How The Federal Reserve System Works

Again -- thanks for all the info. I can see clearly that this is not a simple debate, and there are alot of considerations.

I would tend to disagree with your stance that we should keep the secrecy (reject HR1207) for fear of political pressure. I think that we, as Americans, need to be more responsible with who we elect instead. The politics only become a dangerous game when people stop electing people, and electing parties instead (where we are now). A person can only be elected twice, and would not really be motivated to manipulate markets for reelection -- the people should catch on and not elect that person a second term if they're crooked. Congress' term limits should be capped as well -- that'll take care of that political pressure from them. These are all impossible feats unless the People begin to participate in politics more actively. The problem is that we'll all so disaffected from this fake left/right paradigm, that we don't really care what the politicians do most of the time. So, I agree -- realistically, opening the books exposes the Fed to political pressure, but what's the alternative? Blind trust?
In the end, it's the evils inherent in humans that is the problem. That can never be fixed. To have a government that is trusted by the people, however, I strongly believe we need full transparency. If it's going to cause a problem at the banks that were lent money, then they'll need to consider that price before doing business with the people.
Throughout our history, there as been a grand mistrust of banks. This recent crisis didn't score them any brownie points. In my opinion, they don't deserve our trust, and need to earn it back if they want it. I'm not sure if they can get it back from this generation.
I still don't understand how the Federal Reserve was unprepared for this mess. Like if someone brought in their 2005 R1200GS into my shop, I'd tell them to replace the left tensioner piston with the new style or they're most likely going to break the left chain tensioner...
In other words, it's their job to perform preventative maintenance, and I just don't see how the Fed wasn't prepared for this mess and why they allowed so many banks to fail and save others, seemingly arbitrarily.

You've helped me understand why we don't want to set out on a witchhunt for them, but I still don't trust them.

Your post had nothing to do with this video. The reason for posting videos like these is to point out that the US fake money system is unsustainable.
WAKE THE HELL UP!

I pointed out that the video is not news, it is 13 year old ron paul spam.

Check yourself. Looks like you are the one drinking the koolaide my friend.

Until the majority of the American people realize that the US economic system is fake, this information is news.

and that is where Ron Paul and most of us libertarians differ with him. I do support a separation between church and state and I do support getting the Federal government out of abortion like Dr Paul. Although he and I differ on the state level (which is constitutional), Dr. Paul is about 95% right on with his other issues. It's funny, the ones you are picking on Dr Paul about aren't even libertarian issues as well. You might be more libertarian then you first thought.

This might be a separate topic, but what I'd like to ask you is this: Do you think that people who study "financial economics" or something similar have the ability to remain neutral and criticize the system considering that their education and potential success is based on that very system? Or is is likely that a graduate will accept things they way they are without asking "is this sustainable for future generations?".

Of course we can be objective and independent. The entire point of being a researcher is NOT to accept the status quo. The reason we write papers and collect data and perform tests is so that we can try to reject some part of the current thinking and replace it with something better. That is EXACTLY what we're trained to do.

Granted, a lot of people who go to economics doctoral programs are really mathematicians or computer programmers who do applied math in an economic context. And granted, most people who do go into those programs have a very narrow field of interest, and may not look at the big picture. But there are certainly enough - millions of people - who desperately would love to find new flaws in the system that aren't already known.

So do millions of people who desperately want to find flaws in the system accept that the Federal Reserve is healthy for our economic sustainability? Are they okay with the idea that a few enormously wealthy men created our countries financial institution under a cloud of disguise and secrecy? Is it satisfactory that the Federal Reserve can conjure a staggering amount of money from thin air? I guess I'm more interested in knowing where the hell that currency came from rather than how it moves through the system. Is it sustainable??

@schobiz, we know exactly where it comes from. And you're right, the Federal Reserve simply "prints" money to purchase the bonds that it wants, or it sells bonds to "destroy" money.

There are two objectives to monetary policy. The "dual mandate" is to maintain price stability, and to maximize sustainable employment.

There are other objectives of course. One they don't really talk about, and for good reason, is to prevent third parties from trying to game the monetary policy regimes. They're also in charge of ensuring the health of the banking system, and they do audits and make regulation for banks based on that. Banking regulation is a pretty intense affair managed by lots of regulators, but thats another story.

