Currency Wars_ The Making of the Next Global Crisis - James Rickards [91]
To these failures of price stability, lender of last resort and unemployment must be added the greatest failure of all: bank regulation. The Financial Crisis Inquiry Commission created by Congress in 2009 to examine the causes of the current financial and economic crisis in the United States heard from more than seven hundred witnesses, examined millions of pages of documents and held extensive hearings in order to reach conclusions about responsibility for the financial crisis that began in 2007. The commission concluded that regulatory failure was a primary cause of the crisis and it laid that failure squarely at the feet of the Fed. The official report reads:
We conclude this crisis was avoidable. The crisis was the result of human action and inaction.... The prime example is the Federal Reserve’s pivotal failure to stem the flow of toxic mortgages, which it could have done by setting prudent mortgage-lending standards. The Federal Reserve was the one entity empowered to do so and it did not.... We conclude widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets. The sentries were not at their posts.... Yet we do not accept the view that regulators lacked the power to protect the financial system. They had ample power in many arenas and they chose not to use it.... The Federal Reserve Bank of New York and other regulators could have clamped down on Citigroup’s excesses in the run-up to the crisis. They did not.... In case after case after case, regulators continued to rate the institutions they oversaw as safe and sound even in the face of mounting troubles.
The report goes on for more than five hundred pages to detail the Fed’s regulatory failures in minute detail. As noted in the excerpt above, all of the Fed’s failures were avoidable.
One last test of Fed competence involves the Fed’s handling of its own balance sheet. The Fed may be a central bank, but it is still a bank with a balance sheet and net worth. A balance sheet has two sides: assets, which are the things owned, and liabilities, which are the things owed to others. Net worth, also called capital, equals the assets minus the liabilities. The Fed’s assets are mostly government securities it buys, and its liabilities are mostly the money it prints to buy them.
As of April 2011, the Fed had a net worth of approximately $60 billion and assets approaching $3 trillion. If the Fed’s assets declined in value by 2 percent, a fairly small event in volatile markets, the 2 percent decline applied to $3 trillion in assets produces a $60 billion loss—enough to wipe out the Fed’s capital. The Fed would then be insolvent. Could this happen? It has happened already, but the Fed does not report it because it is not required to revalue its assets to market value. This situation will come to a head when it comes time to unwind the Fed’s quantitative easing program by selling bonds. The Fed may ignore mark-to-market losses in the short run, but when it sells the bonds, those losses will have to be shown on the books.
The Federal Reserve is well aware of this problem. In 2008, the Fed sent officials to meet with Congress to discuss the possibility of the Fed propping up its balance sheet by issuing its own bonds as the Treasury does now. In 2009, Janet Yellen, then president of the Federal Reserve Bank of San Francisco, went public with this request in a New York speech. Regarding the power to issue the new Fed Bonds, Yellen said, “I would feel happier having it now” and “It would certainly be a nice thing to have.” Yellen seemed eager to get the program under way, and with good reason. The Fed’s lurch toward insolvency was becoming more apparent by the day as it