naked capitalism

Senator Jim Bunning gave a long, detailed, specific, and very good list of questions to Fed chair Ben Bernanke, and Bunning has posted the resulting Q&A on his website.

I find this a pretty remarkable document. While a certain amount of bureaucratic jousting is to be expected (ie, there is a level of artful dodging that I would accept as legitimate in this context, given that Bunning and Bernanke are at odds on what level of disclosure by the Fed is reasonable), there are many places where Bernanke offers substantive responses, and I find quite a few wanting and misleading, and some look to be untrue.

Because I am on the brink of coming down with something, my concentration is flagging, so I may have missed some other goodies. I hope readers will also look at the underlying document and add their own questions and observations (I will hoist any important additions from comments and add them to the post).

Numbers in the text refer to question numbers from the document. What struck me is:

1. Complete stonewall on broad information request (1). This is unreasonable but predictable. The information it would provide is important to do a proper review of Bernanke’s job performance (which some Senators like Bunning question) but also important forensic work. Understanding what the decision-making was prior to and during the crisis is key to evaluating Bernanke’s performance and to improving performance in general. Post mortems are standard in sports and medicine. Why not here? If there was a real concern re confidentiality, pare down the list and have a law firm or some other independent and trustworthy party read it and perform an assessment, pointing out noteworthy items. There might be items on Bunning’s list one could argue weren’t necessary to meet that goal, but in general, you do need to look at a lot of stuff to understand what went down and why. For stock offerings, one bit of due diligence that was required in my day was for outside counsel to read the board minutes of the issuer. There is certainly a way to have a third party read, assess, and report on the items that are of legitimate public interest.

In terms of post-mortem items, one huge gap (as pointed out by Perry Mehrling of Columbia University) is the lack of explanations and analyses of firms that were bailed out. The Swiss National Bank required UBS to make an extensive investigation of how it screwed up so badly as to need the rescue, and it prepared two versions, one for the consumption of the authorities, a second written so as to be accessible to laypeople and published as a report to shareholders (which meant it is public information). The Swiss clearly believe more disclosure of what went wrong with its worst miscreant is salutary, and beneficial rather than detrimental to confidence. And the report was extensive. Why has there been no such report on AIG, Bear, or the major TARP recipients?

2. More specifically, the later arguments re not disclosing who is using the various facility users is rubbish. The comparison is to use of the discount window, where banks were reluctant to access it because it would make other banks reluctant to do business with them (it would be an admission of weakness and could lead to an inability to fund in the interbank markets). The discount window issue was DURING THE CRISIS. This is now. And presumably just about every firm is sucking off these facilities. The odds that it will have a prejudicial impact are low now (indeed, you might see the reverse phenomenon: anger that institutions that are seen as strong, like Goldman and JP Morgan, as heavy users, which would suggest the system is being gamed and is serving to subsidize bonuses more than help institutions or markets that need support).

3. Get this juicy exchange (17):

When the first nine large banks received the initial 125 billion TARP dollars, Secretary Paulson and you said those nine banks were healthy. Do you now agree with the TARP Inspector General’s finding that Citigroup and Bank of America should not have been considered healthy by you and Secretary Paulson?

On October 14, 2008, the Federal Reserve joined in a press release with Treasury and the FDIC to announce a number of steps to address the financial crisis, including announcing the implementation of the Capital Purchase Program (“CPP”). The first nine banks to receive CPP funds were selected because of their importance to the financial system at large. In fact, the SIGTARP report notes that approximately 75 percent of all assets held by U.S.-owned banks were held by these nine institutions. In addition, these first nine institutions were considered to be viable, though some were financially stronger than others. The press release referred to these nine systemically important institutions as “healthy” to indicate that these institutions were viable and were not receiving government funds because they were in imminent danger of failure.

The Orwellian “banks were healthy” is now revealed to have mean “we thought the banks were not going to drop dead in the next 24 hours”

4. Continued repetition of the “the French wouldn’t let us cram down their banks, it is against their law to settle” as one of the reasons for the need to pay out 100% on the AIG CDS. Repeated again and it is a complete and utter lie (23):

Furthermore, it would not have been appropriate for the Federal Reserve to use its supervisory authority on behalf of AIG (an option the report raises) to obtain concessions from some domestic counterparties in purely commercial transactions in which some of the foreign counterparties would not grant, or were legally barred
from granting, concessions.

The claim was that French banks could not voluntarily agree to a lesser payment (presumably, they’d have to suffer a default or payment as determined through a bankruptcy process). That was reported in Sorkin’s book and even in the SIGTARP report and it looks like propaganda. This from Janet Tavakoli :

After it saved the day by extending the credit line, the FRBNY should never have settled for 100 cents on the dollar. In August 2008, one month prior to the FRBNY providing A.I.G. with an $85 billion credit line to pay collateral to its counterparties, Calyon, a French bank that bought protection from A.I.G. (including on some Goldman originated CDOs) settled a similar $1.875 billion financial guarantee with FGIC UK for only ten cents on the dollar.

Now it is possible that the French regulators, um, misrepresented the situation of their banks to the Fed (the party line is that the Fed called the French regulators and were told that the banks could not accept a haircut under French law. Of course, these deals were probably subject to UK law, did anybody bother checking?). But for the Fed to continue to maintain that the haircuts could not have been made (as opposed to they were operating from misinformation, and then one has to question why they didn’t know better) changes this from an error to a falsehood.

