Criticism of the Fed Grows as Obama Seeks More Powers

Published September 1, 2009

For most of his congressional career, Rep. Ron Paul (R-TX) has been trying to persuade lawmakers to support audits of the Federal Reserve, and until this year he has gotten almost nowhere.

Now at least 240 of the 435 members of Congress have signed on as sponsors to Paul’s “audit the Fed” bill, even as the Obama administration pushes legislation to give the Federal Reserve sweeping powers to supervise big banks. Democrats and Republicans, liberals and conservatives sponsor Paul’s bill.

“I think we’ve had a moral victory and we’ve had a political victory,” Paul said in a statement. “Even if they close us out and don’t allow this bill to be passed, it will prove our point … that there are a lot of shenanigans going on in the Federal Reserve that deserve attention.”

No Accounting for Bailouts

Supporters of the Federal Reserve are raising objections to the bill, HB 1207, in hopes of derailing it. The bill calls for an audit of everything the Federal Reserve does, including its involvement with the Troubled Asset Relief Program (TARP) and other lending facilities created last year by Congress in response to the financial crisis.

So far the Fed has declined to account for trillions of dollars of financial bailouts, loans, and guarantees to financial institutions and other entities.

Yet as momentum to audit the Fed grows, so does the Obama administration’s desire to give the central bank more powers.

Bid to Watch ‘Significant’ Institutions

In an 85-page paper presented in June, the administration called for the Fed to receive new powers to watch over “systemically significant” institutions whose failure could threaten the overall financial system.

The proposed Fed power increase is part of an Obama administration push for further financial industry regulation requiring, among other things, hedge funds to register with the Securities and Exchange Commission (SEC), creation of a new mortgage watchdog organization, and lenders having to keep some of their loan portfolio instead of selling all their loans in a secondary market.

Couldn’t Pass Own Audit

Skeptics abound. Jim Grant of Grant’s Interest Rate Observer told CNBC he supports Paul’s bill to audit the Fed and pointed out an irony:

“If the Fed examiners were set upon the Fed’s own documents … [they] would shut this institution down,” Grant said. “The Fed is undercapitalized in a way that Citicorp is undercapitalized,” noting the Fed reports $45 billion of capital and more than $2 trillion of assets accepted as collateral for loans it has made. The Fed refuses to reveal the nature of the assets or recipients of the loans, making it impossible for persons outside the Fed to accurately assess the risks of loan losses.

The vast expansion of the money supply and arbitrarily low interest rates the Fed has imposed on the economy in response to the economic downturn equals “a vast experiment in moral hazard,” Grant said.

‘Plethora of Regulators’

Economist Mark Thornton, a senior fellow at the Mises Institute, agrees, saying the Fed’s current interest rate—hovering between 0 and 0.25 percent—is artificially low, and he doubts new regulations would do any good.

“We have a plethora of regulators and regulations in banking. It’s hard to imagine an industry that has more regulation [and] more regulators,” Thornton said.

Thornton notes Bernie Madoff, recently sentenced to 150 years in prison for engineering a $65 billion Ponzi scheme, was repeatedly reported to the SEC but the regulator did nothing.

Fed Causes Bubbles

Thornton added, “Regulation doesn’t address the underlying cause of financial bubbles, which is the central bank’s interest rate policy. When it gets out of whack with markets, you create bubbles. If the interest rate is on the high side, which it rarely is, it causes the economy to slow down. The only thing this regulatory reform can do is hurt the economy. Changing regulations always brings negative shocks and losses to industries.”

Edward Yingling, president and CEO of the American Bankers Association, said the group believes regulatory reform is badly needed, but added, “we believe the administration’s proposal is so vast and controversial that it will be extremely difficult to enact and will produce great uncertainty in the financial markets and among financial regulators while it is pending.

“It needlessly rips apart all the existing regulatory agencies, eliminates charter choices, and creates a new agency with powers to mandate loans and services that go well beyond consumer protection,” Yingling continued.

John Berlau, director of the Competitive Enterprise Institute, said the Obama regulatory proposal “adds additional layers of ‘systemic’ regulation from ‘super’ agencies such as the Federal Reserve. This new mountain of red tape could choke many small businesses, the engines of economic recovery, and do little to prevent the next crisis.”

Bush Increased Regulation

Berlau also challenged the widely cited notion that deregulation played a big role in the financial crisis.

“In 2002, Bush signed the Sarbanes-Oxley accounting legislation, the biggest expansion of securities regulation since the New Deal,” which did “nothing to lessen the current financial crisis,” Berlau noted.

Berlau added,  “A Brookings-American Enterprise Institute study found that the law has cost the U.S. economy more than $1 trillion in direct and indirect costs.”

Steve Stanek ([email protected]) is a research fellow at The Heartland Institute and managing editor of Budget & Tax News.