Part II of our book review of Frederick Sheehan’s Panderer to Power

 

Frederick Sheehan’s excellent 2010 book Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession provides us a window into the sources of the worst financial and economic crisis since the Great Depression.

In part I of this two-part review of Sheehan’s valuable book, we discussed Sheehan’s takeaways from Greenspan’s career before becoming Chairman of the Federal Reserve Board of Governors.

In turn, Sheehan’s review of Greenspan’s nearly twenty years with the Fed gets underway with the Senate confirmation hearing in 1987, after Greenspan’s nomination as Fed Chairman by President Ronald Reagan.  Sheehan notes with some approval the questioning of Senator William Proxmire of Wisconsin, then the chairman of the Senate Banking Committee.  Sheehan praises Proxmire’s willingness to critically examine Greenspan’s forecasting record and his apparent enthusiasm for serving the agenda of large banks.  Greenspan was a director of J.P. Morgan at the time of his appointment, which Proxmire noted along with Greenspan’s lobbying activity as a signal his expertise in banking issues might be more attentive to some interests than others. Read more È

Book Review — Frederick J. Sheehan’s Panderer to Power

Written on the heels of the worst financial and economic crisis since the Great Depression, Frederick Sheehan’s critical biography, Panderer to Power:  The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (2010) provides us with good lessons for the future.

Some perspective can be had from the fantasy classic Lord of the Rings.  Frodo, the hobbit, is on his quest to reach Mount Doom and destroy the Ring of Power.  Having made it substantially through his mission, but weighed by fatigue and fear for what lies ahead should he continue, Frodo asks Gandalf, a wise and powerful wizard, to take the Ring from him and complete the quest.  Gandalf says “No.�

“With that power I would have power too great and terrible. And over me the Ring would gain a power still greater and more deadly. … Do not tempt me! … Yet the way of the Ring to my heart is by pity, pity for weakness and the desire of strength to do good.�

Well, why did Alan Greenspan take the Ring?  Did he just take it when offered, or did he pursue it?  Greenspan certainly ended up in a powerful position, as Chairman of the Board of Governors of the Federal Reserve System – heading our nation’s central bank.  The Fed conducts monetary policy, regulates and supervises banks, serves as a ‘lender of last resort,’ and provides critical payment services for the financial system.  These responsibilities are, well, significant.  Consider monetary policy, where we have a law directing a committee of 12 people at the Fed to control the aggregate amount of money and credit used by over 300 million other people.

Coming on the heels of the worst financial and economic crisis since the Great Depression, Panderer to Power provides a valuable, critical biography.  Alan Greenspan led an institution that advertised its ability to stabilize the financial system – both before and after our recent financial meltdown.  Biography is a form of history, and as Santayana said, “Those who cannot remember the past are doomed to repeat it.â€�  In light of recent years, Sheehan’s biography helps us understand and remember the past, and underscores critical things to watch for in the future. Read more È

The Law Checks Tyranny, but Law can also become a Tool of Tyranny

When you and I write checks, we tend to pay up if the check goes through despite an insufficient balance.  In 2008, the Federal Deposit Insurance Corporation released a study of overdraft fees charged to bank consumers.  This study found that overdraft fees averaged close to $27, which amounted to a huge effective interest rate on the credit extended when compared to the amount overdrawn (one estimate drawn from this study called it over 3000%).   And a more recent study, released in early 2011 from the Pew Charitable Trusts, found that the average overdraft fee came to $35, with total overdraft fee revenue for banks of $39 billion, up from $20 billion in 2000.

You and I use banks when we pay each other money.  Banks pay each other money, too.  They use private and public ‘wholesale’ or interbank payment systems.  This is a dry but fascinating area of research, given the public policy and risk management issues and the large dollar amounts involved. 

Many people immediately associate the Fed with monetary policy, and a smaller subset of the population understands that the central bank also performs a ‘lender of last result function’ along with supervisory and regulatory roles.  But the Fed’s payment system responsibilities are another leg of the stool, and an important one.  For example, the Federal Reserve’s “Fedwire� wire transfer system moves over one trillion dollars every day among banks with access to it.

The Federal Reserve frequently refers to Fedwire as an efficient payment system.  It is certainly popular, and ‘efficient’ from the point of view of the users, but whether it is efficient when it comes to the general welfare is another matter.  In turn, the Federal Reserve’s pricing of this service raises some questions about the meaning of the rule of law. Read more È

Beating a Dead Horse?

