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The Fed's "Independence" Argument Is False

George Washington's picture




 

The House has passed a bill to audit the Federal Reserve. 79% of the American people support a full audit.

In response, the Fed says that an audit would interfere with its "independence".

However,
the Constitution does not empower a central bank, and Congress - which
created the Federal Reserve in 1913 and which has the power to create
credit and money - certainly has the power to audit, dissolve, or do
whatever it likes with the central bank (including stripping it of the power to create credit).

I have previously pointed out that the the independence argument is a red herring.

And I have previously demonstrated that the Fed has done a terrible job of managing the economy, keeping unemployment low, and regulating banks.

Now,
in an interview this weekend with Der Spiegel, Paul Volcker - while
trying to support the Fed's argument for independence - actually undermines it:

SPIEGEL: Lawmakers on Capitol Hill are thinking about tougher controls over the Federal Reserve.

 

 

Volcker:
I think the loss of independence and authority of the Federal Reserve
would be a very serious matter for the United States. Not just in terms
of monetary policy but in terms of our place in the world. People look
to strong, credible institutions and I think the Federal Reserve has
been such an institution. If that's lost or too hamstrung by
legislation I think we will regret it.

 

SPIEGEL: But is
the Fed still the same kind of institution as during your tenure as
chairman? Or is it now more of a governmental instrument? The Fed is
managing the TARP program and is also buying government bonds.

 

Volcker:
In some sense the Federal Reserve is always an instrument of the
government. It is a government body but it is independent within
government. But you are right in the
sense that part of the concern is that they have involved themselves
quantitatively in entering markets and in that process, you are
supporting some markets and not others. That is an area in which the
Federal Reserve has never wanted to get into and one that most central
banks don't want to get into. If you are going to maintain your
independence you have to avoid that. To intervene in particular sectors
of the market is not the proper role for the central bank over time.
It could be justified only by extreme emergency.

Intervening and supporting some market players (Goldman, AIG, etc.) and not others (Lehman, etc.) is precisely what
Bernanke has been doing. Whatever can be said for the Fed in the past,
picking winners and losers is "not the proper role for the central
bank", in Volcker's words. Without an audit, we will never know which
"winners" were saved and which "losers" were left to die, or why.
Nor do we really currently know which bailouts and other actions were
truly performed under emergency conditions - to stave off catastrophe -
and which were done to help out financial companies for other reasons.

Moreover, Bernanke gave many billions to private foreign banks and foreign central banks (and see this). Has the Fed been picking winners and losers among countries? Among private banks?

As
former Federal Reserve economist William Bergman wrote (he sent me this
by email; it was previously published in article form, but is not
available on the Web):

 

One of the
principal laws governing audits in the Federal Reserve was passed in
1978, the Federal Banking Agency Audit Act. This law established audit
authority in the Comptroller General of the United States, who leads
today’s General Accountability Office (GAO). The GAO conducts audits
and surveys for a wide range of Federal Reserve activities, with over
100 conducted since 1978. Audit authority also resides in the Federal
Reserve Board’s Office of Inspector General, who can audit Board
programs as well as Reserve Bank operations when carrying out functions
delegated by the Board.

The Federal Reserve’s financial
statements are audited every year. The Board of Governor’s financial
statements are audited by an independent auditor selected by the
Board’s Office of Inspector General. The Reserve Banks’ statements are
also subjected to outside audits, conducted by firms retained by the
Board of Governors. These latter audits must have been an interesting
exercise this year, given the massive expansion in Reserve Bank balance
sheets in 2008. In turn, more generally, the Board of Governors
conducts a wide range of reviews of Reserve Bank operations as part of
its mandated oversight authority.

In this brief review of the
Fed audit landscape, it’s worth noting that things haven’t always been
this way. From the early 1930s to the early 1950s, for example, one of
the shoes was on the other foot, as audit teams from the Reserve Banks
examined the Board of Governors books. The GAO was actually precluded
by law, law passed by Congress, from audit responsibility for the Fed,
at least until the 1978 act referred to above. The main lesson here is
that the structure of reporting and audit authority has changed in the
past, and it can change again in the future.

But today, authority for auditing the Fed is in place. So why do so many people think we need an Audit the Fed Act?

