Tuesday, December 15, 2009

Audit The Fed? Pros and Cons. . .

There has been a lot of disinformation surrounding the Federal Reserve. In fact, spreading disinformation about the Fed has become a cottage industry. The left originally viewed the Fed as the tool of international bankers bent on enslaving the world. In the 1950s, the John Birchers decided that the Fed was the agent of international communists. Fed-hate continues to run wild today in various groups. The Fed, apparently, is the secret cabal of the Bilderberg Group, the Communist Party, Zionist Bankers, and perhaps even a few extra terrestrials. Let’s cut through the garbage.

What Is The Fed?
The Federal Reserve was created by an Act of Congress on December 23, 1913. The Federal Reserve System consists of twelve Federal Reserve Banks located throughout the United States. These banks are governed by a seven member Board of Governors. The members of that Board are appointed by the President and are confirmed by the Senate. They serve 14-year terms and are term-limited to one term, unless they are appointed to complete an unexpired term, in which event they can be re-appointed to a full term.

Contrary to the rumors, the identity of every member of the Board and every officer and director of every Federal Reserve Bank is known and available to the public. In fact, their names are available online, see. e.g. Officers and Directors of the Federal Reserve Bank of Boston.

This, by the way, is one of the first lies told by anti-Fed people, that "no one knows who is on the Fed." I say lies because even when these people are confronted with the facts, they continue to deny them and simply move to more gullible audiences. Indeed, I had an interesting run in with one at Big Hollywood a few months back. Despite my presentation to him of evidence that he could verify with his own eyes that contradicted every single thing he claimed, he simply insisted on repeating his false claims over and over -- eventually accusing me of being “an agent of the Fed.” This is fairly typical behavior from this group.
What The Fed Does: Monetary Policy
The Federal Reserve has numerous responsibilities, but two are relevant here. The first is to handle “monetary policy” for the United States government. Monetary policy involves adjusting the prime interest rate, buying or selling bonds, and setting reserve requirements at banks to control the amount of money available to the economy and the “velocity” of money within the economy -- velocity means how often money gets spent.

In this regard, the Fed has been statutorily charged with holding inflation in check while also encouraging economic growth. European central banks, by comparison, generally are charged only with fighting inflation -- often leading to anti-growth policies.

Many people are upset that the Fed handles this function, and they argue that the Fed should be abolished. In the 1970s, they complained that the Fed caused inflation. In the 1980s, they complained that the Fed artificially kept the economy in check by overly-restricting the amount of money available in the economy. Now they complain that the Fed has created bubbles by allowing too much easy money to circulate in the economy.

There is some truth to each of these assertions as the Fed is not perfect. But the idea that eliminating the Fed would improve the situation is simply not accurate. The Fed was established to act independently of the political process; they are supposed to make their decisions based on the best available economic thinking. If the Fed was eliminated, the duty to handle monetary policy would fall upon the Treasury.

Unlike the Fed, the Treasury is a political creature. Shifting monetary policy to the Treasury would mean that the President, who is subject to election every four years -- and who seeks campaign contributions from people who could benefit directly from such decisions, would be deciding whether or not interest rates should be raised or lowered and whether or not liquidity (i.e. more money) should be injected into the economy.

Moreover, the Congress, which gets elected every two years -- and which seeks money from the same interests, would likely attempt to force the President’s hand whenever they felt the economy needed a boost. That’s a recipe for economic chaos and corruption.

But the other side of that coin is that the President and Congress are more directly accountable to the voters than the independent Fed. That's the trade off.

