On December 6, 2011, Ben Bernanke, Chairman of the Federal Reserve System (the Fed),responded to recent media accusations regarding the Fed's emergency lending during the financial crisis. In attempting to correct "numerous errors and misrepresentations", Mr. Bernanke himself relies on a variety of misleading, if not outright deceptive, tactics and fact-twisting. It's important to set the record straight, which is that the Fed abhors transparency and indeed subsidized to the greatest extent the large banks that it faithfully serves.
Below, I excerpt and comment on the most egregious affronts on truth made by Mr. Bernanke, which he presents as evidence of his claims. All emphasis is mine.
Correction of Recent Press Reports Regarding
Federal Reserve Emergency Lending During the Financial Crisis
Recent press reports contain numerous errors and misrepresentations about Federal Reserve emergency lending during the financial crisis.
First, these articles have made repeated claims that the Federal Reserve conducted "secret" lending that was not disclosed either to the public or the Congress. No lending program was ever kept secret from the Congress or the public. All of the programs were publicly announced when they were initiated, and information about all lending under the programs was publicly released--both on a weekly basis through the Federal Reserve's public balance sheet release and through detailed monthly reports to the Congress, both of which were also posted on the Federal Reserve's website.
This is a common tactic of Mr. Bernanke, whereby he cloaks himself in the after-the-fact limited disclosures provided on the websites of the Fed and the Federal Reserve Banks, often made only after significant arm twisting. Most of the details, when they are released, such as counterparties or program agreements, are done so long after the time when public debate might have increased scrutiny on what now look like suspicious dealings.
For instance, when Bear Stearns failed and most of its operations and portfolio were taken over by JP Morgan Chase (JPM), the Federal Reserve Bank of New York (FRBNY) loaned $28.82 billion to a new corporate entity it helped create called Maiden Lane, in which about $30 billion of the most toxic Bear Stearns assets were placed. The Fed sold the program to Congress and the public as a wind-down facility, yet when details finally began to be dribbled by the Fed and FRBNY over a year later (and only because of substantial Congressional and public pressure), it became apparent that Maiden Lane was being aggressively traded by BlackRock, as asset manager. Indeed, the value of the mortgage backed securities (MBS) portion of the portfolio, a potential profit center in contrast to other distressed assets, such as Red Roof Inn loans, swelled from $11.4 billion as of September 30, 2008 to $19.9 billion as of June 30, 2010.
In addition to the FRBNY loan, JPM had also loaned Maiden Lane $1.15 billion and was first in line to take a loss. Inasmuch as BlackRock was also trading MBS securities on behalf of the Fed as part of its $1.25 trillion MBS purchase program, there are significant potential conflicts of interest that arise. Indeed, the Government Accountability Office (GAO) found numerous conflicts of interest in the way no-bid contracts were awarded by FRBNY during the crisis. Personal research, which will be happily shared should you request, reveals that FRBNY outright lied to the GAO with respect to one of the largest no-bid contracts. In a follow up report,the GAO noted that the Fed did not provide adequate guidance to its Federal Reserve Banks to ensure that emergency program participants were treated equally. Clearly, the Fed was not treating everyone equally and has much to hide.
It is true that, generally, the names of the counterparties and borrowers from the emergency facilities were not immediately disclosed, consistent with general central banking practice. Releasing the names of these institutions in real-time, in the midst of the financial crisis, would have seriously undermined the effectiveness of the emergency lending and the confidence of investors and borrowers. These matters were discussed extensively at the time in the press, and the Chairman and other members of the Board discussed them numerous times in hearings before the Congress.
In point of fact, the Federal Reserve took great care to ensure that Congress was well-informed of the magnitude and manner of its lending. As required by the Emergency Economic Stabilization Act, passed in late 2008, the Federal Reserve reported regularly on the outstanding balances in its Sec. 13(3) lending facilities as well as on collateral (by type and quality) for the loans. Beginning in June 2009, the Federal Reserve went well beyond these legal requirements in the information it made available in its monthly public reports to the Congress, which were also posted on the Federal Reserve's website.
It bears repeating that the Fed is only forthcoming when it faces substantial pressure or when it is outright compelled to because of Congressional or Judicial action. When Mr. Bernanke thumps his chest about the details released on these programs, be assured these disclosures were not his preferred choice.