Well,
for one thing, the appearance of extensive auditing authority doesn’t
mean audits are effective. Good auditing requires the willingness and
ability of auditors to do their jobs. Some people view the Inspectors
General, generally, and the Federal Reserve Board’s Office of Inspector
General, specifically, as less than effective or independent in
pursuing their mandates. In turn, some people question whether the
Board’s oversight of the Reserve Banks, including the Federal Reserve
Bank of New York, might be less than arms-length. More fundamentally,
from the point of view of the supporters of the recently introduced
legislation, there are a variety of restrictions on the ability of the
GAO to audit the Fed. There are significant exceptions for monetary
policy and transactions with foreign central banks and international
organizations like the Bank for International Settlements and the IMF.
The law proscribes GAO inspections of ‘deliberations, decisions, or
actions on monetary policy,’ for example, as well as ‘transactions made
under the direction of the Federal Open Market Committee.’ The proposed
legislation under H.R. 1207 and S. 604 would remove those exceptions.

Why are the exceptions there in the first place? Well, a
widespread mantra has it that Federal Reserve independence is crucial
in allowing it to effectively pursue the statutory goals of maximum
employment and stable prices.
If we let politicians start
mucking around in that arena too much, Fed leaders and supporters
stress, we aren’t going to see very effective monetary policy. At a
‘town hall’ meeting last weekend, while addressing the audit issue, Fed
Chairman Bernanke said ‘I don’t think people want Congress making
monetary policy.’ But these audit bills don’t call for the Congress to
make monetary policy. They call for broader authority for an
independent audit of the Fed, from the General Accountability Office.
Supporters feel it this authority would allow the Congress to do a
better job of overseeing the performance of an entity to which the
Congress has delegated the authority to ‘coin money, and regulate the
value thereof,’ under Article I of the U.S. Constitution.

How
independent is the Fed, right now, to begin with? The Fed is not an
apolitical beast. It has had politicians working there in formal
leadership positions as well as staffing roles. The Fed’s regulatory
performance matters for the conduct of monetary policy, and the Fed’s
relationships with the banks it regulates and bails out deserve
scrutiny. Recently, we’ve been through a financial calamity, and have
endured the biggest spike in the unemployment rate since World War II.
Investment returns crumbled in 2007 and 2008, and Federal Reserve
monetary and other regulatory policy played a significant role in this
calamity. Looking back a little further, how effective has the
‘independent’ Fed been as source of stable prices? Congress passed the
law first mandating ‘stable prices’ as a goal for Fed monetary policy
in 1977, and the CPI has tripled since then.

The debate over
curtailing the current legal restriction on GAO audits for
‘transactions made under the direction of the Federal Open Market
Committee’ makes for a good case in point. This provision, on the
surface, helps insulate monetary policy from Congressional oversight
and/or second-guessing, promoting independent policymaking. But the FOMC conducts monetary policy under authority delegated by the Congress.
It seems reasonable to allow for some form of stronger inquiry in this
area, especially after the worst financial and economic crisis since
the Great Depression. One facet of a possible future investigation
could deal with individual monetary policy ‘transactions.’ Under the
quantitative easing posture adopted by the Fed in recent years, with a
wider range of financial instruments bought to liquify the banking
system and promote monetary and credit growth, the question arises – at
what price were those instruments bought? Were they ‘market’ prices, or
were they another way to apply public resources to overpay for bad
assets and help large financial firms that got into trouble?

That
may or may not be a valid avenue of inquiry, but it seems like we could
benefit greatly from learning about the broader range of issues that
could be tackled.

Audit the Fed? Sounds good to me.

 

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Tue, 12/15/2009 - 11:52 | 164538 B9K9
B9K9's picture

Zero Hedge has such a well informed reader base that it represents an excellent place in which to educate people as to the true nature of the Fed. First of all, let us dispense with the notion that it acts in the interests of its "owners", the private banks that comprise its nominal control. Secondly, let us deflate the belief that some sort of evil conspiracy was cooked up to create the Fed in the first place.

If we are to win the battle for free-markets, the primary culprit must first be indentified: the US government. Yes, it is they who created this monster and it is they who did it for a very simple reason: to enable the further growth of government via stealth taxation ie inflation. It is a mistake to think Ben is executiving monetary policy on behalf of the individual banks. They are simply (extremely) well paid agents doing the work of the federal gov't.

