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Willem Buiter Takes Fed and Treasury to Task

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Not that they listen to him, sadly. Buiter famously told the Fed in a presentation at its Jackson Hole conference that it was guilty of cognitive regulatory capture.

Buiter argues that the games the Fed and Treasury are playing, with the Fed providing loans and guarantees that properly should come from the Treasury, is bad for accountability and puts Fed independence at risk. The idea of the Fed chief appearing jointly with the Treasury secretary to pitch an initiative to Congress would have been completely unthinkable pre Greenspan. Buiter also argues that if the Fed sustains too much in the way of losses, it will need to go to the Treasury for recapitalization (while it in theory can simply print money, in practice it can undermine monetary policy).

From VoxEU:

The Fed does not have a full indemnity from the US Treasury even for its outright purchases of private securities. It has no guarantee or indemnity for private credit risk assumed as a result of its repo operations and collateralised lending.

For the Fed’s potential $1 trillion exposure to private credit risk through the Term Asset-Backed Securities Loan Facility, for instance, the Treasury only guarantees $100 billion. They call it 10 times leverage. I call it the Fed being potentially in the hole for $900 billion. Similar credit risk exposures have been assumed by the Fed in the commercial paper market, in its purchases of Fannie and Freddie mortgages, in the rescue of AIG, and in a host of other quasi-fiscal rescue operations mounted by the Fed and by the Fed, the Federal Deposit Insurance Corporation, and the US Treasury jointly.

I consider this use of the Federal Reserve as an active (quasi-)fiscal player to be extremely dangerous and highly undesirable from the point of view of the health of the democratic system of government in the US.

There are two reasons for this. First, it undermines the independence of the Fed and turns it into an off-budget and off-balance sheet special purpose vehicle of the US Treasury. Second, it undermines the accountability of the Executive branch of the US Federal government for the use of public resources – taxpayers’ money.

As for the Fed’s independence (whatever independence remains), first, even if the central bank prices the private securities it purchases appropriately (that is, there is no ex ante implicit quasi-fiscal subsidy involved), it is possible that, should the private securities default, the central bank will suffer a capital loss so large that the central bank is incapable of maintaining its solvency on its own without creating central bank money in such quantities that its price stability mandate is at risk. Without a firm guarantee up front that the Federal government will fully re-capitalise the Fed for losses suffered as a result of the Fed’s exposure to private credit risk, the Fed will have to go cap-in-hand to the US Treasury to beg for resources. Even if it gets the resources, there is likely to be a price tag attached – that is, a commitment to pursue the monetary policy desired by the US Treasury, not the monetary policy deemed most appropriate by the Fed.

As regards democratic accountability for the use of public funds, even if the central bank has sufficient capital to weather the capital losses it suffers on its holdings of private securities, the central bank should never put itself into the position of becoming an active quasi-fiscal player or a debt collector. The ex post transfers or subsidies involved in writing down or writing off private assets are (quasi-)fiscal actions that ought to be decided by and accounted for by the fiscal authorities. The central bank can act as a fiscal agent for the government. It should not act as a fiscal principal, outside the normal accountability framework.

The Fed can deny and has denied information to the Congress and to the public that US government departments like the Treasury cannot withhold. The Fed has been stonewalling requests for information about the terms and conditions on which it makes its myriad facilities available to banks and other financial institutions. It even at first refused to reveal which counterparties of AIG had benefited from the rescue packages (now around $170 billion with more to come) granted this rogue investment bank masquerading as an insurance company. The toxic waste from Bear Stearns’ balance sheet has been hidden in some SPV in Delaware.

The opaqueness of the financial operations of the Fed in support of the financial sector (which are expanding in scale and scope at an unprecedented rate) and the lack of accountability for the use of taxpayers’ resources that it entails threaten democratic accountability. Even if it enhances financial stability, which I doubt, democratic legitimacy and accountability are damaged by it, and that is too high a price to pay.

The post also has a very useful discussion of the limitations of the ECB.

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18 comments

  1. ndk

    Buiter argues that the games the Fed and Treasury are playing, with the Fed providing loans and guarantees that properly should come from the Treasury, is bad for accountability and puts Fed independence at risk.

    I think Fed independence has been a joke for a long time that only sees light during times of crisis. Putting Geithner aside, read the Treasury’s own biography of William Miller, who went from Fed chair to Treasury Secretary in 1979.

    As Fed Chairman he worked closely with the White House planning a joint assault on inflation by government, private industry, and labor groups.

