Ron Paul, G.O.P. Loner, Comes In From Cold

WASHINGTON — As virtually all of Washington was declaring WikiLeaks’s disclosures of secret diplomatic cables an act of treason, Representative Ron Paul was applauding the organization for exposing the United States’ “delusional foreign policy.”

For this, the conservative blog RedState dubbed him “Al Qaeda’s favorite member of Congress.”

It was hardly the first time that Mr. Paul had marched to his own beat. During his campaign for the Republican presidential nomination in 2008, he was best remembered for declaring in a debate that the 9/11 attacks were the Muslim world’s response to American military intervention around the globe. A fellow candidate, former Mayor Rudolph W. Giuliani of New York, interrupted and demanded that he take back the words — a request that Mr. Paul refused.

During his 20 years in Congress, Mr. Paul has staked out the lonely end of 434-to-1 votes against legislation that he considers unconstitutional, even on issues as ceremonial as granting Mother Teresa a Congressional Gold Medal. His colleagues have dubbed him “Dr. No,” but his wife will insist that they have the spelling wrong: he is really Dr. Know.

Now it appears others are beginning to credit him with some wisdom — or at least acknowledging his passionate following.

After years of blocking him from a leadership position, Mr. Paul’s fellow Republicans have named him chairman of the House subcommittee on domestic monetary policy, which oversees the Federal Reserve as well as the currency and the valuation of the dollar.

Mr. Paul has strong views on those issues. He has written a book called “End the Fed”; he embraces Austrian economic thought, which holds that the government has no role in regulating the economy; and he advocates a return to the gold standard.

Many of the new Republicans in the next Congress campaigned on precisely the issues that Mr. Paul has been talking about for 40 years: forbidding Congress from any action not explicitly authorized in the Constitution, eliminating entire federal departments as unconstitutional and checking the power of the Fed.

He has been called the “intellectual godfather of the Tea Party,” but he also is the real father of the Tea Party movement’s most high-profile winner, Senator-elect Rand Paul of Kentucky. (The two will be roommates in Ron Paul’s Virginia condominium. “I told him as long as he didn’t expect me to cook,” the elder Mr. Paul said. “I’m not going to take care of him the way his mother did.”)

Republicans had blocked Mr. Paul from leading the monetary policy panel once before, and banking executives reportedly urged them to do so again. But Republicans on Capitol Hill increasingly recognize that Mr. Paul has a following — among his supporters from 2008 and within the Tea Party, which helped the Republicans recapture the House majority by picking up Mr. Paul’s longstanding and highly vocal opposition to the federal debt.

Aides, supporters and television interviewers now use words like “vindicated” to describe him — a term Mr. Paul, a 75-year-old obstetrician with the manner of a country doctor, brushes off.

“I don’t think it’s very personal,” he said in an interview in his office on the Hill, where he has represented the 14th District of Texas on and off since 1976. “People are really worried about what’s happening, so they’re searching, and I think they see that we’ve been offering answers.”

If there is vindication here, Mr. Paul says, it is for Austrian economic theory — an anti-Keynesian model that many mainstream economists consider radical and dismiss as magical thinking.

The theory argues that markets operate properly only when they are unfettered by government regulation and intervention. It holds that the government should not have a central bank or dictate economic or monetary policy. Once the government begins any economic planning, such thinking goes, it ends up making all the economic decisions for its citizens, essentially enslaving them.

The walls of Mr. Paul’s Congressional office are devoid of the usual pictures with presidents and other dignitaries. Instead, there are portraits of Ludwig von Mises and Murray Rothbard, titans of the Austrian school. For years, Mr. Paul would talk about their ideas and eyes would glaze over. But during his presidential campaign, he said he began to notice a glimmer of recognition among those who attended his events, particularly on college campuses.

Mr. Paul now views his exchange with Mr. Giuliani in 2008 as a crucial moment in his drive for more supporters. “A lot of them said, ‘I’d never heard of you, and I liked what you said and I went and checked your voting record and you’d actually voted that way,’ ” he said. “They’d see that the thing that everybody on the House floor considered a liability for 20 years, my single ‘no’ votes, they’d say, ‘He did that himself; he really must believe this.’ ”

His campaign that year attracted a coalition that even he recognizes does not always stand together: young people who liked his advocacy of greater civil liberties and the decriminalization of marijuana; conservatives who nodded at his antidebt message; and others who agreed with his opposition to the Iraq war.

During George W. Bush’s presidency, he was out of favor with the reigning neoconservatives who were alarmed at his anti-interventionism. He still gives many conservatives fits with comments like his praise for WikiLeaks.

And many of those who follow the Fed closely say his ideas are “very strange indeed,” in the words of Lyle E. Gramley, a former governor of the Fed who is now a senior economic adviser at the Potomac Research Group. “I don’t think he understands what central banking is all about,” Mr. Gramley said.

Putting such a critic of the Federal Reserve chairman, Ben S. Bernanke, in such a prominent role, he added, could damage economic confidence.

“The public doesn’t understand how serious the problem was and why the Fed had to take the action it did,” Mr. Gramley said. “Having someone in Congress taking shots at the Fed makes the situation uneasy.”

Still, Mr. Paul says, his colleagues respect his following outside Washington. “I was on the House floor today,” he said, “and somebody I don’t know real well, another Republican, he was talking to two other members, and he knew I was listening. He pointed at me and said, ‘That guy has more bumper stickers in my district than I do!’ ”

Interview requests are so common that Mr. Paul has set up a camera and studio backdrop in his district office to save him the hour’s drive to television stations in Houston.

His bill demanding a full audit of the Fed, which he had unsuccessfully pushed for years, attracted 320 co-sponsors in the House this year.

And the lunches that he has held in his office every Thursday, where lawmakers can meet intellectuals and policymakers who embrace Austrian economics, have become more crowded, drawing Tea Party celebrities like Congresswoman Michele Bachmann of Minnesota.

“For a long time, a lot of people in Congress on both sides of the aisle agreed with Ron a lot of the time but felt it wasn’t safe to go there,” said Jesse Benton, a longtime Ron Paul aide who ran Rand Paul’s Senate campaign.

