I understood that there was an Audit the Fed amendment that passed the House, and that Bernie Sander’s amendment duplicating it in the Senate was getting a lot of attention, with administration officials suggesting that they will try to stop it “at all costs.”
I wanted to get a better sense of why such a proposal might be important, and what it would actually do and mean for the Federal Reserve. So I was lucky to speak with Dean Baker about the matter.
Dean Baker is co-director of the Center for Economic and Policy Research in Washington, DC. Dean previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University. He has also worked as a consultant for the World Bank, the Joint Economic Committee of the U.S. Congress, and the OECD’s Trade Union Advisory Council. Many of you know him from his blog, recently moved, Beat the Press, and any number of media appearances or his books, the latest of which is False Profits: Recovering from the Bubble Economy.
Mike Konczal: What does the Federal Reserve do?
Dean Baker: The Federal Reserve is the country’s central bank. It has regulatory powers over the banks within the banking system. Its most important task is probably to control monetary policy, so basically it decides short-term interest rates, decides the rate at which we create money, and in that way has an enormous impact on the economy. You can’t always speed growth if you try but it can certainly slow growth and raise unemployment by raising interest rates
During the economic crisis, a lot of people said that the fed took extraordinary actions to stop the crisis. Everyone saw that it lowered interest rates, but what are some of the other things it did?
They were trying to keep this wave of bank collapses from continuing, so we had Bear Sterns in march 2008. They actually arranged for a takeover of Bear by JP Morgan. They did this by guaranteeing many of the bad assets that Bear had, otherwise JP Morgan would not have wanted to do that.
Then they created a number of special facilities, special lending facilities, which they allowed banks, other financial institutions and in fact even non-financial institutions to access. They bought up commercial paper from non-financial corporations, they did this to keep credit flowing in the economy, and at the peak of the financial crisis they had over 2 trillion dollars lent out to various financial institutions through these special facilities
Now there’s very little transparency in that. We have people who oversee the TARP money that was given out by Congress, but we don’t really have people who oversee these facility for the public, right?
That’s right. There’s basically no transparency. If I wanted to I could go on the treasury’s website and find out what Citigroup owed, what interest rates it paid, whatever was paid back with the TARP money, all that information is readily available.
If I wanted to know what Citigroup borrowed through these special facilities, I have no information whatsoever. All the Fed’s done has been to release information about how much in aggregate has been given out, not who they lent it to, whether they paid it back, what the terms of specific loans were, what collateral was posted, we have none of that information, almost none of it is available to congress, basically they’ve kept it to themselves.
So obviously we had a crisis and we’re very happy it’s not a Great Depression, but are people worried this is a new normal for the Federal Reserve, that this is how the Federal Reserve will act into the future?
Yeah, I mean it’s a serious question. The Fed is a creation of Congress. There’s an argument that you want it to be independent, because we don’t want Congress micromanaging monetary policy or manipulating banks. This is just like we don’t want Congress deciding which drugs the FDA approves.
But at the same time there’s always been the expectation that they were accountable, and suddenly we have them taking on this enormous role. 2 trillion dollars is almost two thirds the size of the budget. These are loans of course rather than spending, but this money was enormously important to the banks at the time, it made a huge difference to the companies that got it as opposed to those who might have wanted the loan and not got it.
This is an enormous amount of power that they had, and though they don’t expect another crisis like this but you can’t rule it out. Furthermore, it’s up to the Fed to decide when we’re in crisis, so, I think they made the right call. We were in a crisis. But nonetheless, if they say they’re not answerable to Congress, they don’t have to account for what they did with the money. They could say in a year or two “oh, things are bad, we’re gonna create other special facilities, again.” I don’t expect them to abuse their power, but if they’re saying Congress has no right to hold them accountable for what they did with the money, then I don’t know what would prevent them from abusing their power.
And from a distributional point of view, the Fed has its window where it can lend to banks to make sure the payment system’s preserved, and that’s relatively broadly available to bank holding companies, but from my little understanding of it is that these special lending vehicles primarily benefited risky lenders, the biggest, insolvent lenders that were heavily involved with shadow banking. That this is particularly skewed to the very largest players who we’re very worried about right now in the future. Is that fair?
Well we don’t really know the answer. The Fed has told us in very narrow terms they had at one time 13 different lending facilities and they said how much was out in each of them by month I think, possibly weekly. But we don’t even know exactly who fit in each category, since several of these were directed toward bank holding companies.
For example, we don’t know where Goldman Sachs would qualify, but there also were facilities directed for investment banks and primary dealers, this could also include Goldman Sachs, and there were others that were somewhat ambiguously defined. For example the commercial paper facility that was one of the largest at one time, there’s over 500 billion outstanding where the fed has bought up commercial paper. now that could have been commercial paper of non-financial companies, it could have been commercial paper financial companies, we don’t know.
So it’s really hard to say, and again I wouldn’t work from the presumption that they did anything improper. But that’s the whole point, that this information should be on the table and then we would know that.
So what are some solutions that can help us bring transparency to this without compromising what we want the Federal Reserve to do?
Well the Fed has been giving two arguments against having the government audit their books to see who got what money under what terms, what the collateral was, etc. and making that information available.
Now with the audit its up to Congress to decide whether to release the information to the public, so having the government audit it doesn’t mean it automatically becomes publicly available. It would be made available to the appropriate committees who would then make that decision. I personally would say it should be made public, but in any case the point would be to get a full accounting here so we can know what happened with the money.
The first argument the Fed is giving is that this would create a stigma for the banks, I’m kind of at a loss to understand what they even mean. They can give an argument that if you have a banking crisis and Bear is about to meltdown, and they suddenly need money from the Fed, and there’s this public statement saying that Bear went running to the Fed and borrowed 5 billion, that puts Bear in big trouble and a bank run could start.
But we’re talking about a year and a half, two years later. So I don’t understand how that creates a crisis. Does that create a stigma, that the banks were in trouble? Well maybe, but I’m not sure why we should care. The fed is not in the business of covering up banks’ bad financial shape. The principle we want is transparency. If they know a bank’s in trouble, again we don’t want to create a run, but after the fact the Fed should be making the banks’ condition more transparent, not helping them conceal it, as they did with Lehman for many months,.
So this stigma story I don’t quite understand. The other argument is this would hurt their independence. But again, I just don’t see any legitimate meaning of that term, independence, that it interferes with. We want them to make what they think are the best calls. But after the fact, do they have to answer for it? Should they have to say that these are the calls we made, this is why we made them? Absolutely.
I don’t understand how that isn’t independent. So those are the two arguments, on the one hand the stigma that will be created if at some point it’s known that banks go to the Fed, and on the other hand, that it somehow harms their independence. I mean, the FDA has to give a full account, we reviewed this drug, we reviewed that drug, this is why we approved this drug, here’s why we didn’t. I don’t understand why the fed should operate differently.
And there’s an issue with this kind of mechanism where banks have two problems, liquidity crises and insolvency crises, and it’s difficult to determine one from the other in the middle of a crisis. That’s kind of the Lehman problem the Fed observed. If we delay the result of the audit, there’s no reason to think that the markets aren’t smart enough to tell the difference between the two. I think that’s the stigma they mean. Either really there’s just was a liquidity crisis and this bank was fine, or really it was completely insolvent and we just forebeared it through the Fed’s lending facilities. The market should be able to tell the difference between those two things.
Absolutely, particularly in the past tense. In the middle of it, for example with bear sterns, well it was in an insolvency crisis, so maybe that’s not the best example. But if we had a bank that was in a liquidity crisis and we hear somehow that they went to the Fed and people don’t have full access to all their books and it’s not transparent, the big problem is that the value of their assets is not transparent, then it could make a liquidity crisis appear to be an insolvency crisis. But that’s not the issue.
Again, I think the Fed, or at least people in this debate, are being somewhat misleading, because no one is saying the fed should have to disclose this in real time, in other words if they make the loan at 2:00 then at 2:30 everyone’s gonna know the bank had to go to the Fed.
We’re talking in this case almost a year after the facilities have been closed, but in any case, some time after the fact making this information available – again, not even immediately available to the public, but to the relevant committees in Congress. Again, assuming it does get made public, what possible concern would you have about the appropriate information getting to the public? They’ll find out that Citigroup or whatever bank went to the Fed. I would want them to have that information, I don’t see what the issue is.
Can you talk a little bit more specifically about what the audit would do as proposed in the Sanders amendment being considered in the Senate?
Well an audit would mean basically a full accounting. As it stands now I could go to the Fed’s website and find it lent 500 billion in the commercial paper facility, how much was lent out each week or each month. The audit would say, okay, this much was lent out this day to Citigroup and this was the collateral, this was the interest rate charged, it was repaid two weeks later or a month later or maybe it wasn’t.
We would find that out, loan by loan, what the terms were, what the collateral was, and they would in principle be able to give a full account to the committees in Congress.
Another claim people make is that Fed’s already audited by all kinds of people. That argument cuts both ways: so what does it matter if there’s one more? But what do they mean by that, and how relevant are they to assuage the concerns we have?
Well there are audits that are done for the Fed and the information goes to the Fed. I couldn’t tell you details, but as I understand it would be like an audit like any company would have on its books and in principle they’d make it available to its board, so in this case it just goes back to the Fed. It doesn’t go to Congress.
It does nothing in the way of offering congressional oversight, but it’s worth noting that it’s not that different from what the government accountability office would do if the Sanders amendment passed. So they would go through loans and say these were the conditions, now again, there’s a somewhat different issue in that audit. They’d just be making sure the accounting was done properly, while a principal concern in congress would be were there political considerations, was everyone treated fairly.
So again, the audit is done by a major accounting firm, but it’s not going to say was the fed right to give Citigroup this loan on this day, were the terms right for Goldman Sachs on this loan, they’re not going to be asking questions like that, just what was loaned out and what was paid back. Whereas an audit by the government accountability office would presumably be saying , well, it looks like you gave Citigroup a really good deal, it looks like you gave Goldman a really bad deal, whatever it might be, that would be part of their responsibilities I presume.
Right because they claim this would politicize the matter. But it’s already politicized. So if anything it could provide a check on what could be a political issue. Again, not to accuse or imply anyone of anything, but the concerns over the potential for these political abuses are often best dealt with through sunlight and transparency.
Right, it’s a really important point, because the people associated with the Fed, they sort of talk out both sides of their mouth on this. On one side it’s that somehow we don’t want it to be politicized, which of course we don’t. But secondly they acknowledge that they’re responsive to the banks. I remember hearing Lawrence Meyer, a former Governor of the Federal Reserve Board, and he was talking about, this was like ’01, ’02, after the stock bubble, whether they should have taken steps to deflate the bubble before it got so large that we eventually had a recession in 2001 because of the collapse.
And he said it’s not politically acceptable for the fed to do something like that, we can’t destroy wealth like that, and it was a very telling comment. We want the Fed to do what’s best for the economy, but here was a governor saying we can’t do what’s best for the economy because it wouldn’t be politically acceptable. Well why not? You know, they’re not going to be fired. I mean, this is the sort of thing we should try to get out on the table. I presume the rest of the answer would run something like, well, we talked to all the people at these banks and they would have been really upset at us. Maybe that wouldn’t have been the rest of the answer, I don’t know, but the point is the Fed already responds to political influences, it’s not like this would be the first time that there would be any questions raised about Fed conduct. The point is that you get it on the table so at least the public’s included in this discussion and not just the big Wall Street banks.
I noticed a comment that came out earlier this week, Ryan Grim noted it, that while analyzing the housing bubble Alan Greenspan said: “We run the risk, by laying out the pros and cons of a particular argument, of inducing people to join in on the debate, and in this regard it is possible to lose control of a process that only we fully understand. “
The level of secrecy and, frankly, contempt for the general intelligence of the market and democracy was really telling about what goes on there.
Yeah I saw that. It was striking, and their arrogance was obviously completely wrong, that’s the greater irony about it. Not only were they showing contempt for the public and their ability to participate in the debate, but it turns out the Fed was as wrong as you can possibly be with disastrous consequences.
So this idea that the Fed is almost like this church that the public shouldn’t be let in on, it’s an old battle, we’ve had it again and again. it makes me think back in the ‘70s when congress required that the Fed chairman would appear before congress twice a year in what was called a Humphrey Hawkins testimony. He’d talk about the state of the economy, what the issues are, what the Fed’s goals are.
They originally said that was questioning the Fed’s independence, because they were telling the Fed chair you have to come down here and the fed was saying, well you can’t do that. Now, the fed chair goes there voluntarily because that part of the law has expired. He thinks its good to share that information with Congress and the general public.
There was a big issue about, if you go back to the ‘80s, the minutes of the meetings that would come out six weeks after the meetings, they would almost just say “we talked about monetary policy” and give you no information. Now they give you some sense of what the nature of the debate was, although they’re still relatively limited.
Then there was this huge debate, Greenspan did everything he could to conceal the fact from Henry Gonzalez, who was the head of what was at the time known as the House Banking Committee and is now known as the Financial Services Committee, he was trying to find out whether there’s anything more than the general minutes that were kept about the meetings. Greenspan concealed the fact that they were taped, so they had actually verbatim transcripts of the meetings, and when Gonzales found out about, he insisted they be made public, and Greenspan said oh no, we can’t do that or the world would end. And eventually they worked out an arrangement where they went public after I think it’s a 5 year lag, give or take, and again it gives us a lot of insight into what the fed was thinking.
How that compromised their independence is hard to see, but that was exactly the argument they made at the time. And this is happening again and again and again in any number of contexts where there have been efforts by Congress to open up the Fed and open up the process of monetary policy and each time the Fed resisting with every inch of its power, and as Congress has won, it’s shown that there haven’t been any problems and very often the Fed’s turned around and said, yeah, that was a good thing.
My last question: What’s the issue with not doing something here? What’s a bad case scenario, or what do we lose by not taking action and just saying, you know what, the fed kept us safe, we’re not in a great depression, lets just let them do what they do.
d: Well I guess its two things. One is just a general principle that we should want democracy. And if you have an institution like the Fed which could use this much power, and with over 2 trillion dollars having been distributed, that really undermines democracy. What about other government agencies, what if HUD spent 2 million dollars with no questions asked?
And the other question is, I think we do want to know what went on, and again I don’t have any particular reason for thinking it was anything improper. But I think we have a right to know what happened to our money, we want to know what this history was, and without knowing what loans the fed made and what were the terms, you really can’t know that. And I don’t mean history in the sense of going back and looking at old artifacts, but if we want to understand the dynamics of this downturn, we should want to know who was really dependent on the Fed for money and at what times. Maybe there’s nothing there, maybe we’ll take a look and go, oh, we already knew all that. But we can’t know that until it’s made public.