    Burns, Greenspan, and Bernanke played for both teams in some capacity as well. Heck, even Volcker, politically reviled at one time, has now accepted an administration position.

    Without a firm guarantee up front that the Federal government will fully re-capitalise the Fed for losses suffered as a result of the Fed’s exposure to private credit risk, the Fed will have to go cap-in-hand to the US Treasury to beg for resources.

    I will eat my hat if this happens during any time of crisis, much less at all. Even if the Fed reported openly having negative equity, unlikely in and of itself, it would almost certainly just sit that way.

    It can wait until seigniorage gradually bails it out — heck, they’d have just given those proceeds to Treasury anyway, right? Their operational capacity would not be impaired in any way, now that they can pay interest on deposits. I don’t even believe it matters if that causes the Fed to gradually run deeper into the red. It’s essentially the same as a fiscal deficit, and we’re not so prude about those.

    Even if it enhances financial stability, which I doubt, democratic legitimacy and accountability are damaged by it, and that is too high a price to pay.

    This, on the other hand, is a very valid point. I would rather Buiter have abandoned the pretense of independence and risks to it and dug into this issue instead. Combine financial sector contributions to the executive and legislative branch with the opacity and secrecy enabled by the quasi-public nature of the Fed and you’ve got some real problems on your hands.

  2. Russ

    It looks like the financial trust has been using the Fed to do an end-run around democracy for awhile.

    So the program is to privatize both economic and political policy (though privatized politics is technically a contradiction in terms).

    If I recall correctly, back in September it was Bernanke who asked Paulson to accompany him to Congress.

    It’s amazing is how they’re still such fanatical dead-enders in this shell game of shifting an ever more bloated debt bubble from place to place. It used to be the Fed’s implied printing press which rendered Treasury borrowing credible. And now the Fed is engaged in crazed leveraging based on what: the government’s taxation power?

  3. Anonymous

    I completely don’t understand the implication of moving CDS into federal budget.

    all those CDS are still covering some risk. what if this or that large banks are bankrupt? The fed is now in AIG position.

    Why can’t they just cancel the naked CDS? maybe negotiate little cash compensation to cover the lost.

  4. Anonymous

    I am not a banking lawyer, but it seems like it is illegal under either the corporate law doctrine of ultra vires or the constitution for the Fed (ultra vires) and FDIC (constitution) to give money away. If Geithner’s plan is for them to give away underwater non-recourse loans and guarantees, those seem like gifts.

    If you want to view the Federal Reserve member banks as private corporations, then it seems like a violation of the ultra vires case law that a corporation lacks power to do things it is not legally authorized to do and the Federal Reserve Act does not seem to authorize the Federal Reserve to make gifts. McCormick vs. Market National Bank, 165 U.S. 538 (Supreme Court on ultra vires acts being illegal and void). If you want to view the Federal Reserve member banks as government entities, it seems like a violation of the Constitution because only Congress is authorized to spend money. Article I, section 9, clause 1. United States v. MacCollom, 426 U.S. 317, 321 (1976).

    In particular note that the Federal Reserve Act says member banks authorizes member banks to “To exercise by its board of directors, or duly authorized officers or agents, all powers specifically granted by the provisions of this Act and such incidental powers as shall be necessary to carry on the business of banking within the limitations prescribed by this Act.” 12 USC 4.4.7. This seems to only give member banks the power to do things authorized by the Federal Reserve Act.

  5. Anonymous

    Independence started to wane the first time Fannie and Freddie got into trouble and was compounded when they were taken into conservatorship. Now China has stopped buying Fannie and Freddie debt billions need to be pumped into them each month in order to have mortgage interest rates lower than they should be. The FED and Treasury are now market makers and as such their decisions could have a big political impact. Imagine the impact if they decided to break up Fannie and Freddie and return its parts to private ownership.

    Just what are the losses likely to be on all this market activity that private investors will not touch with a barge pole. We have to assume that more and more treasuries will be sold to finance this and eventually when nobody wants the treasuries the debt will be monetized by effectively running the printing machines. We know that the UK is already hitting the markets tolerance for QE as gilt auctions fail, not that we should be surprised since some German auctions started to fail before Christmas, so we should expect the US to get into similar difficulties fairly soon(looking at the current yields that could be very soon). The upshot of this could be that government and state budgets have to be balanced which would be an ominous threat to Obama’s fiscal stimulus package. Equity prices and the dollar could tank as a result.

