Reasons Against Auditing the Federal Reserve and Why They're Wrong

The case for a meaningful and recurring audit of the Federal Reserve, because we deserve an honest, transparent government.  The legislative and judicial battles to audit the Fed will go down in history as a textbook example of populism vs. corporatism.

It’s official, Senator Sanders’ financial reform amendment requesting a one-time disclosure of emergency lending by the Fed passed with a 96-0 vote.  Succumbing to pressure, Sanders’ amendment is a gutted version of his bill S.604 The Federal Reserve Sunshine Act.  H.R.1207 The Federal Reserve Transparency Act, introduced by Congressman Ron Paul boasts 320 cosponsors and its recurring audit language passed in the House financial reform bill as the Paul-Grayson amendment.  The two amendments will meet in conference committee negotiations once the senate financial reform bill passes.  

Senator Vitter, an S.604 cosponsor, introduced the Paul-Grayson language as an amendment attempting to reinstate a recurring audit into the senate financial reform, but it was voted down 37-62.

This subject deserves attention, as President Obama, Wall Street, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Tim Geithner have effortlessly lobbied against a meaningful audit for several months through editorials, presence on the hill, etc.

The "Audit the Fed" movement has hardly lacked ammunition to build coalitions between the liberal left and conservative-libertarian right to battle the Fed.  The Fed failed to manage the economy and dismissed concerns of a housing bubble reported within their own FOMC meetings by regional bank presidents in 2004. Those meeting transcripts were released this past month.  FOMC transcripts are withheld from government-public review for five years with the excuse of market stability and political independence to control the debate on policy.

Certainly market stability was not present while the financial system collapsed neither was political independence shown when Fed and Treasury officials coerced our representatives to bailout their member banks lest stock markets collapse and martial law be declared.  Let's address the reasons for denying a recurring audit: political independence, market stability, policy effectiveness, etc.

Political Independence

The opposition argues an audit would strip the central bank's political independence of setting monetary policy, but would an audit interfere with their independence or setting monetary policy?  Jim Rogers, renowned American investor, says no.

"It cannot interfere with their independence at all.  Setting interest rates and looking after what happens in the bond market, and they are supposed to maintain a sound currency.  Why does auditing the fed affect that?  I've heard no explanation from them that has any credibility at all."

Executing an audit requires examining and reporting findings.  There is no dictation involved unless a law is found to be broken, upon which procedures initiate to correct the matter.  No entity of government should be exempted from our democratic form of government and the audits every individual and business in America are subject to. 

Although the cry for independence is heard often, they lack such independence due to the structure of our government and the objectives of monetary policy as expressed by Fed Chairman Bernanke on January 1, 2008 stating:

"With that objective, the FOMC implemented a sequence of rate increases, beginning in mid-2004 and ending in June 2006, at which point the target for the federal funds rate was 5.25 percent--a level that, in the judgment of the Committee, would best promote the policy objectives given to us by the Congress."

The Federal Reserve lacks political independence and their monetary policy is political in nature, as it must compliment fiscal policy and the overall economic policy objectives while accomplishing their dual mandate of maximum sustainable employment and price stability.  Which begs the question; do they ever accomplish their dual mandate?

In his own words Fed Chairman Bernanke confirms this complimentary relationship between policies.  On January 17, 2008 he stated:

"A number of analysts have raised the possibility that fiscal policy actions might usefully complement monetary policy in supporting economic growth over the next year or so.  I agree that fiscal action could be helpful in principle, as fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone.  But the design and implementation of the fiscal program are critically important."

If the design and implementation of fiscal policy are critically important in complimenting monetary policy it would require the Fed engage in the discussion to assure the effectiveness of their own monetary policy while being exposed to political pressure.  However, the argument for an audit can be more direct and simple.  As renowned economist Murray Rothbard put it:

"These are government agencies and operations...to say that government should be "independent of politics"...government can only be accountable to the public and to its representatives in the legislature."  A government independent of politics is an oligarchy, accountable to no one and would be more suitable for a dictatorship than for an allegedly democratic country.

Market Stability

There’s the argument an audit would reveal which banks accept money at the discount window and if not paid back in a timely manner, would be viewed as weak.  The banks would be reluctant to participate in the discount window, known as the 'stigma problem.'  It should be obvious in the case these institutions are unable to settle discount window or auction facility obligations in a timely manner they’re indeed weak.  This problem is demonstrative of the dilemma faced by the fractional-reserve banker: the fear of being found insolvent otherwise known as the 'insolvent bank problem.'

If institutions like the FDIC or any consumer protection agencies are to protect banking customers it would require this vital information be available for anyone who desires to perform such due diligence.  After all, it is the customers' money in the banks.