An independent central bank is accepted as beneficial, because it removes the politics out of monetary policy. Back in the good ol' days, politicians constantly had agendas to cause inflation or deflation or to overheat the economy. For example, if you're in a congressional district that is full of farmers with mortgages, you want high inflation so that its easier for the farmers to pay off their mortgages, but if you represent a district with a bank, you want deflation, so those farmers have to pay you more according to the terms of your mortgage contract. This was a huge political issue in the late 19th century.

Why fiat money? Its easier to control than gold. If you have full gold convertibility, then gold brokers, miners, and jewelers really control the value of the dollar. For example, when Fisk and Gould attempted to corner the gold market, it caused massive repercussions in the financial markets.

Another related issue is the confusion over what is the best level of inflation. Most economists think the answer is around 2%, because inflation encourages you to spend your money faster, it makes your long term debts less onerous, and its a progressive tax on the rich. Under a gold standard, the amount of "high powered money" is controlled by what gold enters circulation through mining, international trade, etc, and there is really no "control." Since banks don't know what level inflation will be, they need to have higher interest rates, cutting off lending and growth and employment.

I have a question. Bernake and the like keep saying HR 1207 a bad thing. What do you think? I don't understand how auditing the Fed is a bad thing, myself.

Second, I saw your other post -- if we do already audit the Fed and it's banks (which I cannot find reference to asset and activity audits, please provide), how come they cannot account for trillions of dollars missing (http://www.youtube.com/watch?v=PXlxBeAvsB8)? Who's fault do you think that is? The auditors, or the Fed? How do you propose correcting this issue and preventing it from occurring again?

Also, I'd like your opinion on how you see us getting out from the $12 trillion of debt the Fed just created for us (http://www.bloomberg.com/apps/news?pid=20601087&sid=armOzfkwtCA4). Is this going to lead to the devaluation of the dollar, and do you see their power as a good thing?

Lastly, you claim the entire video is "malarky," which implies the Mises Institute and Austrian Economics is "malarky" as well, please expand the argument a bit more so that a lowly mechanic can understand... that video seems to make sense to me, as I'm sure it does to many others.

I went to some shitty school called UCLA, and no I don't work for the Fed. That's all that's relevant.

You're right the Fed doesn't disclose who borrows at the discount window, for exactly the same reason that the FDIC doesn't disclose which banks are in trouble. That's all about keeping raiders from gaming the system by causing mass destruction to make a little profit, and preventing bank runs. There should be nothing wrong with publishing those records a year after the fact, but in the current environment, it's just reckless.

Now the second point is more interesting. Being bankrupt doesn't mean you don't have equity, it means you can't pay your debts. So by definition the Fed could make some banks not bankrupt by lending them money, though banks also need a capital cushion that the FDIC, the Fed, and OTS should be carefully monitoring. So far very few banks have gone under (not including non-bank financial institutions), which has been a stabilizing force on the financial sector. If banks are bad today, some of that isn't their fault. If they're still bad next year, it's their fault, and they should disappear.

And I agree that there are legit questions as to who they're lending to, how much, and why. Now this is purely my opinion, but I trust the Fed more than I trust Congress in allocating money for these purposes. Congress usually loses around 30% to waste and cronyism when it handles money, while Fed traders have very sophisticated risk managers. Typically, Fed lending has focused on areas of the lending markets that faced counterparty risks, liquidity risks, and similar, non-market risks to "add oil" where necessary.

I am absolutely certain they screwed some things up. No doubt in my mind. But I am equally certain that they have done better than Treasury or Congress could ever hope to do. Lesser of two evils.

Thanks for asking that, though I don't know how helpful my short comment was.

"I'd like your opinion on how you see us getting out from the $12 trillion of debt the Fed just created for us"

That's an easy one. The Federal Reserve Banks are first and foremost banks. If a bank has a debt, that's because they acquired an asset. If a Federal Reserve Bank conducts open market operations (that is, they buy or sell stuff on the market), they're paying the market price for it. If the Fed is buying an asset because the market is breaking down, that means the price is getting too low for a non-market reason (the guys who would normally be buying it can't because their risk managers said "sell everything, buy nothing till the storm is over"). Thus, the Fed is creating "debt" by buying those assets at below normal market price. So almost certainly, the Fed is going to make a PROFIT off of this, with those profits all being redistributed to 1) banks who own stock in the Reserve Bank (all banks are required to own a share) 2) the US Treasury.

