets and essentially embarking upon what most would view as fiscal policy, the Fed is redefining itself; though permitted under law, this expansion of power must be offset with greater accountability in the form of greater transparency. For this reason and others the Fed should be audited.

The public deserves to know what banks are on life support and the public is entitled to know more about the assets the Fed has acquired in expanding its balnce sheet. By charter they are supposed to hold only AAA securities but I do not think they have adhered to this standard; I think its been relaxed with the offset of additional collatteral.

The Fed also maintains a $ trillion custodial account to hold securities purchased by central banks; as of late the balance of agency debt has been declining while the balance of Treasuries has been increasing. Chris Martenson suggest something like this may be happening:

Shell #1: Foreign central banks sell agency debt out of the custody account.

Shell #2: The Federal Reserve buys those agency bonds with money created out of thin air.

Shell #3: Foreign central banks use that very same money to buy Treasuries at the next government auction.

Given that the Fed has expanded its role and compromised its presumptive independence while using taxpayer money, I believe the public is entitled to know (1) what zombie banks are being kept afloat through the Fed, (2) the nature and quality of the assets acquired by teh Fed and (3) more about the odd dynamics in the balance changes of the custodial account.

Sep 01 07:45 AM

[LKofEnglish:]

first off shelve the term "independence." that's not the Fed's mandate. The mandate is to be a reliable intermediary and nothing more. Of course show me a bank failure where a depositor lost a penny, too! Sure Lehman collapsed, hence making Goldman and Morgan into banks because all those billionaires realized their "deposits" weren't safe. THAT'S CALL CAPITALISM. This is a regime of the rich, by the rich and for the rich which has morphed into "against the risk, against the risk, against the risk." Hillariously predictable but can it be any more undemocratic? actually i think the word is "totalitarian." we've already seen this administration's response to a democratic revolution in Iran. what else need be said? this isn't "change we can believe in." this is "meet the new boss worse than the old boss."

Sep 01 11:12 AM

[GeminiAtlas:]

It does seem like the big banks are using (manufacturing?) this as an opportunity to shake competition down by blackmailing the federal gov't out of bailout money, ensuring their own survival while at the same time weeding out the competitive field of the smaller upstart banks. This is to increase thier market share in the future.


On Sep 01 07:41 AM nyse 30 wrote:

> big banks will win big from the collapse as they will prosper even
> when DJIA will be 5000, in the end only up to 30 banks will remain
> in US

Sep 01 12:33 PM

[expat in China:]

Thank you everyone!

we did get rich off the american people and thank you for the bailouts.

No really you had to do it because we could not credit your need is you hurt us and now i will sell your future to other countries be cause why not.

Mr. Buffet

Sep 01 01:03 PM

[Dirtnap:]

Nothing like some trillion dollar rent-seeking to destroy our economy.

Sep 01 01:26 PM

[Bailmeout2:]

"The Fed is arguing that if it reveals the names, that could trigger a run on those banks, because customers will worry about their solvency." If those banks truly are not insolvent what do they have to worry about? These banks are the ones that got this country into this financial mess in the first place. They should be allowed to fail. Why would we want to continue supporting a bunch of insolvent banks that are just sucking up funny money that the Federal Reserve keeps throwing at them, trillions at a time, with no government oversight? It's time to End the Fed!!!

Sep 01 02:23 PM

[Dave Wrixon:]

"The public deserves to know what banks are on life support and the public is entitled to know more about the assets the Fed has acquired in expanding its balnce sheet. By charter they are supposed to hold only AAA securities but I do not think they have adhered to this standard; I think its been relaxed with the offset of additional collatteral."

So that is why they persist with the lie that Treasuries are AAA.

Perhaps, they define anything held by the FED as AAA.

Sep 01 03:10 PM

[jeffz:]

let's all start calling the FED and demand that they release this info!!!

Sep 01 08:39 PM

[Tom Jacobs:]

1. The Fed remits its operating balance (profit) each year to the US Treasury. For every $ not remitted, taxes must be higher. By definition any funds spent by the Fed on anything that take away from this equation is money that must be made up by taxpayers.

2. As significant balances such as transaction accounts and amounts above the FDIC insurance limit are uninsured, traditional runs are still a problem. Just examine what led the FDIC to move on WAMU and Wachovia.

Sep 01 11:04 PM