Willem Buiter Takes Fed and Treasury to Task

Not that they listen to him, sadly. Buiter famously told the Fed in a presentation at its Jackson Hole conference that it was guilty of cognitive regulatory capture.

Buiter argues that the games the Fed and Treasury are playing, with the Fed providing loans and guarantees that properly should come from the Treasury, is bad for accountability and puts Fed independence at risk. The idea of the Fed chief appearing jointly with the Treasury secretary to pitch an initiative to Congress would have been completely unthinkable pre Greenspan. Buiter also argues that if the Fed sustains too much in the way of losses, it will need to go to the Treasury for recapitalization (while it in theory can simply print money, in practice it can undermine monetary policy).

From VoxEU:

The Fed does not have a full indemnity from the US Treasury even for its outright purchases of private securities. It has no guarantee or indemnity for private credit risk assumed as a result of its repo operations and collateralised lending.

For the Fed’s potential $1 trillion exposure to private credit risk through the Term Asset-Backed Securities Loan Facility, for instance, the Treasury only guarantees $100 billion. They call it 10 times leverage. I call it the Fed being potentially in the hole for $900 billion. Similar credit risk exposures have been assumed by the Fed in the commercial paper market, in its purchases of Fannie and Freddie mortgages, in the rescue of AIG, and in a host of other quasi-fiscal rescue operations mounted by the Fed and by the Fed, the Federal Deposit Insurance Corporation, and the US Treasury jointly.

I consider this use of the Federal Reserve as an active (quasi-)fiscal player to be extremely dangerous and highly undesirable from the point of view of the health of the democratic system of government in the US.

There are two reasons for this. First, it undermines the independence of the Fed and turns it into an off-budget and off-balance sheet special purpose vehicle of the US Treasury. Second, it undermines the accountability of the Executive branch of the US Federal government for the use of public resources – taxpayers’ money.

As for the Fed’s independence (whatever independence remains), first, even if the central bank prices the private securities it purchases appropriately (that is, there is no ex ante implicit quasi-fiscal subsidy involved), it is possible that, should the private securities default, the central bank will suffer a capital loss so large that the central bank is incapable of maintaining its solvency on its own without creating central bank money in such quantities that its price stability mandate is at risk. Without a firm guarantee up front that the Federal government will fully re-capitalise the Fed for losses suffered as a result of the Fed’s exposure to private credit risk, the Fed will have to go cap-in-hand to the US Treasury to beg for resources. Even if it gets the resources, there is likely to be a price tag attached – that is, a commitment to pursue the monetary policy desired by the US Treasury, not the monetary policy deemed most appropriate by the Fed.

As regards democratic accountability for the use of public funds, even if the central bank has sufficient capital to weather the capital losses it suffers on its holdings of private securities, the central bank should never put itself into the position of becoming an active quasi-fiscal player or a debt collector. The ex post transfers or subsidies involved in writing down or writing off private assets are (quasi-)fiscal actions that ought to be decided by and accounted for by the fiscal authorities. The central bank can act as a fiscal agent for the government. It should not act as a fiscal principal, outside the normal accountability framework.

The Fed can deny and has denied information to the Congress and to the public that US government departments like the Treasury cannot withhold. The Fed has been stonewalling requests for information about the terms and conditions on which it makes its myriad facilities available to banks and other financial institutions. It even at first refused to reveal which counterparties of AIG had benefited from the rescue packages (now around $170 billion with more to come) granted this rogue investment bank masquerading as an insurance company. The toxic waste from Bear Stearns’ balance sheet has been hidden in some SPV in Delaware.

The opaqueness of the financial operations of the Fed in support of the financial sector (which are expanding in scale and scope at an unprecedented rate) and the lack of accountability for the use of taxpayers’ resources that it entails threaten democratic accountability. Even if it enhances financial stability, which I doubt, democratic legitimacy and accountability are damaged by it, and that is too high a price to pay.

The post also has a very useful discussion of the limitations of the ECB.


Originally published at Naked Capitalism and reproduced here with the author’s permission.

4 Responses to "Willem Buiter Takes Fed and Treasury to Task"

  1. devils advocate   March 26, 2009 at 1:37 pm

    seeing what is going on – which you sum up – is hard to believe- it leaves me aghast with my jaw on the floor and my teeth chatteringthe Groucho Marx Brothers would have fun with the goings on

  2. Mark   March 26, 2009 at 3:20 pm

    Under normal circumstances, the Treasury would be calling the Fed on its inappropriate actions and handing the problem off to the President and Congress for review. But in this case, the Treasury and Fed are colluding to initiate spending programs of unprecedented magnitude and to do so without congressional mandate. We can only hope that our representatives wake up in time to avoid a disaster.

  3. Guest   March 26, 2009 at 9:04 pm

    The exploding Treasury debt is the real problemThe Campaign to Cancel the Washington National Debt by 12/21/2012 through constitutional amendment begins. See our facebook page at http://www.facebook.com/group.php?gid=67594690498&ref=tsWe are also planning to have a booth at FreedomFest 2009, the world’s largest gathering of free minds! July 9–11 http://www.freedomfest.com in Las Vegas. Ron

  4. Guest   March 27, 2009 at 1:01 am

    I think there has been a conflation of the Fed and Treasury because Bernanke has been the sole source of intellectual leadership. His thinking has been behind all the government’s actions since the days of collaboration with Paulson. When, mid-stream in a raging financial crisis, an incoming Administration moved the head of the NY Fed was to Treasury, Treasury became a kind of outpost of the Fed. I don’t think Bernanke or Geithner have any objective other than public service, but it makes sense to both of them to expand the powers of the Fed. I agree strongly that there is a worrisome departure from our democratic traditions in what is happening and more, a tendency to try to save the financial system as we find it rather than question its suitability. Expanded regulatory powers may not translate into greater safety and security. On the contrary, that might be better achieve by a withdrawl of licensing certain activities altogether–let the buyer beware.