So there's two net results: 1) catastrophe averted and 2) Fed makes money. Both of these are good for the country as a whole, though who benefits most is up for debate.

"if we do already audit the Fed and it's banks (which I cannot find reference to asset and activity audits, please provide), how come they cannot account for trillions of dollars missing"

I can't say I know precisely which facilities (jargon for ways the Fed is legally allowed to give money for things) produced these off balance sheet transactions, but OBTs are not unusual at all in financial organizations. For example, contingent obligations (like insurance, for example) are kept off balance sheet unless there's a solid actuarial method of valuing them. Under GAAP, it's highly industry specific how you account for these types of obligations, so any number of derivative contracts or related instruments could appear as off balance sheet. It doesn't mean that they are liabilities - in fact it means they aren't known to liabilities.

Now, I imagine some of these are under the Foreign Exchange Swap Facility, which lets the Fed enter into currency swaps with a few other foreign central banks, but that I think was maxed at $600 billion in notional terms. The purpose was to help banks who are stuck with one currency more easily get to other currencies.

Some of it may be used to shore up the bottom end of the credit default swap market, especially in the mortgage backed securities market so crucial to keeping thrifts liquid. But the Fed should at least be able to report what markets and types of contracts that trillion in notional capital is in.

Note, a trillion in notional capital is not much real money moving about. For example, a vanilla swap (swapping a fixed rate bond for a floating rate bond) typically has a settlement payment of maybe .1% of the notional capital per year. A trillion in off balance sheet obligations is actually nothing to worry about in the grand scheme of things. Lots of private banks have trillions in off balance sheet transactions.

Hi Bags, thank you for sticking with us for questions. It is becoming clearer to me that we shouldn't be attacking the Fed with fire and pitchforks just yet, but it also seems that alot of it is a matter of opinion rather than fact. For instance, you say that the Fed will make more money from it's $12 trillion investment. Doesn't that assume that those assets regain value?
What if they don't regain value? What if the dollar actually starts to weaken, and that $12 trillion becomes more due to inflation? Does that mean we are headed for the Wiemar Republic with wheelbarrows of cash for bread?
I still don't understand how the Fed could think Ron Paul's audit bill is bad, too. To me it looks good to know how they are spending my hard-earned money. They get to live in upscale marble apartments and drive BMWs, where I get to live in a small house and fix their BMWs.

While you are being helpful with your answers, I still see no evidence that refutes the claims in the video, and I still think that the Fed cannot be trusted. Just hearing Bernake skate around Congress's questions is enough for me to know he's lying. I can tell when people are lying if I can get a good close up of their face. When I was in the military, I was trained for these interrogation techniques. I believe Bernake is lying... whether he's covering something up to protect our nation, or whether he's protecting his banksters buddies remains to be seen.

Could you please comment on the HR1207 bill?

I would also be grateful if you would share your opinion of Austrian economics. It seems there are alot of smart people who say it's a great system and I hear nothing but ridicule for Keynes these days.

All I know is that I'm an honest mechanic, so I get offended when people assume that I will rip them off. However, I won't defend the industry, because I've encountered alot of crooked folks in my 52 years. I can only assume there are parallels with the banking industry. That makes me think the Fed needs to be reexamined. I can be convinced otherwise with enough facts, and if you truly believe the Fed is a good thing, it is your duty as an American to help us lowly blue-collar workers get "edumacated." lol. Thanks again.

I will need to research OBT more and notional capital... might as well have been speaking in Peanuts-Parents. Way over my head. lol

Could you maybe help me and put them in context? For instance, hypothesis why they can't account for that money with a real-world example. If we can see it and say "oh, that's just a quarter in the cushion... an accident that will eventually be found" I think we'll all feel a little better. But honestly your explanation, while I understand your being helpful, is confusing to the layman.

"For instance, you say that the Fed will make more money from it's $12 trillion investment. Doesn't that assume that those assets regain value?
What if they don't regain value? What if the dollar actually starts to weaken, and that $12 trillion becomes more due to inflation? Does that mean we are headed for the Wiemar Republic with wheelbarrows of cash for bread?"