    Willem’s blog for the 24th is all about how the US Treasury is surreptitiously squeezing the tax payer and the Fed until the PPIPs squeak and concludes that they should stop ‘leveraging’ the tax payers’ money. Stop using the Fed as an opaque SPV of the Treasury. Tell the people the truth. Ask for more resources and pay for them by raising taxes or cutting public spending.

    All of which makes me think the stimulus plan will stall and states like California will be waiting a very long time for that bailout.

  6. Anonymous

    This is slowly turning into a red pill, blue pill world.

    Law, what law, where and for who.

    To many forces competing for the last crumb on the table.

    Skippy….good luck to all.

  7. john bougearel

    Janet Yellen has just proposed the Fed could issue interest bearing debt to recap itself! So they already have a strategy to get around its own insolvency problem.

    From Moody’s economy.com last night:
    Fed Has More Tricks Up Its Sleeve
    Wednesday, March 25, 2009
    The Federal Reserve is not out of ammunition, even as it has adopted a quantitative easing regime. San Francisco Fed President Janet Yellen subtly hinted at a possible course of action for the central bank as it constructs an exit strategy. She suggested the Fed explore the idea of issuing interest-bearing debt. The Fed’s exit from its massive intrusion in financial markets will be tedious.

    Yellen proposed the Fed issuing interest-bearing debt as a strategy because it will allow the Fed to tighten monetary policy while maintaining a large balance sheet.
    Yellen said interest-bearing debt would help by reducing the volume of reserves in the financial system. A reduction in the volume of reserves will put upward pressure on the fed funds rate without shrinking the size of the central bank’s balance sheet. The issuance of bills could help the central bank exit from quantitative easing but will require Congressional approval.

    Yellen’s speech in NY may have touched off that intraday volatility on the stock mkt yd afternoon

  8. Anonymous

    Buiter is a system shill! It is this kind of oblique bullshit that only serves to validate and give credibility to the gangster system status quo that writes his pay checks ….

    “I consider this use of the Federal Reserve as an active (quasi-)fiscal player to be extremely dangerous and highly undesirable from the point of view of the health of the democratic system of government in the US.”

    And …

    “Even if it enhances financial stability, which I doubt, democratic legitimacy and accountability are damaged by it, and that is too high a price to pay.”

    What “democratic legitimacy and accountability” is he referring to? The “health” of what “democratic system of government in the US?” is he talking about?

    Rather than validate the entrenched system gangsters (as deviously and obliquely intended) he makes himself a fool. Yes, he needs to address ‘democracy’ and more specifically, deception, (his own) and the aggregate generational corruption that has poisoned the now scam ‘rule of law’.

    ———-

    The Perception Machine

    In the land of scamerica.
    The homeland of deception,
    There’s a trillion dollar media,
    Controlling your perception,

    It hides exploitation’s pecker,
    Planted firmly up your ass,
    Its made you a moron,
    Sorry to be so crass,

    But you need a little slap now,
    Along side your empty head,
    Its time to pay attention,
    Or soon you will be dead,

    Your rule of law has been hijacked,
    The wealthy elite own the rules,
    They also own your perception,
    And they have turned you into fools,

    So take a little breather now,
    Forget those suggestions for the man,
    He really doesn’t give a shit,
    He’ll just trash them in the can,

    Its time to dig much deeper now,
    To consider what you’ve been through,
    And realize that your choices today,
    Are your future and up to you …

    It is going to take very radical measures to change this ever more rapidly deteriorating situation … it begins with questioning everything, especially the co-opted ‘rule of law’ and the contrived scamerican ‘left’ …

    Deception is the strongest political force on the planet.

    i on the ball patriot

  9. ndk

    Janet Yellen has just proposed the Fed could issue interest bearing debt to recap itself! So they already have a strategy to get around its own insolvency problem.

    John, this doesn’t help the Fed recapitalize itself. It has to pay out this interest rather than receive it; it would only get dollars in return. The interest it receives is on the assets it owns, which may be toxic, and may be longer dated.

    They want to do this because it allows them to match their duration risk better and enact less variable and volatile monetary policy.

    If there were some outburst of inflation in the future, the Fed would have to increase the rate it pays on deposits significantly to contain it. However, it can’t adjust the rate it receives on assets it’s bought already. This could lead to a deeply bankrupt Fed, and/or significant volatility in borrowing rates.

    Issuing CD’s would allow the Fed to match their duration risk on the (garbage) assets they hold, placing it instead in the hands of a private investor, probably to be bailed out on a future date.