The father is about to gain even greater visibility. He says he will use his new chairmanship to renew his push for a full audit of the Fed and to hold a series of hearings on monetary policy.

On Web sites for Ron Paul fans, there are urgent pleas for a father-son (or son-father) “Paul/Paul 2012” ticket. But in an interview, the senior Mr. Paul seemed taken by surprise by the suggestion of teaming up. While he is bursting-proud of his son, he is not necessarily ready to yield the spotlight: He is pondering another presidential run on his own.

“I’d say it’s at least 50-50 that I’ll run again,” he said, adding that he would look at where the economy is. (Aides add that it would depend a lot on what his wife, Carol, says.)

But for all the ways the Tea Party echoes Mr. Paul on fiscal issues, it is not clear such support would carry over into a presidential campaign. The last time he ran, he won less than 2 percent of the vote, though that was before the Tea Party became a force in politics.

Even many Tea Party conservatives are not on board with Mr. Paul’s beliefs about scaling back the United States military worldwide. And Paul supporters look on the Tea Party with some disdain.

Mr. Paul acknowledged the sometimes competing interests among Tea Party supporters and his fans. “What brings them together is this acceptance that there’s something really wrong, that we’ve spent too much money and government’s too big,” he said.

That, he added, was why he had to work at keeping up his influence, particularly in spreading the word about the cost of foreign interventions.

Still, he noted: “We’re further along than I would have expected in getting our message out in front. I thought I’d be long gone from Congress before anybody would pay much attention.”

\\NEW YORK TIMES

G20 summit agrees to reform IMF

Andrew Walker

Finance ministers from the G20 leading economies have agreed reforms of the International Monetary Fund, giving major developing nations more of a say.

At a meeting in South Korea, they agreed a shift of about 6% of the votes in the IMF towards some of the fast-growing developing countries.

Those nations will also have more seats on the IMF’s Board, while Western Europe will lose two seats.

But the US will retain the veto it has over key decisions.

Such decisions require an 85% vote – Washington holds 17% under the IMF’s weighted voting system.

The ministers also agreed to refrain from competitive devaluations of their currencies and move towards more market-determined currency systems.

‘Currency manipulation’

The talks in the city of Gyeongji come against a background of strains in financial markets which some have called a currency war.

Much of the tension in the currency market is being blamed on the US and China, although it is not clear that either country will be restrained by the latest agreement.

The pressure has been on China to end its policy of holding the yuan down to maintain its competitiveness.

There was, however, no timetable for change in the devaluations agreement, so Beijing has kept to its long-held position that it will reform its currency policy gradually.

In the US, low interest rates and other central bank policies have led many investors to seek higher returns in developing countries, which tends to push their currencies higher, undermining competitiveness.

This is partly a result of policies in the US which mean investors are seeking higher returns elsewhere. US officials would argue the weak dollar is not the result of a deliberate devaluation, but rather a side effect of policies aimed at stimulating the domestic US economy.

It is possible that there will be more dollar weakness: One of the policies behind it – the Federal Reserve boosting the US money supply – might be extended in the next few weeks.

German Economy Minster Rainer Bruederle suggested that US policies, if not reversed, amount indirectly to currency manipulation – an accusation more often levelled at China.

\\BBC NEWS

Minutes Show Fed Leaning Toward New Stimulus

Minutes released by the Fed on Tuesday revealed some of the division among officials over the need for more stimulus.

WASHINGTON — A critical mass of officials at the Federal Reserve appear to favor taking new actions to reinvigorate the lagging recovery in the absence of clear signs of improvement in the economy, according to minutes of the central bank’s last policy meeting.

Minutes released Tuesday of the Sept. 21 meeting of the Federal Open Market Committee, which sets monetary policy, confirmed that a considerable number of officials now “consider it appropriate to take action soon,” given persistently high unemployment and uncomfortably low inflation.

But other Fed officials “saw merit in accumulating further information before reaching a decision,” according to the minutes of the Sept. 21 meeting, which lasted 5 hours and 10 minutes, longer than usual — a sign of the complexity of one of the hardest choices the Fed has faced since the recession began.

Over all, the minutes reaffirmed the “considerable uncertainty” about the outlook for the economy that Fed officials have expressed in recent speeches, many of them since the September meeting.

In essence, the debate is between those who believed the Fed should act “unless the pace of economic recovery strengthened,” and those who thought action was merited “only if the outlook worsened and the odds of deflation increased materially.”

The Fed lowered short-term interest rates to nearly zero in December 2008, and then bought $1.7 trillion in mortgage-backed debt and Treasury securities in an effort to lower long-term rates, a process that ended in March.

Now, with unemployment hovering just below 10 percent and with inflation well below the Fed’s unofficial target of nearly 2 percent, the Fed is considering renewed intervention: creating money to buy long-term Treasury debt. That would put additional downward pressure on long-term rates, making credit even cheaper.

Former Fed officials interviewed Tuesday appeared as divided as the current ones.

“If you lead the horse to water and it won’t drink, just keep adding water and maybe even spike it,” said Robert D. McTeer Jr., a former president of the Federal Reserve Bank of Dallas, and a well-known “dove” on inflation. “You definitely don’t want to take the water away.”

Mr. McTeer said the markets had made too big a deal of the prospect of additional asset purchases. The Fed should pursue the strategy in a gradual and incremental fashion, rather than making it appear to be such a significant decision, he said.

“From the outside it might look like they’re dithering,” he said. “Maybe they are, maybe they’re not. They haven’t done a very good job at communicating.”

H. Robert Heller, a former Fed governor, had the opposite view.

“I would do nothing,” he said, expressing anxiety that the Fed might appear to be “monetizing the debt,” or printing money to make it easier for the government to borrow and spend.

“If they start to monetize the federal debt, they will dig themselves a much deeper hole later on,” he said. “That’s what we learned from the 1970s, when the Fed undertook a very expansionary monetary policy. It took a double recession in the early 1980s to wring inflation out of the economy. We don’t want to repeat that.”

