Is It Time to Put a Bigger Saddle On the Fed?

Virtually Absolute Power
There is, perhaps, no entity within (and without) our government that is more powerful, unknown, misunderstood, and deliberately obfuscated from the public than the Federal Reserve System.

And, in fact, I would even go as far as to say that the House and Senate, arguably, have greater review powers and control over (and access to) our nation's intelligence agencies than they do over the Federal Reserve.

Proving my point: Here's perhaps one of the most pathetically absurd statements I've ever read relating to the absence of oversight that's led us into this abyss we're referring now to as "our nation's financial woes," from the "Government Regulation and Supervision" section of the Federal Reserve System page in Wikipedia. (See link in paragraph below it.) This is just rich:

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Thanks for clearing that up Mr. Greenspan

Former Federal Reserve Chair Alan Greenspan, perhaps the number one person responsible for getting us into the economic mess we're in now, has really gone and lost it,  at least if his latest quote on, tonight, is accurate: "Greenspan Says U.S. May Not Be Doing Enough to Promote Recovery."

Bloomberg (February 18)--"There is a general belief that somehow we can regulate very complex organizations, and we can't," he said. "What we've got to do is to try to make them more efficient, to put far more capital into these organizations."

The quote, above, came from an interview before a speech Greenspan gave on Tuesday to the Economic Club of New York.

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On the Geithner and TARP II Drama, Kuttner Nails It!

Robert Kuttner, a co-founder of the Economic Policy Institute,  Boston Globe columnist, publisher of American Prospect Magazine, and former investigator for the Senate Committee on Banking, Housing and Urban Affairs, among many other distinguished career achievements, has absolutely nailed it in terms of defining everything that's wrong with the current vague excuse for a TARP II proposal now being put forth to all by U.S. Treasury Secretary Tim Geithner: "What Went Wrong for Tim Geithner."

Along the way to doing this, Kuttner also provides us with some great behind-the-scenes insights as to how this all played out in the Obama administration over the past few days, right down to explaining what happened with that so-called New York Times leak about all of this on Monday night, and on which I blogged earlier in the week (and for which I caught a bit of flack from a few bloggers in denial), as well. Kuttner's narrative and opinions are a great read!

(NOTE: I'm not going to pimp my three or four diaries on all of this which I've published in the past week. But, they're there if you'd like more background.)

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The End of Monetary Policy

I apologize in advance since this post isn't as tight as I'd like it but I've been dwelling on three things this evening, the President-elect's news conference on Monday in Chicago, the expected fed funds rate cut on Tuesday and some comments by Paul Krugman in Germany's Der Spiegel. So with this introduction . . .

Another reduction to the Federal Reserve's funds rate, the interest banks charge each other on overnight loans, is all but certain to be announced tomorrow. The Fed's funds rate is already near historical lows at 1.0% but most economists expect the Federal Reserve to cut the rate in half to 0.5%. Some economists are even pushing for a more aggressive three-quarters of a point reduction. Their argument is that such a cut might cushion some of the economic fallout and prevent a tailspin. Well, I think that's already too late. I think I am sanguine when I say we'll be lucky to lose only 750,000 jobs next year.

My sense is that a fed rate cut is spit in the ocean. Not that I am against the rate cut, it should be cut, but rather that the cut in and of itself isn't likely to spur the American economy much less the global economy. The bitter truth is that we have reached the end of monetary policy as an instrument. To spur the economy, we really waiting on President Obama's fiscal stimulus. Only a Keynesian style investment program is likely to soften the edges of the economic downturn.

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15 yrs Amortization of Wall Street's Cumulative-Losses: Sensible Bailout Formula

This morning we woke up to the news of a government bailout for Citigroup.  A bailout that would have the taxpayer holding the bag for the excesses of some greedy managers who ignored risks and pursued profit at all cost.  The summary of the term of the bailout as outlined below:  

NEW YORK, (Reuters) - The U.S. government moved to bail out Citigroup Inc, agreeing to shoulder most potential losses from $306 billion of its toxic assets and inject $20 billion of new capital, its biggest effort yet to prevent a big bank from failing.......
The $20 billion of U.S. government capital is in addition to $25 billion it injected into the bank last month. The government is buying preferred stock that will pay an 8 percent dividend.
In exchange for the bailout, Citigroup slashed its quarterly dividend to a penny per share from 16 cents. It cannot raise the dividend for three years without U.S. consent.  Even so, taxpayers are now on the hook for nearly $250 billion of losses resulting from the bank's missteps.
"The authorities will do whatever they feel is necessary to ensure that the Great Depression will not return," said Gavin Graham, director of investments at BMO Asset Management in Toronto. "The effect on confidence is too great." Graham manages about $50 billion and owns some Citigroup debt.
Citigroup will absorb the first $29 billion in losses on a $306 billion portfolio of loans and trading assets, plus 10 percent of any additional losses, for a maximum total exposure of nearly $57 billion. Treasury, the Federal Deposit Insurance Corp and the Federal Reserve would absorb the rest.
In return, Treasury and the FDIC will get $27 billion in preferred shares as well as warrants to buy $2.7 billion in Citi common stock at $10.61 per share. m/us_citigroup

I'm not against all bailouts.  I'm against dumb bailouts that privatize profits and nationalize losses; I'm against dumb bailouts that ignore the basic tenets of our market economy.  To the contrary, I like bailouts.  I believe that the Automakers should be bailed out if they present a reasonable plan of actions.

Having done my mandatory ranting, let's move ahead and introduce what I believe would be a novel formula for current and future bailouts of all and any corporation in all or any industry:

It's a 15-20 years amortization of cumulative losses.  This is an accounting tool that would keep private losses private while helping the economic system to stabilize in the long run:  Let's take for example the current Citigroup bailout and re-write it with this model:

Current Bailout Plan and distribution of current and future losses (in Billions):

Total potential losses             $     306 or 100%
Citi's share of the losses     $      57  or    19%
Taxpayers' share of the losses     $     249  or    81%

Proposed Bailout Plan and Distribution of Current and Future Losses:       
Total potential losses             $     306 or    100%
Citi's share of the losses     $     306  or    100%

Let's assume that Citi eventually sold all those assets at $150 billion.  This scenario would result in a $156 billion in losses to Citigroup.  Because Citi might not be in a position to absorb this huge loss in a single year and still maintain a viable business, it is allowed to capitalize it as a long term liability on its book, and amortize the cumulative-losses over a period of 15 years.  In the meantime, the government would give Citi a loan equal to the cumulative-losses ($156 billion) at say 8% as a working capital replacement to help Citi to slowly and methodically absorb the cumulative-losses over 15 years.  This capital replacement would be amortized over the life of the amortizable cumulative-loss, matching loss recognition to Fed-loan repayment.

Potential Taxpayers' bailout contribution in this scenario would be equal to the amount of capital provided to Citigroup to cushion the capital loss from the sales/liquification of the $306 billion assets.

Balance Sheet treatment of this special sale should be as follows:

Credit to $306-billion-asset-account for $306 billion (Asset Sales)   
Debit Cash for $150 billion (Asset)
Debit Amortizable Cumulative losses for $156 Billion (Asset)
Credit Government bailout capital injection $156 billion (liability)    
Debit Cash for $156 (Asset)

Thus the corporation's cash flow would receive a big boost from the transaction; potential liquidity problems solved; and corporate profitability lightly impacted in current period.

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