Some recent and not-so-recent news items help reinforce the arguments for broader audits of the Federal Reserve.

The Government Accountability Office recently issued two special audit reports relating to the Fed’s activities leading up to and amidst the recent financial and economic crisis.  The reports from those audits outlined the breathtaking scope of the Fed’s bailout (“rescue�?), and also described some of the conflicts of interest arising within the Fed while pursuing those efforts.  But these audits were constrained by the law that required them (Dodd-Frank).

A congressional effort remains underway to broaden the scope and deepen the authority of Congressional oversight of the Fed.  This effort is resisted by defenders within and attached to the Fed, with some of their most important arguments rooted in concern that the Fed’s operations should retain their ‘independence’ from murky political forces.

Three interesting but little-discussed topics related to Fed independence matter for the effort to develop a more strenuous audit.  They include a recent scolding of a large accounting firm, a curious Fed income statement line item, and some older information from visitor logs.

Peek-A-Boo!

When faced with demands for audits, the Fed and the public frequently have to deal with shrill but sometimes-uninformed complaints that “the Fed isn’t audited.�  The Federal Reserve Banks have internal auditors, and the Reserve Banks are also overseen by the Federal Reserve Board of Governors, a government agency.  The Federal Reserve Banks produce financial statements, and those financial statements are audited by independent accounting firms.  And the Congress has directed the Government Accountability Office (GAO) to conduct special Fed audits in the past.  The Fed frequently points to these facts in its defense.

But existing audit mechanisms could still be inadequate, particularly in light of special issues relating to the financial crisis, such as the prices paid for risky securities that the Fed has purchased in its open market operations in massive quantities recent years.  The law currently puts monetary policy out-of-bounds for GAO audits, for example, and the GAO was so constrained in the most recent audit on this score as well.

And several weeks ago, a news item arose that undermined one of the defenses that the Fed uses to deflect demands for more forceful Congressional oversight and auditing.

The Public Company Accounting Oversight Board (the PCAOB, sometimes referred to as PeekABoo) was created by law in 2002 in response to the Enron and related scandals.  The PCAOB is directed to oversee the work of public accounting firms.  The PCAOB issues standards, examines auditors, and pursues enforcement actions.  In mid-October, the PCAOB released a previously-private portion of an inspection report of Deloitte Touche LLP, one of the largest accounting firms in the world – and the firm that audits the Federal Reserve Banks.  The release of this previously-private portion of its inspection report indicated that the PCAOB found insufficient progress at Deloitte in addressing issues for which it was cited in previous years. Read more È

“Beyond a certain limit, military spending constitutes the classic example of parasitic growth.�- Thomas E. Woods, JR.

Thomas E. Woods, Jr.; Rollback:  Repealing Big Government Before the Coming Fiscal Collapse; Regnery Publishing, Inc. (2011)

In Rollback, Thomas Woods provides a thoughtful, clearly written wake-up call.  The breadth of the topic is a bit ambitious, particularly for such a portable read, but Woods provides numerous, wide-ranging examples that will lead readers to reconsider some of their assumptions and expectations.  At times, one might be left a bit confused whether Woods thinks government fiscal collapse is inevitable, or if we still have time to forestall that collapse by ‘repealing big government.’  Either way, however, he leaves no doubt he believes we have large-scale upheaval ahead of us, and that the architecture of much of our federal as well as state government faces a forced and forceful diet. 

Woods is a fellow at the Ludwig von Mises Institute.  The Mises Institute was founded in 1982 by Lew Rockwell, former chief of staff for Rep. Ron Paul of Texas.  The Institute has been a center for academic scholars dedicated to the principles of the “Austrian School� of economics as well as classical liberalism more generally.  The Austrian school is so named due to the influence and collaboration of founding members like Friedrich Hayek, Ludwig von Mises, and Carl Menger.  In the United States, Murray Rothbard became one of the leading Austrian voices, which rejected much of the mathematical and statistical foundations of mainstream economics and their application in government economic programs.  The Austrian school stands out for its dedication to free markets and a sharply curtailed role for government in society, and Woods’s Rollback clearly reflects this perspective.