Incidentally, one of the arguments made for abolishing the Fed is that inflation has been be “out of control” since the Fed came along. But this is a red herring. First, looking at inflation in a vacuum is misleading because it is the comparison of wages to inflation that matters, not inflation itself. In other words, it doesn’t matter if bread costs 100 times what it cost fifty years ago if your income rose 100 times as well. Moreover, an examination of foreign currency exchange rates (a better measure of the value of the dollar than an examination of inflation) shows that the dollar has nearly doubled in value against all major currencies (and gold) in the past 100 years. Thus, the assertion that the Fed’s actions have hurt the dollar is completely wrong.
What The Fed Does: Discount Lending
The Fed also provides temporary loans to banks that are suffering from liquidity problems, i.e. those that are temporarily short of money. This is what they are talking about when you hear about banks “using the Fed’s discount window.” These loans are made at low rates and in secret to protect the identity of the bank. The fear is that knowledge that a particular bank was short of cash would cause people to try to get their money out of the bank, causing a run on the bank and collapsing an institution that likely only needed a short term loan.
The Audit Issue
This leads us to the audit issue. The conspiracy theorist claim that “the Fed has never been audited.” This too is a lie. The Fed is audited each year by independent accounting firms. For example, here is a link to the 2005-2006 audit conducted by KPMG. This audit is fairly typical of the independent audits normally conducted of banks or large businesses.

Moreover, Congress already has the right to audit the Fed, with one caveat. In 1970, Congress passed a law allowing the General Accounting Office to audit the Fed and all of its functions with the exception of the two mentioned above: the Fed’s decision making process for monetary policy and the Fed’s discount lending practices.

The reason the Congress did not allow the GAO to audit the Fed’s monetary policy decision making process was the fear that allowing such audits would interfere with the Fed’s independence. The thinking was the Congress would use these audits to pressure the Fed.

And even though the GAO cannot currently audit that function, this does not mean the Fed is acting in secret. The Fed releases the meeting minutes for each meeting of the Board of Governors which explain broadly the Fed’s thinking on monetary policy. It also releases reports for each region of the country, called the Fed Beige Book, which outline the Fed’s observations regarding all aspects of the economy in each of the Federal Reserve Bank regions. Finally, the Fed Chairman testifies on Capitol Hill on an on-going basis.

The Congress did not allow the GAO to audit the Fed’s lending practices for fear that this would reveal the banks who needed the Fed’s assistance with liquidity, which could cause runs on those banks.

Now the Congress is looking to pass a bill that would allow it to audit these two functions. The cons are those just identified. The pros are that the Congress, as the maker of our laws, should be able to know the thought processes employed by the Fed to make sure that it is acting in a manner which is consistent with the law and that the Congress can continue to support.

With regard to monetary policy, there certainly is a legitimate fear of a loss of the Fed’s independence. Once Congress starts tinkering, the Congress is unlikely to stop tinkering. Soon the Fed’s independence could disappear and we could end up with Congress directing the Fed to do its bidding. But the possibility that Congress may overreach is a poor excuse for denying Congress the oversight that is its responsibility under the Constitution. Not to mention that Congress could just as easily overreach now.

So perhaps allowing an audit is an excellent idea. It’s only the next step that becomes problematic.

With regard to auditing the discount lending practices, the same arguments apply, as well as the concern about creating runs on banks. If the current bill protects the secrecy of those banks that seek the Fed’s help, then an audit of these practices also should be supported. But if it does not, then the risk to the system, with banks avoiding seeking help to prevent possible bank runs, might be too potentially damaging to the banking system to allow.

In the end, those are the choices. There are no conspiracies, no secrets, no Zionist bankers or evil plots by our alien-masters. It is just the difficult trade-off between a process that is independent of political tinkering, but not responsive to voters, versus a process that would likely be more damaging to the economy but more responsiveness to the people.

28 comments:

MegaTroll said...

Thanks for breaking this down for us. I keep hearing that no one has ever audited the fed and I just don't understand that. Now I do. I agree an audit is a good idea, and I also don't want Congress or Obama taking over the fed's job. That's like handing an alcoholic a limitless credit card to a liquor store.

AndrewPrice said...

You're welcome Mega. I think the audits are a great idea -- I am always in favor of Congress doing it's oversight role fully.

But I don't like the idea of taking the Fed's monetary function and giving it to the Congress or the White House. They already manage the fiscal part of monetary policy and they've shown they can't handle that. I think it would be a disaster to give them more toys to play with.

JG said...

This is going straight to facebook. I remember that conversation you had on BH, btw. (Not that I'm a crazy stalker or anything... :p) But yeah, that's usually how it goes when I try to have that conversation, too. "Obviously they falsify those annual audits...and the meeting minutes...you can't trust them at all..." Of course, these same people say the same things about the Congress they want to audit the Fed...but they trust them enough to audit the Fed? It just doesn't make any sense.

