Commentary—

Bringing The Fed Out Of The Closet

By Ryan Alexander

With the recent US Navy actions off the Somali coast, the public has been understandably interested in pirates. But they missed a sighting in the financial sector. While much of the recent focus has been on Treasury and the congressionally approved bailout package, the Federal Reserve has quietly shipped out a pirate’s chest worth of booty. With the insular and arcane world of the Fed, the public knows little about how decisions are made or even what the potential costs are.

To put it in perspective, the balance sheet of the nation’s bank has ballooned from $825 billion before the financial crisis began to more than $2 trillion today. And that doesn’t capture many of the other activities that could risk trillions more. As recently noted by Federal Reserve Chairman Ben Bernanke, the Fed has “been creative deploying [its] balance sheet” by establishing a multiplicity of new programs and acronyms. You would almost think the Fed has a staffer dedicated to name creation. There are the Commercial Paper Funding Facility, Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, Money Market Investor Funding Facility, and Term Asset-Backed Securities Loan Facility, just to name a few. The Fed is now involved in far-flung activities like backing car, credit card, and mortgage lending — having recently purchased more than $1 trillion in mortgage-backed securities.

But all of that debt-backing carries a risk. With so much money on the street and interest rates near zero, a major concern is that when the economy starts to recover, inflation will run rampant and be difficult to control without an overcorrection that double dips the economy into another recession.

The most anxiety-producing actions, both to the Fed and taxpayers as a whole, have been the direct Federal Reserve interventions in the market. These include easing the acquisition of investment bank Bear Stearns by J.P. Morgan Chase in early 2008, multiple investments into American Insurance Group to ensure its survival, and investments in two of the world’s largest banks, Citigroup and Bank of America. These actions bear the greatest risk — AIG is now 80 percent owned by the US government — and the furthest extension ever of the Fed’s “emergency” powers.

But in each of these cases, the public — and more importantly Congress — was briefed on the actions after the decision was made. And in many cases, the “briefing” was pretty brief.

To be fair, the Fed has lately seen some limits to its powers and seems to be pursuing more openness. It balked at stepping in to save the Big Three automakers, stating that was a Treasury and congressional decision. Public appearances and discussions about Fed strategy have increased. Moreover, the Federal Reserve has put more information about its programs on its website.

Most notably, it described the factors included in its recently announced “stress test” initiative, undertaken to determine the financial health of banks. It remains to be seen how much we will learn, and many analysts see the initiative as laying the groundwork to justify hundreds of billions of additional dollars for bailouts. But at the least, this is a small step in the direction of transparency.

Considering that taxpayers are going to have to walk the fiscal plank if these efforts fail, it is all the more critical for the Fed to be transparent about its decisions and their associated risks. To date, the Fed has largely operated behind closed doors, making the opaque bailout decisionmaking at Treasury look like a paragon of transparency.

(Ms Ryan Alexander is president of Taxpayers for Common Sense, a nonpartisan federal budget watchdog; www.taxpayer.net.)