FedUpUSA

Archive for December 15th, 2009

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You may have missed it in the mainstream news media, but statistical societal indicators are reading red across the board. Before exposing the root causes of this breakdown, let’s look at some vital statistics and facts:

* The inequality of wealth in the United States is soaring to an unprecedented level. The US already had the highest inequality of wealth in the industrialized world prior to the financial crisis. Since the crisis, which has hit the middle class and poor much harder than the top one percent, the gap between the top one percent and the remaining 99% of the US population has grown to a record high.

* As the stock market went over the 10,000 mark and just surged to a 13-month high, the three big banks that took taxpayer money and benefit the most from the government bailout have just set a new global economic record by issuing $30 billion in annual bonuses this year, “up 60 percent from last year.” Bloomberg reported: “Goldman Sachs, the most profitable securities firm in Wall Street history, had a record profit in the first nine months of this year and set aside $16.7 billion for compensation expenses.” Goldman Sachs is on pace for the best year in the firm’s history, they are also benefiting by only paying 1% in taxes.

* The profits of the economic elite are “now underwritten by taxpayers with $23.7 trillion worth of national wealth.”

As the looting is occurring at the top, the US middle class is just beginning to collapse.

* Workers between the age of 55 – 60, who have worked for 20 – 29 years, have lost an average of 25 percent off their 401k. During the same time period, the wealth of the 400 richest Americans went up by $30 billion, bringing their total combined wealth to $1.57 trillion.

* Home foreclosure filings “hit a record high in the third quarter [of 2009]… They were the worst three months of all time… 937,840 homes received a foreclosure letter” in this three month period. “3.4 million homes are expected to enter foreclosure by year’s end, with some experts estimating that next year will be even worse.”

President Obama has enacted a $75 billion taxpayer funded program that has been a spectacular failure in stemming the foreclosure crisis and has proven to be another massive waste of billions of taxpayer dollars.
LINK HERE

Lily, the official fatcat mascot of LOLFed, won’t go out without a disguise ever since President Obama made that comparison between fat cats and bankers. The Reformed Broker has one of the funniest things I’ve seen in a while, an official letter from The American Fat Cat Society to the President:

In contradistinction between the zaftig feline kind and the objects of the President’s ire, most cats (including fat ones) are patriotic, pragmatic, cunning and blessed with an inherent instinct for survival… [W]e would like to remind the President that batting around balls of yarn did not put the country into $12 trillion dollars in debt…easy money and securitized lending did.

We can look past being called fat but the banker association is, frankly, unmeowable.

The fat cats have demanded an apology – and I think they deserve it, so Lily can take off that wig and fly her fatcat flag with pride again.

The Arab states of the Gulf region have agreed to launch a single currency modelled on the euro, hoping to blaze a trail towards a pan-Arab monetary union swelling to the ancient borders of the Ummayad Caliphate.

“The Gulf monetary union pact has come into effect,” said Kuwait’s finance minister, Mustafa al-Shamali, speaking at a Gulf Co-operation Council (GCC) summit in Kuwait.
The move will give the hyper-rich club of oil exporters a petro-currency of their own, greatly increasing their influence in the global exchange and capital markets and potentially displacing the US dollar as the pricing currency for oil contracts. Between them they amount to regional superpower with a GDP of $1.2 trillion (£739bn), some 40pc of the world’s proven oil reserves, and financial clout equal to that of China.

Saudi Arabia, Kuwait, Bahrain, and Qatar are to launch the first phase next year, creating a Gulf Monetary Council that will evolve quickly into a full-fledged central bank.
The Emirates are staying out for now – irked that the bank will be located in Riyadh at the insistence of Saudi King Abdullah rather than in Abu Dhabi. They are expected join later, along with Oman.
The Gulf states remain divided over the wisdom of anchoring their economies to the US dollar. The Gulf currency – dubbed “Gulfo” – is likely to track a global exchange basket and may ultimately float as a regional reserve currency in its own right. “The US dollar has failed. We need to delink,” said Nahed Taher, chief executive of Bahrain’s Gulf One Investment Bank.
LINK HERE

Senator Bunning sent in a written request to Bernanke following his re-confirmation hearing – and Bernanke has responded.  You can read the entirety of both; I am going to focus this Ticker on one section that I have repeatedly opined upon, as there is apparent clarity here:

Bunning: 28. In response to a question posed by Senator Corker, you stated “On the mortgagebacked securities, we have a longstanding authorization to do that. I do not think there is any legal issue.” Please provide the Fed’s legal analysis on the authority to purchase such securities, particularly those issued by Fannie Mae and Freddie Mac, which are not full faith-and-credit obligations of the United States.

Bernanke: Section 14(b)(2) of the Federal Reserve Act (12 U.S.C. 355) authorizes the Federal Reserve Banks, under the direction of the FOMC, to “buy and sell in the open market any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States.” The Board’s Regulation A (12 CFR 201) has long defined the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Government National Mortgage Association (Ginnie Mae) as agencies of the United States for purposes of this paragraph. All mortgage-backed securities (MBS) acquired by the Federal Reserve in its open market operations are fully guaranteed as to principal and interest by Fannie Mae, Freddie Mac, and Ginnie Mae.

