Thursday, March 31, 2011

29,000 Pages Under the Sea: The New Federal Reserve Loan Disclosures

After thwarting Freedom of Information Act requests by Bloomberg and Fox for over two years, the Federal Reserve today released over 29,000 pages of secret loan documents under court order. The release contains names of financial institutions that borrowed from the discount window during and after the financial crisis, establishing a new precedent in Fed history. 

Public interest in these disclosures is bound to be minimal as it was when details of the emergency lending programs were made public. It will be interesting to note however, if there are political consequences to the new information. I'm certainly not one to place much hope in Congress, but there is a plethora of "American Exceptionalism" floating around and the "China is a currency manipulator" narrative hasn't gotten old yet. Hopefully the reactionaries in Congress will be alarmed by the fact that foreign banks were the recipients of tax-payer-backed loans during the crisis, when credit was scarce for everybody. 
According to Bloomberg, "the New York branch of Bank of China Ltd. was the second-largest borrower from the discount window during a nine-day period in August 2007 as subprime-mortgage defaults first roiled broader markets. The unit of China’s oldest bank borrowed $198 million on Aug. 17 of that month as two Deutsche Bank AG divisions borrowed $1 billion each, according to a document released today, which covered outstanding credit in the period from Aug. 9 through Aug. 17. The firms were the largest borrowers listed." 
The Fed also lent to Arab Banking Corp., a lender part- owned by the Central Bank of Libya. In October 2008, the bank, which was then 29% owned by the Libyan state, borrowed $1.1 billion through the discount window. Curious that we often supply countries with money and arms before we bomb them.

Missing from the release is the collateral the Fed accepted as it expanded the monetary base through discount window lending operations. This half of the equation is vital, revealing the risks involved in all loan activity. If the collateral posted is worth less than 100 cents on the dollar, in the case that a borrowing institution defaults, the loss on that loan is paid for by ordinary tax payers through price inflation. If the loans are backed by good collateral there is no legitimate reason for the public not to know about the details of the loan. The only institutions that care for such secrecy are the banks that like cheap free money and fear public knowledge of how close they are to insolvency, and the Fed that serves to "provide stability" and inflate the money supply. 

And we do indeed have an example of a zombie bank that was kept alive by the Fed.
One bank, Chicago-based Park National, owed the Fed $345 million before regulators shut it down in October 2009, according to data gleaned from a Freedom of Information Act request. Park National had been a constant customer at the window for more than 18 months before it failed, records show. “Solvency is the big issue,” said Arthur Wilmarth, a professor at George Washington University Law School in Washington. “Was the Fed keeping banks alive when they should have died?”
“The Fed really provided an inexpensive source of funding,” Daniel Watts, the former executive vice president at Park National in charge of all business lines, said in a telephone interview. The Federal Deposit Insurance Corp. estimates Park National’s closure cost its insurance fund $656 million. The FDIC typically repays discount window loans in the process of resolving a failed bank.
So it is actually confirmed that the Fed does take losses on loans made through the discount window. But instead the costs aren't passed on to taxpayers through price inflation: They're passed on through the FDIC. This means consumers are either paying higher premiums in fees for the banks to keep the FDIC solvent, or the taxpayers are paying for the FDIC fund through its direct line to the Treasury. 

And of the banks that have failed, eight of them had outstanding discount window loans according to Bloomberg. We also have some insight into the process of establishing a line of credit to the discount window:

First Bank of Idaho in Ketchum established its discount window borrowing program with the San Francisco Fed in May 2008, according to Peter Minford, the former chief financial officer. He said the program “was very easy to administer.”
“Basically, once the line was established, no questions were asked when draws were requested,” said Minford, now president of Data Informatics LLC, a Ketchum, Idaho-based firm that provides accounting software to community banks.
The fight for Fed transparency up until now has been a remarkable one. In 2009, Representative Ron Paul released H.R. 1207 in the House of Representatives and the bill went on to garner support from 320 cosponsors. This was later accompanied by a Rasmussen poll conducted in July of 2009 which showed 75% of Americans supported his proposal to Audit the Federal Reserve. The Fed, along with the Clearing House Association, a group of major U.S. and European banks, continually fought the FOIA requests in the courts. In the spring of 2010, when Dodd-Frank was on the verge of passage, Senator Sanders of Vermont caved in to pressure from the White House, the Fed, and Treasury. He subsequently watered down his proposed Fed audit to a one-time audit of the Fed's emergency lending programs. Resistance to pushes for further disclosure was halted at the request of the Obama Administration. Part of this was due to the fact that all discount window loans made after July 21, 2010 are to be made public after a two year time lag; another result of the Dodd-Frank law. And here we are, with over 29,000 pages of documents detailing loan operations with no idea how large the release would be if it included all transactions with foreign governments, foreign central banks, the IMF, the World Bank, monetary policy functions including open market operations, and all activity engaged in by the Federal Open Market Committee.

Fed apologists as always are at the ready when aiming to protect the secrecy of the central bank.
“The full monty may not be a good thing,” says Frederic Mishkin, a former Fed governor.
“I am concerned that in the next crisis it will be more difficult for the Federal Reserve to play the traditional role of lender of last resort,” said Donald Kohn, former Fed vice chairman and senior fellow at the Brookings Institution in Washington. “Having these names made public, or the threat of having them made public, could well impair the efficacy of a key central bank function in a crisis -- to provide liquidity to avoid fire sales of assets -- because banks will be reluctant to borrow.” 
But as Ron Paul says, independence is just a euphemism for secrecy.  
William Greider, author of the 1989 Fed history “Secrets of the Temple,” says the bank is losing the battle to maintain its mystique. “What has happened in the last three years is the mask has been torn away from the central bank,” he says. “And they can’t put it back on.” 
And there you have it. In July, the GAO is due to release the findings of an audit that is bound to release some further information. But it won't be enough. And we are losing momentum.

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