Moreover, Congress was well informed of the volume of borrowing by large banks. For instance, the monthly reports showed the daily average borrowing during the month in the aggregate for the five largest discount window borrowers, the next five, and the rest. Similar information was also provided for lending at the emergency facilities.
In addition, the issue of counterparty disclosure was well-known to the Congress and was addressed as part of the Dodd-Frank Act. Under provisions of the Sanders Amendment, the names of all counterparties and borrowers from the emergency lending facilities and the Term Auction Facility (TAF) were disclosed on December 1, 2010. Data provided included the names of the borrowers, the date that credit was extended, the interest rate, information about the collateral, and other relevant terms. Similar information is supplied for swap line draws and repayments. Details for each agency MBS purchase included the counterparty to the transaction, the date of the transaction, the amount of the transaction, and the price at which each transaction was conducted. Additional disclosures of discount window borrowers and transactions information were made on March 31, 2011.
As Bloomberg notes in its refutation, without proper detail of all the transactions, you and your colleagues in Congress were indeed in the dark. Also, Mr. Bernanke uses a subtle deception to imply complete disclosure has been made regarding the Fed's MBS transactions, which constitute its largest asset class of purchases. Details released by the Fed (and only because of Congressional mandate) were made only for the period January, 2009 through August, 2009, when actual MBS purchases and sales began in late 2008 and continued through mid-2010, having again restarted recently.
In addition, all such disclosures were made only with respect to the Fed's $1.25 trillion MBS purchase program. Few details of the MBS transactions in the Maiden Lane "wind down" portfolio of Bear Stearns assets have been made. And when they have been disclosed, they are for different windows in time. Accordingly, it is possible (though not possible to prove based on the incomplete public record) that BlackRock was trading both sides to generate profits for Maiden Lane to avoid a $1.15 billion loss by JPM. This by itself suggests the Fed deserves more, not less, scrutiny, the self-serving, deceptive pleas of Mr. Bernanke notwithstanding.
Although the articles do not stress this point, it is important to note that nearly all of the emergency assistance has, in fact, been fully repaid or is on track to be fully repaid. This fact has been verified both by the Board's independent auditors and the Government Accountability Office (GAO).
Importantly, Federal Reserve lending should in no way be compared with government spending. Federal Reserve lending is repaid, with interest, and the Federal Reserve has never suffered a credit loss. As provided in the Dodd-Frank Act, the GAO conducted a review of all of the emergency lending facilities and confirmed in its report on July 21, 2011, that not only were there no material issues with respect to the design, implementation and operation of the facilities, but that all loans to the facilities were fully repaid or expected to be fully repaid.
Mr. Bernanke touts the fact that the emergency lending facilities are (or are on track to be) repaid. With respect to Maiden Lane, that is indeed thanks to the aggressive trading performed by BlackRock, contrary to the Fed's public disclosures made in early to mid 2008 in your chambers. More importantly, in mentioning that the Fed has never suffered a credit loss, Mr. Bernanke evades a more important point--that it will likely take substantial capital losses on many of its purchases. That is, the Fed bought many of the securities in its portfolio above prevailing market prices, which itself is a subsidy for its primary dealers, and it will lose money on a substantial number of these purchases when they mature. This is especially so with its more than $1 trillion portfolio of MBS securities, which lose money when mortgage rates fall (as they have done several times over the last year and a half). More on this in a bit.
Third, the articles make no mention that the emergency loans and other assistance have generated considerable income for the American taxpayers. As reported in the Annual Report of the Board of Governors, alongside the Board's audited financial statements, the emergency lending programs have generated an estimated $20 billion in interest income for the Treasury. Moreover, in 2009 and 2010, the Federal Reserve returned to the taxpayers over $125 billion in excess earnings on its operations, including emergency lending. These amounts have been publicly announced and are reflected in the Office of Management and Budget's financial statements for the government and have been verified by the Federal Reserve's independent outside auditors. The Federal Reserve is on track to return a comparable amount to taxpayers this year as well.
