Secrecy and Moral Hazard

According to Reuters, the Federal Reserve recently got a stay of a federal district court’s order that the Fed must reveal details about which banks accessed its emergency loan programs during the financial crisis. The arguments on each side are pretty straightforward. Bloomberg, the plaintiff, is arguing that the public has a right to know where their taxpayer money,* via the Federal Reserve, is going. The Fed is arguing that if it reveals the names, that could trigger a run on those banks, because customers will worry about their solvency; it is also arguing that revealing names now will make banks less willing to access emergency lending programs in the future, taking away an important tool in a financial crisis.

I find both of the Fed’s arguments weak.

I agree that immediate revelation of who is borrowing at the discount window (the Fed’s facility for lending to banks directly) could make creditors worry about a bank, triggering the modern version of a bank run. (Traditional bank runs shouldn’t happen because of FDIC insurance.) But we’re talking about things that happened last year, and the government has done everything it can to convince the public that the banking system is sound again. Even if Citigroup borrowed at the discount window last September, the ample bailouts it has received since then should convince any jittery investors that Citigroup isn’t going anywhere.

That is also something that apparently Barney Frank and Ron Paul agree on – any Fed disclosure should be delayed by several months.

The second Fed argument is interesting. Basically it says that if banks need to be bailed out in time of crisis, we want the ability to bail them out in secret. This only weakens the incentives for bank managers to run their companies prudently. Knowing that the Fed will bail me out in times of trouble already creates moral hazard. Knowing that they will bail me out without even my shareholders ever knowing only increases the moral hazard. Where does this stop?

* I know you can argue about whether Fed lending counts as “taxpayer money,” since the Fed is arguably an independent entity. The argument on the other side is that when the Fed lends money to dodgy institutions, the ultimate downside risk is taken either by the taxpayer, or by anyone who has dollar-denominated assets that would be hurt by inflation.

By James Kwak

41 responses to “Secrecy and Moral Hazard

  1. The argument on the other side is that when the Fed lends money to dodgy institutions, the ultimate downside risk is taken either by the taxpayer, or by anyone who has dollar-denominated assets that would be hurt by inflation.

    It is more basic than that… Profits that the Fed earns on its loans are remitted to the Treasury, so any losses against those profits are a straight loss to the taxpayer.

    Actually, it is even more basic than that. The Fed creates U.S. dollars that are “good for all debts, public and private”. Those dollars only have value in the first place because they are the currency in which you can denominate a debt that U.S. courts will enforce.

    In short, it is our currency. The idea that a private institution should have the power to create and throw it around in secret is frankly absurd.

    “Transparency” is the opposite of “secrecy”. You cannot have both.

  2. Lavrenti Beria

    “That is also something that apparently Barney Frank and Ron Paul agree on – any Fed disclosure should be delayed by several months.”

    Worshipped in libertarian environments almost as a kind of demi-god, Ron Paul performs the distinct public disservice of encouraging the illusion that something can and just might be done via parliamentary means meaningfully to fix this irremediable system. Paul is a unconscionable schmendrik, the clarity of certain of his insights on war and imperialism having developed only derivatively. Frank, on the other hand, is simply a frog, an ambitious, self-serving excresence that typifies what the word “congressman” has come to mean. And, of course, both counsel delay, what else? God forbid that the American people might come to possess in any timely way the evidence necessary to jail poseurs like these.

  3. Personally, I think the Fed should give up the information.

    But I doubt the Fed wants secrecy for the sake of secrecy here, and the thought that this information is still worth hiding is pretty disturbing.

    For the information to make market participants less willing to work with a financial institution, the information would have to make market participants view an institution differently in the context of how things are now.

    Either that, or they do not want people to really understand how bad things had become.

    I’ve never really understood the second argument. It seems silly to me to argue that a bank actually has a choice to make between preserving its reputation and surviving.

  4. Honesty – now that is a radical idea, indeed. Forget moral hazard. That there could be a discussion about it is symptomatic enough of our moral decadence.

    In their personal life, most people will agree that “honesty is the best policy.” But honesty in business is seen as a revolutionary concept, is said to be impractical and often equated with failure.