Murray Rothbard discusses the emergence of government created central banking in this paper:

http://mises.org/money.asp

Here's a key excerpt:

But if government can find ways to
engage in counterfeiting—the creation of new money out of
thin air—it can quickly produce its own money without
taking the trouble to sell services or mine gold. It can then
appropriate resources slyly and almost unnoticed, without
rousing the hostility touched off by taxation.
In fact, counterfeiting
can create in its very victims the blissful illusion of
unparalleled prosperity.

Counterfeiting is evidently but another name for inflation—
both creating new “money” that is not standard gold
or silver, and both functioning similarly. And now we see
why governments are inherently inflationary: because inflation
is a powerful and subtle means for government acquisition
of the public’s resources, a painless and all the more
dangerous form of taxation.

Tue, 12/15/2009 - 09:01 | 164343 Anonymous
Anonymous's picture

yeah the government is more smart then the FED.
Our money will be safe...

ps: I bought a bag of cheezy pufs today and the vending machine didn't give me my change back! I NEED A BAILOUT MISTER CONGRESMAN!

Tue, 12/15/2009 - 07:12 | 164315 gigeze787
gigeze787's picture

On MTP Greenspan attempted to imply that his policies were not influenced by "political short-term considerations." But that is exactly what he did by giving Bush a green light to massive deficit spending and an "ownership society" based on Alt-A and Subprime loans. Greenspan should be in jail...

http://www.msnbc.msn.com/id/34380027/ns/meet_the_press/page/5/

NBC MTP, Sunday, 13 Dec 2009 - transcript (video at link):

MR. GREGORY:  Are you worried about the Fed's independence?

DR. GREENSPAN:  Very much so.

MR. GREGORY:  What do you think the consequences of some of the legislation on Capitol Hill are now?

DR. GREENSPAN:  If, in fact, specifically, they take away the amendment that was passed in 1978 which prohibited the GAO, the General Accounting Office, from auditing monetary policy, if that is removed, I think that will very significantly compromise Federal Reserve independence.  And what you will be getting is a monetary policy more dedicated to political short-term considerations, not to the longer-term considerations which the Federal Reserve Act was specifically constructed to do.

Tue, 12/15/2009 - 06:51 | 164313 agrotera
agrotera's picture

  The independence of the Fed is independence to keep all legislating in their pocket...it is just so evil.

Tue, 12/15/2009 - 04:22 | 164294 Rick64
Rick64's picture

Audit the FED!! No audit defies common sense.

Tue, 12/15/2009 - 04:20 | 164293 Rick64
Rick64's picture

This is the man they called the wizard. I'd rather have a normal joe running things than an economic wizard. I haven't been too impressed with these types. Now the derivitive markets are so complicated its almost impossible to regulate. He was adamantly against the regulation in 1998 when it was only a 25 trillion market. Didn't see any danger there even after LTMC. (which was a hedge fund) that was leveraged 1.25 trillion to 4 billion in capitol. Is this guy lying or is he really that stupid.

Tue, 12/15/2009 - 04:08 | 164285 Rick64
Rick64's picture

Well its easy to critisize, and in the FEDs case really easy. Greenspan gave testimony before the House oversight committee where he admitted that his economic philosophy was wrong. This is after how many years in the Fed and in financial markets and at whose expense did he learn. He believed that banks and financial institutions would protect the investor and shareholder. Are you fucking kidding me? He didnt believe fraud needed to be regulated and the market would take care of itself. Really? where did he get these crazy ideas? Maybe partly from his wife.

Tue, 12/15/2009 - 03:26 | 164276 Anonymous
Anonymous's picture

The mission of any Central Bank is to facilitate commerce and trade through a common means of exchange, or "credit" (vide Adam Smith). Any other purposes are contrary to the needs of the People who avail themselves of such services. The argument that the CB must "conduct monetary policy" is thus clearly fallacious, because it is derived from a false assumption that a "balance" must exist between money and goods. Credit is not money. Credit is a contract based on trust, not a promisory note to pay back, and much less with interest. Indeed, the People can extend an infinite credit to themselves, if they so wish. It is the mutual trust that they have a difficulty with. The "independence" of the CB can thus be asserted under only one premise - that of the holder of trust. If the CB wishes to collect a fee for its services, the so called "interest", then its amount should be determined by the People, and only by the People, in sofar as the CB, by its exclusive charter, is a monopoly exempt from open market competition. Clearly, allowing lower fees to money institutions a.k.a banks, whether "investment" or "commercial", or otherwise, and higher fees to the People, is illegal. Everybody, without exception, must be treated in the same manner. Otherwise, the role of the CB in the society at large is null and void.