Because of its massive purchase programs and balance sheet expansion, the Fed has indeed remitted $125 billion over the last two years to the US Treasury from the proceeds of interest on its securities (after payment of the Fed's own, largely non-disclosed expenses). If I can hammer one thing home, Congress, that serves your vital interest, it is the following:large payments by the Fed to the Treasury are a temporal anomaly and will not last. In fact, it is more likely that the member banks of the Fed, disproportionately, the larger banks, will end up with this cash instead. Read on, as to why.
After the Fed massively expanded its balance sheet through the creation of reserves (printing digital money), it has attempted to mitigate price inflation by encouraging banks to keep such reserves parked at the Fed. This program, accelerated by you, Congress, in October, 2008, approved the payment of interest on reserves. As long as short term rates are exceptionally low (and Mr. Bernanke said they would be through mid-2013), this is a minor expense. Meanwhile, the Fed is earning higher interest rates on the $2 trillion+ in securities it bought as part of its so-called QE programs. It is the spread between what it earns and what it must pay that allows the Fed to remit funds to the Treasury, and by extension the taxpayers.
When (and not if) short term interest rates rise (and the markets might force this in a violent fashion long before Mr. Bernanke would prefer), the Fed could easily go cash flow (or carry) negative. That is when the cost of paying banks interest on reserves (to reign in price inflation) exceeds the Fed's interest income it receives on the securities it holds. Consider that just under three decades ago, short term rates quickly reached nearly 20%.
In response, the Fed could outright sell assets that it holds, but I urge you to consider what happens when the world's largest holder of Treasury securities switches from being a net buyer to a net seller of Treasurys and what it would do to the United States' long term borrowing rates. Mr. Bernanke believes that he can blissfully guide the Fed to a graceful exit from its $2 trillion+ balance sheet expansion. You might not wish to give him the benefit of the doubt.
This scenario is not lost on the Fed, which is why in March, 2009, its Board of Governors concocted a fraudulent accounting scheme (implemented retroactively to include the year 2008), which allows it to operate with negative income. It also prevents its member banks from having to pony up the difference, which was the case prior to the accounting change. Instead, in this scenario, the interest that the Treasury pays on securities held by the Fed will go to the banks, instead of back to the Treasury.
It's beyond the scope of this response to discuss all the details. However, in brief, the Fed allows a line item on the liability side of its balance sheet (specifically, the one that covers remittances to the US Treasury) to go negative. It creates a deferred asset from a hypothetical amount it will be remitting to the Treasury at some non-specified time in the future.
The heads of anyone with accounting knowledge ought to be spinning right now. For everyone else, it's as though you or I could log into our bank account and increase our balance in any given month in which expenses exceed income, with the promise that we will correspondingly lower our balance the next time we have a surplus.Only, there is no guarantee that you or I would ever again generate a surplus--meaning, we would have printed ourselves money not to be repaid. Similarly, there is not any reason to believe that once the Fed goes cash flow negative that it will ever again generate a surplus.
This creates the absurd scenario that the Fed could end up printing money as a tightening measure to reign in price inflation. Welcome to the grave that Mr. Bernanke continues to dig deeper for us. He assures us there will be nothing but an orderly withdrawal from this unprecedented activity. However, markets have a way of punishing central banker hubris.
Fourth, the articles discuss the lending made to large banks but never note that Federal Reserve lending programs went far beyond such institutions--all in furtherance of supporting the provision of credit to U.S. households and businesses.Literally hundreds of institutions borrowed from the Federal Reserve--not just large banks. The TAF had some 400 borrowers and the discount window some 2,100 borrowers. The TALF made more than 2,000 loans, while the commercial paper funding facility provided direct assistance to some 120 American businesses.
The articles also fail to note that the lending directly helped support American businesses by providing emergency funding so that they could meet weekly payrolls and on-going expenses. The commercial paper funding facility, for example, provided support to businesses as diverse as Harley-Davidson and National Rural Utilities, when the usual market mechanism for their day-
to-day funding completely dried up.
Not surprisingly, not once in Mr. Bernanke's missive does he even allude to the primary cause of the freezing of the very funding markets he takes credit for saving. Namely, his yo-yo manipulation of the money supply, noted by Austrian economist Robert Wenzel at EconomicPolicyJournal.com in real time, just prior to the onset of the crisis. To be sure, this might not be the position of most "mainstream" economists. Yet, if it is their guidance upon which you are relying, consider the article quoted in the prior link by FRBNY's own Simon Potter, Executive Vice President and Director of Economic Research at FRBNY, wherein he candidly admits the failures of mainstream economic forecasts.
