1. The Federal Reserve is not a government institution …

The Federal Reserve is NOT a government institution as many believe. It is a PRIVATE organization owned and operated by its member banks for the purposes of insuring the profitability and welfare of its shareholders. That the Fed has a Congressional Charter to serve as the Nation’s Central Banker does not supersede the  Fed’s duties to its owners. Even their name, “Federal Reserve” implies a relationship with the government which is non-existent.

2.  The Federal Reserve is not transparent or accountable to the Administration nor the Congress …

The Federal Reserve is a power unto itself. There is no Federal Reserve oversight committee and most Congressional and Administration activities are “consultative” in nature.

3.  The Federal Reserve has failed its basic mission of preventing boom/bust cycles  …

The primary reason for the creation of the Federal Reserve was to eliminate the “boom and bust” cycles which resulted in severe national depressions. Their other stated goals of regulating inflation, enhancing economic growth and stimulating employment are all secondary to their prime mission of acting as the nation’s central bank.

Many can argue that the Federal Reserve has violated its basic mission and is the proximate cause for the last major boom/bust cycles with its money policy that favors the large financial institutions and not the American people. Arguments that the abnormally low interest rates put in place by Fed Chairman Alan Greenspan to assist in the recovery of the .dot com recession led to the current crisis in the mortgage meltdown.

4. The Federal Reserve has failed to be an adequate regulator, especially in the areas of controlling systemic risks …

There is no doubt in anyone’s mind that the Fed did not recognize or attempt to control the looming systemic risks of the major financial institutions. The Fed did not exhibit any interest in the derivatives market nor did they attempt to examine how derivatives were used to buffalo the regulators in a post-ENRON era. They also took little or no interest in the ratings agencies who, encouraged by those financial institutions which paid them for their ratings advice, rated junk bonds as triple-A investment grade securities and this spread the contagion to pension funds and other pools of investor’s hard-earned money. 

5.  The idea of the Federal Reserve being a regulator of Financial Institutions or as a safeguard of consumer affairs is a violation of the fundamental principles of good control and governance.

Simply stated, the governed can not govern themselves, the regulated cannot regulate themselves. Just as it is a major control violation for the same person to handle the money in the bank and then attest to the accuracy of the count, a similar case can be made for a non-government institution owned and operated by its member banks for regulating their own activities without some form of independent and external oversight. The fact is that the Federal Reserve is not an “audited” financial institution and its activities are opaque to the government and the people of the United States. Of course, the Fed argues that they cannot fulfill their sensitive mission as the nation’s banker if they were open and transparent. Which I find to be a specious argument because I am hard-pressed to see where Federal Reserve policies negatively impacts those financial institutions that own and operate the Federal Reserve.

6.  The monetary policy of the Federal Reserve, based on the fractional banking system, guarantees that the value of money is automatically inflated as it is generated …

It has been a long time since our money supply has been backed with a tangible asset such as gold. In fact, banks are only required to maintain reserves of approximately ten percent of the money that is being circulated – so we have an inherent inflation factor of 90% before a single dollar starts its circuitous route around our economy.

Did Ben Bernanke shade the truth when he testified to Congress about the Fed’s capabilities and effectiveness? Here we will report and let you decide …

In a speech before the House Committee on Financial Services, Bernanke testified on the Federal Reserve’s role in bank supervision. So with the benefit of 20-20 hindsight, do the following statement ring somewhat hollow?

The Federal Reserve's involvement in regulation and supervision confers two broad sets of benefits to the country. First, because of its wide range of expertise, the Federal Reserve is uniquely suited to supervise large, complex financial organizations and to address both safety and soundness risks and risks to the stability of the financial system as a whole. Second, the Federal Reserve's participation in the oversight of banks of all sizes significantly improves its ability to carry out its central banking functions, including making monetary policy, lending through the discount window, and fostering financial stability.

The first statement appears to be demonstrably false as the Federal Reserve did not see the accumulating systemic risk at the major financial institutions. And the second statement rings hollow as the Federal Reserve’s monetary policy is what set the stage for the crisis and the Fed’s solution was to pump billions of dollars into the large financial institutions which did little or nothing to foster financial stability on main street. 

“Promoting the safety and soundness of individual banking organizations requires the traditional skills of bank supervisors, such as expertise in examinations of risk-management practices; the Federal Reserve has developed such expertise in its long experience supervising banks of all sizes, including community banks and regional banks.”

Citibank was a large bank, thought by many to be on the brink of insolvency. Washington Mutual was a large bank, which finally imploded. So one may ask; where was the Federal Reserve and their examination of risk-management practices?

“No other agency can, or is likely to be able to, replicate the breadth and depth of relevant expertise that the Federal Reserve brings to the supervision of large, complex banking organizations and the identification and analysis of systemic risks.”

It appears to me that the Federal Deposit Insurance Corporation (FDIC) with its CAMELS ( Capital adequacy, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risk) rating system is more than adequate to supervise large and small financial institutions. Again, if the Fed had this great expertise, why are our financial institutions struggling – needing special accounting rules to produce the appearance of profits – and our economy is in the tank?

