Monday, December 12, 2011

The Fed continues to promote opacity in the financial system

Bloomberg ran an article that asked the question of who was the ultimate borrower from the Fed's central bank swap facilities.

As regular readers know and Joseph Stiglitz, a Nobel prize winning economist, observed

the “fundamental problem” is that capital markets need information to work properly, yet the Fed is saying, “we believe in capital-market discipline without information.”
Please re-read Professor Stiglitz comment as it is one of the central themes that your humble blogger has been discussing since before the beginning of the solvency crisis on August 9, 2007.

This comment does not just apply to the Fed's central bank swap facilities.  It applies to every interaction between the Fed and the financial system including loans to the banks under all the various Fed programs as well as to regulatory oversight of the banks.

For all the transparency forced on the Federal Reserve by Congress and the courts, one of the central bank’s emergency-lending programs remains so secretive that names of borrowers may be hidden from the Fed itself. 
As part of a currency-swap plan active from 2007 to 2010 and revived to fight the European debt crisis, the Fed lends dollars to other central banks, which auction them to local commercial banks. Lending peaked at $586 billion in December 2008. 
While the transactions with other central banks are all disclosed, the Fed doesn’t track where the dollars ultimately end up, and European officials don’t share borrowers’ identities outside the continent. 
The lack of openness may leave the U.S. government and public in the dark on the beneficiaries and potential risks from one of the Fed’s largest crisis-loan programs. 
The European Central Bank’s three-month dollar lending through the swap lines surged last week to $50.7 billion from $400 million after the Nov. 30 announcement that the Fed, in concert with the ECB and four other central banks, lowered the interest rate by a half percentage point. 
“Increased transparency is warranted here,” given the size of the Fed’s aid and current pressures on European banks, said Representative Randy Neugebauer, a Texas Republican who heads the House Financial Services Subcommittee on Oversight and Investigations. 
Whether the U.S. should make disclosure of the recipients a condition of the swap lines is “probably a discussion we need to have,” possibly in a hearing that includes Fed Chairman Ben S. Bernanke, Neugebauer said.

The secrecy surrounding foreign central banks’ emergency lending contrasts with unprecedented transparency at the Fed, which was compelled by the 2010 Dodd-Frank Act and court-upheld Freedom of Information Act requests to release details on more than a dozen programs used to combat the U.S. financial crisis from 2007 through 2010. Bernanke this year began holding regular press conferences and has said he is considering ways to make the Fed’s objectives more clear to the public. 
Michelle Smith, a Fed spokeswoman, said there is “no formal reporting channel” for the identities of borrowers from other central banks, which are the Fed’s only counterparties on the swap lines and assume any credit risk. 
“U.S. taxpayers have never lost a penny” on the program, she said. “Decisions about disclosure by foreign central banks of their financial arrangements with financial institutions in their jurisdictions is an issue for the foreign central banks.”...
Foreign central banks borrowed dollars from the Fed for terms as long as three months in return for euros, pounds and yen. The ECB accounted for 80 percent of total swap-line loans during the mortgage-induced financial crisis, according to the U.S. Government Accountability Office, the congressional auditor. The ECB won’t publicly disclose names of borrowers under any circumstances and doesn’t share the identities outside the 17 euro-area central banks, a spokesman wrote in an e-mail. 
“These banks have a right to enjoy the standard confidentiality attached to banking transactions,” the spokesman wrote. 
In Europe, bank may have the right not to provide ultra transparency.  In the US, banks and regulators lost this right, if they actually ever had it, when taxpayers had to be tapped to deal with the solvency crisis of 2007.
European officials may be concerned that future lending might be inhibited by a “stigma phenomenon” if past borrowers are made public, said Ralph Bryant, former director of the Fed’s international-finance division and now a senior fellow at the Brookings Institution in Washington. The concept is “usually overplayed by people, but it’s not something that’s trivial.”
Actually, the stigma phenomenon was made up by the Fed to justify secrecy over its discount window loans.

If banks were required to provide ultra transparency by disclosing on an on-going basis their current asset, liability and off-balance sheet exposure details, market participants would know exactly how much they were borrowing from the Fed.

When banks are providing ultra transparency, it is fundamentally naive to believe that market participants cannot tell the difference between a solvent and an insolvent bank.  As a result, market participants know exactly how to interpret any Fed lending, whether discount or through some other program, to a bank.

There is no stigma for the bank that receives this money as market participants already know why it is needed.
The Bank of Japan, which tapped 3.9 percent of the aggregate swap dollars according to the GAO, has no plans to publicize borrowers’ identities and declined to comment on whether it shares the names with the Fed, a spokesman said. The Swiss National Bank, which accounted for 4.6 percent, “as a matter of principle” doesn’t publish counterparties, said Walter Meier, a spokesman. 
The Bank of England doesn’t publish details of individual financial institutions’ use of its facilities. Confidence in banks “can best be sustained” if support is disclosed “only when conditions giving rise to potentially systemic disturbance have improved,” it said in its annual report....
There is not a single shred of evidence to support the BoE's claim.  There is nothing.

As this blog and the NY Fed documented, there is considerable evidence that confidence in banks is best sustained through disclosure.  It was disclosure of all the useful, relevant information for depositors, namely an implied 100% guarantee of deposits, that broke the back of the Great Depression and ended bank runs by retail depositors.
Bernanke didn’t know which financial institutions got dollar loans, he said during a July 2009 House Financial Services Committee hearing
Not having the identities would restrict the Fed’s ability to understand the “overall risk exposure of the institutions it’s supervising,” said Robert Eisenbeis, a former research director at the Federal Reserve Bank of Atlanta who’s now chief monetary economist for Sarasota, Florida-based Cumberland Advisors Inc. 
It just doesn't restrict the Fed's ability to understand overall risk, it also restricts market participants ability to assess each bank's risk.

No comments: