Sunday, 14 February 2010

Imaginary Dialogue with a Fed-Secrecy Defender

The make-believe dialogue that follows was inspired by this New York Times story that recaps the events leading up to, and the arguments surrounding, Bloomberg LP vs. Board of Governors of the Federal Reserve. That's Bloomberg's court battle to get the details on a bank bailout that has reached a staggering $2 trillion (according to the Times and, depending on how you count, may be actually a trillion or two higher). Much of the bailout has been cleverly orchestrated by the Fed behind the scenes, so Americans know little of who got what. Bloomberg wants to pierce the veil of secrecy to find out which banks received money, how much, in exchange for what collateral, under what terms.

And the Fed is stonewalling like crazy, fighting this tooth and nail through the court system.

So here's my imaginary dialogue with a Fed-secrecy defender (abbreviated below as "FD"). The parts in bold are taken right from the Times article; other secrecy arguments I have extrapolated on somewhat, in keeping with what I have read so far is the Fed's position.

Me: $2 trillion ... wow. That's a lot of Subway sandwiches. The mother of all bailouts. Seriously, what's the problem with revealing who got what through this hidden bailout?

FD: It's a terrible idea. Such disclosures could stigmatize financial institutions by suggesting they were desperately in need of government money and, therefore, weak.

Me: Hmm. That's an interesting line of defense. Let's make it more concrete. So you're saying disclosure of significant weakness is a bad idea. Sort of like if someone forced you to reveal you just took $3.4 billion of losses. That certainly might give the market the idea you were pretty weak and ripe for a boost from good ol' Uncle Sam.

FD: Right.

Me: Well, take a look at this. This is Citigroup admitting to investors in its 10Q regulatory filing from the second quarter of 2008 that it wrote down $3.4 billion of subprime mortgages. In fact, this entire filing seems to be full of stigmatizing disclosures of various types.

FD: That's different.

Me: Besides, such a "stigma" may be a good thing.

FD: How do you mean?

Me: We keep talking about "moral hazard" in this crisis, as in an actor tends to be more reckless when he knows somebody else will pick up the tab for his mistakes. So maybe a little "stigma" is a way to reduce moral hazard? Banks, realizing the stigma attached to being a recipient of a federal bailout program, will be more cautious and take on less risk next time.

FD: It's not that simple though. The banks, if perceived as weak, could be subject to 1930s-style bank runs.

Me: Oh really? So you'd say we're as vulnerable to bank runs now as we were in the 1930s. Ok, let's take a look. Most of these bank runs you're referring to were from 1929 to 1933. Do you want to guess what happened on Jan. 1, 1934?

FD: I'm not sure.

Me: Insurance of bank deposits took effect through the Temporary Federal Deposit Insurance Fund. Today most Americans know their bank deposits are FDIC-insured up to a generous limit ($250,000 currently). So bank runs are much less of an issue nowadays. And if you recall, all during this financial crisis, the government has thrown its weight behind the financial industry, further soothing anyone who panics easily. Remember the "Stress Tests" for the banks? Team Obama made it clear upfront that no one would be allowed to fail. So the idea of bank runs seems rather far-fetched.

FD: Listen, releasing this information would be a bad idea for other reasons too. Think of the future impact, if there were another crisis and the Fed had to rescue the financial system again! Even strong banks that were considering taking money might instead retreat in trepidation.

Me: Whoa, hold on a second. I'm a little confused. Why are we bailing out strong banks?

FD: Well, you have to be fair and account for the fact that, in the midst of such a crisis, a strong bank may need more capital than it originally set aside.

Me: Then shouldn't it turn to the capital markets?

FD: It may be too expensive to raise the needed funds in the capital markets. It's a credit crisis!

Me: I hate to sound heartless but maybe the "strong bank" just bites the bullet and raises the money the expensive way. Next time it prepares better for a rainy day huh? Or if it really can't raise the funds at all without being in danger of going under, I would question your premise that it's a "strong" bank. Maybe it's only a "strong" bank when the economy is roaring along. And if we rescue this "strong" bank, what signals are we sending to a more conservative bank that is smaller and less profitable only because it avoided taking the risks of the "strong" bank during the boom times?