The minutes suggested that Fed officials were fairly unified in some views of the economic outlook. The consensus is that the economy is unlikely to enter another recession but that growth “could be slow for some time.” Most also thought that the recovery would pick up gradually next year.

But that shared assessment did not result in a unified view on whether the Fed should act.

A few Fed officials noted that recoveries trigged by financial crises, like this one, have historically been uneven and slow. But others worried that “the sluggish pace of growth and continued high levels of slack left the economy exposed to potential negative shocks.”

Similarly, some Fed officials have argued that the high unemployment rate might have structural causes: mismatches between the jobs that are available and the skills needed to perform them; an inability of workers to move because their mortgages are greater than the value of their homes; and the effects of extended unemployment benefits.

Other Fed officials argued vigorously against that view, saying that “the current unemployment rate was considerably above levels that could be explained by structural factors alone.” Employment has fallen across a range of industries, job vacancies are low, and demand for goods and services is weak, these officials pointed out.

In general, inflation expectations — which can be critical in influencing price movements — have remained fairly stable, despite recent signs that they are rising. One strategy debated by the Fed was to shape these expectations by being more specific about its desired inflation rate, aiming at a price level rather than an inflation rate, or aiming at a path for the level of gross domestic product, the broadest measure of economic output.

“As a general matter, participants felt that any needed policy accommodation would be most effective if enacted within a framework that was clearly communicated to the public,” the minutes noted.

That communication is expected to continue later this week, when the Fed’s chairman, Ben S. Bernanke, gives a speech Friday at a conference in Boston on how monetary policy should be conducted in a low-inflation environment.

The speech will be Mr. Bernanke’s first major address since August, when he said in a speech at a Kansas City Fed symposium in Jackson Hole, Wyo., that the Fed was open to additional action if warranted.

\\NEW YORK TIMES

Bernanke, Geithner Put Taxpayers On The Hook For Junk Bonds, Told Congress They Were ‘Investment Grade’

Fed Made Taxpayers Unwitting Junk-Bond Buyers

Federal Reserve Chairman Ben S. Bernanke and then-New York Fed President Timothy Geithner told senators on April 3, 2008, that the tens of billions of dollars in “assets” the government agreed to purchase in the rescue of Bear Stearns Cos. were “investment-grade.” They didn’t share everything the Fed knew about the money.

The so-called assets included collateralized debt obligations and mortgage-backed bonds with names like HG-Coll Ltd. 2007-1A that were so distressed, more than $40 million already had been reduced to less than investment-grade by the time the central bankers testified. The government also became the owner of $16 billion of credit-default swaps, and taxpayers wound up guaranteeing high-yield, high-risk junk bonds.

By using its balance sheet to protect an investment bank against failure, the Fed took on the most credit risk in its 96- year history and increased the chance that Americans would be on the hook for billions of dollars as the central bank began insuring Wall Street firms against collapse. The Fed’s secrecy spurred legislation that will require government audits of the Fed bailouts and force the central bank to reveal recipients of emergency credit.

“Either the Fed did not understand the distressed state of some of the assets that it was purchasing from banks and is only now discovering their true value, or it understood that it was buying weak assets and attempted to obscure that fact,” Senator Sherrod Brown, an Ohio Democrat and member of the Senate Banking Committee, said in an e-mail when informed about the credit quality of holdings in the Maiden Lane LLC portfolio. The committee held the April 3 hearing.

Bear Stearns Purchase

Maiden Lane, named for a street bordering the New York Fed’s Manhattan headquarters, was created to hold the assets the central bank acquired to facilitate JPMorgan Chase & Co.’s purchase of Bear Stearns.

The Fed disclosed the Maiden Lane holdings in March after Bloomberg News went to court using the Freedom of Information Act, and the U.S. District Court in New York held that the Fed should release documents related to Bloomberg’s request.

“The Federal Reserve was not straightforward with the American people regarding the risks they were taking with taxpayer money, despite my efforts to obtain such clarity at the time,” U.S. Senator Richard Shelby of Alabama, the Senate Banking Committee’s top Republican, told Bloomberg News. “It is apparent that the Fed withheld from the Congress and the public material information about the condition of these securities.”

Downgraded to Junk

When Bernanke and Geithner testified in April 2008, $42 million of the CDO securities the Fed would eventually buy had been downgraded to junk, data compiled by Bloomberg show. By the time the central bank funded its $28.8 billion loan to Maiden Lane 12 weeks later, about $172 million of such securities the Fed purchased were rated below investment grade, according to data compiled for Bloomberg by Red Pine Advisors LLC, a New York firm specializing in the valuation of complex, illiquid securities.

CDOs bundle assets ranging from mortgage bonds to high- yield loans and divide them into new slices, or tranches, of varying risks. High-yield, or junk, bonds are those rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s.

“As was noted in testimony, all of the cash securities in the Maiden Lane portfolio were investment grade on March 14, 2008, when the deal was agreed to in order to facilitate the acquisition of Bear Stearns and to prevent the systemic consequences of its sudden and disorderly failure,” Michelle Smith, a spokeswoman for the Fed’s Board of Governors, said in an e-mail.

Recover Principal

“The Federal Reserve considered not just credit-rating valuations, which have varied some over time based on economic conditions, but also relied on a separate assessment from an independent investment firm, which advised us that over time, we would likely fully recover our principal and interest,” Smith said. “We continue to expect the loan to Maiden Lane to be fully repaid.”

The Fed valued the loan at $27 billion as of the end of last year, $1.8 billion below the amount that was funded in 2008, according to financial statements audited by Deloitte & Touche LLP.

More than 88 percent of Maiden Lane’s CDO bonds and 78 percent of its non-agency residential mortgage-backed debt are now speculative grade, according to data compiled by Bloomberg based on holdings as of Jan. 29.

Securities, Derivatives

The nonagency home-loan bonds and CDO securities made up about 44 percent of the $74.9 billion in face amount of Maiden Lane’s assets, Fed data show. Maiden Lane also contains commercial real-estate loans and other mortgage debt. The central bank hasn’t released how or at what prices it has valued the securities and derivatives, which are contracts whose values are tied to assets, including stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

Being “investment grade” was a requirement for Maiden Lane’s bonds even after Bernanke and Geithner publicly criticized inflated ratings for helping to cause the financial crisis.