AndrewPrice said...

Thanks JG! :-) Crazed stalker? LOL!

You're absolutely right about this whole area of debate. There are some very complex and important issues to consider regarding the Fed and how we handle monetary policy, but it's very difficult to discuss them because there are people who just go crazy whenever this issue comes up.

I'm not saying that the Fed is perfect (obviously) or that it might not need more oversight, but it certainly is not the mysterious monster that some people insist on making it out to be.

I'm a firm believer that before you can really discuss an idea, you need to get a grasp of the real facts. Sadly, too many people like to run with half-facts (or mere suspicion). That's dangerous (at worst) and counter-productive (at best).

JG said...

Okay then, follow-up question (by someone I know in the End the Fed camp): so who owns the Fed? Just because those people are on the board, it doesn't mean they control it. "They just pull the levers. Who owns it?"

I'm not sure I even understand the question...but there it is....

AndrewPrice said...

JG, I've heard that too. The short answer is that the government owns it.

There is no "ownership" in the traditional sense of there being stockholders or shareholders or partners. Instead, the Fed is simply part of (and owned by, and responsible to) the government.

The Congress created the Fed as an independent agency of the United States government -- other examples include the Federal Election Commission, the FCC and a dozen more.

Independent agencies are usually considered part of the Executive Branch, though a few fall under the Legislature.

The "independent" part comes from the way they exercise their powers. While the Fed would be considered part of the Executive Branch, and the President has the power to appoint its Board members, the President has no power to run the Fed day to day or to direct its actions. In other words, the Fed has the power to act independently of the President.

That said, the Fed's powers are limited to those it has been given by Congress and it must strictly obey any limits or directives placed upon it by the Congress.

Congress also has the power to change the Fed's mandate or procedures in any way they see fit, at any time -- through legislation.

But, again, the short answer is that there is no private ownership of the Fed, it belongs to and is responsible to the United States government.

Does that answer the question?

LawHawkSF said...

Andrew: Excellent analysis. Healthy suspicion of what our government is up to is necessary for the protection of liberty. When it becomes paranoia, that's dangerous. And the conspiracy-theorists are always with us. I have my criticisms of the Fed, but I can't say that I have ever seen it work purposefully against the interests of the American people (unlike our current Congress and the Marxist White House).

And at the risk of upsetting purists everywhere, I firmly believe that many governmental administrative functions are best done away from the public eye in order to carry out legitimate purposes which are very public (i.e., your example of short-term loans to banks with solid financial underpinnings and a temporary liquidity problem).

The public doesn't need to see everything that goes on in a judge's chambers, or what goes on in the operating room at the hospital. You hire the best people you can find. Then you let them do their jobs without taking a vote on their every action on TV. The last people on earth you want making these difficult decisions are the politicians who are already legislating us into bankruptcy--very publicly.

Congress and the president can't make head or tail out of health care, let alone how much it will really cost. So they use their phony "concepts" and present them to the CBO to make up phony financial figures to go with the phony plans. I'll take the procedures of the Fed and independent audits any day.

AndrewPrice said...

Thanks Lawhawk. One of the problems with conspiracy theories is that they often poison the debate and keep people from looking at the legitimate issues.

And oversight is a legitimate issue. I am a firm believer in strong oversight of all aspects of government, except in extremely narrow instances. I think that government of the people only works when the people know what the government is doing.

JG said...

Andrew: Thanks, that answers it for me. :)

JG said...

Oh geez. So I passed along an abbreviated version of your answer to this person I'm talking to, and his repsonse: "NOOOO!!!! And that is the problem. It is a private bank. The FCC is an agency the we the people own. The Fed is privately owned by banking families. WE pay them interest on OUR money they lend to US under the guise of monetary policy. Who owns it? Where did the money go? That is why an audit must happen. And then that monster must be abolished."

So, as I said, you answered it for me. But like the Climategate emails, not even the truth will sway true believers.

AndrewPrice said...

