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What Might Be Hidden in the Fed’s Books?


Sen. Bernie Sanders (I-Vt.) wrote the Audit the Fed amendment that was passed by the Senate on Tuesday. (EPA/ZUMApress.com)

On Tuesday, the Senate voted in a landslide to approve the Audit the Fed amendment to Sen. Chris Dodd’s (D-Conn.) financial regulatory reform proposal. Sen. Bernie Sanders (I-Vt.), the author of the amendment, has directed the Government Accountability Office to publish a report on the Fed’s books by Dec. 1, 2010, reviewing in a way that “does not interfere with monetary policy” but does “let the American people know the names of the recipients of over $2,000,000,000,000 in taxpayer assistance.”

[Economy1] But what will the Fed audit be looking for? What might it find? The shortest answer is that the audit will review and post online thus far unpublished details about the Federal Reserve’s emergency lending programs — the alphabet soup of initiatives the Fed created in haste to provide liquidity to and restore confidence in the banking sector during the financial crisis. The programs have garnered criticism as the Fed created them unilaterally, without the input of the Hill, due to the “unusual and exigent circumstance” of the crisis.

Fed audit proponents say some of those programs — most notably, the Fed’s Maiden Lane portfolio of assets bought from Bear Sterns and AIG — might seem questionable or even prove embarrassing under public scrutiny. “The transparency is nonexistent, and the possible taxpayer losses are huge. The Fed should not be in the business of managing these assets. And we’ll finally get to see what they are,” said one Democratic Hill staffer without permission to speak on the record.

The audit is roughly limited to the period of the recession, from Dec. 1, 2007 until the date that the Senate approves the final regulatory reform bill. Most of the Fed audit will be noncontroversial, even if it does make public new details about the Fed’s books. It will include a careful review of the Fed’s straightforward lending programs, each designed to pump liquidity into the market for a different kind of asset. The names are boggling: the asset-backed commercial paper money market mutual fund liquidity facility, the primary dealer credit facility, the commercial paper funding facility, the term securities lending facility. But the idea behind each is simple. Give a low-cost loan for a fixed period of time to a financial firm impacted by the seizing of credit markets. Make sure you require usable collateral for the loan. And therefore help the market while ensuring taxpayers are not on the hook. The majority of these programs sunsetted on Feb. 1, 2010, leaving the Fed’s books with few taxpayer dollars required.

So what will the audit reveal about these programs? Details. Thus far, the Fed has provided only aggregate data about its lending programs. The audit will reveal what banks received what loans, at what interest rate, in return for what collateral as well as when the Fed was paid back. The data for most programs is not expected to prove controversial. But if the Fed continually allowed one bank to post dodgy collateral, or offered beneficial interest rates to big banks but not smaller ones — that could prove questionable and could earn the Fed additional scrutiny as well as criticism.

A few emergency lending programs remain, and those will receive a thorough audit as well. Among them are the term auction facility, which auctions collateralized loans to banks (that is, lends banks cash if they put up bonds, stocks or some other asset in case they cannot pay back the New York Fed) and continues to help ease short-term lending. Its most recent auction, in March, pumped $25 billion into the market.

Another — and a program Fed audit boosters want analyzed closely — is the Term Asset-Backed Securities Loan Facility, or TALF. The program supports the market for financial products backed with streams of income from consumer loans, like student loans, car payments, credit cards and Small Business Administration loans, later expanded to include commercial mortgage-backed securities. When the credit markets seized up during the financial crisis, the market for those asset-backed securities froze as well. The Federal Reserve Bank of New York created the program to lend up to $1 trillion to people looking to buy AAA-rated asset-backed securities, and the largest part of the program closed in March. The facility only ended up issuing around $100 billion in securities and was hailed as a success.

The controversy over TALF stems from a quirk of the program’s design. When the Fed lent money to companies looking to purchase asset-backed securities, it made them put up stocks, bonds or other financial instruments as collateral. The Treasury pledged funds to buy that collateral from the Fed in case the debtors could not repay their loans. But a Government Accountability Office criticized how the Fed and Treasury vetted that collateral and slammed the program as opaque. The report said: “[Treasury] has not developed measures to analyze and publicly report on the potential purchase, management, and sale of such assets. Without such a plan, Treasury cannot measure TALF’s success in meeting its goals.”

Neil Barofsky, the government watchdog for the Treasury’s emergency programs, also criticized TALF for relying on credit ratings agencies to determine which asset-backed securities were AAA. The ratings agencies wildly misrepresented the risk of mortgage-backed securities in the run-up to the financial crisis, Barofsky noted. And the government was trusting them without performing its own due diligence. “Treasury and [Fed] should examine Moody’s assertions and develop mechanisms to ensure that acceptance of collateral in [TALF] is not unduly influenced by the improper incentives to overrate that exist among the rating agencies,” his report argued.

The most controversial part of the audit — indeed, one of the most controversial of the Fed’s programs, full stop — will be the Maiden Lane funds. (Maiden Lane is the street behind the Fed building in New York City.) The Fed created the funds to support the purchase of Bear Sterns by Wall Street giant J.P. Morgan Chase and the winding down of AIG. Maiden Lane I includes assets from Bear Sterns; Maiden Lane II includes AIG’s securities business; and Maiden Lane III includes AIG’s credit default swaps.

Maiden Lane I is the most controversial. The New York Federal Reserve Bank created the fund specifically to back the worst of Bear Sterns’ assets — the ones nobody wanted when the firm was cratering. Many on Wall Street and the Hill contend that the government overpaid for the assets to convince J.P. Morgan to buy up the rest of Bear Sterns, essentially transferring free money to the Wall Street bank. Furthermore, J.P. Morgan’s chief executive officer, Jamie Dimon, was on the board of the New York Fed at the time of the deal.

The uncertainty over the value of the fund — initially and currently — also has garnered Congressional heat. The Fed had promised that it does not expect “any net loss to the Federal Reserve or taxpayers” from Maiden Lane. But Maiden Lane I has declined in value at least 10 percent — and many on the Hill and on Wall Street do not trust the valuation of the assets, which until now have not received Congressional scrutiny. Rep. Darrell Issa (R-Calif.), for instance, has slammed the Fed over Maiden Lane. After it announced losses, he said, “the American people have a right to know what the true value of the assets they now own are and if the people controlling those assets project any further losses that may result from the Federal Reserve’s actions in bailing out Bear Stearns.”

Then, there are Maiden Lane II and III, which purchased around $50 billion of toxic assets from AIG. Most believe that the government overpaid for those assets as well — and the Hill wants more insight into how they are managed. “If the audit only looked at Maiden Lane, it would almost be worth it,” the Hill staffer said.

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