“The complexity of structured credit products, as well as the difficulty of determining the values of some of the underlying assets, led many investors to rely heavily on the evaluations of these products by credit-rating agencies,” Bernanke said in a January 10, 2008, speech in Washington. “However, as subprime-mortgage losses rose to levels that threatened even highly rated tranches, investors began to question the reliability of the credit ratings and became increasingly unwilling to hold these products.”

Princeton, Dartmouth

Members of Congress pressed Bernanke, who received a doctorate in economics from the Massachusetts Institute of Technology and served as chairman of Princeton University’s economics department, and Geithner, a Dartmouth College graduate who earned a master’s degree in economics and East Asian studies from Johns Hopkins University, about the quality of the assets during the April Bear Stearns hearings.

“You’ve got about $30 billion of collateral. And some comments have been made that you feel comfortable because it’s highly rated,” Senator Jack Reed, a Rhode Island Democrat, told Bernanke, according to a transcript. “But a lot of highly rated collateral these days is being subject to questions.”

“Senator, as was mentioned, it is all investment-grade or current performing assets,” Bernanke responded. “We do not know for sure what will transpire,” he said. “But we have engaged an independent investment-advisory firm who gives us reasonable comfort that if we can sell these assets over a period of time that we will recover principal and interest for the American taxpayer.”

Chances for Loss

When asked by Shelby during the hearing what the chances were for a loss, Robert Steel, then the U.S. Treasury undersecretary for domestic finance, said the transaction “was $30 billion, approximately, of collateral, all investment-grade securities, all of them current in interest and principal.”

Steel, who was named deputy mayor for economic development last month by New York City Mayor Michael Bloomberg, declined to comment through Andrew Brent, a spokesman for the mayor’s office. The mayor is founder and majority owner of Bloomberg News parent Bloomberg LP.

Bernanke and Geithner didn’t detail during the hearing that the Fed would expose itself to below-investment-grade assets through credit derivatives it was also acquiring. The $16 billion of credit-default swaps included bets protecting some junk-rated asset-backed securities against default, according to two people familiar with the agreement who declined to be identified because the terms weren’t made public.

‘Related Hedges’

The Fed hasn’t disclosed how much was tied to below- investment-grade debt. Geithner, who is now Treasury secretary, said in an addendum to the text of his remarks only that the Fed was assuming “related hedges,” without elaborating.

Credit-default swaps are used to hedge against losses or to speculate on creditworthiness. The derivatives pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

“I strongly object to the mischaracterization of the portfolio,” Sylvain Raynes, a principal at R&R Consulting in New York, said in an interview. “The ratings that were purportedly investment-grade had long lost their utility” and to call several billion dollars of derivatives “related hedges” is “nonsense” and a “material omission.”

So-called hedges aren’t without risk, said Raynes, who is also co-author of “Elements of Structured Finance,” which was published in May by Oxford University Press. “You can be on the wrong side of a hedge, by definition. Which side are they on?”

Shrinking Holdings

Maiden Lane has been unwinding its credit-default swaps, according to the people familiar with the agreement. The holdings shrank to a face amount of $11.8 billion in December 2008 and $7.3 billion at the end of last year, according to its financial statements.

Of the $7.3 billion, $2.45 billion were contracts guaranteeing debt against default, including $2.1 billion of junk-rated securities. The bank valued the credit swaps it sold at a $1.8 billion loss, according to the 2009 statement.

Overall, Maiden Lane assumed more bets against securities than for them, the people familiar with the agreement said. The market value of its entire swaps book, including more than $3 billion of interest-rate contracts, was $1.13 billion as of Dec. 31, 2009, according to year-end financial statements.

The Senate Banking Committee also called JPMorgan Chief Executive Officer Jamie Dimon to testify on the Bear Stearns deal on April 3, 2008.

Riskier, More Complex

“The assets taken by the Fed consist entirely of loans that are current and rated investment grade,” Dimon said, according to a transcript. “We kept the riskier and more complex securities in the Bear Stearns portfolio for our own account. We did not cherry-pick the assets in the collateral pool.”

If the Fed hadn’t engineered the takeover, “the consequences could have been disastrous,” Dimon said.

JPMorgan didn’t pick the individual securities for Maiden Lane, Geithner said in an annex to his April 2008 testimony. Instead, it selected groups of assets that met criteria set by the central bank, and the Fed and its adviser, New York-based BlackRock Inc., reviewed those assets, according to one of the people familiar with the agreement. As part of the bailout, JPMorgan agreed to absorb the first $1 billion in losses.

Assets, Liabilities

JPMorgan had to weigh how many real-estate assets it could absorb against its existing inventory, Dimon said, adding that the New York-based company acquired about $360 billion of Bear Stearns assets and liabilities in the transaction.

JPMorgan spokesman Justin Perras declined to comment further on Maiden Lane.

“We certainly had doubts at the time: Why wouldn’t JPMorgan want a bunch of AAA assets?” said Mark Calabria, a former Senate Banking Committee staff member who was present at the April 2008 hearings and is now director of financial- regulation studies at the Cato Institute in Washington. “The answer is it was all borderline junk.”

The average CDO security was cut 7.6 grades by Moody’s and 7.3 levels by S&P in the 22 months between the time the Fed funded the loan and April 2010, according to Red Pine.

“That is quite steep,” said Wade Vandegrift, a Red Pine partner. “The default rates and the delinquency rates of these deals were a significant multiple of even the worst-case projections that rating agencies and other people projected.”

Foreclosed Loans

WaMu Asset-Backed Certificates Series 2007-HE1 M2, a $4.1 million mortgage-bond position the Fed acquired, was backed by home loans originated by the subprime-lending unit of Washington Mutual Inc., the Seattle-based thrift that went bankrupt in September 2008. As of March 2008, the month Bear Stearns collapsed, more than 26 percent of the loans were at least 60 days late, in foreclosure or the properties had already been seized, according to data compiled by Bloomberg.

