Crony Capitalism: The Federal Reserve Edition

The Government Accountability Office has just completed its second audit of the Federal Reserve. The report, a summary available here, focuses on “the enormous conflicts of interest that existed at the Federal Reserve during the financial crisis.”

Some of its findings:

• The affiliations of the Federal Reserve’s board of directors with financial firms continue to pose “reputational risks” to the Federal Reserve System.
• The policy of the Federal Reserve to give members of the banking industry the power to both elect and serve on the Federal Reserve’s board of directors creates “an appearance of a conflict of interest.”
• The GAO identified 18 former and current members of the Federal Reserve’s board affiliated with banks and companies that received emergency loans from the Federal Reserve during the financial crisis including General Electric, JP Morgan Chase, and Lehman Brothers.
• There are no restrictions on directors of the Federal Reserve Board from communicating concerns about their respective banks to the staff of the Federal Reserve.
• Many of the Federal Reserve’s board of directors own stock or work directly for banks that are supervised and regulated by the Federal Reserve. These board members oversee the Federal Reserve’s operations including salary and personnel decisions.
• Under current regulations, Fed directors who are employed by the banking industry or own stock in financial institutions can participate in decisions involving how much interest to charge to financial institutions receiving Fed loans; and the approval or disapproval of Federal Reserve credit to healthy banks and banks in “hazardous” condition.
• The Federal Reserve does not publicly disclose its conflict of interest regulations or when it grants waivers to its conflict of interest regulations.
• 21 members of the Federal Reserve’s board of directors were involved in making personnel decisions in the division of supervision and regulation at the Fed.

The GAO included several instances of specific individuals whose membership on the Fed’s board of directors created the appearance of a conflict of interest including:

Stephen Friedman, the former chairman of the New York Fed’s board of directors.

During the end of 2008, the New York Fed approved an application from Goldman Sachs to become a bank holding company giving it access to cheap loans from the Federal Reserve. During this time period, Stephen Friedman, the Chairman of the New York Fed, sat on the Board of Directors of Goldman Sachs, and owned shares in Goldman’s stock, something that was prohibited by the Federal Reserve’s conflict of interest regulations. Mr. Friedman received a waiver from the Fed’s conflict of interest rules in late 2008. This waiver was not publicly disclosed. After Mr. Friedman received this waiver, he continued to purchase stock in Goldman from November 2008 through January of 2009. According to the GAO, the Federal Reserve did not know that Mr. Friedman continued to purchases Goldman’s stock after his waiver was granted.

Jeffrey Immelt, the CEO of General Electric, and board director at the New York Fed

The GAO found that the Federal Reserve Bank of New York consulted with General Electric on the creation of the Commercial Paper Funding Facility established during the financial crisis. The Fed later provided $16 billion in financing to General Electric under this emergency lending program. This occurred while Jeffrey Immelt, the CEO of General Electric, served as a director on the board of the Federal Reserve Bank of New York.

Jamie Dimon, the CEO of JP Morgan Chase and board director at the New York Federal Reserve

Dimon served on the board of the Federal Reserve Bank of New York at the same time that his bank received emergency loans from the Fed and while his bank was used by the Fed as a clearinghouse for the Fed’s emergency lending programs. In March of 2008, the Fed provided JP Morgan Chase with $29 billion in financing to acquire Bear Stearns. During this time period, Jamie Dimon was successful in getting the Fed to provide JP Morgan Chase with an 18-month exemption from risk-based leverage and capital requirements. Dimon also convinced the Fed to take risky mortgage-related assets off of Bear Stearns balance sheet before JP Morgan Chase acquired this troubled investment bank.

You can read the the full GAO report here.

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11 Aftereffects of Operation Twist

Keith Weiner explains:

“Operation Twist” as the financial blogosphere has been calling it, is simple in its mechanics. Sell short duration and buy long duration Treasurys. I am not sure that I believe they will sell anything. They surely do not want the interest rate on the short end of the yield curve to rise, much less for the yield curve to invert! But perhaps demand is so strong that they haven’t had to manipulate short end anyway for months? I don’t know, and they aren’t saying.

By plowing money into the 6-30 year maturities, they will push up bond prices there. Since the interest rate and the bond price are a see-saw, mathematically and rigidly related, this will push down the rate of interest on 6+ year bonds. I would guess that the Fed thinks that this will spur more borrowing and lending. The theory is that with lower rates, businesses will make a case to borrow for new projects (I think they have many reasons not to.) And investors will be forced to take more risk to earn a decent yield. Maybe, but I remain doubtful.

Some of the (unintended?) consequences:

7. Assuming any business does borrow at the new, lower rate, it will have a permanent competitive advantage over its competitors who borrowed at the old, higher rate. The new borrower will either be able to produce the same good at lower cost (due to lower debt service) or be able to attract customers to the new restaurant, hotel, resort, cruise ship, shopping mall, etc. Customers love higher ceilings, lavish landscaping, opulent gilding dripping from the marble columns, etc.

8. Thus capital destruction will continue and accelerate.

9. The process of halving of interest rates will continue. It is just as damaging to go from 1.5% to 0.75% as it was to go from 12% to 6%.

10. Debt accumulation will continue.

11. All, of course, until it cannot continue.

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Disband The Black Caucus

Investors Business Daily shines the light on The Black Caucus.

Founded in 1971 by 13 civil-rights leaders as “the conscience of the Congress,” the caucus has strayed far from its original mission. Now boasting 42 politicians — including some of the most radical and unethical in Congress — it chiefly serves its own interests.

Its lavish annual gala is an unseemly shakedown of corporate donors unwittingly funding a war chest for Marxist causes. While the living conditions of average African-Americans worsen, this elite black power club has empowered and enriched its own.

The group has become an embarrassment not just to the black community and the civil-rights legacy it deigns to uphold, but the Democratic Party from which it draws almost all of its members. It should be disbanded. Here’s a bill of indictment.

And here’s something I learned regarding the disaster called Dodd-Frank:

While under investigation, Waters got a provision added to the Dodd-Frank act exempting minority-owned banks from the new oversight. She also inserted an amendment creating 20 offices of “minority inclusion” at financial agencies including the Federal Reserve. The new diversity cops will enforce minority hiring quotas for regulators.

Very un-politically correct.  Fair assessment?  Read the whole thing and you be the judge.

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