Fed Economic Rocket Scientists on Auditing the Fed, Liquidity Crises
Audit the Fed!!!!!?? I think. Wait a minute, sloppy Fed accounting? I think I just... nevermind.
NYT (an op-ed by William Barnett, shit you not the man is an actual economic rocket scientist, called Who's Looking at the Fed's Books):
On Tuesday, Senator Jeff Merkley, Democrat of Oregon, and Senator Bob Corker, Republican of Tennessee, introduced legislation to allow the Government Accountability Office to audit some of the Federal Reserve's lending programs. Different bills calling for more comprehensive Fed audits already have widespread support in the House and Senate. Expanding this oversight is long overdue.
After the financial turmoil of the last year, it should be clear that we depend on the Fed for high-quality financial data and that the Fed should be held to the highest standards of transparency. And yet we cannot be assured of either of these things unless the Fed is subjected to a thorough audit of its numbers. I worked on the staff of the Federal Reserve Board 30 years ago, and I know that without comprehensive audits to double-check Federal Reserve data, the risk exists of inadequate and sloppy accounting from the Fed.
Consider the data the Fed presented last year on nonborrowed reserves. Nonborrowed reserves are total bank reserves minus money borrowed by banks and held as reserves. Clearly, the money borrowed cannot exceed the total reserves, so nonborrowed reserves should not be negative. Yet for a few months last year, the Fed reported banks' nonborrowed reserves at billions of dollars below zero. In its calculations of nonborrowed reserves, the Fed included in borrowed reserves new forms of bank borrowing not being held as reserves. Such incompetent accounting would not survive an unconstrained, fully informed audit.
The information the Fed releases on bank deposits is similarly biased and contaminates data on the money supply and thereby on the liquidity of the economy produced by Federal Reserve policy. In order to evade reserve requirements, which mandate that a certain fraction of deposits be held in reserve and not lent out, many banks sweep much of their checking account deposits into shadow money-market-deposit savings accounts before reporting those deposits to the Fed. Since such accounts have no reserve requirements, this allows the banks to decrease the amount of total reserves they're required to have. But the liquidity provided to the economy from checking accounts is the pre-sweeps amount, not the reported post-sweeps amount.
Why does the Fed not require banks to go public with their real checking account deposit data? If the Fed doesn't see it as a problem that banks evade reserve requirements on checking accounts, why doesn't it just remove those requirements? Such evasion would be less likely to continue in the face of a comprehensive audit by the Government Accountability Office.
But while the Fed needs to be audited substantially, creating an independent data institute to monitor the Fed's monetary and financial data would be better than expanding a Government Accountability Office audit. An independent institute would have the highest specialized expertise to produce economic data for the Fed.
Alright, smarty pants, define independent. The Fed claims independence. So do I, surely I am swayed by some kind of personal or professional bias? How can an institution (much like a corporation in that its primary objective should be self-preservation) possibly claim independence? We have unfortunately given entities human characteristics like independence. Put some eyeball stickers on your stapler, don't go assigning features exclusive to humanity to entities. We are terribly lost.
Here is one "non audit" opinion:
Someone asked me about the Fed.......The game they are playiing is a virtual high wire act over a pond full of hungry crocodiles. The information they have is way beyond what we have available. I hope their road is the correct choice for all of our sakes. If I were religious I would say my prayers are with them. We are headed into a meat grinder as an economy and as a country. You will find out soon what you are made out of. Do you have the fortitude to lead your family through this.
Oh snap, the meat grinder!
K, I'm not down with that scenario, so what is the alternative? Barnett is on to something; while this might not be the best interpretation of the "Fed audit" I've seen lately, it's still not the solution. Neither is storming the joint with the tin foil battering ram.
Barnett argues that banks are not required to reveal consumer checking account deposit data but I argue that they are. Isn't that what audits are for? We have x amount of deposits that equal y. Aa ("Auditor asshat") has to check controls and run substantive tests and blah blah blah blah. Bank of America can't say "we have $12 bazillion in deposits but no, you can't look at our complete financial picture, just the picture we determine is best for you to see" now can they? What bank gets priveleges like that?
The same bank that somehow made it so we owe JP Morgan for buying the good parts of Bear Stearns at fire sale prices. But no, who needs to audit that?
Anyway, the point is that the Fed does not have to answer to anyone as to its "objective" in doing what it does and the GAO can't change that, nor could a so-called independent audit. Will this suddenly force the Fed to be accountable to the taxpayer? Why? Audits are performed for the sake of shareholders, not management. If the Fed supposedly serves us as our monetary machine, doesn't that make us management? The question then becomes who are the shareholders and what incentive would the Board have to present the statements as positively as possible? Well a system of checks and balances would be great but I for one will not be holding my breath.
Barnett also wondered "What Broke the Bubble" in this November 2008 research paper (fucking research economist rocket scientists and their papers) and believed monetary policy was - peep this - too tight when the recession hit. Oh Billy. We need to talk.
The position taken by this opinion editorial is that the declining trend of total reserves during the recent period of financial crisis was counterproductive, and the declining level of the federal funds rate during that period was an inadequate indicator of Federal Reserve policy stance. But the recent startling surge in reserves potentially offsets the problem, although for reasons not motivated by the issues raised by this article. In fact, the reason for the surge is associated with the declining stock of Treasury bonds available to the Federal Reserve for sterilization of the effects of the new lending initiatives on bank reserves.
I think I like this dude.
More on Barnett's perspective:
In an unpublished paper entitled “The Frozen Pond of Liquidity,” Michael Belongia and William Barnett (of the University of Kansas) argued that monetary policy last year was actually rather contractionary. Here is a passage from that paper, which discusses how this situation came about:
The reason for this starvation is a classic and repeated mistake Fed officials have made during each business cycle since the end of World War II. Believing that it, and it alone, controls activity in the federal funds market, the Fed interprets changes in the funds rate as the product of its policy actions. Thus, if the funds rate declines, it must be the result of an expansionary monetary policy action; if the funds rate rises, it must be because the Fed has taken actions to be more restrictive. How else, the thinking on Constitution Avenue goes, could the funds rate move, without actions on their part?
Missing from this analysis is the entire other side of the reserves market: If the Fed is the only supplier of reserves, those who demand reserves must have some ability to affect the price – the fed funds rate – at which reserves trade. Those demanders are banks, and banks see the demand for reserves rise and fall along with the demand for loans: When the demand for loans rises, the demand for reserves by banks rises; when the demand for loans falls, the demand for reserves by banks declines. What all of this means is that the fed funds rate can decline – because of declines in the demands for loans and reserves – without the Fed taking any policy action. But, if the Fed interprets the world as its oyster, it will interpret this type of decline in the funds rate as “evidence” of an easy policy stance, when, in fact, the real signal in the market is that the economy is weakening and, if anything, the Fed may be starving the banking system of much-needed liquidity.
This was written right before the large upsurge in bank reserves last fall. It could be argued that the failure of that increase to lead to high inflation, or at least high inflationary expectations, tends to discredit their monetarist approach. But of course most monetarist models did not assume any interest was going to be paid on reserves, so it is hardly fair to criticize them for failing to predict the resulting increase in the demand for reserves.
K. So he's only slightly out of his mind, there never was a liquidity problem. Take his thoughts on auditing the Fed with a grain of salt and possibly a Xanax.
As for me, this might be my favorite subject these days. see also: They're Comin for Dat Ass, Bernanke: Defining "Federal Reserve Accountability"