Sorry, that’s not sufficient.

Here’s the relevant link to the CFR section cited:

§ 201.108   Obligations eligible as collateral for advances.

An ADVANCE is a loan – you don’t take collateral against a purchase, you take it against a loan.  Note that this is the TITLE of the section in question.

(a) Section 3(a) of Pub. L. 90–505, approved September 21, 1968, amended the eighth paragraph of section 13 of the Federal Reserve Act (12 U.S.C. 347) to authorize advances thereunder to member banks “secured by such obligations as are eligible for purchase under section 14(b) of this Act.” The relevant part of such paragraph had previously referred only to “notes  *  *   eligible  *  *   for purchase”, which the Board had construed as not including obligations generally regarded as securities. (See 1962 Federal Reserve Bulletin 690, §201.103(d).)

(b) Under section 14(b) direct obligations of, AND obligations fully guaranteed as to principal and interest by, the United States are eligible for purchase by Reserve Banks. Such obligations include certificates issued by the trustees of Penn Central Transportation Co. that are fully guaranteed by the Secretary of Transportation. Under section 14(b) direct obligations of, and obligations fully guaranteed as to principal and interest by, any agency of the United States are also eligible for purchase by Reserve Banks.

That’s correct – The Fed can purchase securities that hold a full-faith-and-credit guarantee on The Credit of The United States.  The operative clause here in the lead sentence, which controls (since there is no clause negating or making the second subservient) is AND.

Following are the principal agency obligations eligible as collateral for advances:

The Fed can LOAN against any of the below instruments – note that it did not say “elegible as collateral for advances or for purchase“:

(1) Federal Intermediate Credit Bank debentures;

(2) Federal Home Loan Bank notes and bonds;

(3) Federal Land Bank bonds;

(4) Bank for Cooperative debentures;

(5) Federal National Mortgage Association notes, debentures and guaranteed certificates of participation;

Fannie

(6) Obligations of or fully guaranteed by the Government National Mortgage Association;

Ginnie

(7) Merchant Marine bonds;

(8) Export-Import Bank notes and guaranteed participation certificates;

(9) Farmers Home Administration insured notes;

(10) Notes fully guaranteed as to principal and interest by the Small Business Administration;

(11) Federal Housing Administration debentures;

FHA direct debt.

(12) District of Columbia Armory Board bonds;

(13) Tennessee Valley Authority bonds and notes;

(14) Bonds and notes of local urban renewal or public housing agencies fully supported as to principal and interest by the full faith and credit of the United States pursuant to section 302 of the Housing Act of 1961 (42 U.S.C. 1421a(c), 1452(c)).

(15) Commodity Credit Corporation certificates of interest in a price-support loan pool.

(16) Federal Home Loan Mortgage Corporation notes, debentures, and guaranteed certificates of participation.

Freddie Mac

(17) U.S. Postal Service obligations.

(18) Participation certificates evidencing undivided interests in purchase contracts entered into by the General Services Administration.

(19) Obligations entered into by the Secretary of Health, Education, and Welfare under the Public Health Service Act, as amended by the Medical Facilities Construction and Modernization Amendments of 1970.

(20) Obligations guaranteed by the Overseas Private Investment Corp., pursuant to the provisions of the Foreign Assistance Act of 1961, as amended.

I remain steadfast in my assertion: An advance is a LOAN, not a purchase.

The above says that any of the above paper is eligible for advances, not purchases (without recourse to the “emergency” authority of 13(3)).  For the paper to also be eligible for purchase it must carry a full faith and credit guarantee binding on the credit of The United States.  The word between the clauses is AND, not OR.  Therefore the section you cited as justification does not apply.

While Bernanke can (and it appears has) twisted this language into allowing unlimited purchases for paper that in fact is exposed to credit risk – an act that is clearly contrary to the intent of both The Federal Reserve Act and the CFR section cited – both the intent and letter is, from my read, rather clear – and directly contrary to what is asserted.

The following section, sub(c) also makes quite clear the intent – that a full faith and credit guarantee by the government of the United States is the intended requirement:

(c) Nothing less than a full guarantee of principal and interest by a Federal agency will make an obligation eligible. For example, mortgage loans insured by the Federal Housing Administration are not eligible since the insurance contract is not equivalent to an unconditional guarantee and does not fully cover interest payable on the loan. Obligations of international institutions, such as the Inter-American Development Bank and the International Bank for Reconstruction and Development, are also not eligible, since such institutions are not agencies of the United States.

Again, you can try to weasel here, but the intent of the CFR is clear – the guarantee required is that of the full faith and credit of The United States.  That is, recourse must be to the sovereign credit and be unconditional. 

This distinction is not “ministerial” and while the language may be tortured, the intent certainly appears clear: instruments purchased by The Federal Reserve must carry the full faith and credit of the United States Government. 

The section Bernanke cited provides an exception for the purpose of advances (loans), not purchases.

