Federal Reserve: Shadow Government

Member Group : Lincoln Institute

Former President Obama declared the financial crisis was the result of fundamental failures in the financial institutions:

"The financial crisis was the result of a fundamental failure from Wall Street to Washington. Some on Wall Street took irresponsible risks that they didn’t fully understand and Washington did not have the authority to properly monitor or constrain risk-taking at the largest firms. When the crisis hit, they did not have the tools to break apart or wind down a failing financial firm without putting the American taxpayer and the entire financial system at risk. Financial reform includes a number of provisions that will curb excessive risk taking and hold Wall Street accountable." (Source: Whit ehouse.gov (under Pres. Obama)

Retired Sen. Dodd and retired Congressman Barney Frank were been quick to blame the banking industry for the housing bubble bursting and responded in kind with the Dodd Frank bill.

Nowhere in that legislation did Congress and the regulatory bodies accept their duplicity in the crisis and rein themselves in. The legislators who passed the bill proclaimed moral outrage at the banking industry and responded with a bill that has since made the big banks even bigger. The Federal Reserve responded with a policy of quantitative easing the likes of which have never been seen before in history.

Unfortunately, the structural financial problems in an economy will never be fully resolved until all parties accept their personal responsibility and accountability for the crisis which ensued.

The Federal Reserve specifically had a direct hand in the crisis of the housing bubble and its eventual bursting which lead to financial meltdown in the economy the effects of which have been felt for almost 10 years.

It is extraordinarily disingenuous for Congress and the regulatory bodies not to accept the responsibility for their role in this crisis.

The Federal Reserve through its CAMELS rating system audits for safety and soundness of the financial institutions and supervises, along with the FDIC and the Office of the Comptroller of the Currency, the banking industry. It is amazing that the federal regulators could pass on the safety and soundness of the very loans of the banks that eventually failed while then blaming the banking industry only.

The Federal Reserve’s own statement on the issue contends:

"The main objective of the supervisory process is to evaluate the overall safety and soundness of the banking organization. This evaluation includes an assessment of the organization’s risk-management systems, financial condition, and compliance with applicable banking laws and regulations. The Federal Reserve works with other federal and state supervisory authorities to ensure the safety and soundness of financial institutions, stability in the financial markets, and fair and equitable treatment of consumers in their financial transactions". (source Federal Reserve)

For instance, the entire process of evaluating and valuing homes based mainly on comparable values is suspect and yet the Federal Reserve and regulators do not seem to understand this weakness which, in part, led to the housing bubble.

It makes sense that appraised values would go up and mortgages would increase during periods of rising home values. It also makes sense that appraised values would go down and mortgages would go underwater during periods of decreasing home values. The danger however is that in a period of declining values the capital of the banks that are making the loans becomes impaired and the banking industry collapses due to the capital structure of bank lending standards.

Quite candidly, if the regulators had done nothing, most home values would have recovered allowing a significant number of the banks that collapsed to have survived.

In a similar vein, the damage that the Federal Reserve has done to the states and to municipalities and their budgets with its policy of quantitative easing is almost incalculable.

Due to the ERISA standards, state and municipal pension funds are invested in a balanced portfolio using the prudent person rule. Therefore during periods of artificially low interest rates returns on bonds are below rates which would normally occur with markets which have not been interfered with.

For Pennsylvania, the losses on the pension funds, due to quantitative easing, are in excess of $15 billion. That same $15 billion is part of the state’s $70 billion of unfunded pension liabilities. Repayment of this deficiency is made up by increasing property taxes and income taxes for the citizens of the Commonwealth.

The damages for the nation for all the states and municipalities would likely to be in excess of $140 billion.

These losses reflect a hidden tax caused by the Federal Reserve and imposed on states and municipalities. The Federal Reserve must be held responsible for covering the losses of some of the bank loan losses due to their duplicity and the policies which created the housing bubble to begin with. Additionally the Federal Reserve should be held liable and responsible for the underperformance of investment assets held by state municipalities due to quantitative easing.

The Federal Reserve and its monetary policies attempt to control the economy while at the same time not knowing all the factors which impact an economy. By doing so the Federal Reserve has interfered with and caused damage to the states and localities in much the same way the Federal Reserve accused the banking industry.

In addition to the damages the Federal Reserve should be required to pay damages to the states and municipalities. The Federal Reserve must also be overhauled to include a formal audit and risk assessment of its financial statements and operating standards to permit greater oversight by the Department of the Treasury and the Department of Justice. Too much is at stake not to rein in this shadow government.

Col. Frank Ryan, CPA, USMCR (Ret) represents the 101st District in the PA House of Representatives. He is a retired Marine Reserve Colonel and served in Iraq and briefly in Afghanistan and specializes in corporate restructuring. He has served on numerous boards of publicly traded and non-profit organizations. He can be reached at [email protected].