Let Freedom Wane: The Fed's Role as Regulator and Obama's Failure to Reform

The proposal put forward by the Obama Economic Team to expand the purview of the Federal Reserve as a regulator, perhaps even THE regulator, was always troubling for several reasons.

1. The Fed is in fact not a government institution, but owned by private and corporate banking interests. The failure of self-regulation and regulators who have been 'captured' by the corporations they regulate is one of the great lessons of this crisis.

2. The Fed is notoriously opaque, with the occasional gesture towards transparency, and is often resistant to releasing information to the public in a timely manner, claiming a sort of 'executive privilege.' The Fed is and should remain independent but accountable on review. This precludes them from acting fully and routinely as a government agency responsible to the voters for all of their actions.

3. The Federal Reserve of NY often acts as a member of the 'banking club' with very heavy ties to Wall Street. The objective of financial reform should be to insulate regulators from undue influence by the organizations which they regulate, and more influenced by the law and the public good first and foremost. This is a basic principle of the regulatory process. One cannot successfully regulate their peers when the tough decisions have to be made to uphold justice and expose corruption and conflicts of interest.

This latest incident with Goldman Sachs merely serves to illustrate the too often unilateral decision-making by the Fed in an ad hoc manner, without sufficient explanation.

What the United States needs to reform its financial system is a group of Untouchables who are not on the payroll of Wall Street, or regular participants in the revolving door between government and the industry it regulates. The failure to create this effective reform, and instead gravitate toward ineffective consolidation in one of the key actors in the failure of the system is an error that is as fundamental and basic as one can imagine. It strains credibility that this could merely the result of inexperience.

It was the appointment of Larry Summers that first put us off the Obama 'reform' message. Larry Summers is a holdover from the same team that brought us some of the worst Federal Reserve policy decisions and interference in the regulatory process ever seen.

The Administration needs to convert its vision into action, and stop playing to the Wall Street lobby which created and is still benefiting from this crisis. If that requires replacing the Chief of Staff, Rahm Emmanuel, who is a heavy recipient of Wall Street donations, then so be it.

Whoever is promoting the Fed as uber-regulator within the Obama Administration should be fired, immediately. We hear it is Larry Summers, and this sounds like the politically tone-deaf, impractical, arrogant, and conflicted solution which Larry or Rahm might promote.

Can you imagine what our crisis would have been like if Alan Greenspan had even more power, more control over the markets?

Obama, quite frankly, needs to demonstrate that he is a man of integrity and principled action, vision that is not confined to oratory. He must now demonstrate that he is his own man, and is not owned by powerful special interests that seem to be controlling the American political process in both major parties.

If even a mandate such as Obama received does not energize the Democrats, then the best hope for America is a third party, a Progressive / Libertarian party as was seen at the turn of the 19th century with the rise of Teddy Roosevelt.

Baseline Scenario
A Short Question for Senior Officials of the NY Fed
By Simon Johnson
October 3, 2009

At the height of the financial panic last fall Goldman Sachs became a bank holding company, which enabled it to borrow directly from the Federal Reserve. It also became subject to supervision by the Federal Reserve Board (with the NY Fed on point) – hence the brouhaha over Steven Friedman’s shareholdings.

Goldman is also currently engaged in private equity investments in nonfinancial firms around the world, as seen for example in its recent deal with Geely Automotive Holdings in China. US banks or bank holding companies would not generally be allowed to undertake such transactions - in fact, it is annoyed bankers who have asked me to take this up.

Would someone from the NY Fed kindly explain the precise nature of the waiver that has been granted to Goldman so that it can operate in this fashion? If this is temporary, is it envisaged that Goldman will cease being a bank holding company, or that it will divest itself shortly of activities not usually allowed (and with good reason) by banks? Or will all bank holding companies be allowed to expand on the same basis. (The relevant rules appear to be here in general and here specifically; do tell me what I am missing.)

Increasingly, the issue of “too big to regulate” in the public interest is being brought up – an issue that has historically attracted the interest of the Department of Justice’s Antitrust Division in sectors other than finance. Should Goldman Sachs now be placed in this category?

Given that the Fed has slipped up so many times and in so many ways with regard to regulation over the past decade, and given the current debate on Capitol Hill, now might be a good time to get ahead of this issue.

In addition, there is the obvious carry trade (borrow cheaply; lend at higher rates) developing from cheap Fed dollar funding to the growing speculative frenzy in emerging markets, particularly China. Are we heading for another speculative bubble that will end up damaging US bank balance sheets and all American taxpayers?