For purchases the question is simple:

Is the entity that issues the obligation a Federal Agency as defined at law, and do their various credit instruments carry an irrevocable guarantee as to full payment of both principal and interest?

The fact of the matter is this: The United States “official web site” does not list either Freddie or Fannie as **government agencies**.  Ginnie Mae, however, is listed as an agency.   Indeed, the 1968 Charter Act split Fannie Mae into two parts: Ginnie Mae AS A FEDERAL AGENCY and Fannie Mae as a government-sponsored private corporation.  Freddie was never a federal agency.

The most recent Fannie 10Q and every prospectus makes clear that Fannie and Freddie paper is not carrying a full-faith and credit of The United States as a government agency.  Specifically:

Fannie Mae is a government-sponsored enterprise (“GSE”) that was chartered by Congress in 1938. Fannie Mae has a public mission to support liquidity and stability in the secondary mortgage market, where existing mortgage loans are purchased and sold. We securitize mortgage loans originated by lenders in the primary mortgage market into mortgage-backed securities that we refer to as Fannie Mae MBS, which can then be bought and sold in the secondary mortgage market. We also participate in the secondary mortgage market by purchasing mortgage loans (often referred to as “whole loans”) and mortgage-related securities, including our own Fannie Mae MBS, for our mortgage portfolio. In addition, we make other investments that increase the supply of affordable housing. Under our charter, we may not lend money directly to consumers in the primary mortgage market. Although we are a corporation chartered by the U.S. Congress, and although our conservator is a U.S. government agency and Treasury owns our senior preferred stock and a warrant to purchase our common stock, the U.S. government does not guarantee, directly or indirectly, our securities or other obligations.

An agency relationship – complete with the credit of The United States – only exists if it really exists.  You can’t define it into existence by bald claim where isn’t there, especially when Congress has explicitly declined to do so. 

Fannie Mae is a corporation – NOT AN AGENCY!

The government could have (and still can) cure this deficiency any time it would like.  Indeed, such an action was debated when Fannie and Freddie were taken into conservatorship but that action was specifically rejected as the CBO insisted that such an act would force the government to take these entities onto its balance sheet since the United States Government would then be legally responsible – full faith and credit – for Fannie and Freddie’s obligations.

Treasury desired to be able to limit the government’s exposure to the amount allocated in the “rescue”, that of $200 billion each, or approximately 8% of the total MBS and debt outstanding.  This was judged an acceptable risk, but this explicit limitation on risk once again speaks to the lack of the required backing of the credit of The United States.

The reason for this restriction in Sections 13 and 14 of The Federal Reserve Act is clear – The Fed is forbidden to take credit risk, as it acts without specific appropriation of Congress.  It is therefore required to loan against good collateral and purchase only that which contains a full-faith-and-credit protection traceable back to the United States Federal Government.

Let us contrast this with the guarantee provided by Ginnie Mae on their prospectuses:

GINNIE MAE GUARANTY

The Government National Mortgage Association (“Ginnie Mae”), a wholly-owned corporate instrumentality of the United States of America within HUD, guarantees the timely payment of principal and interest on the Securities. The General Counsel of HUD has provided an opinion to the effect that Ginnie Mae has the authority to guarantee multiclass securities and that Ginnie Mae guaranties will constitute general obligations of the United States, for which the full faith and credit of the United States is pledged.

Ginnie Mae paper clearly complies with the strictures of Section 14 of The Federal Reserve Act.

Fannie and Freddie paper does not.

The Fed has the clear statutory authority to purchase obligations of Ginnie Mae, because Ginnie is a Federal Agency and issues paper with the full faith and credit of The United States.

Fannie and Freddie ARE NOT Federal Agencies and DO NOT issue paper with the required full faith and credit guarantee.  The limited exception cited by Bernanke applies only to the MAKING OF LOANS, not to the outright purchase of securities.

If Congress wishes to authorize The Fed to purchase (not loan against – that The Fed is permitted) Fannie and Freddie paper it must formally designate these entities as having a full-faith-and-credit guarantee with recourse to The United States as general obligations.

Congress, despite multiple opportunities to do so both prior and subsequent to these entities being taken into conservatorship, and prior to The Fed’s purchase of these MBS, has explicitly declined to provide that guarantee.

It was declined for the specific reason that doing so would obligate The Government to back the entirety of their $5 trillion balance sheet (between the two) with full recourse to the general fund. 

I happen to believe, given the near-generation-long record of poor internal controls, accounting restatements and other evidence of both malfeasance and misfeasance Congress was exactly correct to refuse to provide that guarantee.

Absent that guarantee it remains my contention that The Federal Reserve has no authority to buy their paper, irrespective of the form it is in or the torture The Fed applies to the written word.

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

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

Indeed, the whole idea of independence means that the Fed should be shielded from political pressure to artificially pump up the economy with easy money right before elections. Congress never intended Fed “independence” to mean independence from Congressional oversight to ensure that the Fed is acting within its mandate and in the best interests of the country. These are two totally different concepts, and the Fed and its boosters are being disingenuous when they argue that an audit will interfere with independence from pressure to pump up the economy right before elections.

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.

To Congress: Your Loan Has Been Called