Now, that $12 billion figure wasn't all loans and buying debt (same thing) by the Fed, its distributed across the Fed and the Federal Government. I bet you the Fed gets a much higher rate of return than the Federal Government does on its investment.

The Federal Reserve controls inflation, so they get to chose how much they lose from it. Last I checked, we're in deflation - banks are reducing lending, which decreases the money supply. Deflation just makes the Fed's position more profitable, but in general deflation is a VERY BAD THING. Google "deflationary spiral." Much safer to have inflation.

Of course some of the loans will default, and others will make huge profits. The key risk factor for the value of the Fed's acquired portfolio is the growth of the US economy. Which, incidentally, it has a bit of control over through the interest rate policy. Typically, you have a high growth or low inflation tradeoff, but right now inflation is way too low because of lending contraction. In the long run (12-24 months), we'll be fine, because productivity is still increasing, confidence is increasing, leverage is stable, growth is coming back, and spending will come back up soon. Few banks want to invest in long term risks like that right now, because they may need all their spare cash tomorrow if one of their business partners starts acting weird. This is Fed acting as a 'lender of last resort' - even though other banks would normally love to be able to lend to each other, its in their own best interest to be as conservative as possible when shit is hitting the fan.

It's an interesting question how the Fed will play 2010 and 2011. The Fed needs to get rid of all these loans at some point, and that means selling them to banks, which means destroying money. But banks also have to choose when to make more of their own loans, which means making more money.

The longer the Fed holds these loans, the more money they'll make off it, though making money is not their objective - price stability and full employment are. They'll have to time their sales carefully to destroy any excess liquidity as it pops up because of increased lending. I'd guess it'll take them several years to sell off all these assets, but which ones when is also important.

There's a lot of execution risk there, and moderate inflation (3 or 4%) is certainly possible for a couple years. But I don't expect a 5% inflation year next year. 3% inflation when they expect 2% is a huge deal to banks, not so important to consumers. Hyperinflation is inconceivable with an independent central bank. I'd guess there's less than a 1% chance of 10% inflation in the next few years.

A weak dollar is a completely different issue. "Strength" and "weakness" are relative to other currencies. A strong dollar doesn't really buy more in the long run, it just means more of what you buy is imported. Detroit and the Rust Belt would kill for a weak dollar - American industry has basically been destroyed because of the strong dollar pushing manufacturing overseas. That's an issue of international trade, not Fed policy.

Hi Bags, thanks again. Alot of what you're saying makes sense to me. I have some more questions.

Can you explain why hyperinflation is impossible with a central bank?

Also, how is it justifiable that the Fed charges us interest on the money it lends? For this reason, it seems to me that the US Treasury is a better place to print the money -- interest free. There are ways to keep politics out of it to answer your concerns... just create a Treasury board that mirrors the Fed. Done deal, no? Am I missing something? Why is it good that we pay interest on money that we have rights to print interest-free?

"Could you maybe help me and put them in context?"

Swaps aren't really complicated, so I'll try to break one down for ya. Say you have a mortgage worth $100k, and your interest rate is prime rate, and no amortization, you just pay interest every year, and the $100k back at the tend of 30 yrs. You don't like prime rate, because its a floating rate (like adjustable rate), and it changes every month, and you want more certainty in life. So I say I'll "swap" it for a fixed rate mortgage at 7% or whatever. Then when your adjustable rate is 6.9%, you pay me 7%, and I pay 6.9% to the bank. But if your adjustable rate is 7.1%, you pay me 7%, and I pay 7.1% to the bank. If it's $100k loan, then thats the notional capital of the swap. So in those examples I'd be making or losing .1% on the $100k of notional capital. So I'd really only be making or losing $100 per year, but I have no idea which, so I can't say its an asset and I can't say its a liability. So it stays off my balance sheet. And bam, $100k in off balance sheet transactions.

Of course, I wouldn't agree to take on more risk in the floating interest rate market without expecting to make something off it... you get piece of mind, I now have to watch how the prime rate moves every day.

Credit default swaps are very similar, as they are basically trading a riskless bond (like a Treasury bill) against a risky bond (a form of credit) that may default. So its really more like an insurance policy - if i sell you a CDS on a Lehman Brothers bond, you know that even if Lehman goes bankrupt, you'll still get your money, and since Lehman is a good credit risk, what could possibly go wrong? Sure, theres that one in a hundred chance of the world economy collapsing and Lehman going bankrupt...