Three weeks after the Fed agreed to the Bear Stearns rescue and four days after Bernanke’s April testimony, Moody’s cut the security to junk. S&P followed a month later and now rates it D.

“It is hardly surprising or particularly newsworthy that the value of” the Maiden Lane “portfolio deteriorated in the midst of the worst financial crisis in generations, but it is unlikely that the taxpayers will lose a dime on the government’s loan,” Treasury spokesman Andrew Williams said in an e-mail. The Congressional Budget Office estimates the Fed will make $200 million on Maiden Lane from inception through 2020.

Demanding Accountability

Billions of dollars in Fed loans — some possibly involving subsidies for the biggest banks and corporations — remain secret, and Congress is demanding more accountability from the Fed than at any time in its history.

House and Senate negotiators agreed on the sweeping Dodd- Frank Wall Street Reform and Consumer Protection Act last week, which requires the Government Accountability Office to audit the Fed’s emergency loans and forces the Fed to reveal recipients of such credit by Dec. 1. The House approved the measure 237-192 yesterday. It awaits approval by the Senate and will then go to President Barack Obama for his signature.

Vermont Senator Bernard Sanders wrote the legislation requiring an audit of Maiden Lane and other credit facilities. The act also would make it more difficult for the Fed to provide emergency loans in the future.

“We need to lift the veil of secrecy at the Federal Reserve,” Sanders, an independent, told Bloomberg News when informed about the credit quality of Maiden Lane’s holdings. “We need a complete and independent audit. The American people have a right to know what the Fed is doing with trillions of their taxpayer dollars.”

\\BLOOMBERG

How did the big banks nearly take down the entire economy and still continue to profit? Nobel Prize-winning economist Joseph Stiglitz explains

The Great American Bank Robbery

The following is Part I of a two-part excerpt from Freefall: America, Free Markets, and the Sinking of the World Economy by Joseph Stiglitz ( W.W. Norton & Co., 2010). Read AlterNet’s recent interview with Stiglitz by Zach Carter.

Bankruptcy is a key feature of capitalism. Firms sometimes are unable to repay what they owe creditors. Financial reorganization has become a fact of life in many industries. The United States is lucky in having a particularly effective way of giving firms a fresh start—Chapter 11 of the bankruptcy code, which has been used repeatedly, for example, by the airlines. Airplanes keep flying; jobs and assets are preserved. Shareholders typically lose everything, and bondholders become the new shareholders. Under new management, and without the burden of debt, the airline can go on. The government plays a limited role in these restructurings: bankruptcy courts make sure that all creditors are treated fairly and that management doesn’t steal the assets of the firm for its own benefits.

Banks differ in one respect: the government has a stake because it insures deposits….The reason the government insures deposits is to preserve the stability of the financial system, which is important to preserving the stability of the economy. But if a bank gets into trouble, the basic procedure should be the same: shareholders lose everything; bondholders become the new shareholders. Often, the value of the bonds is sufficiently great that that is all that needs to be done. For instance, at the time of the bailout, Citibank, the largest American bank, with assets of $2 trillion, had some $350 billion of long-term bonds. Because there are no obligatory payments with equity, if there had been a debt-to-equity conversion, the bank wouldn’t have had to pay the billions and billions of dollars of interest on these bonds. Not having to pay out the billions of dollars of interest puts the bank in much better stead. In such an instance, the role of the government is little different from the oversight role the government plays in the bankruptcy of an ordinary firm.

Sometimes, though, the bank has been so badly managed that what is owed to depositors is greater than the assets of the bank. (This was the case for many of the banks in the savings and loan debacle in the late 1980s and in the current crisis.) Then the government has to come in to honor its commitments to depositors. The government becomes, in effect, the (possibly partial) owner, though typically it tries to sell the bank as soon as it can or find someone to take it over. Because the bankrupt bank has liabilities greater than its assets, the government typically has to pay the acquiring bank to do this, in effect filling the hole in the balance sheet. This process is called conservatorship. Usually the switch in ownership is so seamless that depositors and other customers wouldn’t even know that something had happened unless they read about it in the press. Occasionally, when an appropriate suitor can’t be found quickly, the government runs the bank for a while. (The opponents of conservatorship tried to tarnish this traditional approach by calling it nationalization. Obama suggested that this wasn’t the American way. But he was wrong: conservatorship, including the possibility of temporary government ownership when all else failed, was the traditional approach; the massive government gifts to banks were what was unprecedented. Since even the banks that were taken over by the government were always eventually sold, some suggested that the process be called preprivatization.)Long experience has taught that when banks are at risk of failure, their managers engage in behaviors that risk taxpayers losing even more money. The banks may, for instance, undertake big bets: if they win, they keep the proceeds; if they lose, so what? They would have died anyway. That’s why there are laws saying that when a bank’s capital is low, it should be shut down or put under conservatorship. Bank regulators don’t wait until all of the money is gone. They want to be sure that when a depositor puts his debit card into the ATM and it says, “insufficient funds,” it’s because there are insufficient funds in the account, not insufficient funds in the bank. When the regulators see that a bank has too little money, they put the bank on notice to get more capital, and if it can’t, they take further action of the kind just described.

As the crisis of 2008 gained momentum, the government should have played by the rules of capitalism and forced a financial reorganization. Financial reorganizations—giving a fresh start—are not the end of the world. Indeed, they might represent the beginning of a new world, one in which incentives are better aligned and in which lending is rekindled. Had the government forced a financial restructuring of the banks in the way just described, there would have been little need for taxpayer money, or even further government involvement. Such a conversion increases the overall value of the firm because it reduces the likelihood of bankruptcy, thereby not only saving the high transaction costs of going through bankruptcy but also preserving the value of the ongoing concern. That means that if the shareholders are wiped out and the bondholders become the new “owners,” the bondholders’ long-term prospects are better than they were while the bank remained in limbo, when they were not sure whether it would survive and not sure of either the size or the terms of any government handout.