    Honesty in business is more than the absence of fraud; it means that statements and promises about goods and services are accurate, and that misunderstandings are promptly and carefully remedied. Statements that are inaccurate, vague or confusing and actions that do not compare with words are less than honest.

    Nevertheless, media promote the myth that mysteriousness, ruthlessness, and existing solely for profit make good business sense. Deceptive advertising, deceptive pricing and secrecy about employee wages are the norm.

    Proponents of business honesty contend, however, that it is simply a much better way to run a business.

    Being open is the key. Since honesty is harder to detect in business than in people, secrecy is assumed to cover up an attempt to deceive the customer.

    In most restaurants where proud chefs prepare excellent food, for example, patrons who appreciate their food are welcome to enter the kitchen and thank the chef. Where such openness is encouraged, customers get the chance to learn a lot about the nature of the restaurant, especially its cleanliness.

    In a few so-called excellent restaurants, however, patrons are kept out of the kitchen with explanations like: “You will be in the way “, “It is too busy in there”, or “Our insurance does not allow it”. This makes it easy for the customer to imagine that the restaurant is hiding something: a dirty kitchen, frozen food reheated in the microwave or underage staff, perhaps.

    Openness and secrecy are opposites. Openness exposes fraud and deceit: the less open, the more room for dishonesty. An excellent restaurant can survive without letting customers see its kitchen. But a similar restaurant that is open will do much better.

    Thus a closed, secretive business is not automatically dishonest, but keeping your honesty secret is self-defeating. Yet relatively few companies have been prepared to open their books, for example, to employees, customers, and suppliers.

  5. Scot Griffin

    What I don’t understand is how financial institutions that are public companies are not already obligated to file a form 8K when the Federal Reserve bails them out. One would think that a loan that staves off insolvency is a material agreement that requires disclosure. If it isn’t, it should be.

    This brings up an alternative to requiring the Fed to disclose this kind of information. All of the financial institutions that are public companies. If the SEC rules are not explicit enough already, it seems like it would be a lot easier to amend the SEC rules to make the fact of Fed “secret” bailouts something that must be disclosed than it would be to pass entirely new legislation that tries to audit the Fed. In the end, you want to do both, but the SEC rules can be changed right now with much less gnashing of teeth.

  6. “But we’re talking about things that happened last year, and the government has done everything it can to convince the public that the banking system is sound again.”

    Dude, what part of “ignorance is strength” do you not understand?

    “the thought that this information is still worth hiding is pretty disturbing”

    Not as disturbing as having a rat attached to your face, if you get my drift. Stop thinking about this right now.

  7. I never wanted to tell my Dad where the college money went………….but I was overruled.

    My point is those responsible for paying the bill have the right to know.

    I think the taxpayers are “paying the bill” and therefore have the right to know.

  8. So name calling really is smart?

    When keeping people alive by not being the worlds policemen, getting out of the drug war, and revoking the patriot act is unconscionable – we have entered the twlight zone.
    How many life time enemies have we created by bombing their weddings and towns?
    And oh yes, the Fed is so good at thier job that they created the two worst financial disasters of the last 100 years.
    By hey Lavrenti Beria maybe you can keep calling people names.

  9. ‘”Transparency” is the opposite of “secrecy”. You cannot have both.’

    Seems simple, doesn’t it? Now try saying “Democracy without Transparency is not Democracy.”

    First we accepted “National Military Security” as a justification for “our” government hiding what it is doing from us. We are already in the middle of accepting “National Financial Security” as a second justification, adding a much bigger corpus of information to the secrecy. Perhaps the Court (it will make it to the Supremes) will stop this second anti-democratic coup, but they sure facilitated the first one.

  10. So what’s the real reason for the Fed not wanting to disclose names?

  11. By the way if you did a little research Ron Paul (who has been the only one pushing for this bill) and is its sponser and author, said less then a year on holding the informationn from the audit.
    He knows that if a full audit is really done the story of the FED will be changed forever.

  12. Manshu has the right idea, the taxpayer does have the right to know, but it’s a moot point, we really already know the biggest recipients of the emergency loan program , TBTF. The question that worries me is why won’t the Fed really disclose the names and why is there still some K Street mechanism by which these banks prevent the dissemination of this information?