More representative of the falsehood that secrecy at the discount window is the only solution for the ‘stigma problem’ are the words by Fed Chairman Bernanke himself identifying a rather new auction facility that seemed to alleviate such a stigma.  On January 10, 2008 Chairman Bernanke stated: 

"To address the limitations of the discount window, the Federal Reserve recently introduced a term auction facility, or TAF, through which pre-specified amounts of discount window credit can be auctioned to eligible borrowers...it appears that the TAF may have overcome the two drawbacks of the discount window, in that there appears to have been little if any stigma associated with participation in the auction." 

He went on to discuss the dilemma between banking reserves and the target federal funds rate.  While Mr. Bernanke recognized that restructuring facilities might address the stigma problem, near 80% of the banks' customers suggest honesty and transparency.

By denying outside analysis of discount window operations, the Fed shields its member banks, but what is the Federal Reserve System hiding, money or lack thereof?  Could it be the very nature of a fractional-reserve system, insolvent banks?  If this were the case, than a significant portion of FRB operations focuses on propagating recurring bailouts and the unsound banking practices of its member banks.  This arrangement of inadequate capital reserves is culpable for the housing and financial crisis according to former Fed Chairman Alan Greenspan.

An investigation into these matters is denied as the opposition argues without common sense and overlooks the current state of affairs with respect to the big picture.  While representing the White House's opposition to a Fed audit, Deputy Secretary of the U.S. Treasury, Neal Wolin said:

"We think that independence has served this country very well over a long period of time. We think that countries that have had either the reality or the perception of political influence in their central banks have had real problems, problems with respect to inflation, with respect to the cost and availability of credit including to consumers and to small businesses."

This simple thinking has plagued the opposition's arguments.  With all due respect the housing market crashed, financial markets crashed and unemployment ticked up to 9.9%.   Credit is hardly available unless you are a member bank of the Fed; to which trillions of dollars of credit is available backed by the taxpayers.  The American public in the beginning of this century were led to believe that the Federal Reserve System would prevent such crisis, but only since their creation have there been such events as a Great Depression or global economic crisis. 

Protection of Monetary Policy

The justification for gutting Bernie Sanders’ amendment from an audit into a one-time disclosure of emergency lending was to guarantee monetary policy is not inspected.  However, by allowing an inspection of emergency lending facilities such as the TAF, the Fed has conceded such protection.  The TAF become an important supplemental tool to the discount window in facilitating monetary policy.

Federal Reserve Chairman Bernanke himself identifies this to be true.  On January 10, 2008 he stated:

"To address the limitations of the discount window, the Federal Reserve recently introduced a term auction facility, or TAF, through which pre-specified amounts of discount window credit can be auctioned to eligible borrowers. "

He followed by revealing the large amounts of taxpayer money passing through this supplemental facility of the discount window saying:

"In December 2007, the Fed successfully auctioned $40 billion through this facility…the European Central Bank and the Swiss National Bank lent an additional $24 billion. These two central banks obtained the dollars from the Federal Reserve through currency swaps...we will auction an additional $60 billion …

Lack of transparency and honesty regarding the assets, securities and financial condition of various firms were significant factors of the uncertainty that plagued the financial markets most noticeable in the Fall of 2008.  Alongside this was something called "regime uncertainty" which prevented the execution of due diligence needed for major market participants to take a position.  How could they with the certainty that the Federal Reserve and Treasury would void such due diligence through market interventions?

The Fed Fails

The Fed has failed to achieve their dual mandate of maximum sustainable employment and price stability.  Unemployment just ticked up to 9.9% and prices in housing, commodities like oil and gold, education and health care have been all but stable.  Prices go up when an economy is based on cheap money.

While evidence that dissent existed amongst the FOMC in 2004 has now been released in 2010, Chairman Bernanke downplayed the deteriorating condition of the housing market and financial industry as late as 2007 and 2008.  Most savvy investors understood the situation while Mr. Bernanke during a speech on the subprime mortgage market on May 17, 2007 stated:

"All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system."

On January 10, 2008 months before our largest financial institutions like Bear Stearns, Countrywide, Washington Mutual and Lehman Bros. collapsed or sold themselves to avoid bankruptcy, Fed chairman Bernanke stated:

"Fortunately, after a number of years of strong earnings, most financial institutions entered the current episode in good financial condition. Thus, notwithstanding the effects of multi-billion dollar write-downs on the earnings and share prices of some large institutions, the banking system remains sound. Nevertheless, the market strains have been serious, and they continue to pose risks to the broader economy."

