Close Down the Federal Reserve

by: Avery Goodman

During a 2002 speech given for the 90th birthday party of the famous economist Milton Friedman, Ben Bernanke admitted that the Federal Reserve caused the Great Depression.  He said, and I quote:

“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve System. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.”

So, now we all know the dirty truth… the Fed caused the Great Depression.  But, apparently, that’s not the end of it.  Having created artificial 1% interest rates, early in the 21st century, it proceeded, under the Chairmanship of Alan Greenspan, to create the biggest asset bubble in history.  That has set the stage for Great Depression II, Great Hyperinflation I, or a repeat of the type of severe stagflation we saw 1970s, depending on what decisions are made now. The events in progress, whatever their ultimate outcome, are clearly a direct result of repeated attempts by the Federal Reserve to micro-manage the economy.  We must stop them from continuing to do that.  Because of the existence of the Federal Reserve, we have widespread systemic problems that cannot be cured simply by throwing $700 billion dollars around.  The problem is not one purely of money, and errors by big banks, but, rather, arises out of the fundamental manner in which our financial system is constructed.  One thing is sure.  In this mess, all roads lead back to the Federal Reserve.

Many politicians, most notably Treasury Secretary Henry Paulson, have stated that they want to confer more regulatory power on the Federal Reserve.  This a serious mistake.  The over-concentration of economic power, in the hands of a few unelected men and women, is the root of our troubles. The Federal Reserve does not need more power.  It needs less.  It has had more than ample regulatory power for many years to have done everything needed to prevent the crisis that we are now experiencing.  Yet it did nothing.  It could issued banking rules that would have stopped the creation of toxic mortgage instruments, including, but not limited to, CDOs, CDSs, subprime mortgages, Option-ARM mortgages, Alt-A, etc.  Instead, it encouraged banks to create them.  The Fed allowed banks to do as they pleased.

As a result, bank executives peddled irresponsible behavior, and irrational debt levels.  All of this was done in pursuit of short term profits, especially those that came in the form of bonuses and benefits.  This is all the result of influence peddling in Washington DC.  Because the Fed Board is indirectly controlled by the Federal government, Wall Street based bankers have been able to gain effective control over Fed policy choices by virtue of getting their choices for the Board appointed.

The Federal Reserve is a quasi-private institution, capitalized and supported with taxpayer dollars.  However, for years it has been used as a slush fund for private banks on Wall Street.  Over the past year, the banks managed to unload about $777 billion worth (in terms of par value at maturity) of their most toxic debt paper onto the Fed balance sheet. 

No rational private industry player would have agreed to have its balance sheet polluted by the combined mistakes of its clients. However, according to the Wall Street Journal, the Fed was willing to take in this toxic waste “collateral” on a non-recourse basis, giving the banks cold hard cash, or valuable T-bills in return. Non-recourse is a legal term which means that if the borrower fails to pay back the loan, the only thing the Fed can do is sell the collateral.  The other assets of the bank, are immune from attachment.  The bad collateral consists of mortgage backed paper and other currently depressed paper instruments, worth about $0.22 on the dollar, or much less, on the free market.  I use the $0.22 figure, because that is the price obtained at a recent sale of such assets by Citigroup.  Yet, in spite of the free market value of this collateral (and $0.22 on the dollar is being very liberal about valuation), the Federal Reserve has paid 90% of par value for this trash. 

Lehman Brothers is an example of a bank which was allowed to use its close connections at the New York branch of the Federal Reserve, to borrow tens of billions of dollars, based on bad collateral.  During the time it borrowed money, everyone had to know, including Timothy Geithner, President of the New York Federal Reserve Bank, that the company was insolvent.  Now, Lehman is officially bankrupt.  It will never pay back the debt.  In short, under the leadership a Board of Governors heavily influenced by Wall Street, the Fed has already managed to lose a fortune of taxpayer money.

Ben Bernanke claims that the Fed took a “haircut” to protect itself. A haircut is the percentage difference between the alleged “market value” of the collateral and the amount that can be borrowed.  The “margin” is the difference between the price that the Fed can get for the collateral if it needs to sell it, and the cash given out.  Margin is supposed to protect from loss.  But, with respect to the cash given in return for this worthless collateral, there is no margin.  Instead, there is immediate loss.  As I said, they’ve been paying 90% of par value, when these assets are really worth less than about 22%. 

The Fed has repeatedly renewed the loans so that the banks never need to pay them back.  What has been characterized as “loans”, therefore, are really gifts. The Fed lost money the very instant it gave the banks cash in return for this trash.  There is no active market for this worthless paper.  No sane business wants it.  Only the Fed will accept it.  That because the Fed Board of Governors is an unelected group that puts taxpayers at risk, not their own pockets.  Do you think they would buy such bad paper at a 90% valuation, for their own personal accounts?  Not a chance!  But, the Fed serves as a “slush fund” for the big banks.  It is a model for structural corruption.  Here is the Fed’s own table of so-called “haircuts” that are applied to collateral. Click to enlarge:

Click to enlarge
As you can plainly see, the “haircut” for mortgage backed securities for which “market price is not available” is 90% of par value.  That is what they’ve been paying for nearly worthless assets.  In other words, under the incompetent leadership of Chairman Ben Bernanke, the Federal Reserve has paid banks $700 billion for securities that have a par value at maturity of about $777 billion.  Let’s give them the benefit of the doubt, and access the value at $0.22 per dollar.  That means the collateral is worth about $171 billion.  It also means an immediate net loss to the taxpayers, and a subsidy payment, going into the pockets of Wall Street bankers, of $606 billion.  How can this be described as anything other than outrageous?