  13. to open their books, for example, to employees, customers, and suppliers.

    let’s not forget shareholders, bankruptcy trustees, government regulators, and outside auditors.

  14. Exactly, it’s time for us as a country to put this in the past and just move on….to the next round of bailouts yey!

  15. The real reason is that the people behind those names are very private retiring sorts of people who are too shy to be named in public.

  16. The argument on the other side is that when the Fed lends money to dodgy institutions, the ultimate downside risk is taken either by the taxpayer, or by anyone who has dollar-denominated assets that would be hurt by inflation.

    Don’t you think the dollar should be renamed to “renminbi” (trans. the people’s money), so that everyone knows to whom the money really belongs?

  17. LOL!

    Sorry for the unrelated link, but I found this interesting story about healthcare in the Atlantic, and thought people here might like to read it.

    http://www.theatlantic.com/doc/200909/health-care/

  18. Lavrenti Beria

    How could I have guessed that you were a Ron Paul devotee before even reading your comment, aldante? Could it be that long experience has taught me that almost any critical remark about Ron Paul posted on the internet will be met with the most furious insecurity by his adolescent band of synchophantic enthusiasts. And to call Paul a schmendrik, a schlemeil, just has to grate on those well nurtured libertarian loyalties in the most incomprehensible of ways. Why the nerve, the cheek!

    I have an announcement for you. Paul’s audit initiative, as noble as it may be in some purist sense, will find its way into the black hole in Congress usually reserved for legislation dangerous to the ruling clique. Guided by an reptile of Frank’s dimensions – I mean who could forget the Steve Gobie business, eh – Paul’s quixotic egoism will find itself and that of his co-sponsors shepparded lemming-like right over the precipice. And if it does survive, the initiative will have been gutted of any meaningful content. That latter process already can be seen as emerging! One can just imagine, then, Paul’s “victory” speech in such circumstances, delivered in a voice suggestive of someone experiencing a manic episode that had managed to inhale a bit too much nitrous oxide. Sorry, my friend, I don’t share your vision of this guy.

  19. This has NOTHING to do with national security. Where is the argument that the general public is better off without information??? This is EXTREMELY dangerous. Maybe even more dangerous than censorship. This is censorship of financial information. IT IS THE IDEOLOGICAL EQUIVALENT OF YOUR BANK TELLING YOU, “YOU DON’T HAVE THE RIGHT TO SEE YOUR CHECKING OR SAVINGS ACCOUNT BALANCE, BECAUSE YOU MIGHT MAKE RASH DECISIONS.”

    If we decide the general public doesn’t have the right to know some types of financial/economic information, where does it end?!?!?! WHO makes these decisions of what we have the right to know and what we DON’T have the right to know??? Ben Bernanke???–the same Bernanke who stood side by side with Greenspan and did nothing while Greenspan was the toast of the town for years taking little chops until the interest rate went to zero???

    Look at housing foreclosures now, look at the employment rate now. We want to trust these guys to hide even MORE information from us??? If Bloomberg loses this court case it is a MAJOR danger sign for America.

  20. It’s one thing to have elected representatives decide, for reasonably supportable policy reasons, to protect certain information (in the middle of the game) that jeopardizes effective governance. It is something else entirely to have an entire powerful institution continuously filter information which creates a deep moral hazard that can have an immense impact on the public weal. I love Ben Bernanke, but I believe that he and the Board of Governors of the Fed must operate within the public view, and be, at least to some extent, subject to the scrutiny of Congress and the President.

    If there are some negative aspects to this, there are slso some negative aspects to all of the theory and practice of democracy. So be it. Maybe it’s time the wonks trusted the citizenry with the ability to judge the prudency of their govenance. I believe it is.

  21. but whenever the Fed influences the Dollar it inevitably influences foreign policy …

    even though I am personally all for openness I can’t imagine foreign policy being possible without secretly exploring the possibilities there are before the red carpets are rolled out
    - even if the US could do it all in the open smaller more wobbly states/governments cannot

  22. There seem to be this charade, this kabuki theater, wherein the socalled MSM and parrot and brute the predatorclass nonesense that America is the land of the free and home of the brave, – that there is justice for all and goodwill towards men, and the rule of law and that quaint thing called the Constitutions that binds us all together, – but the sad reality is that all these myths and fictions are dead and rotting, and only exist on TV, and in the hollow gibberish and chari-vari of the various and sundry talking heads. Seonding Michael, Lavrenti Beria, and Bayard above – {“Transparency” is the opposite of “secrecy”. You cannot have both.’