Someone asked about the auditing, oversight, and financial statements of the Fed monetary policy. Here's a good place to start:
http://www.federalreserve.gov/monetarypolicy/bst_oversight.htm

Bags -- I thank you once again, and I will stop monopolizing your time. :)

Your example put swaps and credit default swaps in a format I can understand. I now understand why the Fed can't account for all of that money, and the big thing is that it very well could be an honest mistake, and it is not necessarily stolen. I also understand what happened, and why ALL banks across the whole world were affected in that crash... I had some trouble wrapping my brain around that one, as I'm sure many do. The news doesn't really break it down as well as you did. I wouldn't doubt your posts have help many others here, as well.

Please do come back to these discussions involving the Federal Reserve. We need people who fully understand the system to kick us in the head when we start screaming "fire" because we smell smoke. There may be better ways to do things, but I'm not so certain we need to burn down the Fed just yet. We'll wait outside with the pitchforks for a little while longer. :)

ALL the money the Fed lends is MINE. The Debt is mine, therefore the Loan is mine...I have EVERY right to audit them in any manner I see fit. If you want to put a nations monetary system into the hands of a privately owned bank, then I will demand whatever I wish. Never in history has that ever been a good idea. Also this nation was NEVER on a Gold standard, it was on a Gold an SILVER standard. This was a way to insure that the nations money could not be "cornered" in the private market. Since there are so many more people today, one could say with good reason that even a Gold and Silver standard today is too risky, but the concept of having money with actual value instead of perceived value is not a bad one.

"ALL the money the Fed lends is MINE. The Debt is mine, therefore the Loan is mine...I have EVERY right to audit them in any manner I see fit."

Actually, you don't. The Federal Reserve does not belong to the Congress or to the Executive. As a matter of fact, it literally belongs to the banks who pay it to regulate them. The Congress does not give the Federal Reserve money. The Treasury does not give the Federal Reserve money. On the contrary, the Federal Reserve gives the Treasury money, precisely to take the politics out of money.

I know this may seem like bizaroland, but it's true - this is the legal structure that was designed for the Fed by the elected representatives of the people.

Now, the REAL problem with the Fed is that some of the regulations it writes suck. They're too complicated, and in my opinion they let a lot of pure bullshit slide because bank lawyers keep begging for it. For example, have you ever read your credit card contract, or your bank deposit contract? No one has. But we already know we're going to get reamed with stupid fees we don't see coming, and there's little we can do about it.

Of course, the Fed does similar things to its clients, the banks themselves. Reserve requirements, capital adequacy standards, check clearance systems, etc... fine here, fine there... Banking is very legal intensive because of the very complex regulation surrounding every possible action. And at least the Fed does its oversight job correctly, if not its regulation writing job. Many, many bank managers would love for the Fed to just go away so they could start raping their customers more.

It's an odd balance, that's for sure.

"I now understand why the Fed can't account for all of that money, and the big thing is that it very well could be an honest mistake, and it is not necessarily stolen."

No, the Fed knows exactly where that money is. They may have a couple trillion dollars, but they know usually down to around a million or so where everything is. They just aren't going to tell you to protect their borrowers.

How would you feel if every time you went to borrow money the whole world got to see the details? "Ooh, $50 on the credit card at Victoria's Secret - it he getting something for his wife, his mistress, or for himself to wear? Oh, a "personal loan" with that high an interest rate? He either is incompetent with his money, or he's developed a coke habit!"

Exactly the same thing would happen, except on a much bigger scale, if the Fed had to disclose how much money it lent to who at what time with what terms. Speculation and rumors and wild betting on this and that, and it would drive the financial system into a panic. It's a bad idea.

IF the debt is mine, the loan is mine. I should clarify that all money the fed "lends" to the US is my debt. I am saying in essence, I am not paying on a debt from a fiat, fractionally lent money without full access to all the books. I don't care what anyone else voted on, I did not vote for that. And I am not bound to a debt that I did not incur.

"I don't care what anyone else voted on, I did not vote for that. And I am not bound to a debt that I did not incur."