The only good thing to come of this is that the Federal Reserve slush fund is now so tied up with toxic assets that it is close to insolvent.  Very soon, absent the Congressional bailout, it will be insolvent.  By virtue of that insolvency, it will have no money left to help its friends, and harm American taxpayers. If, however, we shift this toxic debt burden to the U.S. Treasury, the Fed balance sheet will be free again.  It will be free to start giving away even more taxpayer money.  
Right now, the toxic paper simply sits on the Federal Reserve balance sheet.  It is not a direct obligation of the U.S. government.  It should either stay there, or, more appropriately, be handed back from whence it came, with a demand to return the cash.  If we allow the $700 billion bailout for billionaires, we will have privatized gains, and socialized huge losses. We will free the Federal Reserve to do more damage to our economy. 

The Fed has become so low on cash that the U.S. Treasury had to use its existing authority to sell another $158 billion worth of T-bills to recapitalize it, just last week. This money may have already been used by the Fed to micromanage the stock market, catalyzing a rise in the latter half of last week.  The Fed balance sheet shows that it injected a total of about $262 billion, probably into the stock market, over the last two weeks, pumping up prices on Wall Street.  The practical effect will be to allow people in-the-know to sell their equities at inflated prices to people-who-believe-and-trust, but don’t know.  Sending so much liquidity into the U.S. economy will stoke the fires of hyperinflation, regardless of what they do with interest rates.  In a capitalist society, the stock market should not be subject to such manipulation, by the government or anyone else.  It should rise and fall on its own merits.  If it is meant to fall, let it do so, and fast.  It is better to get the economic downturn over with, using shock therapy, than to continue to bleed the American people slowly to death through a billion tiny pinpricks. 

With respect to the Federal Reserve, we must remember the warnings of one of our greatest American Presidents, Thomas Jefferson, who stated:

"I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs."  Thomas Jefferson, Letter to the Secretary of the Treasury Albert Gallatin (1802) 3rd president of US (1743 - 1826) 

Later, another patriotic President, Andrew Jackson, vetoed legislation in 1831, that would have extended the charter of the Second Bank of the United States.  In 1833, he announced that the U.S. Treasury would no longer deposit federal funds at the bank.  Like Jefferson, Jackson warned that allowing a central bank to hold sway, by manipulation of the nation’s currency, would push the people into a world of perpetual debt, while enriching the fortunes of a small minority of people.  Since the creation of the Federal Reserve Bank, in 1913, that is exactly what has happened. 

Banks serve essential functions in our economy.  We cannot do without them.  However, we must insure that all banks are treated equally, and that those on Wall Street are not favored over others.  This is impossible so long as the Federal Reserve continues to exist.  The continued existence of the Federal Reserve Bank insures that a small minority of bankers will continue to twist the President, Congress and the entire American economy into knots, by using government funds, to assist in creating private profits, and/or to save them from their foolish mistakes 

The Federal Reserve was formed in 1913 in the hope that it would reduce instability. Just twenty years later, it caused the Great Depression.  Now, its continued attempt to substitute the opinions of a few men for the conclusions of the markets as a whole, have caused another potential catastrophe.  Too much power has been placed in the hands of a small group of unelected men and women.  We have foolishly endowed them with the ability to use our money to manipulate our money, however they see fit, including altering interest rates, and intervening in the stock, bond and commodity markets to assist their primary dealers.  The results of this liberalism are in.  Instead of a stabilizing force, the Federal Reserve is a destabilizing one.

We do not have a credit crisis.  We have a lack of transparency.  The money market is flooded with cash.  The Federal Reserve, ECB and other central banks have seen to that.  Banks are simply afraid to lend it out, because they fear that other banks are lying to them.  That is one of the fundamental problems with central bank activity.  They create money when and where it is not needed.  We must address this problem by increasing transparency, not by increasing the money supply.  We don’t need a central bank to accomplish that goal. Once transparency is restored, and everything is out in the open, banks will feel confident like never before.  All shaky banks must be closed.  Remaining banks will be eminently credit worthy.  Credit markets will be freed up, in a free market, without creating additional moral hazards. 

Congress should pass groundbreaking reform legislation. However, it should reject the $700 billion dollar bailout for billionaires. On the contrary, we need legislation that will allow the Federal government to send out an army of auditors.  The auditors must use their government authority to carefully examine the books of, and shut down all insolvent and shaky savings, commercial and investment banks, as soon as possible.  The process of shutting them down should be handled much like the shutdown of Washington Mutual.  The assets of the banks that are closed must be immediately sold to the highest bidder, with the government absorbing some of the shortfall. This will cost money, but not $700 billion.  In the course of selling WaMu, for example, the government incurred no loss at all.  Meanwhile, Congress needs to revoke the charter of the Federal Reserve.  The Fed must be closed down before it can do more damage.