FD: Nevertheless, I don't think you realize what damage would be caused, making public the specific, detailed information Bloomberg seeks. It would cause serious competitive harm.

Me: And I hate to sound like a broken record but -- one way a bank could avoid that "harm" is not to tap the government's aid programs. Plan better next time, take less risk, and you won't have to grab hold of the Fed lifeline -- and be exposed for doing so.

FD: That's easy to say, but the fact remains, we have to deal with the hand we're dealt.

Me: Okay, then, tell me what's this "serious competitive harm" exactly? Especially when most of the big banks are already drawing assistance from the panoply of Fed programs. How seriously is Citigroup harmed if we learn it's 85 percent on the government teat and Bank of America, its big competitor, is only 79 percent? Say we find out that JPMorgan has $200 million of collateral parked at Fed Loan Facility X. You think JPMorgan is suddenly going to go out of business as investors panic?

FD: You have a naive understanding of markets. We're not talking about just public perception. Savvy traders could quickly get their hands on such data in the future and use it to their advantage even as the government was trying to stabilize the markets.

Me: Okay. Let me ask you something. Have you ever wondered why a company's share price makes a few suspicious-looking spikes in the days running up to an announced merger in which it will be acquired at a premium?

FD: Obviously someone has gotten wind of the deal and is buying the shares to profit from that knowledge.

Me: Exactly. Markets are notoriously leaky. Savvy traders are already hearing things about Fed aid, and figuring out things, and acting on rumors, when it comes to the bets they're making on these banks. But what you have now is imperfect leakage: investors are punishing some banks that shouldn't be punished, others are being punished to an imperfect degree, and yet others are going scot-free when they should be punished.

FD: Well, still, disclosure has the potential to whipsaw the market at a very volatile and sensitive time.

Me: February of 2010? When Bernanke is saying the economy has recovered well enough that we ought to think more seriously about raising interest rates?

FD: No, I'm talking about the height of the crisis naturally.

Me: But the documents would be released now, and this isn't the height of the crisis. And, if the Fed fears timing is an issue going forward -- if it needs to be able to make decisions during times of stress without the immediate scrutiny of the market -- why not work out a time frame that allows a 60-day or 90-day period before disclosures?

FD: You have to admit that if this information were to come to light all at once, it would be terribly disruptive to the markets.

Me: I agree it could be. But why? Because the Fed has sat on so much information, in the dark, for so long -- almost a year and a half. If the Fed had a timetable for periodically releasing details of what it's doing, and with whom, the market would be better able to assimilate the revelations. So when do you advocate that the Fed come clean? Never, right?

FD: Well, you don't understand the Fed's culture. It has a longstanding policy against disclosure.

Me: So that makes it right? Do you support slavery?

FD: Of course not.

Me: Someone in the year 1850 could have argued that the U.S. Constitution had a longstanding "policy" of condoning slavery. The law of the land at the time said that escaped slaves had to be returned to their rightful owners.

FD: Obviously our Founding Fathers got that one wrong. But you don't understand that the Fed needs to be insulated from public opinion to do its job effectively.

Me: Actually I do and I think we need to be sensitive to that issue. But there are other issues too. Such as who watches the Fed? What if a malevolent personality were to be installed as Fed chairman, and the place became a sinkhole of graft and corruption. It seems ridiculous now, but it's certainly not beyond the pale. What body can effectively rein in the Fed? Shouldn't we be a little worried about an agency that engineers a covert $2 trillion bailout, the details of which we know very little about? It seems that the Fed, in return for the latitude that we give it to make decisions about monetary policy, should reward our trust with more transparency.

FD: Well, rant all you will -- you won't win this one. You'll see.

Me: You know something? That's finally something we agree on. I have little faith the Supreme Court will do the right thing. But "won't win" isn't the same as "shouldn't win."