Woods opens Rollback with two neat quotes, including a long running truth from a Roman senator and historian named Tacitus – “The more corrupt the state, the more numerous the laws.� This idea is fleshed out most explicitly in Rollback’s Chapter 6, “The Myth of Good Government,� where Woods looks carefully at the asserted justifications and politically practical sources of demand for a variety of government programs and extensive regulatory practices.  One common thread to those examples is the notion of regulatory capture, where regulation is sought out and developed by the industries being regulated, at the expense of consumers and the common good.

But the fiscal challenges we face arise from a broader set of political influences, including general public laziness and acquiescence in programs based, in Woods’ eyes, on fiscally unsustainable promises.  He takes a closer look at Medicare and Social Security, and depicts demographic icebergs likely to sink the ship. 

Some fun facts from Rollback’s opening chapter include:

A May 2010 poll found that an incredible 85% of graduating college students planned to move back in with their parents after graduation, facing an average of $23,000 in debt before they even start working.

Many states are ‘going bust;’ seven states likely to see their pension systems fail by 2020, and thirteen more by 2025.

Dozens of cities are contemplating bankruptcy.

Washington D.C. has seen demand for new homes rise faster than another other large American city, and it also has the highest median household income of any of the 25 largest metropolitan areas.

This last item is related to Wood’s opening quote about ‘the more corrupt the state, the more numerous its laws.’  Included along with the 50 states, Washington D.C. has by far the highest income per capita, and it also has by far the largest numbers of lawyers per capita.  When you want to get cynical, one way to think about DC is as a factory full of lawyers and lobbyists, who make laws and programs enriching their clients and themselves at the expense of the rest of us.

In Chapter 2, Woods turns to Barack Obama and the “Change We Can Believe In,� finding not much change nor little to believe in, particularly in the new Administration’s health care programs.  The chapter’s strongest and most interesting elements, however, deal with the stimulus programs for the weak economy, their pork-barrel origins, and their unseen costs that can actually retard recovery. 

From there, Woods broadens his perspective to a general review of the role of government in economic crisis, with particular reference to the origins and solutions developed for our Great Recession in recent years.  Woods provides a careful review of housing market finance and the consequences of government programs like Fannie Mae and Freddie Mac, and their interplay with monetary policy of the Federal Reserve. 

Woods and others have strong words, in hindsight, for what they assert were artificially low interest rates arising from Fed monetary policy in 2002-2006 as seeding the recent housing crisis.  This perspective may be a little too easy, in hindsight, and it can also deflect attention from other worthy sources of investigation into regulator behavior, including the Fed’s outsourcing of capital and other financial regulations to the anointed set of credit rating agencies.  This proved a critical point of failure, Fed advertising that it promotes financial stability to the contrary.  But to his credit, Woods at least notes the credit rating interaction with capital regulation problem.  And those that think the effective repeal of the Glass-Steagall separation of commercial and investment banking in the Gramm-Leach-Bliley Act of 1999 was a central element of our latest meltdown would do well to look at Woods’ argument here.  It wasn’t the repeal of Glass-Steagall, for example, that allowed banks to invest so heavily in well-rated but disastrous mortgage-backed securities.  They were allowed to do so before the Glass-Steagall repeal, as well. 

Woods has harsh words for the financial regulators and their claims to expertise and foresight before our latest crisis.  In turn, more and better regulation, the argument goes, is not the solution for our financial system down the road.  Fewer public guarantees and government programs could be a better route.  Along these lines, Woods cites economist and historian Robert Higgs, who has said of the regulators: Read more È

The GAO Fed Audit(s):  Some Missing Links?

The Dodd-Frank financial reform legislation passed in 2010 directed the Government Accountability Office (GAO) to conduct two audits of Federal Reserve operations.  The GAO issued a report in July on the first audit, which dealt with the Federal Reserve’s emergency lending facilities developed in the 2007-2010 financial crisis.  The second audit includes a broader examination of Federal Reserve Bank governance practices, and the GAO is expected to issue this report in October.

In calling for the GAO to audit the Fed’s emergency lending facilities, Dodd-Frank included provisions directing the GAO to assess, in part, ‘the effectiveness of the security and collateral policies established for the facility in mitigating risk to the relevant Federal Reserve bank and taxpayers,’ and ‘whether there were conflicts of interest with respect to the manner in which such facility was established or operated.’  The GAO produced a long and thoroughly-detailed report discussing these and other elements, but some questions remain.  The GAO’s report on its first audit is available here. 

