Tuesday, December 6, 2011

Bernanke letter on Fed lending programs confirms need for Fed to be ultra transparent

The Federal Reserve posted a letter from its Chairman, Ben Bernanke, to Congress attempting to explain the Fed's version of its secret lending programs.

The letter confirms the need to end opacity at the Fed and require that the Fed, like the banks it supervises, be required to provide ultra transparency for all of its dealings with the banks.

How does the letter confirm that the Fed should be required to provide ultra transparency for all of its dealings with the banks?

The letter reflects an argument over what should be indisputable historical facts that market participants needed to have at that time if they were to have access to all the useful, relevant information in an appropriate, timely manner for making investment decisions in the banks.

For simplicity sake, I ask the readers to imagine a simple loan database that any lender must have.  The loan database has all the information on the Fed's loan programs in it.  This database would include on a daily basis the name of any borrower, the amount borrowed under each of the programs, the interest rate paid and the date the loan was repaid.

There is nothing in this database that is disputable.  It is all historical facts.

Since the data is in a database, it is easy to share with all market participants so that they can see how much was outstanding in total, by program or by borrower on a daily basis.  

Furthermore, it is easy to see what a borrower's average cost of funds was.  If the Fed truly lent at a premium it should be easy to verify.

As this blog has discussed previously, market participants knew that the banks were and still are insolvent (it is scary if the Fed examiners did not confirm this fact) as solvency is a function of the relationship between the market value of the bank's assets and the book value of its liabilities.  

The moment the Fed adopted regulatory forbearance (think extend and pretend) and supported suspension of mark to market accounting, the Fed confirmed this insolvency.

Hiding the details of the loan programs did not alter this perception of insolvency.  Market participants are not stupid, they knew the banks were overexposed to opaque toxic securities, second mortgages to sub-prime borrowers and commercial real estate loans.  

All the Fed's secretive activities achieved was to highlight the need for banks to provide ultra transparency so that market participants can assess the risk of an investment in a bank again.

This is a lesson that any scholar of the Great Depression should know!

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