    They floated this in December, and I was strongly in support then. I thought it died on the vine. I’m very glad to see the Fed returning to this strategy.

  10. doc holiday ♥'s Ben and Tim

    Yields crashing

    Also see: U.S. commercial real estate — valued at about $6.5 trillion — is financed by debt of about $3.1 trillion, according to the Real Estate Roundtable. The delinquency rate on $700 billion worth of commercial loans has soared since September, and some are now concerned that the impact on the financial sector could be significant…

  11. doc holiday ♥'s Ben and Tim

    Yields crashing

    Also see: U.S. commercial real estate — valued at about $6.5 trillion — is financed by debt of about $3.1 trillion, according to the Real Estate Roundtable. The delinquency rate on $700 billion worth of commercial loans has soared since September, and some are now concerned that the impact on the financial sector could be significant…

  12. Anonymous

    Interbank lending rates for euros fell and closely-watched
    spreads, a measure of market stress, tightened a bit ahead of
    next week’s European Central Bank policy meeting which some
    analysts say could yield further liquidity-boosting measures.
    The yield on U.S. 1-month Treasury bills briefly slipped
    below zero on Thursday, as investors looked for places to park
    cash near quarter-end.
    One-month T-bills, considered a cash equivalent,
    yielded minus 0.015 percent in early trading, down from
    Wednesday’s close of plus 0.046 percent, TradeWeb said.
    The one-month bill yield last turned negative in
    mid-December ahead of year-end.
    “It’s just a reflection of a lot of cash out there. A lot
    of cash is hanging out in these Treasury only money market
    funds,” said Derrick Wulf, portfolio manager at Dwight Asset
    Management Co in Burlington, Vermont.

  13. Anonymous

    Sanders Blocks Vote to Confirm Gensler as CFTC Chair

    U.S. Senator Bernie Sanders said he is blocking a Senate vote on the nomination of Gary Gensler to be chairman of the Commodity Futures Trading Commission because of Gensler’s past support for deregulation.

    Sanders, a Vermont independent, said today in an e-mailed statement that Gensler had worked to deregulate electronic energy trading and exempt from regulation credit default swaps, which Sanders blamed for the downfall of American International Group Inc.

    “At this moment in our history, we need an independent leader who will help create a new culture in the financial marketplace and move us away from the greed, recklessness and illegal behavior which has caused so much harm to our economy,” Sanders said. He usually votes with the Democratic majority.

  14. Anonymous

    Timmy wants the Fed to have lower borrowing costs, so that AIG, et al XMAS bonuses will be easier for tax payers to pay for>>

    While this will lower the cost of borrowing for the United States government, economists worry that a widespread hunkering-down could have broader implications that could slow an economic recovery. If investors remain reluctant to put money into stocks and corporate bonds, that could choke off funds that businesses need to keep financing their day-to-day operations.

    Investors accepted the zero percent rate in the government’s auction Tuesday of $30 billion worth of short-term securities that mature in four weeks. Demand was so great even for no return that the government could have sold four times as much.

    In addition, for a brief moment, investors were willing to take a small loss for holding another ultra-safe security, the already-issued three-month Treasury bill.

    http://www.nytimes.com/2008/12/10/business/10markets.html?hp

  15. MyLessThanPrimeBeef

    I usually skip anything more than 2 paragraphs. I was right because just look at what I found:

    quote

    “…that is, a commitment to pursue the monetary policy desired by the US Treasury, not the monetary policy deemed most appropriate by the Fed.”

    end of quote

    Now, that’s interesting…’not the monetary policy deemed most appropriate by the Fed.’ – is that the ultra-low interest rate policy pursued by Greenspan in recent years, or the one that led to the dot com bubble or some other one?

  16. Anonymous

    The lawyers listed below helped Geithner design his PPIP auction plan, which may involve unlawful activity by the Fed and FDIC (ultra vires for the Fed Member Banks and unconstitutional for the FDIC).

    The lawyers below are all NY lawyers. People should ask Cuomo to investigate to see if Geithner’s plan involves illegal activity, and if so, these lawyers violated NY’s ethics rules in helping Geithner design and execute his plan. Or giving opinions that his plan is legal. If they violated NY’s legal rules of ethics, Cuomo could bring charges and have them sanctioned or worse.

    Lee Meyerson
    Barrie Covit
    David Eisenberg
    Brian Steinhardt
    Marcy Geller
    Catherine Kidd
    Nentcho Nentchev
    Parker Kelsey
    Brian Korchin
    Jennifer Marsh

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