The bondholders involved in a restructuring would have gotten another gift, at least according to the banks own logic. The bankers claimed that the market was underestimating the true value of the mortgages on their books (and other bank assets). That may have been the case—or it may not have been. If it is not, it is totally unreasonable to make taxpayers bear the cost of the banks’ mistake, but if the assets were really worth as much as the bankers said, then the bondholders would get the upside.

The Obama administration has argued that the big banks are not only too big to fail but also too big to be financially restructured (or, as I refer to it later, “too big to be resolved”), too big to play by the ordinary rules of capitalism. Being too big to be financially restructured means that if the bank is on the brink of failure, there is but one source of money: the taxpayer. And under this novel and unproven doctrine, hundreds of billions have been poured into the financial system.

If it is true that America’s biggest banks are too big to be “resolved,” this has profound implications for our banking system going forward—implications the administration so far has refused to own up to. If, for instance, bondholders are in effect guaranteed because these institutions are too big to be financially restructured, then the market economy can exert no effective discipline on the banks. They get access to cheaper capital than they should, because those providing the capital know that the taxpayers will pick up any losses. If the government is providing a guarantee, whether explicit or implicit, the banks aren’t bearing all the risks associated with each decision they make—the risks borne by markets (shareholders, bondholders) are less than those borne by society as a whole, and so resources will go in the wrong place. Because too-big-to-be-restructured banks have access to funds at lower interest rates than they should, the whole capital market is distorted. They grow at the expense of their smaller rivals, who do not have this guarantee. They can easily come to dominate the financial system, not through greater prowess and ingenuity but because of the tacit government support. It should be clear: these too-big-to-be-restructured banks cannot operate as ordinary market-based banks.

I actually think that all of this discussion about too-big-to-restructured banks was just a ruse. It was a ploy that worked, based on fear-mongering. Just as Bush used 9/11 and the fears of terrorism to justify so much of what he did, the Treasury under both Bush and Obama used 9/15—the day that Lehman collapsed—and the fears of another meltdown as a tool to extract as much as possible for the banks and the bankers that had brought the world to the brink of economic ruin.

The argument is that, if only the Fed and Treasury had rescued Lehman Brothers, the whole crisis would have been avoided. The implication—seemingly taken on board by the Obama administration—is, when in doubt, bail out, and massively so. To skimp is to be penny wise and pound foolish.

But that is the wrong lesson to learn from the Lehman episode. The notion that if only Lehman Brothers had been rescued all would have been fine is sheer nonsense. Lehman Brothers was a consequence, not a cause: it was the consequence of flawed lending practices and inadequate oversight by regulators. Whether Lehman Brothers had or had not been bailed out, the global economy was headed for difficulties. Prior to the crisis, as I have noted, the global economy had been supported by the bubble and excessive borrowing. That game is over—and was already over well before Lehman’s collapse. The collapse almost surely accelerated the whole process of deleveraging; it brought out into the open the long-festering problems, the fact that the banks didn’t know their net worth and knew that accordingly they couldn’t know that of any other firm to whom they might lend. A more orderly process would have imposed fewer costs in the short run, but “counterfactual history” is always problematic.

There are those who believe that it is better to take one’s medicine and be done with it, that a slow unwinding of the excesses would last years longer, with even greater costs. Perhaps, on the other hand, the slow recapitalization of the banks would have occurred faster than the losses would have become apparent. In this view, papering over the losses with dishonest accounting (as in this crisis, as well as in the savings and loan debacle of the 1980s) would be doing more than just providing symptomatic relief. Lowering the fever may actually help in the recovery. A third view holds that Lehman’s collapse actually saved the entire financial system: without it, it would have been difficult to galvanize the political support required to bail out the banks. (It was hard enough to do so after its collapse.)

Even if one agrees that letting Lehman Brothers fail was a mistake, there are many choices between the blank-check approach to saving the banks pursued by the Bush and Obama administrations after September 15 and the approach of Hank Paulson, Ben Bernanke, and Tim Geithner of simply shutting down Lehman Brothers and praying that everything will work out in the end.

The government was obligated to save depositors, but that didn’t mean it had to provide taxpayer money to also save bondholders and shareholders. As noted earlier, standard procedures would have meant that the institution be saved and the shareholders wiped out, with the bondholders becoming the new shareholders. Lehman had no insured depositors; it was an investment bank. But it had something almost equivalent—it borrowed short-term money from the “market” through commercial paper held by money market funds, which acted much like banks. (One can even write checks on these accounts.) That’s why the part of the financial system involving money markets and investment banks is often called the shadow banking system. It arose, in part, to circumvent the regulations imposed on the real banking system—to ensure its safety and stability. Lehman’s collapse induced a run on the shadow banking system, much as there used to be runs on the real banking system before deposit insurance was provided; to stop the run, the government provided insurance to the shadow banking system.

Those opposed to financial restructuring (conservatorship) for the banks that are in trouble say that if the bondholders are not fully protected, a bank’s remaining creditors—those providing short-term funds without a government guarantee—will flee if a restructuring appears imminent. But such a conclusion defies economic logic. If these creditors are rational, they would realize that they benefit enormously from the greater stability of the firm provided by conservatorship and the debt-to-equity conversion. If they were willing to keep their funds in the bank before, they should be even more willing to do so now. And if the government has no confidence in the rationality of these supposedly smart financiers, they could provide a guarantee, though they should charge a premium for it. In the end, the Bush and Obama administrations not only bailed out the shareholders but also provided guarantees. The guarantees effectively eviscerated the argument for the generous treatment of shareholders and long-term bondholders.

Under financial restructuring, there are two big losers. The executives of the banks will almost surely go, and they will be unhappy. The shareholders too will be unhappy, because they will have lost everything. But that is the nature of risk-taking in capitalism—the only justification for the above-normal returns that they enjoyed during the boom is the risk of a loss.

Joseph Stiglitz, a Nobel laureate, is a professor of economics at Columbia University.