“We have also been taking the lead in addressing flawed compensation practices by issuing proposed guidance to help ensure that compensation structures at banking organizations provide appropriate incentives without encouraging excessive risk-taking.”

Let me see if I understand the situation correctly. The Federal Reserve’s monetary policy provided billions of dollars at little or no cost to financial institutions which then used that money to embark on a spending spree – with little or no restrain because the total institutional risk of success seemingly outweighed the risk of individual project failure. Prudent underwriting criteria for loans was almost non-existent because financial institutions did not need to prioritize their invested capital into the best investments; as they would have normally done had the cost of capital been more expensive. But through the Federal Reserve’s easy money policy, the financial institutions thought they could bet on everything in sight. And now the Fed wants to exert control over those who earned a significant amount of money playing the Fed’s easy money game?

“Less formally, but equally important, since 2005 the Federal Reserve has been leading cooperative efforts by market participants and regulators to strengthen the infrastructure of a number of key markets, including the market for securities repurchase agreements and the markets for credit derivatives and other over-the-counter derivative instruments.”

Here I must call bullshit! By less formally, I would think Bernanke meant nonexistent. There was no indication the Federal Reserve or any other regulatory agency had supervisory oversight of the derivatives marketplace and that, even today, there is no oversight over repurchase agreements, derivatives, the derivative’s marketplace and the “dark pools” where securities and derivatives may be traded electronically among counterparties without any market recordation or notice.

It was the use of derivative products which caused much of the growing risk to be hidden from regulators in “off balance sheet accounts.” In one case, a very large financial institution had leveraged its portfolio in such a manner that a relatively mild 5% market downturn exceeded all of the institution’s equity and rendered the institution technically insolvent. Had it not been for the Administration’s political involvement and the availability of billions in taxpayer funds, this signature institution would be as dead as Lehman Brothers.

Admitting the failure of their previous system?

“To improve both our consolidated supervision and our ability to identify potential risks to the financial system, we have made substantial changes to our supervisory framework. So that we can better understand linkages among firms and markets that have the potential to undermine the stability of the financial system, we have adopted a more explicitly multidisciplinary approach, making use of the Federal Reserve's broad expertise in economics, financial markets, payment systems, and bank supervision to which I alluded earlier.

Yada, Yada, Yada. Same old. Same old. Nothing new here except “we have these new systems and maybe they will work this time?”

“Many of these changes draw on the successful experience of the Supervisory Capital Assessment Program (SCAP), also known as the banking stress test, which the Federal Reserve led last year.”

Many economists and others believe that the stress tests were unrealistic and highly manipulated to produce pre-ordained results. “A major problem with the ‘stress test’ is it depends on modeling and it’s the precise practice responsible for much of this economic and financial mess. It’s extraordinary that so many people believe that the Fed and Treasury, after missing the financial disaster, housing debacle, recession and derivative implosion, can now extrapolate economic conditions and resultant financial affects from its models. How did all that rocket-science modeling for subprime defaults and securitization workout? Yet many people already forget or ignore this reality. <Source>

“In summary, the Federal Reserve's wide range of expertise makes it uniquely suited to supervise large, complex financial institutions and to help identify risks to the financial system as a whole. Moreover, the insights provided by our role in supervising a range of banks, including community banks, significantly increases our effectiveness in making monetary policy and fostering financial stability. While we await enactment of comprehensive financial reform legislation, we have undertaken an intensive self-examination of our regulatory and supervisory performance. We are strengthening regulation and overhauling our supervisory framework to improve consolidated supervision as well as our ability to identify potential threats to the stability of the financial system. And we are taking steps to strengthen the oversight and effectiveness of our supervisory activities.”

Bottom line …

The Fed’s “easy money” monetary policy was the proximate cause of the mortgage meltdown and their lack of real supervision over financial institutions led to these institutions acting egregiously and putting the entire United States economy at risk.

How we can allow a PRIVATE institution, owned and operated by the MAJOR FINANCIAL INSTITUTIONS, regulate themselves is beyond the “best practices” of a separation of control between the regulators and those that they regulate.

After all, didn’t the Fed allow the large investment banks to covert themselves into depository institutions so they could access funds through the Fed? An after-the-fact decision that did much to help these firms avoid insolvency and retain their billion dollar bonus structure. All using the taxpayer’s funds.

Didn’t the Fed also conspire with the Treasury Department to insure that AIG was bailed out with taxpayer money – and that AIG’s debts to Goldman Sachs and a few other large institutions were paid off at 100-cents on the dollar; especially when such debt was highly suspect and worth far less. Doesn’t sound like a prudent move to me? Maybe to the top men in the Fed and the Government who came from Goldman Sachs?

My suggestions is that we debate the usefulness of the Federal Reserve and its governance policies before  extending any more power to this private institution.

-- steve

Chairman Ben S. Bernanke ,  The Federal Reserve's role in bank supervision before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C. (March 17, 2010)

My Way News - Bernanke to wage fresh battle for Fed powers