Well, I never voted to let Wyoming be a state, but they have two senators who get fewer votes than my LA city councilman. And I never voted for Reagan's weapons programs, or for war in Vietnam, or for Social Security, or for Medicare - things that have accumulated far more debt. Responsibility is part of maturity.

"I should clarify that all money the fed "lends" to the US is my debt."

All money ANYONE lends to the US is your debt.

The true line of argument I think you want is that you don't want to risk the profits that the Federal Reserve creates for the Treasury. For example, the Fed's operations produced $29 billion in profits for the government in 2006 on assets of around $800 billion.

Sure it's News, many people have never heard about this, it is News to them. That's like saying your comment is not a comment, for which it truly is, although a horrible one at that.

sorry mike, some lame video a decade old is not news,

However, the fact that you would claim it is news reveals something about your integrity and judgement..

No, you debating this strawman argument shows your lack of education. Watch everyone, I wouldn't doubt it if this comment gets deleted, she can attack other people's integrity but I cannot call her out for her obvious lack of education.

From Merriam-Webster:

News - previously unknown information, something having a specified influence or effect, matter that is newsworthy

These policies are still in place and completely relevant to today's realm. It's okay uni, I don't expect much from those who blindly and unknowingly support slavery like yourself.

Call me out anytime you want, I have no power to delete your remarks.

The fact that you want to argue that your post is news, is simply ridiculous, juvenile, sophistry.

Now run along, and enjoy your ron paul circle jerk.

Uni - while I respect your fervent dedication to current.com, I find it a little disturbing that you continually make remarks like this. You display signs of intelligence, yet post remarks that have little to no substance and make you look like an elitist bigot. Have you ever explored the idea that your frustration and attitude are a product of a re-occurring self destructive thought process? Just my two cents, which you could probably care less about :)

That's the thing, I don't want to have to respond to your false claims and lies, I don't want to have to defend myself against your slander, but I must. Trust me, I do NOT want to argue with you, it's like arguing with a pile of pee, it stinks. Furthermore, you simply can't stand the fact that we have truth blaring over your slavery lies everyday. Sorry, but if you are going to enslave us, you first will hear us roar for Freedom!

I mean, Ron Paul circle jerk?!?!?.....
as you said.....simply ridiculous, juvenile, sophistry. Thanks for showing us a perfect example of what you describe....once again unknowingly.

circle jerk - group of adolescent males masturbating

you clown are just jerking off to ron paul, there is no discussion, just idol worship and silly slogans.

psychoanalysis aside, my original claim still holds true - this is not news, it is over 10 years old.

Sorry, not a circle jerk, thanks for harming your own credibility with the childish insults. Enjoy your cult of slavery and continue to get upset over articles that are still pertinent today and still hold true just because you don't believe it should be on current.com and they go against your slavery system. Sorry, but we will continue to fight you violent and forceful enslavers until we are dead, no matter how hard you try to censor us and oligopolize industries around us.

This isn't news and uni is spot on.

Unimatrix, are you against or in favor of auditing the Fed? Regardless of whether this is spam or not. Where do you stand on the issue?

The Federal Reserve is audited regularly. Their accounting procedures, reporting procedures, their assets, liabilities, and equity are all publicly reported. Their profits are paid to their shareholding banks and to the Treasury. If you don't think giant banks, the Democratic run Treasury, and the Republican run Treasury have an interest in keeping track of where the money is coming from and going to, you're an idiot.

Furthermore, the Congress already has an official oversight, for example in 2008 there were 35 official hearings where the FRB testified to Congress in open session. The Government Accountability Office (one of the few institutions in Congress anyone has respect for anymore) already DOES audit the Federal Reserve.

The Office of the Inspector General conducts dozens of audits per year of the Federal Reserve, and many other investigations.

Ron Paul has no clue what he is talking about.

UNI: If you could expand upon why you do not feel this is news, I would appreciate it. I am aware of the Ron Paul connection to most things dealing with the Fed today. However, the ideas that Ron Paul talk about outdate even his birth, so I am not sure why everything touching on the Fed is automatically associated with Ron Paul. Myself, I am NOT a Ron Paul supporter, yet I DO support the abolishment of the Fed. Must the two always be intertwined? Or can the issue of the Fed be debated regardless of Ron Paul's views in regards to the institution?