Taylored Tales of the Monetary Bards

The title of this blog may appear a bit rude, and it is not intended to be denigrating of this particular paper from the Kansas City Fed linked below, but rather the organizational mindset that uses it to adjust anything more complex than the timing on a 1967 small-block Chevy with a straight face and a clear conscience.

Although a bit wonkish, "Was Monetary Policy Optimal During Past Deflation Scares?" does an exceptionally good job of explaining the Taylor Rule, how it has been derived and is utilized by Central Banks in evaluating and formulating monetary policy, ie., short term interest rate targets. The author gets high marks for clarity of language and a willingness to allude to some of the shortcomings of the method which is remarkable for most Fed research papers.

Financial engineering reminds one of saying we used to have in Bell Labs , when some individual or group was trying to formulate a practical response to a complex problem based on dodgy theories and elaborate field data: "Measure it with a micrometer, mark it with a grease pencil, and cut it with a hatchet."

One suspects that in this case, reducing the complexities of the economy to the output gap, real inflation gap, and the equilibrium nominal interest rate is like trying to arrive at the average depth of the ocean by using a micrometer to take a few ocean depth readings in a hurricane.

Yes each component has additional inputs, that vary widely and are difficult to measure, but to paraphrase, it does not matter if you calculation works, as long as it looks good, and darling doesn't this economy look marvelous.

It would be interesting to see the fun that Benoit Mandelbrot would have dissecting the Taylor Rule equation, derived from an 'optimal period' in US monetary policy. His book The The Misbehaviour of Markets is a must read for anyone who needs to be convinced that much of modern financial engineering and risk models are exercises in mathematical oversimplification and misdirection.

For those that are not so inclined to read this paper, let us just say that the data going in to the equation is subject to wide disagreement, adjustment, and interpretation, and the data coming out has enough spread from lack of modeling robustness to support just about anything, any outcome. Given the 'thinness' of the equation, which as the author refreshingly and freely admits, can choose from widely varying measures of 'core inflation,' while taking no account of asset prices and government industrial policy among other things.

I am sure the Board of Governors would respond that this Taylor Rule is merely one input into the collective decision-making of a group of wise men, who at the end of the day are combining their various perspectives into a judgement as to the optimal course of action, which includes their vast experience and readings of not only tools such as this, but anecdotal data from their various regions.

Too bad that our last Fed Chairman was a dissembling, blithering idiot, a standing joke in his private practice, who could not find the optimal monetary policy with both hands. But he was a masterful politician and bureacrat, surrounded by fellow sycophants, and did know how to serve the banking interests and make himself look credible, at least to outsiders. And in retrospect, this paper asserts that in fact the Committee under Chairman Greenspan did make a mistake in easing too aggressively for too long a period in the early 2000's. (well, duh).

And too bad the Fed has a significant amount of influence and power, so that even academic economists are too cowed by fear and greed to have said much while Sir Alan and His Merry Pranksters blew serial bubbles in support of the new banking economy. Because if Her Majesty the Queen wishes to be truly illuminated, that is why most economists failed to see the Crash coming: you get what you pay for.

Like Elliot Waves, this Federal Reserve process and these tools 'look good' when applied to historic examples, but one wonders who could possible use it to predict anything and take action on that with any level of success. Has the US Fed really had any unqualified successes based on their own initiatives, other than when Volcker took the economy in hand and, applying a sufficient amount of will, personal resolve, and common sense, tamed the pernicious inflation of the 1970's? They appear to have created more problems than they have solved.

So what is the answer? To do nothing and let the markets play themselves out? That is folly as well, because for better or worse markets are highly subject to manipulation from a number of sources, and the distortions caused therein are potentially devastating, when one considers the willingness for example of the Asian states to manipulate their currencies in support of a mercantilist policy of importing jobs as a means of solving domestic social problems. Or the propensity of the Anglo-American establishment to perpetuate gross fraud as a means of ravaging foreign peoples that too trustingly adopted the globalist model of deregulated banking and modern derivative financing.

The answer of course is that only a significant systemic change can take us out of this cycle. It will have to be one that recognizes that globalism is not an a priori good in a world where nations and peoples wish to settle on their own way of life, and solution set to particular problems in ways that suit them.