Tue, 12/15/2009 - 02:30 | 164240 digalert
digalert's picture

Taking dollar strength, economy, bank regulation and employment alone warrants an F for fail. What was bubble Ben doing in 2007, getting his head polished?

Then the TARP blunder for this Too Free To Continue (TFTC) institution should be enough to pull the rug on the FED. While congress was voting on TARP for one thing, shifty Paulson and bubble Ben already had other plans.

At the very least, "these powers were given way back when" BBBernanke needs a short leash with a choke chain.

Tue, 12/15/2009 - 02:29 | 164239 Anonymous
Anonymous's picture

when is Tiger foreclosing ?

Tue, 12/15/2009 - 01:18 | 164207 Anonymous
Anonymous's picture

If they claim independence is so necessary and and audit to be counter to this need, why do they also claim to be fully audited already?

Mon, 12/14/2009 - 19:51 | 163905 Anonymous
Anonymous's picture

Let us see how many fools think Fed independence has anything at all whatsoever to do with money!

It doesn't.

The reason that the Fed is to not be touched is because it is absolutely without a doubt politically fallible. An organization that seeks ONLY to preserve the rich and acting on their behalf.

Even Ray Charles can see that it is, and has been and seeks to be.

The Red Herring is that the Fed seeks anything at all whatsoever in the best interest of Main Street (with gimmicks and chicanery such as "employment.")

They are a puppet of the rich and have acted on none other than their behalf - nothing less.

Mon, 12/14/2009 - 19:35 | 163888 AnonymousMonetarist
AnonymousMonetarist's picture

The truth is cruel, vicious, mean and ugly and you better know it.

http://anonymousmonetarist.blogspot.com/2009/12/dont-need-to-be-weatherman-to-know_08.html

 

Mon, 12/14/2009 - 19:08 | 163835 Anonymous
Anonymous's picture

The hottest place in hell is reserved for those who remain neutral in times of great moral conflict.

call/ Email your congressman/woman show them your outrage.

What is the FED? Its job is to preserve its wealth against all comers ,including the American voter.

http://www.youtube.com/results?search_query=what+is+the+fed%3F&search_ty...

Mon, 12/14/2009 - 19:07 | 163834 DaveyJones
DaveyJones's picture

"In response, the Fed says that an audit would interfere with its "independence'."

two letters short of the truth

Mon, 12/14/2009 - 18:50 | 163816 Careless Whisper
Careless Whisper's picture

These guys at the Fed have the biggest fcukin' balls in the world. How dare they think that they shouldn't be subject to an audit.

Mon, 12/14/2009 - 19:16 | 163850 drbill
drbill's picture

Tsk tsk. How dare you question our superoirs!!

Mon, 12/14/2009 - 18:47 | 163811 ghostfaceinvestah
ghostfaceinvestah's picture

The Fed should be independent of the Administration, not Congress who abdicated their Constitutional rights to it.

As it is the Fed is independent of Congress, but very much in bed with the Administration (e.g. the Fed bailout of the GSEs by buying their product, allowing the Administration to kick the fate of the GSEs down the road).

This is the exact opposite of how it should be.

Tue, 12/15/2009 - 02:54 | 164256 Gubbmint Cheese
Gubbmint Cheese's picture

Ghost.. loved your comments about the mbs purchases via CR today.. was wondering if you follow the Cdn version of Fannie and Freddie (the CMHC) - I get the feeling we are running our own version up in these parts.

Do you run a blog at all?

 

 

Mon, 12/14/2009 - 19:06 | 163833 Rainman
Rainman's picture

Well, I guess since the Prez does the Chair appointment, the Fed is a creature beholden to the Executive Branch. Congress is the rubber stamper. Maybe it needs to be turned around. That Fed/Treasury linkage reporting to the same boss is a mighty strong combo for reinforcing power plays.

When 2 branches of government are riddled with corruption and/or incompetence , it ain't easy to suggest a reporting structure that would be entirely untainted by politics.

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