5. Bernanke tries to explain his claim in earlier testimony that the Fed’s supervisory authority aided in its monetary policy decisions (25). It’s vague and unconvincing. If the information gathered by regulatory supervision was all that useful, the Fed could have an arrangement whereby a bank supervisor shares certain types of data with the Fed. But how can the Fed claim with a straight face that it was using G2 from its regulatory role in monetary policy and missed the biggest credit bubble in the history of man?The evidence on the ground is that whatever could have been learned from regulatory supervision was not simply not used, it was affirmatively ignored.

And this strains credulity:

In addition, supervisory expertise in structured finance contributed importantly to the design of the Commercial Paper Funding Facility, the Money Market Investor Funding Facility, and the Term Asset-Backed Securities Loan Facility, all of which have helped to stabilize broader financial markets

They have no “expertise” in structured finance; if they did, they would have recognized, among other things, what a bad idea ABS CDOs were and would have stopped them from existing. And the supervisory types had little or nothing to do with the facilities. Per Economics of Contempt:

What about all those “creative emergency lending facilities” like the PDCF and the CPFF that the Fed implemented, and that Bernanke is always getting so much credit for? Those were in reality designed largely by the NY Fed’s Markets Group (headed at the time by William Dudley, who’s now the NY Fed President), not Bernanke.

Just to be clear, the Markets Group is not in the bank supervision business.

6. The attempts to claim that the price of gold (in response to multiple questions) does not reflect concerns re inflation and the dollar down the road is another howler.

7. The argument in 27 re Fed needing confidentiality to maintain independence is also rubbish. As Martin Mayer has pointed out, the Fed is supposed to be independent of the Executive. It is SUPPOSED to be supervised by Congress!

8. 28 (that the Fed can buy Freddie and Fannie bonds even though they are not full faith and credit obligations) looks like Imperial Fed. I’d love to see their theory tested in court. They take a statutory provision and justify it via their own regulation, ie, interpretation. Yes, this was no doubt a long-established practice, and the markets also long treated Freddie and Fannie bonds as if they were full faith and credit obligations (as many foreign buyers did) but the fact that a lot of people accepted this erroneous assumption does not mean the Fed’s interpretation holds water in a narrow legal sense, which was the focus on this question. If you look at the entire section (which has been amended a zillion times over the years), it does read as if the intent is to limit the Fed’s activities here to the purchase of bona fide government obligations, so the question is not as nit-picking as it might sound.

9. Many answers are complete feints, such as 30 (Bunning asks what activities the Fed might consider prohibiting banks engaging in, keying off a specific Bernanke remark to Senator Gregg), 34 (on whether tax policy distorts financial institution behavior), 69 (on too big to fail and why Bernanke differs with Volcker, Greenspan, and Mervyn King) or so non-specific as to be useless (33 on why the TARP switched from buying toxic investments to making equity injetcions, 44 on what would the Fed do if unemployment stayed high and commodities prices continued to rise). 62 (uses a recent Bernanke statement at an FOMC meeting to argue that it implies the Fed should welcome greater transparency) is a particularly astute question, and is blown off. 63 and 64 (on whether the Fed knew that it was bailing out Eurobanks when it rescued AIG) looks even more carefully worded than the other responses. It reads like an effort to obfuscate, but steer clear of a denial, which suggests they knew bloody well and are not prepared to admit it. The refusal to even acknowledge the question re bonuses (42) is offensive. He won’t even admit it as an issue.

10. 40 Bernanke thinks there is nothing wrong with derivatives, just how they are managed. I’m sorry, CDS are a terrible, terrible product and need to be eliminated, which unfortunately cannot happen quickly. And many complex OTC derivatives need more than just better risk management. Former derivatives salesman and now law professor Frank Partnoy says they need to be regulated like securities (disclosure and fraud standards need to be tougher).

11. On 43 (empirical examples of high inflation and resource slack co-existing in Latin America and therefore being a possible outcome for the US) he just denies the data. He is a complete prisoner of neoclassical economics.

12. 50, He forcefully denies the existence of the PPT. My conspiracy-minded readers will be outraged, or will argue the Fed just does it through winks and nods to dealers (as in answer is technically accurate but substantively untrue).

13. The answer to question 53 (“Do you believe the Fed’s policies are enabling banks to put off recognizing their losses?”) is another canard. In fact, it is the explicit object of policy! Why did the Fed balloon its balance sheet by $1 trillion buying MBS and Treasuries? The excuse was that they were trying to channel credit to particular markets, and whether or not that was the operative reason, the effect, and presumably the intent, was to prop up housing prices via making mortgages super cheap. In addition, there has been considerable regulatory forebearance, particularly on the accounting front.

14. 54 is another bald faced lie, it basically say, “oh we couldn’t rescue Lehman, we lacked the tools”. The Fed could have used the same device it did for Bear, a bad asset vehicle largely guaranteed by the Fed, that is in fact what Barclays wanted, which stood ready to buy Lehman (and did pick up the US brokerage in the end).

15. 55 is another distortion (the Bernanke claims that the Fed is now getting more information about derivatives, which is true, and that it is fully competent to analyze the data, which is another matter). I have readers who are in direct contact with the NY Fed who tell me that the staff recognizes that it lacks the analytical capacity to understand what the data says in terms of systemic risk implications, which is the point of the exercise.

16. on 59, the Fed continues to assert that it will take no losses on its SPVs. That is simply implausible. It is a virtual certainty that the Bear vehicle (Maiden Lane) contained ABS CDO tranches. AAA ABS CDOs are trading either at zero, or 15-20 cents on the dollar for “high grade” ABS CDOs.