Ron Paul for Executor

     

These days, America’s federally compliant, too-big-to-fail financial institutions are hard at work on their living wills. The next time disaster strikes, the authors of the Dodd-Frank reform legislation stipulate, banking behemoths must have plans at the ready to dissolve themselves, rather than have the taxpayers pay to wind them up. The Federal Deposit Insurance Corp. was pushing for such an approach to crisis management even before the 848 pages of HR 4173 landed on the nation’s coffee table this summer with such a startling thud. Don’t worry, Sheila Bair has told the bankers whose deposits her agency insures: It won’t take more than 500 hours to throw together an acceptable submission.

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But we have been thinking: If the likes of Bank of America, J.P. Morgan and Citigroup have to draw up end-of-days contingency plans, what about the central bank that lit the fuse on the bomb that nearly blew up the economy? Surely, it should have to make preparations for its own dissolution, too. Following is a short-form living will for the Federal Reserve. We submit it pro bono.

Actually, it may hearten Chairwoman Bair to know that it takes nothing like 500 hours to draft a suitable plan. Colleague Evan Lorenz was on the job for no more than 90 minutes, and he seems to have hit the highlights, starting with the identity of the Fed’s executor (it’s the Republican congressman from Texas).

Why would the Fed ever have to go out of business? Highly leveraged financial institutions forever wobble on the cusp of disaster, and the Federal Reserve Bank of New York, the largest of the Fed’s 12 satellite banks, is leveraged 71:1. Maybe its management will zig when it ought to zag, and financial problems will overwhelm the parent.

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More likely is that the Fed will encounter insurmountable political difficulties. What might Congress do if the gospel of H. Parker Willis (Grant’s, Sept. 17) took root? Or if the people rose up to protest against the unanticipated consequences of zero-percent interest rates, quantitative easing and improvisational central planning? The Fed came into the world on a wave of Progressive Era reform. Maybe it will leave the world on a wave of modernist, free-market reform.

The Fed is vast and multitasking. It fixes the funds rate, regulates banks, administers the distribution of cash and coinage, clears checks, watches over buried gold at the New York branch, manages assets and lends (as a matter of last resort) to illiquid or even insolvent depository institutions in times of crisis. Shutting down such an enterprise in an orderly fashion will require careful planning, just as Christopher Dodd and Barney Frank were saying.

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As to the funds rate, to which so much econometric research and learned discussion within the Federal Reserve is devoted, we hereby entrust it to the market. As recently as the chairmanship of Paul A. Volcker, it was the supply and demand that set the interest rate. In general, the central-planning remit of the Federal Reserve – nowhere to be found in the enabling legislation – should disappear with the institution that tries (futilely) to discharge it.

No. 2, the regulatory function. The Fed is merely duplicative or triplicative. The FDIC and the Office of the Comptroller of the Currency (not to mention the state banking commissions) do what the Fed does. If the central bank’s voice vanished from the national regulatory choir, who would miss it? Pre-Fed, banks held much more equity capital than they have post-. If the cost of failure were moved squarely back to the officers, directors and shareholders, perhaps the nation could get by with fewer regulators, fewer rules and fewer bailouts. When did the taxpayers vote themselves a first- or second-loss position in the too-big-to-fail capital structure?

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No. 3, the distribution of cash and loose change, and the clearing of checks. Let Brinks handle the cash and Coinstar the pennies, nickels, dimes, quarters and newfangled, base-metal, president-themed dollars. Check clearing? Maybe the Fed’s employees would choose to carry on in a private setting. They could do a management buyout.

Next comes the trove of monetary gold buried underneath the New York Fed on Liberty Street in lower Manhattan. Goldline could assume the guardianship function – marketing, too. Glenn Beck and Monica Crowley would share spokesperson duties.

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The Fed has, of course, been accumulating a mountainous portfolio of mortgage-backed securities, Treasurys and miscellaneous risk assets (the latter, a legacy of the bailout to save Bear Stearns). Blackrock and Pimco already manage the so-called toxic portion of the Fed’s balance sheet. We bequeath the rundown of the investment-grade segment to our friends at Annaly Capital Management (NLY) and Redwood Trust (RWT).

As to the critical lender-of-last-resort function, let the Treasury do it. Having managed the Troubled Asset Relief Program (TARP), Alexander Hamilton’s old department knows all too much about crisis intervention. Come to think of it, in the new, post-Fed world, maybe Treasury could forget what it learned and let insolvent financial institutions go to their just rewards. Better margins for the survivors.

You say that the foregoing is nonsense? Perhaps, but what about the pre-need funeral planning being forced on the big commercial banks? Can you imagine old man Morgan or George F. Baker meekly turning over to the government a set of directions for disassembling their good and liquid and storm-proof banks? It’s a measure of how far down the road of the socialization of credit we have collectively traveled that nothing about the living-will initiative seems especially out of the ordinary. Futile? Yes, perhaps – but not extraordinary. Really, shouldn’t it seem extraordinary?

Reprinted with permission from Grant’s Interest Rate Observer.

October 13, 2010

James Grant, author of Mr. Market Miscalculates, Money of the Mind, The Trouble With Prosperity, and biographies of Bernard Baruch and John Adams, is editor of Grant’s Interest Rate Observer.