The Federal Reserve Vs. Ron Paul

There is a rumor that has been around Hollywood for decades that some of the greatest silent film comedy scripts were created by screen writers who would bribe wardens at a local insane asylum to allow a patient to sit in on their story meetings. Allegedly, some of the most hilarious moments in the history of comedic cinema came out of ideas from the minds of people who spent all of their time on locked wards. Even the craziest person in the world can give birth to an idea which is both brilliant and intelligible.

Ronald Ernest Paul, MD, is the member of the House of Representatives from the 14th Congressional District of Texas. He has run for President twice, the first time in 1988 as the candidate for the Libertarian Party. Paul is a man of many talents and has, over the course of his career, published newsletters about investing and the “Ron Paul Survival Report.” Paul is also a coin dealer who believes in home schooling. He is, in other words, a picture perfect member of Congress.

Paul came up with the idea some time ago that the activities of the Federal Reserve are conducted in secret and that the public should have the right to know how, when, and to whom the nation’s central bank lends it money.  He has finally convinced enough of his peers about the validity of his concerns.  Now, the Financial Services Committee has approved an amendment to allow government auditors the right to look at the entire balance sheet of the Federal Reserve. Paul’s quest to bring down the Fed has finally gotten to the point at which the Board of Governors needs to be concerned.

Paul’s amendment is part of a larger bill that intends to deal with the consequences that any future failure of large banks might have on the global credit markets. His program for the Fed may set a precedent that will serve as a model for the entire financial services industry.

The Fed’s argument against Paul’s proposal is simple and defensible. The agency keeps important secrets including which large banks need substantial amounts of money during hard times. The public cannot know these details because it would cause a national panic. What if it was common knowledge that Citigroup (NYSE:C) had borrowed $100 billion in emergency funds from the agency? Citi’s stock could lose 90% of its value in a day. The Fed wants to keep secrets to prevent runs on major banks.  The Fed, its defenders would argue, is the home to impartial financial minds that have the best interests of the nation’s credit system at heart. The average person would not be able to stand the strain of watching the agency’s daily high wire act up close, certainly not during a crisis.

Paul’s logic, as it applies to the Fed, will probably end up being part of a banking system overhaul that will tempt Congress to have audits of private banks made public as well. The people who buy stock in Bank of America (NYSE:BAC) have no idea exactly what the firm carries on its balance sheet. The New York Times recently reported that regulators were aware of the toxic assets on the books of many banks. That is a good deal more than their depositors, shareholders, and customers knew. An open audit of all banks, at least the ones traded on the stock exchanges, would have to be filed with the SEC each quarter as part of a 10-Q if transparency becomes the order of the day. That is the logical end of Paul’s thinking, and it is perhaps the only way to prevent another financial system cataclysm from coming.

Public companies and government agencies have a history of defending secrets that goes back to well before the founding of the modern Federal Reserve and SEC. This secrecy is based almost exclusively on the premise that a typical shareholder is too stupid to understand the complexity of balance sheets, cash flow statements, and profit and loss reports. The information has to be put through a sieve before it can be released beyond the CFO’s office and the audit committee of the board of directors.

Paul’s reason for wanting the Federal Reserve to open its kimono is that the public and members of Congress can understand the details of how the agency works without the help of a math, economics, or physics professor. The public and Congress should be able to influence the Fed because it uses public money and may be putting that capital at unnecessary risk.

The flaw in the thinking about an “open Fed” is that most elected officials and average citizens are too stupid to understand the Fed. They don’t have an IQ problem, but they do suffer, in most case, from a lack of education about complex fiscal policy, macroeconomics, and game theories of John Forbes Nash who was himself schizophrenic. In other words, the Federal Reserve management and staff perform a function that most people cannot possibly understand in any detail. Citigroup may need $100 billion for a week. That does not mean it is going out of business, or, if it is, the Fed knows enough to call the Treasury Secretary immediately.

It is not entirely unfair to compare what goes on inside the Federal Reserve with what happens at the CIA, FBI, or some parts of the Defense Department. Secrets are not, in and of themselves wrong, if they protect something  in the national interest. Ron Paul seems to think that nothing is in the national interest except for dismantling the federal government. Whether that is a good idea or not, it simply cannot be done overnight. It may be good to tear some old institutions down, but it rarely helps if there is no plan to replace them with new institutions of substance. Paul wants to raise the nation’s financial mansion and leave a vacant lot. It could be especially dangerous for this to happen, especially in a time of fiscal crisis.

Paul may have some special standing in Washington or in the mind of the public because he has run for President twice, but so did Ross Perot. The Fed has a number of flaws and most of them were revealed during the credit crisis. That is not solved by letting every person in the republic endorse each check that the Fed sends out.

Douglas A. McIntyre