In the following months it was revealed, amongst others, that accounting tricks were used to mask massive debt, assets were more of liabilities and grossly overvalued, that the SEC-created cartel of credit-rating agencies failed to rate risk properly, that financial firms did not have adequate capital reserves to weather the financial storm and that the Federal Reserve still claims no one saw this coming.  

Our central planners at the Fed, with access to information so vital to our economic stability that it must be kept secret, were unable to foresee any of this with the likely exception that our fractional-reserve banking system is an insolvent system and provides cheap money.

Albert Einstein believed we still do not know one thousandth of one percent of what nature has revealed to us, yet we are to believe a room full of 24 is to centrally plan and regulate our economy in secrecy through the price control of money and whose operations deny the most vital foundation of a functional free society- honest banking and sound money.  The past century has been a history of stepping away from this foundation and has seen problems more severe and widespread.

With access to the most vital and secret of all information the Fed stressed the importance of secrecy.  During an FOMC meeting in 2004, Fed Chairman Alan Greenspan said:

"We run the risk, by laying out the pros and cons of a particular argument, of inducing people to join in on the debate, and in this regard it is possible to lose control of a process that only we fully understand."

Unfortunately they didn't understand the process at all.  Alan Greenspan wanted any dissent amongst the FOMC to be kept hidden.

Between the years 2000-2010, the FOMC swung the target federal funds rate down, up and back down again.  The rate has been held below 2% five of these years otherwise it’s ranged between 6% and 0%.  No wonder markets are unstable.  While understanding that financial and economic conditions may change quickly and justify a change in policy, the point of the above is despite their actions the financial markets collapsed and economy crashed.  

Famed investor Jim Rogers has a simple understanding for it stating:

"This idea that the central bank is somehow smarter than the rest of us...they're nothing but government bureaucrats.  What suddenly made them so smart just because they went to work for the government?"

The Federal Reserve's Response

On November 2, 2009 8 Fed-sponsored economists circulated a letter to our representatives in Congress opposing an audit of the Federal Reserve.  The statement read:

"Subjecting central banks to short-run political pressure makes it more likely that the monetary policy authorities will pursue excessively expansionary monetary policy to lower unemployment in the short run, with an outcome of higher inflation, higher interest rates, and yet no better performance on the unemployment rate in the long-run.  This has happened over and over again in the past, not only in the United States but in many other countries throughout the world."

Let's consider the track record of the Federal Reserve in the past few years.  The Fed failed to manage and identify risks resulting from their monetary policy and failed to connect the dots of poor monetary, regulatory and fiscal policy.  Insult to injury their response taken to clean up the mess has been extending taxpayer-backed credit to facilitate distressed sales of financial firms, appropriating taxpayer-backed funds to purchase stocks of financial firms, and purchasing toxic assets that were bringing down financial firms using taxpayer-backed credit.  

What intelligent thought is required to spend trillions of dollars purchasing everything in sight and pursuing excessively expansionary monetary policy doubling the money supply in mere months, at a rate not even comparable to the previous years, in order to lower unemployment in the short run?  These actions result in the redistribution of income and wealth to the beneficiaries of such actions and will see no better performance on the unemployment rate in the long run.

Indeed the 8 Fed-sponsored economists are very wise in that there appears to be a force of political pressure subjecting our Federal Reserve Bank to pursuing an unsustainable, excessively expansionary monetary policy.  It is only necessary that such political pressure be revealed through an audit of the Federal Reserve.  So in light of this revelation and the Fed’s response to the crisis the following words of Albert Einstein come to mind:

"We can't solve problems by using the same kind of thinking we used when we created them."

Recognizing that despite the Federal Reserve's oversight and interventionist management the financial markets crashed and the economy collapsed, consider the following question.  Is it possible that despite these interventions in the market, the economy could recover on its own?

Famed investor Jim Rogers puts this in perspective saying:

"America has had three central banks in our history, the first two disappeared...the world didn't come to an end.  America continued to become one of the great success stories of the last 200 years."  He asks, "What is this, the world would suffer badly if the Fed were audited?  Even if they found out horrible things, we should know, shouldn't we?  If the world finds great things, fine that would be wonderful."

Conclusion

Sustainable long-term employment and economic growth will be despite these interventions in the market.  Interest rate setting is a mere form of price control of our currency and cheap money doled out to fractional-reserve bankers combined with poor regulatory policy and government initiatives fuel misallocations of capital into unsustainable endeavors, as should be now obvious as experienced with the housing bubble and financial crisis.

The question remains however, does the financial reform in the House and Senate address the causes of the crisis?  The straight answer is no.  Effective reform needs all the vital information to understand the cause that needs to be reformed to prevent the effects.  An extensive and recurring audit of the Federal Reserve would provide this information.