A 'scandal' at the Fed

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Friday, December 3, 2010

WHEN PANIC seizes the financial system, a central bank must be the lender of last resort. This is not the same as bailing everyone out, in the sense of rescuing insolvent firms through permanent infusions of taxpayer dollars. It's the extension of short-term lifelines, secured by recipients' assets and payable, with interest, in a matter of weeks or months. Until private channels of interbank credit revive, the central bank should lend freely at a high rate to solvent firms, on good collateral√, just as Walter Bagehot√, the 19th-century British intellectual, first recommended more than a century ago. And with some variations, that is basically what the Federal Reserve did during the Great Panic of 2008, sparing the U.S. and world economies possibly irreparable harm.

So why are some treating the elucidation of these facts as a scandal? We refer to disclosure Wednesday of 21,000 Fed emergency operations totaling $3.3 trillion from December 2007 to July 2009. Though the broad outlines of these programs were always public, Sen. Bernard Sanders (I-Vt.), the socialist whose amendment to the financial reform bill forced the more specific revelations, persists in calling them "secret loans"; he waxes indignant that the Fed did not demand tougher terms and that some of the money went to "foreign" banks. "Has the Federal Reserve become the central bank of the world?" Mr. Sanders asked.

Uh, yes - because the U.S. dollar is the currency of the world. Providing short-term liquidity to foreign central banks and U.S.-based subsidiaries of foreign private banks is the modest price Americans pay for the benefits of the dollar's reserve currency status - benefits that include the current relatively cheap financing of our huge budget and trade deficits. Mr. Sanders said Wednesday that the Fed should have paused during the panic to demand that banks cut their credit card rates or lend to small businesses as a condition of liquidity aid. But households and small businesses might have gone under completely if the big banks failed while the Fed haggled with them. Given that the banks paid that the Fed back, with interest, and the Fed even turned a profit on some of its lending, we'd say that Chairman Ben S. Bernanke had a more sensible assessment of the relevant trade-offs than his critics.

Most shortsighted of all is the notion - which Mr. Sanders shares not only with others on the left but also with a substantial number of conservative Republicans such as Rep. Ron Paul (R-Tex.) - that the Fed should have detailed its emergency lending programs even earlier. Indeed, Mr. Sanders demanded such disclosure at the height of the crisis. While certainly in keeping with the usual American preference for transparency, real-time disclosure would have defeated the purpose of the Fed's last-resort lending and harmed the public, since it would have triggered a run on any bank that availed itself of short-term aid.

Capitol Hill Fed-bashers hope that Wednesday's disclosures may lead to annual audits of the Fed's interest-rate setting - which would damage the central bank's independence. That must not happen. To be sure, there may be some value in disclosing the specifics of large-scale Fed emergency operations, long after they are over - as was done in this case. Here and there the record may show imprudent risk-taking by the Fed in the heat of a crisis. But what we've seen so far is further evidence of the central bank's vital role in preserving financial stability.


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