    Seems simple, doesn’t it? Now try saying “Democracy without Transparency is not Democracy.”} We are no longer living in a democracy. The predatorclass has commandeered total control of the government, and of course these shaitans, thieves, wanton profiteers, and criminals resist “transparency” because it would expose the entire PONZI scheme and render them useless and insolvent, and indeed massive bankruns would ensue – and that – is in fact what the socalled freemarkets would demand! The TBTF oligarchs would swiftly unravel and be dismembered if the truth were told, – so in fact we the people are fed an endless slurry of lies upon lies, wrapped in lies, and sold and bruted as incontravertable truths.

    The predatorclass must be bled, strangled and hanged by the neck until dead for their to be any hope of recovery or any dream of a return to the once more perfect union that was America. I know it’s hard for all the analytical borderline predators to accept, and even the numbnoneness of the Amerikan middleclass is averse to this kind of radical CHANGE, but the only hope for salvaging what little remains of America is forcing, FORCING accountability, the rule of law on the predatorclass, comewhatmay. Out of the ruins, new worlds will rize, and hopefully some worlds with a conscience and real laws again. Then the predatorclass will be kept in its’ place, and never allowed to run amock raping and pillaging the peoples lives and resources. If not – then understand this predators, – in a world where there are no laws – there are no laws for anyone biiiaaatches!!!

  23. I know that Deutsche Bank ran away with 12 bn of the money
    - it can’t have been the only foreign bank to profit to the point that it could refuse to take German bail-out-money
    - maybe “they” want to shield the American taxpayer from the full knowledge of how much of his money went abroad thereby saving money for foreign taxpayers like it probably did for me in the case of Deutsche Bank
    - maybe all foreign banks have not been treated equally fairly which could raise peoples’ anger not only in the US but also in those countries that could claim to have been slighted
    - once one looks on the globe there seem to be lots of possibilities why the Fed wants to stay mum

  24. But surely this (Fed position) is necessary, if you follow the arguments in Gorton (2008), which you posted previously, i.e. the Fed needs to create informationally insensitive debt, a la the clearinghouse in the National Banking era… No?

  25. America is less corrupt than most nations and this is used as a broad excuse for the abuses and secrecy. So stealing a few billion is fine because Wall Street steals less than, say, Marcos did as a percentage of GDP. Kidnapping and torture are okay because we do less of it (and use lower voltage) than, say, Saudi Arabia or Israel. Bribing politicians is fine because it’s not as egregious as in Nigeria or Malaysia.

    There is no Star Chamber, no secret society, no cabal which pulls all the strings. It’s just that the wealthy, ruling elite have the money and, consequently, the power to make things as they want. They act in their best self interests, most of which are aligned.

    There are a few solutions to these problems including either death penalty or life imprisonment for any politician who commits a felony while in office. Treatment of fraud by directors of public corporations as a crime on par with drug dealing, rape, or treason.

    We like to believe we can be one of them one day, or at least our kids might attain nirvana and join the uber-wealthy. We watch CNBC and listen to NAR propaganda. We believe that our stock broker knows what is best for us and that the Wall Street banks let us invest on a level playing field. We drink the Kool-aid and let them run rampant through our private lives and bank accounts.

    I don’t think we can change anything; humans are just too greedy, stupid, and corrupt. But perhaps starting by arresting Bush and Cheney would at least send a message that no one is above the law (that is not a non-sequitur, it serves as a bold example).