//ALTERNET

Ben Bernanke Snaps At Ron Paul Over Wild Accusations (VIDEO)

In an odd exchange this morning at a House Financial Services Committee hearing, Fed Chief Ben Bernanke — who was in Congress to report on the country’s “nascent” economic recovery — fielded a long series of unusual allegations from Ron Paul.

The Texas Republican and former presidential candidate named the Fed in a number of conspiratorial “cover-ups,” accusing the central bank of facilitating cash for Saddam Hussein’s weapons purchases in the 1980s. (Paul also implicated the Fed In Watergate.)

The Fed may also be covertly planning a bailout of Greece, he said. Paul has championed the movement to audit the Federal Reserve.

“These specific allegations you’ve made,” Bernanke responded to laughs, “I think are absolutely bizarre.”

The Fed has “no plans whatsoever to be involved in any foreign bailouts or anything of that sort.”

WATCH the full exchange:

//HUFFINGTONPOST

Bloomberg News files extraordinary lawsuit to crack Fed secrecy around bank bailout

Battle Over the Bailout
By ALAN FEUER

THE critical lawsuit challenging that mystery of finance known as the Bailout started, oddly enough, with a casual newsroom chat.

Mark Pittman, an investigative reporter for Bloomberg News, had filed a Freedom of Information Act request with the Federal Reserve Board, seeking the details of its unprecedented efforts to funnel money to the collapsing banks of Wall Street. Mr. Pittman, sometimes known as Bloomberg’s Yoda for his Jedi-like command of economic issues, had quietly surmised that the Fed was holding tightly to the secrets of the bailout. So he was hardly surprised when, after four months, it had failed to even answer his request. He was nonetheless annoyed. One day, even grumpier than usual, he approached his boss, Amanda Bennett, as she stood talking in the company’s East Side newsroom with an in-house lawyer named Charles Glasser.

“Pittman was this big shlumpy guy and he was wandering around going, ‘Argh argh argh,’ ” Ms. Bennett said recently. “So we asked him, ‘What’s with your FOIA?’ And Mark says — he used some colorful language — ‘They won’t answer us.’ ”

“That was when we all sat down and said, ‘So what do we do? They can’t just get away with not answering us,’ ” Ms. Bennett recalled. “Charles said, ‘You know, I suppose we could just sue the Fed.’ So we went to Matt” — Matthew Winkler, Bloomberg’s executive editor — “and said, ‘What do you think about us suing the Fed?’ ” As she recounted this story, Ms. Bennett punched her left palm with her right fist — precisely, she explained, as Mr. Winkler had. She added, “He loved it.”

That was in September 2008. Just more than a year later, Mr. Pittman, a booming man with a beat reporter’s taste for whiskey, died unexpectedly at age 52. But his cause has persevered. It is now known as Bloomberg L.P. v. Board of Governors of the Federal Reserve, an attempt to unlock the vault of the largest Wall Street rescue plan in decades — or, as the legal briefs put it, to “break down a wall of secrecy” that the Fed has kept in place for nearly two years in its “controversial use of public money to prop up financial institutions.”

Narrowly construed, the suit, filed in November 2008, seeks the release under FOIA of documents called term reports. Those reports contain information about the hundreds of billions of dollars the Federal Reserve lent to banks at the height of the crisis — first through its discount window and then through an acronymic soup of emergency programs with arcane-sounding names like the Primary Dealer Credit Facility and the Term Securities Lending Facility.

While the Fed does customarily release data in the aggregate about its lending — the bank bailout is about $2 trillion, all told — it has always shielded information about specific loans to specific institutions. If released, the documents in this lawsuit would punch directly through that shield: Who got money from the Fed? How much did they get? In exchange for what collateral? And under what terms?

That, said Charles Geisst, a finance professor at Manhattan College, would represent an unparalleled move toward openness. “It would mean that the transparency we now demand from our corporations, for example, would spread up all the way to the Fed,” he said.

In its own briefs, the Fed has argued that such disclosures could “stigmatize” financial institutions by suggesting they were desperately in need of government money and, therefore, weak. In its doomsday scenario, the Fed has worried that these weak banks could be subject to 1930s-style bank runs and that, in the future, even strong banks that were considering taking money might instead retreat in trepidation, preventing the Fed from practicing the already delicate art of monetary policy.

The Fed’s worries grew last summer when the chief federal district judge in Manhattan ruled in favor of Bloomberg News, setting up a showdown last month in the United States Court of Appeals for the Second Circuit. This appellate battle — which includes a similar suit by Fox News that lost in the district court — has quickly become the New York front in a bitter, two-pronged war against the Fed. (In Washington, legislation is pending to force the central bank to undergo an audit.) Indeed, as the lawsuit moved to its next round, its context was expanded by way of interventions and supporting briefs.

Now, two Manhattan tribes appear to be squaring off: On one side are the news media — among them The Associated Press, The Wall Street Journal and The New York Times, which also has a FOIA bailout suit and has agreed to be bound by the Second Circuit ruling. On the other side are the banks — JPMorgan Chase, Citibank, Bank of America and others — which, of course, have fallen in behind the Fed.

MR. Winkler, a slight man who favors bow ties, started his career covering the Fed for The Daily Bond Buyer decades ago. He said Bloomberg has often pursued information by way of litigation. In 1993, for instance, Bloomberg successfully sued the private press clubs of Japan, called kisha clubs, which had prevented it from reporting on the Japanese economy by denying access to the corporate press releases that often came as a benefit of membership. Today, he said, Bloomberg has 156 FOIA requests pending with the United States government.

Nevertheless, the Fed was not a kisha club, and November 2008 was not necessarily a moment to take an aggressive legal stance toward economic policy makers. Things were still quite raw: it had been only two months since the collapse of Lehman Brothers and only two weeks since the Dow Jones industrial average, already down some 2,200 points in seven sessions, dropped nearly 700 more in the opening moments of a single day.

But Mr. Winkler had already chosen to sue, and had so informed Daniel L. Doctoroff, Bloomberg’s president, and Peter T. Grauer, its chairman. Then, along with the outside law firm of Willkie Farr & Gallagher, he sought to write a document that would mirror in its language the vast sweep of recent economic events. Three days after the election of President Obama, his company filed a complaint that read, in part, “The documents that Bloomberg seeks are central to understanding the government’s response to the most cataclysmic financial crisis in America since the Great Depression.”