JG, Some people simply want to believe things that are not true. They have delude themselves about the world and will not accept reality as it is because it's more comforting to believe that the world isn't perfect because someone evil is manipulating things behind the scenes.

You just can't help people like that, they have personal problems that run much deeper than a political discussion.

If you want to continue the "debate", ask them to provide you with actual proof -- not something they made up or some conspiracy theory idiot made up, but actual proof. I can point you to statutes, written laws, inspector general's reports, and a billion other sources. They can't. . . but then, this isn't about fact.

JG said...

Oh, they did. This is what they came up with: http://www.globalresearch.ca/index.php?context=va&aid=10489

I laughed out loud reading it. If that's all that's needed to constitute proof, then there are unicorns at the North Pole.

LawHawkSF said...

Andrew: I purposely avoided using the word "secret" in my post for obvious reasons. I agree with you entirely that the people must know what the government is doing (I specifically said "away from the public eye"). Oversight is the protection that prevents non-public actions from becoming "secret" actions.

Nothing the Fed does is "secret" even when it is done away from the public eye. Some things just need to be done, and they don't need to be immediately broadcast, for multiple non-nefarious reasons. The public may not get widespread notice of one of those short-term loans you discussed, but there are multiple public officials and private auditors who must publish their results who do. The public will ultimately see it in the final audit. And there's always the Freedom Of Information Act.

Right now, there are more secret deals being made in Congress over health care than the Fed has ever dreamed of. Occasionally we get wind of them (e.g.the Landrieu/Louisiana bribe), but many we will never know about. I don't want any of my financial decisions being made by others, but in the real world, that happens. If I had to choose the Fed or the Congress to make those decisions, I'll take the Fed.

AndrewPrice said...

JG, Wow, that is just wrong on all counts. Seriously, every single sentence is factually wrong. It is simply paranoia poured out on a page without any regard for reality.

The author has no understanding at all of the Fed, the banks, the Treasury or how the government works. The few "facts" they site are easily proven wrong. They don't even have the facts right about who bailed out who or what the roles of the various institutions were -- indeed, they seem to have confused the Fed and the Treasury.

The quotes they pull from journalists (not even experts) are out of context and misinterpreted. And their conclusions bear no relationship to their analysis.

That's about the same quality as the "NASA faked the moon landing" arguments you see all the time.

Unicorns it is!

AndrewPrice said...

But, Lawhawk, the Fed being subject to FOIA does not fit the conspiracy theorists's script.

By the way, here's the link if you want to make a FOIA request:

LINK

LawHawkSF said...

Andrew: Shame on you! Giving me that link is like turning a kid loose in a candy store. Are you trying to kill me? LOL

Joel Farnham said...

Andrew,

Thank you. I have never really understood what the Fed is for. It makes much more sense now. I agree that there should be more oversight. If they can do it without the dangers you pose, I am all for it.

AndrewPrice said...

You're welcome Joel, glad to help!

I think more oversight is always a good thing when it comes to government. I firmly believe that the primary role of Congress should be to look at everything the government does to make sure the government is responsive to the law.

I have no problems with independent agencies, because it helps to reduce the political influence within regulations, but I do like strong oversight over these bodies.

StanH said...

Dammit Andrew, it is a conspiracy!!! : (

If you change conspiracy for system, you’re closer to the truth. And if you desire, with the FOIA, all can be had. Then the other problem, reading intense actuaries, and other tables, unless you’re a qualified auditor or financial expert, it may as well be Greek …this isn’t a small S-Corp, P&L. Watch a congressional hearing with a Fed Chief, it can be educational, and the questioning is deferential, comity at it’s highest, and they generally make the Senators look dumb. In fact think tanks like Heritage, Cato, and other think tanks left and right, act as auditor, and make it their business, as part their mission, to understand the Fed. The point is, there are to many people looking for a “true” conspiracy.