  26. “America is less corrupt than most nations and this is used as a broad excuse for the abuses and secrecy.”
    of course that is not fine but it is also not fine when Americans wallow in mea culpas out of all proportion
    example:
    when students at UC Berkeley get told ridiculously blown up facts about America at war.
    As I am not an expert it is hard for me to catch a professor at an obvious falsehood but when all of a sudden she says that the death toll of bombing Dresden was a hundredthousand when even the highest halfway serious figure is 30.000 then I start wondering how biased against their own country these people are. Don’t get me wrong 20.000 which seems to be the actually agreed on figure is still horrible enough to contemplate but to multiply it by five or more than 3 seems to indicate to me that there is a certain pleasure derived from the misinformation or maligning

  27. On pure legal grounds, it’s worth understanding certain aspects of the law. There are 9 fairly broad exemptions to the Freedom of Information Act:

    http://www.sec.gov/foia/nfoia.htm

    At least 1 could serve as a basis for refusal to release information:

    - Contained in or related to examination, operating, or condition reports about financial institutions that the SEC regulates or supervises;

    Those banks that are publicly traded may fall under this exemption… But the Fed doesn’t seem to be making that argument. They are making a broad public interest argument:

    The Fed might be able to make other (more reaching) arguments. “Our argument is that the public interest in disclosure outweighs the banks’ interest in secrecy,” Perhaps they are aiming to protect banks that are not publicly traded as well…

    It’s hard to see how they ever expected that to hold up against FOIA. I’d guess the Fed is simply trying to delay until the crisis has passed enough that the information is no longer as dangerous. Hence the irrevocable harm claim to delay until after appeal, and the note that it will take time to scour NY Fed for records…

    But if the Fed is simply delaying, that’s not necessarily unreasonable. FOIA primarily exists to allow oversight of government. Oversight can be retrospective (within reason). A 2 year delay would not destroy democracy – Bernanke would still be in office (apparently) and the Fed would still be subject to reprimand and restructuring.

    On the public side, consider the following: what benefit do we get from releasing the records NOW instead of 6 to 12 months from now? Not much… the damage is already done, and the Fed isn’t doing much more damage. The harm, however, could be “irreparable”. So the Fed’s argument seem to be on shaky legal ground, but I can’t say I disagree that there is little harm to delaying the release and significant potential harm to immediate release.

    The arguments for _immediate_ release seem largely political – that we want to use this information to rally the public against the Fed while the public’s (notoriously short) attention span is still focused on the financial crisis.

    Or am I missing something?

  28. “That is also something that apparently Barney Frank and Ron Paul agree on – any Fed disclosure should be delayed by several months.”

    Fine, but Paul’s agreement is likely disingenuous. I see this quickly evolving into a push for instantaneous information. Ultimately, Paul’s oft-stated goal is to see the Fed destroyed, not ‘fixed’. Likely he sees this as a way to mine information that he thinks will cause politically useful levels of outrage toward the Fed.

    “This only weakens the incentives for bank managers to run their companies prudently. Knowing that the Fed will bail me out in times of trouble already creates moral hazard. Knowing that they will bail me out without even my shareholders ever knowing only increases the moral hazard. Where does this stop?”

    But then the incentives become for managers to run their banks imprudently right up until the point where a bailout becomes unavoidable, at much greater cost. There will be plenty of managers that will choose to cross their fingers and hope for the best rather than tell their shareholders (let alone the public) that they’re going through (or even went through ‘several months’ ago) a period of distress. We do not want them taking that kind of chance.

    Remember, the discount window is not necessarily a “bailout” window; it’s about covering temporary liquidity problems and helping _viable_ institutions get through a tough couple days. And this is not a money-losing operation for the Fed.

  29. Fed secrecy is not the only issue under attack. As reported previously, Congress is considering legislation to provide greater Fed transparency and to limit the Fed’s bailout powers. The latest – Reuters reports efforts to rein the Fed’s powers to lend to non-banks in “unusual and exigent circumstances”.http://www.reuters.com/article/ousiv/idUSTRE57T01E20090830?sp=true

    This clause was the basis for the Fed bailout of the investment firm Bear-Stearns and the insurance company AIG. Hertzel reports ( FRB Richmond-Economic Quarterly Vol 95-No 2 ,Spring 2009 p190.) this clause was inserted in the Federal Reserve Act of 1913 in response to a populist cry from House Speaker John Nancy Garner, Roosevelt’s choice for vice-presidential running mate. During a congressional debate he and a fellow Texas Democrat declared “I plead with you to let all of the people have some drippings..”.

    It is ironic that a populist provision turns out to be another gateway for Wall Street to tap the public coffers.