We are probably nearing the end of a long cycle of economic deregulation and monetary mysticism, in which old barriers and protections and particularities were struck down, often with little or no serious thought to the policy implications and long term social practices. The zenith of this trend is the consideration of the IMF or some such body as the global Central Bank, with a council of global governors setting everything from trade rules to de facto living standards. One way to make the models work and end conflict among the nations is to make everyone a slave.

When the financial and social engineers fail, their natural response is to make excuses and seek more power. If the CPI is proving to be an impediment to our calculations, let's change how we measure it. If the measurement of inflation is now adjusted, but gold keeps signaling inflation, let's manage the price of gold. And if people keep making independent choices that are not consistent with the predictions of our model, let us manage their perception, influence their judgement, override their own experience and the advice of their parents, and persuade them to take on more debt than they can possibly ever repay, and still remain free.

Hopefully this trend will fall apart before the globalists can do any more damage in the real world, but if it does not and we do get a Council of Global Governors, remember that their oracle is likely to be in dodgy, over simplistic equations such as this, which will be used to throw some clothing around what is most likely to be an exercise in influence peddling, elitism, and raw, naked power of the few over the many.

"Those in possession of absolute power can not only prophesy and make their prophecies come true, but they can also lie and make their lies come true."
Eric Hoffer

Was Monetary Policy Optimal During Past Deflation Scares?

Icelandic Police Raid KPMG and Price Waterhouse in Banking Frauds

There is serious fraud and criminal activity permeating the global banking industry. So far, few governments have taken serious action to expose the fraud and begin serious investigations, much less criminal indictments.

So far we have seen the occasional outsiders being thrown off the back of the sleigh for the wolves, but the serious insiders contine on, and in the case of the US, it's business as usual with bonuses back to record levels, and banks chasing trading profits using public monies.

Will some party, some group, rise up in the US to break the grip of the monied interests on government? It appears that it will not be coming from the Obama Administration, which is seriously compromised by conflicts of interest, and the Republicans which are the seed bed of corporate malfeasance and corruption.

The banks must be restrained, and the financial system reformed, and balance restored to the economy, before there can be any sustained recovery.

UK Telegraph
KPMG and PwC Reykjavik offices are raided by Icelandic police
By Rowena Mason
9:30PM BST 01 Oct 2009

Police have raided the offices of KPMG and PricewaterhouseCoopers (PwC) in Reykjavik, seizing documents and computer data as part of an investigation into alleged criminal activity at three collapsed Icelandic banks.

The targets of the raids were the firms' banking clients Kaupthing, Glitnir and Landsbanki, but the move is nevertheless likely to cause embarrassment for the two companies, both among the "big four" accountancy names in the world.

The Reykjavik branches of KPMG and PwC are owned by its partners, common with most accountancy practices, but are also part of the multinational network of firms.

The office of Olafur Thor Hauksson, the Icelandic investigator charged with examining the collapse of the three banks a year ago, confirmed that 22 policemen and six foreign accountants took part in the searches yesterday.

"The purpose of the searches was to look for and secure evidence related to the investigation of several charges which have been investigated by the office," a statement said.

Among the matters being investigated are "violation of laws on accounting and annual reports, violation of laws on financial institutions and securities transactions and violations of laws on public limited companies". PwC Iceland could not be reached for comment.

Sigurdur Jonsson, the chief executive of KPMG Iceland, told The Daily Telegraph that the raids related to some of his clients and that none of his staff had been questioned. He refused to comment further on the investigation.

Mr Jonsson has already become embroiled in controversy after it emerged that KPMG Iceland had been responsible for investigating events leading up to the collapse of Glitnir, despite the fact that his son was chief executive of the bank's largest shareholder. KPMG later resigned from the case.

The UK Serious Fraud Office (SFO) agreed last month to send a team of investigators to Iceland to help "get to the bottom" of whether there were any criminal intentions in the country's collapsed banks, which had extensive links with London.

The Icelandic banks, which had large customer bases in the UK, failed last October, leaving 300,000 British savers unable to access their money and institutions nursing billions in losses. Following the crisis, the Treasury had to pay out £7.5bn to compensate UK savers, although £2.3bn of this will be repaid by Iceland over the next 15 years.

Allegations of fraud, embezzlement and market manipulation have been under investigation in Iceland since February. The SFO has separately been gathering intelligence on the Icelandic banking sector and its UK operations both involving investors and borrowers, which intensified after the leak of Kaupthing's loan book on to the internet last month.