But, systems can, and do get manipulated, and you can bet the chairman of Goldman – Sachs can get the head of the NY Fed on the phone when they need to chat, and frankly that’s okay with me, that’s our system. But, when for all the world to see in 9/08, Hank Paulson the Treasury Sec., with his able assistant little Timmy Geithner who at the time was the President for the NY Fed, gives us TARP. This was sold as an emergency and the money was needed to buy troubled assets, well that didn’t happen, and you guys know the rest of the sordid tale. This makes the system look like a conspiracy, when in fact it’s incompetency.

patti said...

dear "agent of the fed",

i too think audits are a good thing, but should barry and crew ever get a hold of this job, we are gonna be in big trouble. you have given a very clear picture here. well done, undercover, even from yourself, fedaralie...

AndrewPrice said...

Stan, I agree absolutely on all points. There are far too many people paying too much attention for any secret group to run the Fed -- both left and right, as well as industry groups.

But, as you note, conflicts of interest are something completely different. Those do concern me -- you may remember my Goldman Sachs article. Government should be for The People not just certain people, and it truly bothers me how much influence these groups have throughout the government.

AndrewPrice said...

Patti, shhh, don't tell anyone about my secret identity! LOL!

Serious, you put your finger right on the problem. If Barry could start the money presses rolling right now, he'd do it in a minute to undo the harm he's causing with his out of control spending. But the Fed, being charged with controlling inflation, simply won't do that.

dbreck said...

"In other words, it doesn’t matter if bread costs 100 times what it cost fifty years ago if your income rose 100 times as well."

Obviously, you are not on a fixed income or saving for the future.

AndrewPrice said...

dbreck, I guess you're living off a settlement for a brain injury? Or are logic and reading comprehension just not things you're good at?

Seriously, do you honestly not understand that you are not being paid in 1910 dollars today? It sure sounds like you don't. Come on, 'fess up.

YoshiSacrifice said...

OK so I get that with our monetary policy the way it is, the Fed makes sense. However, all of your arguments are centralized around the idea that it is legitimate to print money regardless of a lack of value behind it. You wouldn't call an empty carton of eggs eggs, so how can you call money printed without value money...it is fiat. I have read A LOT about this on both sides, and understand all of the arguments you made but they are entirely dependent upon a system in which printing money without a solid backing (some commodity) is legitimate. I guess I'm asking for the reasons why people believe this is necessary. I understand there would be a rough patch if we weened ourselves off this system, but wouldn't it be more sustainable in the long run to have our money have ACTUAL VALUE instead of PERCEIVED VALUE?

AndrewPrice said...

Yoshi, There are two problems with the gold argument. First, it's a fallacy to think gold has independent value. The only reason it has value is because people want it, which is the same reason paper money has value. In other words, switching to gold adds nothing except putting a maximum limit on the amount of currency we have.

But that's a curse more than a benefit. Think about buying a house. You can buy a house because banks will look at your potential future income and decide if its worth loaning you the money. It's the same thing with countries -- our currencies are based on the perceived ability of the economy to pay it back.

If you switch to gold, that will be like switching to a cash-basis. Thus, the only way you can buy a house is if you have the cash on hand. That will shatter the economy.

Also, we are bleeding money to China because of our trade imbalance. It wouldn't take very long at all before all of our gold is in China and then suddenly our currency is worthless. Then what? Do we go take it back? Or just end up like other cash-basis individuals with no cash... homeless, unable to buy anything?

And before that happens, you will see hyper-inflation in the US as people become unwilling to part with anything except for massive amounts of cash because it will all be worthless soon.

Carmen said...

Thanks for this article! I've heard a lot about auditing the Fed, and didn't hear any cons, so I wasn't sure why the audit was debatable. So I Googled "audit the fed pros and cons" and came here :)

"In other words, it doesn’t matter if bread costs 100 times what it cost fifty years ago if your income rose 100 times as well."

As for this point, I think dbreck made a legitimate point. Personally speaking, my salary has increased at least as much as inflation, but my interest in my savings account is a different story :) Seriously, it's like at 0.20% now. I'm pretty sure inflation is at least a magnitude of order higher than that :)

AndrewPrice said...

Carmen, You're welcome. Inflation is definitely a problem for people on fixed income or with low savings rates. There's no doubt about that and that's why inflation needs to be fought. The problem is really that handing the control over the money supply to the Congress again, rather than the Fed, would be a disaster. It would be better to refocus the Fed's mission to focus more on inflation.

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