  30. Implicit in all these comments is the idea that government somehow can be made more honest and forthright in this world of infinite money we have been inflating since 1971. Half the criticism suggests we can simply topple the entire system like czarist Russia in 1917, without ending up with first Lenin and then Stalin and God knows who after that. The other half seems to feel that if only we know to whom the Fed is opening the discount window, our banks will suddenly stop being imprudent and indeed reckless, will cease to fuel speculation and begin lending for productive investment, leading in a few years at most to everything being economically hunky dory.

    I suspect that given the real state of things the Fed is probably doing everything which reasonably can be done to hold chaos at bay, in the hope that businessmen’s animal spirits will revive and consumers will disregard their precarious hold on survival and plunge into a new round of spending, buying houses even at these still inflated prices and cars without modest taxpayer bribes attached. As for the value of a dollar, it ultimately will have to decline even more than it did between 1973 and 1982 (by about 50% and perhaps more) to permit the whole game to continue playing out for as long as climate change permits. If there is a problem with this not all that rosy scenario, it is not lack of transparency at the Fed, but rather immense usury engendered consumer debt and relentless downward pressure on wages resulting from globalization. Nevertheless, one ought to at least consider that perhaps we really have no choice but to try, since the alternative seems to be giving new powers to a whole new crowd of demagogues who have not yet even been identified, except to some extent on the web.

  31. 20,000-40,000 is just an estimate. I’m not really clear on what difference it makes whether it’s 20,000 or 100,000 in terms of bias against ones own country? Can’t even 20 unwarranted deaths be a massacre?

  32. I largely agree with you on both points, but I think its still premature for the Fed to release names. You and Simon don’t believe the crisis has passed, why are you requesting the Fed behave as if it has?

  33. 20,000-40,000 is just an estimate. I’m not really clear on what difference it makes whether it’s 20,000 or 100,000 in terms of bias against ones own country? Can’t even 20 unwarranted deaths be a massacre?

  34. The Times today echoes this discussion in a piece by Bill Emmott (Editor of The Economist from 1993 to 2006) called “The three worst words of all: ‘off balance sheet’”

    http://www.timesonline.co.uk/tol/comment/columnists/guest_contributors/article6816408.ece

  35. Funny thing is that Paul agrees that 1207 has more of a chance of being watered down than passing in its current form. He (and I) hope that people will be moved to action by that fact. In reading your remarks – after looking at a dictionary – I suspect most of your distaste is in the people who claim they support Ron Paul. I suspect you simply do not really know his positions well enough to disagree with him. Just a hunch. Try campaignforliberty.com…..if you are interested. If not suit yourself.

  36. How do we really know?

  37. in my book facts matter and make a difference and the Dresden-figures have been evaluated over and over
    the question here is not what counts as a massacre, the question is does research and the facts it finds matter
    if I follow your argument people who deny there has been any killing have an equal right to teach that to students

  38. Having worked on the front lines of customer service I can say with a fact that a lot of people are still fearful about the state of the economy. They also don’t want their money in a bank that has the potential to collapse.

    So if the fed were forced to reveal the banks in question it could cause a modern run on those banks. Of course, it will depend greatly on how the media handles it.

  39. James, you’re spot on. The Fed’s arguments are incredibly weak. What has happened is that the Fed, whose mission was originally insulated from the ebb and flow of politics for sound reasons, has basically turned into a market maker, plunging into the current financial markets up to its elbows. It’s taking a lot of positions and, unless it’s sitting on some secret multi-trillion-dollar cache of gold that can pay off these positions if things sour, then the public deserves full well to know what’s going on. Does disclosure come with a prohibitive chilling effect? Sorry, but if the Fed wants to make that argument, it MAY be valid in the early days of the crisis. But right now we’re on, what, month 12 of post-Lehman? Mold grows in the dark. Time to let the sunshine in, baby.

  40. Paul would prefer to abolish the Fed but he knows that he will never be able to do that in one fell swoop. My guess is that he is hoping to gradually squeeze out enough information that the ignorant american public might wake up and demand more at that point. I think calling him anything derogatory just reflects poorly on you at this, especially seeing as how I’m guessing neither one of really knows him.

  41. because then someone could do a more detailed investigation into what sort of deals transpired to create the money transfer and they’d likely find all kinds of nefarious activities by greedy scumbags