Three topics relating to these two directives for GAO audits that could have benefited from more complete discussion include the identity of the borrowers under the Fed’s emergency lending programs, the role of credit ratings in the security and collateral policies for those programs, and how the Fed’s previous reliance on credit ratings and the Fed’s role in interbank payment systems mattered for the conflict of interest question.

Who Got the Funding? 

On pages 131-133 of their report, the GAO provided two tables listing the largest borrowing institutions under the emergency programs.  They are ranked in the first table by the total borrowed amount irrespective of maturity length, and in the second table adjusting for the term of the borrowing. Some loans were for relatively brief intervals, even overnight, and others for longer time frames.  Both perspectives are valuable, but the amounts adjusted for borrowing terms tend to do a better job of capturing a comparable read on the simple magnitude of lending.  Total borrowing on this basis totaled $1.1 trillion, according to the GAO’s “Table 9,� while two-thirds of the 15 largest institutions listed were from outside the United States.

On page 132, Table 9, titled “Institutions With the Largest Term-Adjusted Borrowing across Broad-Based Emergency Programs,â€� listed 20 specific ‘institutions,’ while the table continued on to page 133 with one more line item before the totals.  The largest single identified borrower was the Bank of America with $67 billion, ranging down to $15 billion for the smallest identified institution on the list of 20 (Norinchukin Bank, in Japan).   The 21^st line item may well be a matter of importance, however.  It was simply titled ‘All Other Borrowers,’ coming in at a total of $537 billion — over one-half a trillion dollars, and 8 times as much as the largest single institution. 

The table’s overall title referred to ‘Institutions,’ but the Fed’s emergency lending in the crisis was undertaken under Federal Reserve Act provisions that include authority for the Fed to lend to ‘individuals, partnerships, or corporations’ (e.g. nonbanks) in ‘exigent and unusual circumstances.’  Read more È

Fed Governance – Accountable Independence, or a Spider’s Web?

On the heels of the worst financial crisis since the Great Depression, financial reform legislation passed last year directed the Congress’ General Accountability Office (GAO) to examine Fed emergency lending in the crisis, and also to review the Fed’s governance.  Last month, the GAO issued its first report.  This report documented how the Fed extended over $1 trillion of various forms of emergency lending, and politely identified room for improvement in management procedures administering this kind of aid in the future.  The second report, with broader implications for the future of our central bank, will likely be issued in October. 

To help set the stage for that second report, here’s a review of the basic framework for Federal Reserve governance, and a brief introduction to some of the topics relevant for that second report:

The Federal Reserve System, “the Fed,� has a lot of moving, interconnected parts.  The two basic components are the Federal Reserve Board of Governors, and the collection of 12 Federal Reserve Banks.  In turn, the Federal Open Market Committee (FOMC) melds those two parts to make the Fed’s main monetary policymaking body.

The Board of Governors is a government agency, an independent regulatory commission like the SEC.  The Board has 7 seats which are (normally) filled by Presidential appointment, subject to Senate confirmation.  (Two of those seats have been vacant for some time.)  The Board appointments are for 14 year terms, and they are ‘staggered’ (the individual terms do not coincide with one another).  The long, staggered terms are asserted to promote a valuable independence from nearsighted political influence.  By law, one of those seven members is appointed by the President to serve as Chairman.  Ben Bernanke was first appointed to that post in 2006 by George Bush, and he was reappointed to that role by President Obama in 2010. 

The Board of Governors is primarily a policymaking and oversight body, while the day-to-day operations, supervisory and examination roles, and economic reconnaissance are the main province of the 12 Reserve Banks around the country.  The banks are separately chartered government corporations.  The Federal Reserve Act stipulates that they are to be “conducted under the supervision and control of a board of directors.� But Reserve Bank operations are also subject to supervision and regulation from the Board of Governors and Congressional oversight lies behind the scenes as well, at least in theory.  In another melding of authority, Federal Reserve supervisory authority for private financial institutions is rooted in the Board of Governors, but much of that authority is delegated by the Board of Governors to the Reserve banks, with the Board retaining oversight authority after that delegation.