The complaint accused the Fed of failing to produce the documents and positioned Bloomberg, in a watchdog role, as “the eyes and ears of the public.” It concluded that disclosure of the documents was needed so that taxpayers could be “informed of how the Fed is safeguarding the public’s money.”

Nine months later, on Aug. 24 of last year, Loretta A. Preska, of the United States District Court in Manhattan, ruled for Bloomberg and ordered the Fed to release the documents within five days.

“We got the order and looked it at,” Ms. Bennett said, “and thought, ‘My God, it looks like we won.’ ”

They had — pending an appeal. Two weeks later, the Clearing House Association, a consortium of the world’s largest financial institutions, won the right to join that appeal. In court papers, the Clearing House said that it was seeking to protect “the substantial interests of its members in confidential information that they provided to the Federal Reserve.” It suggested that if the information got out it would cause “serious competitive harm” to the banks in a “period of continued market fragility.”

EVEN a layman understands the fundamental role that information plays in the economy. But what about secrecy? Does it have a place in high finance? The Clearing House and the Fed believe it does.

The Federal Reserve has wrapped itself in secrecy since the turn of the 20th century, when a select group of financiers met at the private Jekyll Island Club off the eastern coast of Georgia and, forgoing last names to preserve their anonymity among the staff, drafted legislation to create a central bank. Its secrecy, of course, persists today, with Ben S. Bernanke, the Federal Reserve chairman, refusing to tell even Congress which banks received government money under the bailout. There is also a heated battle to force the Fed to disclose its role in the controversial attempt to save the insurance giant American International Group.

In its appellate briefs, the Clearing House invoked this tradition of silence. It pointed out that the Federal Reserve Board does release information on its Web site about the total money it gives out, although not about loans to specific banks. Bloomberg News, it maintained, was trying to “upset the board’s longstanding policy against disclosure.”

“Since the Fed was created in 1913, its policy has been to keep information about individual bank borrowing confidential,” Robert Giuffra Jr., the Clearing House’s chief lawyer and a partner at Sullivan & Cromwell, said in a recent interview. “The Freedom of Information Act was created in 1966, which means that it and the Fed have coexisted amicably for 43 years. Now, suddenly, the press plaintiffs in this case want to overturn that balance. They’re saying, ‘Oh no, we have a right to information.’ ”

Mr. Giuffra argues that the open flow of information — while ostensibly a virtue — can, in fact, be dangerous. The Fed’s discount window, which provides money on a short-term emergency basis, is a lender of last resort, as is its alphabet soup of special programs. If depositors or creditors were to find out that a bank had reached the point of needing last resorts, it might be compromised in public. And, as Mr. Giuffra notes in his court papers, “banking history is replete with examples of financial institutions failing when the public loses confidence.”

Indeed, his papers can, at times, sound something like the highlight reel from a financial disaster film. They refer to no fewer than eight bank runs — many large, some small — in recent years, though only two had anything to do with central banks.

One of those institutions was a British bank, Northern Rock, which, he argues, suffered a run in 2007 when the BBC reported that it received emergency funds from the Bank of England. The other was Citibank, which in the 1990s had some runs at its branches in Asia after rumors that it had borrowed from the Fed’s discount window.

Bloomberg maintains that arguments like these are speculative and a form of fear-mongering; that depositors and creditors want — and should get — information about banks they are involved with; and that openness concerning the Fed and its lending actually increases the stability of markets. Thomas Golden, Bloomberg’s lawyer, also pointed out that the Citibank debacle, for one, could be subtly turned around: given the same set of facts, he said, one could argue that when word got out that Citibank was taking money from the Fed, there were no runs at its American branches.

To bolster the case that transparency is not, as the news media would have it, an unfettered good, the Fed and the Clearing House filed affidavits from several Fed employees, each one testifying that banks face a “stigma” when their emergency borrowing habits are known. The Fed wrote that these affidavits, coming as they did from experts on the front lines, were themselves enough to prove its case.

Bloomberg’s lawyers have said that this line of argument smacks vaguely of “father knows best.”

ONE of the abiding oddities of the case is that, after 16 months of litigation, it may change precedent but have little effect on the situation that prompted it. In May 2008, when Mr. Pittman first requested the documents, information about who got money from the Fed (and if they got it despite less than stellar collateral) could have, as the saying goes, moved markets. Now, with the passage of time, that seems less likely.

In that respect, at least, the case has become a principled grudge match. The Clearing House has accused Bloomberg News of wanting the information in order to describe a pointless and divisive horse race between strong banks and weak banks, adding that the information itself, if given out by, say, a bank employee, would quickly bring the F.B.I. to his door. Bloomberg, in turn, has said that it wants the information because getting information is what the news media does, and has accused the Fed of dragging out the process so long that the documents will no longer be of interest.

The Fed, meanwhile, has worried that if the appeals court rules for Bloomberg, then 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.

In the midst of these competing accusations sits the three-judge panel from the Second Circuit, which peppered Mr. Giuffra and the Fed’s lawyer, Matthew Collette, with difficult questions during oral arguments last month. It is notoriously hard to infer judges’ leanings from the questions they ask, but even Mr. Giuffra acknowledged that the panel, which is not likely to rule for several weeks, seemed to take a dim view of some of his points. Among them was his argument that the information in the documents was not the releasable kind generated by the government — in this case, by the Fed — but was instead obtained from “a person,” or the banks, and was therefore private and protected.

Whatever the results, Ms. Bennett and her investigative team have walked away from the experience with their tribal energies revitalized.

“You can’t know how exciting and explosive it’s been,” she said. “This wasn’t some plan where we said, ‘We’re going to file the FOIA, then we’re going to wait, then we’ll check it and our ultimate goal is to sue the Fed.’

“It came up spontaneously. It’s like what it was like 30 years ago. Back in the days when journalism was exciting — really exciting.”

//NEW YORK TIMES