While loans in certain programs might be broad-based and cover many industries, it is beyond dispute that the bulk of the loans went to the banks, and to some in particular, in disproportionate amounts.
Skipping ahead, again:
Fifth, the articles misleadingly depict financial institutions receiving liquidity assistance as insolvent and in "deep trouble." During a financial panic, otherwise solvent banks and other financial institutions can be forced to sell assets at fire-sale prices in order to meet the demands of depositors and other sources of funding. Central bank liquidity lending is designed to stem the panic by giving financial institutions a source of financing that permits them to refrain from selling assets during the panic. Again, unmentioned in these articles--but a central point--all discount window loans extended during the crisis were fully repaid with interest, indicating that, with rare exceptions, recipients of these loans generally suffered from temporary liquidity problems rather than being fundamentally insolvent. In the handful of instances when discount window loans were extended to troubled institutions, it was in consultation with the Federal Deposit Insurance Corporation to facilitate a least-cost resolution; in these instances also, the Federal Reserve was fully repaid.
Because of the nature of fractional reserve banking, what constitutes a "solvent" versus an "insolvent" bank, especially in the realm of the too-big-to-fail size is an imprecise, subjective, moving target. Even granting regulator omniscience over events, it is dishonest to assert that one can judge a liquidity versus a solvency problem with the application of 20/20 hindsight when only one option was realized.
For instance, in the maelstrom of the Fall 2008, had the regulators decided to not close Wachovia or WaMu, and had such banks received as much temporary liquidity as the many European banks not subject to those same regulators (such as Belgian bank Dexia and French bank SocGen), who is to say if Wachovia and WaMu might not have emerged "solvent" after months of liquidity injections? It simply displays a lack of imagination for Mr. Bernanke to assert, "well, they didn't fail because we propped them up with liquidity until they could repay the loans, unlike certain other firms that were unilaterally told or allowed to fail based on metrics that are impossible to apply consistently across all firms".
Based on the Fed's own loan disclosures that Mr. Bernanke reluctantly embraced only when faced with the frightening alternative of a full scale audit, the Fed allowed banks to pledge junk-grade collateral for cash at as little as 0.25% over the Fed's Federal Funds target interest rate. Indeed on many days in certain emergency programs, by far the largest asset class pledged as collateral were stocks, including those of bankrupt companies. In other words, the banks with largest trading books had the most assets to pledge to get Fed cash at below market interest rates. This fact, ignored by Mr. Bernanke, disproportionately favored the largest banks that had taken on the largest amount of leverage.
Mr. Bernanke closes with more falsehoods:
Finally, one article incorrectly asserted that banks "reaped an estimated $13 billion of income by taking advantage of the Fed's below-market rates." Most of the Federal Reserve's lending facilities were priced at a penalty over normal market rates so that borrowers had economic incentives to exit the facilities as market conditions normalized, and the rates that the Federal Reserve charged on its lending programs did not provide a subsidy to borrowers.
Note that Mr. Bernanke does not directly challenge the fact that banks received loans at belowprevailing market rates. He makes a temporal shift to say that the Fed loans were made at rates that would pay a penalty under normal conditions. This is irrelevant because it is precisely the ability of those banks chosen to succeed to get loans at below market rates that allowed the rapid and considerable consolidation of the too-big-to fail banks during the crisis period. To deny this was not an outright subsidy to certain borrowers, particularly those with large trading books, is simply a lie.
Being practical, I fear that what will emerge from the populist anti-Fed sentiment might be worse than the present situation. However, this does not mean that the Fed and Mr. Bernanke, in particular, should continue to be given carte blanche to toy with the economy and the lives of billions based on theoretical models that have a history of nothing but failure.
That Mr. Bernanke would feel compelled to respond to Congress in response to a few media articles indicates he is still hiding much, much more than he has been compelled to disclose. It is time to up the ante and mandate a full scale audit of the Federal Reserve System (and not by the GAO or compromised big four).