Each of the 12 Reserve Banks is led by a president, whose appointment by the Reserve Banks’ board of directors is subject to the approval of the Board of Governors in Washington.  Each of the 12 Reserve Banks is governed by their own board of directors, with the boards holding 9 members grouped in three classes.  The 3 Class A directors in each Reserve Bank board are elected by member banks in the district, and ‘represent’ those member banks.  The three Class B directors are also elected by member banks, but ‘represent’ the public, at least in theory.  The three Class C directors are appointed by the Federal Reserve Board of Governors, and they ‘represent’ the public as well.  Read more È

The Audit of Federal Reserve Governance: Wiggle Room for the GAO? 

We’ve recently endured the worst financial and economic crisis since the Great Depression, and for many people, it isn’t over yet.  We’ve had 11 recessions since World War II, and our latest included the largest decline in employment of all of them.  It has also been by far the worst jobs ‘recovery’ despite that fact that it was also the worst recession.  Hard recessions are typically followed by relatively rapid recoveries, but that hasn’t been the case this time.  Total nonfarm payroll employment in the U.S. remains 7 million jobs below where it was at the time the recession started – over 40 months ago. 

During the latest downturn, the national unemployment rate went from about 4.5% to 10%, and remains above 9% at the latest reading.  A recovery has been underway over the last year and a half, led, until recently anyway, by the manufacturing sector.  But the jobs picture has remained very bleak.  Since 1960, we never had a three-year interval where U.S. private sector employment fell at an average annual rate over 1%.  In 2009, that happened for the first time since the Great Depression, and again in 2010.

As the financial crisis was gathering steam in 2008, and as millions of people were losing their jobs, the Federal Reserve lent extraordinarily large amounts of money to large financial institutions.  The assistance was provided to banks as well as other parties not normally able to access central bank credit directly, including American International Group (AIG), one of the largest insurance enterprises in the world.  Loans to nonbanks arose under provisions in Section 13(3) of the Federal Reserve Act that allow the Fed to lend to ‘individuals, partnerships, and corporations,’ e.g., not just banks, in ‘unusual and exigent circumstances.’  The Fed’s emergency lending also included huge loans for foreign financial institutions.  The Fed extended over $1 trillion in emergency credit, at peak levels.  And the Fed’s balance sheet also mushroomed as it embarked on a buying spree of ‘mortgage-backed’ and other securities. Read more È

Halliburton Whistleblower Wins in Court: $970K, Obama: Bin Laden Death Ups Terror Risk for Americans, The Most Dangerous Word in the World, US in ‘�Denial� Over China’s Pacific Plans, The Political Theater & the Debt Ceiling Crisis & More! 

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Israeli President: Syrian Leaders Assad Must Go

Afghanistan: Long-Term Deal with US Conditional

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Read more È

Why Did the GAO Just Audit the Fed?

Some of the shriller Fed critics offer simple but misleading slogans like “The Federal Reserve is a private entity� and “The Fed isn’t audited.�  The truth is more complicated, and the historical background matters for citizens trying to understand why, how, and how well the recent GAO audit of the Federal Reserve was conducted.

The Federal Reserve was created in the Federal Reserve Act of 1913, a product of compromise among a variety of political forces. Back then, as well as over time, the Fed’s governance has included a variety of interesting features designed, in theory, to promote the independence of monetary and related policies from muddy political forces.  Fed independence is constrained by law, however.  Independence does not mean unaccountability, or freedom from scrutiny by Congress.

The proximate moving force for the creation of the Fed has been called the ‘Panic’ of 1907.  In this episode, increasingly widespread but rational concern about the quality of bank deposits led to bank runs and disruption in lending and payment systems, together with a sharp economic downturn.  The new central bank was designed and advertised to promote banking stability and an ‘elastic currency’ — a money stock that was managed to meet the needs of commerce, and didn’t drive downturns all by itself.

Twenty years later we had the worst banking crisis in our nation’s history, the product of a few forces including Federal Reserve policy itself.  We added a new government agency, the Federal Reserve Board, to ‘govern’ the government-chartered but member-bank ‘owned’ Federal Reserve Banks.  We added a new Federal Deposit Insurance Corporation on top of the Federal Reserve as another means to try to instill and maintain depositor confidence in banks.  We also added a similar Federal Savings and Loan Insurance Corporation for the banks’ sister industry.  In 1970, after a euphemistically-named ‘paperwork crisis,’ a new Securities Investor Protection Corporation was created to stand behind investor accounts at securities firms.

We didn’t stop there, of course, including the development of a variety of government guarantees and entities advertising safer and more liquid investments for housing and related financial markets. Read more È