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Why I Want More Thorough Fed Audits

By Greg Giroux
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The U.S. Federal Reserve has grown massively in recent years. Since the 2008 financial crisis, it has increased its balance sheet from less than $1 trillion to an incredible $4.4 trillion. Given this sharp increase in the Fed's risk, it's reasonable that the Fed should be audited more thoroughly than in the past. 

My bill to audit the Fed is just three pages long, and simply says that the Government Accountability Office should conduct a full audit. It has 32 co-sponsors in the Senate and 142 in the House. 

QuickTake The Fed's Countdown

Legislation to audit the Fed has twice passed the House by overwhelming majorities. The Fed opposes the measure on the view that it is already audited enough and that a broader audit might cause political interference. 

I invite a thoughtful congressional discussion of the pros and cons of a more thorough audit. I've been encouraged by the broad public support for one and disappointed by the Fed's opposition. Confidence in our currency is important to all of us, and my view is that more information can only help. 

According to Deloitte & Touche, which conducts a conventional audit of the Fed's financial statements, the Fed spent $6.1 billion for operating expenses in 2013 and an additional $5.2 billion in interest paid to banks. The audit I would like to see would assess whether those payments are reasonable and necessary or whether they raise conflicts of interest between the Fed's role in monetary policy and its role as a bank regulator. 

The Constitution is explicit in assigning responsibility for money to Congress, and it is particularly blunt when it says: "No money shall be drawn from the Treasury but in consequence of appropriations made by law." None of the payments made by the Fed are pursuant to appropriations, but the Fed's actions facilitate the continued growth of the national debt, which is putting our economic future at risk. 

If it goes forward with an interest-rate increase, the Fed is contemplating a doubling of its payments to banks to an annual rate of well more than $10 billion. In her recent testimony, Fed Chair Janet Yellen said the amounts owed to the banking system will decline only gradually. That points to a multiyear escalation of the Fed's payments to banks as interest rates go up. The GAO could address the question of whether the Fed has explored more cost-effective options. 

The GAO could also determine the market value of the Fed's assets, not just their cost or par value. If bond yields go up, the Fed could easily find itself with a negative mark-to-market net worth. 

The Fed says it intends to hold its bond portfolio to maturity, avoiding losses, so it isn't required to report market values under accounting rules. But the minute the Fed's net worth falls toward zero on a mark-to-market basis, currency markets and bond-rating companies will know it and publicize it. 

The Fed has never had a negative net worth, so someone is sure to question the safety of a central bank with negative net worth and its ability to run monetary policy. It would be better if the Fed were transparent on this issue, routinely reporting the market value of its positions and explaining the strength of its financial position.

The Fed is able to continue adding to its size and power, undermining monetary and fiscal policy. The Fed owns $4.5 trillion in taxpayer-guaranteed bonds, mostly Treasuries. To put these big numbers in perspective, if all of the Fed's holdings were $200,000 houses, it would be as if the central bank owned 22 million houses financed 100 percent by a giant, adjustable-rate mortgage. 

The Fed crows that it earns interest and has made great profits on its portfolio. But that's just one part of government lending to another part. There's no value creation. It's like charging interest to your spouse and counting it as family income. 

The assets are bought not with real capital but with "computer-entry" fictions. The danger is that, at some point, the market will become aware that quantitative easing is an illusion and that the Fed can't cause growth or maintain calm, zero-interest markets with more computer-entry purchases. 

Danger exists also in a market in which the most universal of prices, the price of money, is so manipulated as to lose its essential feedback mechanism. Danger exists in a market that is deprived of the information that freely floating interest rates provide.

In a market economy, savers are taught the power of compound interest and businesses learn discipline through the cost of capital. How does that work when interest rates have been set at zero for more than six years? 

And when interest rates escape the clutches of the Fed, what happens then? 

The Fed's interest payments to banks raise numerous questions: Which banks received the most interest? What percentage of the payments are going to U.S. banks versus foreign banks through their U.S. branches? Are there any conflicts of interest for the Fed in determining these payments? Are there any checks and balances on their size? 

It would be important for a GAO audit to comment on the fiscal impact of the Fed's decisions. Regarding the Fed's interest payments, for example, do they increase the fiscal deficit and by how much? Could they be reduced? 

The Fed has been purchasing longer-term bonds, which tend to pay higher yields. Has this reduced recent fiscal deficits? Is there a risk that it will increase future fiscal deficits as interest rates rise? What are the other ways the Fed is changing the fiscal deficit?

The Fed worries that these types of inquiries will scare markets, but I doubt it. The goals of the audit are constructive and clear -- to improve transparency and ultimately to make the Fed more effective. Markets are flexible and benefit from more information. The Fed itself has emphasized the importance of communication with markets to enhance its effectiveness. 

The audit I want would evaluate the Fed's decisions in light of the relevant laws. 

Earlier Congresses turned much of their constitutional responsibility for money over to the Fed, often during times of war or crisis. The Fed is sometimes called the fourth branch of government, even though the Constitution created only three branches. Congress is complicit in this concentration of power, and should take responsibility for helping the Fed find constructive limits. A more thorough audit would be a good start.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Rand Paul at press@randpaul2016.com

To contact the editor on this story:
Paula Dwyer at pdwyer11@bloomberg.net