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Friday, August 7, 2009

"Audit the Federal Reserve!" - Not Gonna Happen

I still subscribe to the Ron Paul mailing lists. More accurately, I never bothered unsubscribing. Ron Paul has been the sponsor of a bill that will require the Federal Reserve to submit to a Congressional audit.

Surprisingly, the bill may have enough support to pass the House. I doubt it would pass the Senate or get signed by the President. What probably will happen is a watered-down version of the bill will pass. This allows the bad guys to pretend to be giving concessions, while actually admitting nothing.

I never understood the argument "If the Federal Reserve submits to a public audit, then that will prevent us from conducting impartial monetary policy." A more accurate statement is "If the Federal Reserve submits to a public audit, then that will prevent us from looting and pillaging as our crimes would be obvious to everyone."

When the Federal Reserve conducts its operations, there is nothing preventing the Federal Reserve from giving one bank more favorable treatment than another. There is no requirement for the Federal Reserve to disclose out how much money it lent to each bank.

Real interest rates are negative. The Fed Funds Rate is 0%-0.25%, and the Discount Rate is 0.50%. Inflation is 20%-30% or more. Since real interest rates are negative, when the Federal Reserve lends a bank money, it's like the Federal Reserve is giving the bank money.

For example, suppose the Federal Reserve decides to lend Goldman Sachs $500B for 1 year at 0.50%. Suppose that the Federal Reserve decides to lend Citigroup $100B for 1 year at 0.50%. Suppose that true inflation is 20.5%. It's like the Federal Reserve gave Goldman Sachs $100B and Citigroup $20B. When it's time to repay the loan, the value was lost via inflation. In the meantime, executives at Goldman Sachs and Citigroup can use the Federal Reserve's free money to buy assets or make loans. Suppose that Goldman Sachs uses a 10x leverage ratio. If the Federal Reserve lends Goldman Sachs $500B, then Goldman Sachs may now issue $5T of loans.

The banksters borrow at the Fed Funds Rate and lend at 6% or more. They profit from the interest rate spread times their leverage ratio. When the Federal Reserve gives the banksters free money, this money does not count against their leverage ratio requirement. Free money from the Federal Reserve helps give the banks the illusion that their balance sheet is better than it actually is. During a recession/depression, this helps the banks from being forced into bankruptcy.

Large banks get a bailout from the Federal Reserve. Small banks are forced into bankruptcy. It only makes sense to operate a banking business if you're "too big to fail" and "too politically connected to fail".

The Federal Reserve insiders incur no cost when they lend the banksters money. When the Federal Reserve lends out money at the Fed Funds Rate or Discount Rate, it is literally lending out new money printed out of thin air. The Federal Reserve's operations aren't free. The rest of society pays the cost as inflation.

In the above example, Goldman Sachs received $500B but Citigroup received only $100B. Insiders at the Federal Reserve have broad discretion regarding who receives how much free money, and on what terms. Executives at large banks have an interest in lobbying the Federal Reserve for favors.

These "special loans" that the Federal Reserve made don't count as part of the bank's liabilities, due to legal loopholes in the way they're structured. The most common mechanism is via "repurchase agreements", where assets are temporarily moved from the bank's balance sheet to the Federal Reserve's balance sheet, and replaced with Treasury debt.

Suppose that Goldman Sachs and Citigroup have subprime mortgage bonds. The face amount of the bond is $10B but the fair market value is $1B, for both Goldman Sachs' and Citigroup's bonds. These are illiquid "Level 3" assets, where there's no clear fair market value.

Suppose that the Federal Reserve makes a repurchase agreement with Goldman Sachs. The Federal Reserve decides to value the bonds at $2B. The Federal Reserve agrees to buy the bonds from Goldman Sachs for $2B and sell them back in a year for $2.01B (adding in 1 year of interest at the discount rate of 0.5%). The Federal Reserve takes the bonds on its balance sheet at a value of $2B, and gives Goldman Sachs Treasury bonds worth $2B. In a year, the Federal Reserve will receive back Treasury bonds from Goldman Sachs and return the bonds to Goldman Sachs.

However, suppose that housing prices rise by 10% a year, not unreasonable since inflation is 20% or more. If the subprime mortgage bond is one of the lower tranches, it could rise in value by more than 10%. In the meantime, Goldman Sachs got $2B of cash that it could invest elsewhere.

These repurchase agreements are the "expanding of the Federal Reserve's balance sheet" that you sometimes hear mentioned. Shaky debt is taken of the balance sheet of banks and placed on the Federal Reserve's balance sheet temporarily. The Federal Reserve can do this without cost, since the Federal Reserve is literally printing new money out of thin air to finance the transaction.

Continuing the above example, suppose the Federal Reserve insiders agree to buy Citigroup's bonds. This time, Citigroup is given a valuation of $1.5B instead of the $2B valuation given to Goldman Sachs.

Notice that Goldman Sachs received a larger State subsidy than Citigroup. Federal Reserve insiders have broad discretion to do whatever they want.

If there were full disclosure of the Federal Reserve's activities, it would reveal exactly how much new money was printed and given to which banks. It also would reveal that some banks are receiving favorable treatment relative to other banks.

Even though Goldman Sachs got a better deal than Citigroup, it's in the best interests of executives at both banks to lobby against full disclosure. Both of them received a massive State subsidy.

The banksters do *NOT* want full disclosure of their looting and pillaging. With the ability to print new money out of thin air, they can always profitably lobby to block reform.

If you're offended by the largesse of the Federal Reserve and financial industry, your only recourse is to boycott the dollar and use real money instead (gold or silver). To boycott the Federal Reserve, you must also boycott the income tax. IRS bureaucrats demand that taxes/tribute be paid on all work, and only Federal Reserve Points are accepted as payment. Reform via statist means is impossible, because insiders can always profitably lobby to block reform.

The most likely outcome of the "Audit the Federal Reserve!" movement is that some token disclosures may be made, but not full disclosure.

1 comment:

CorkyAgain said...

I *tried* to unsubscribe from the Ron Paul mailing lists, but there are a few I can't seem to get rid of.

One is called the AMERICAN UNDERGROUND NETWORK, in all caps just like that. I keep getting email from them, inviting me to join a "National Collective Conscious Conference Call." To an individualist like me, that sounds like an invitation to join the pod people.

There is no unsubscribe header on their email, nor can I find any other instructions on unsubscribing. I eventually gave up and wrote a procmail rule to send their stuff to /dev/null. Still, it's annoying as hell that I can't get my name off their list. I wish I'd never spent any time in the Ron Paul forums or the Meetup groups.

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