Federal Reserve

I was wondering how long it would take before the threats really started to show up in earnest..

Kansas City Fed president Thomas Hoenig is circulating a book titled “The Balance of Power: The Political Fight for an Independent Central Bank.” Charles Plosser of Philadelphia said on Sept. 29, “we must preserve” the Fed’s structure.

Must?  That implies that there is an "or else" in there somewhere... let's see.... can I find an "or else"?

U.S. stocks, bonds and the dollar would collapse if investors perceive Congress violating the independence of the policy-setting Federal Open Market Committee, said Former Fed Governor Laurence Meyer, now vice chairman of Macroeconomic Advisers LLC.

There it is!

Let's see.... stocks and bonds eh?   Which stocks and bonds would be "threatened" if The Fed was forced to account for its actions, like, for instance, to show us all what it bought, with what it bought, and to provide us with CUSIP's so we could look at the current market value (if any!) of these stocks and bonds?

Would that, per chance, be the stocks and bonds of banks that are holding hundreds of billions of dollars of HELOCs on their balance sheets at or close to PAR (100% of face value) when the first mortgage hasn't had a payment made on it in a year, the house is worth 50% of the first mortgage's outstanding balance, and the home is in BubbleVille, CA?

Or would it be the stocks and bonds of institutions that have (between them) well north of a trillion dollars of off-balance sheet "stuff" in a big black box labeled "good as gold", when "gold" really refers to the fact that it is "used dogfood" and has the same color - but not the same mass or consistency?

Would it be all those myriad institutions that The Fed was (along with OTS, OCC and the FDIC) responsible for overseeing and enforcing the strictures of Prompt Corrective Action (12 USC Chap 16 Sec 1831o), a law that has been entirely ignored when it comes to the larger banks in the financial system for more than a decade?

Would it be the institution (Goldman Sachs) linked to the NY Fed who has had board members who also served as the former Chairman of the company that isn't a commercial bank but managed to finagle itself a bank holding company charter - with the permission of the very same NY Fed?

The central bank has also come under fire for granting a waiver allowing a former Goldman Sachs Group Inc. chairman to remain on the board of the New York Fed after the company opted to come under Fed oversight.

What did Dodd have to say?

Allowing banks to select their supervisors is “absolutely backwards,” Dodd said this month, without mentioning Fed interest-rate policy.

Really Chris?  That didn't seem to bother you for the last how many years?  Why now?  A bit short on campaign contributions this cycle?

Some legislators want to “make the institution more political, and I think that’s terribly unfortunate,” Hoenig, 63, Kansas City’s president since 1991, said in an Oct. 9 interview.

Oh, I disagree Mr. Hoenig.

If the process becomes more political it will be by your own hand, and that of the rest of the Fed Governors, and it will be a side effect, not an intended outcome.

You really ought to go stand in front of a mirror, along with Bernanke, Plosser and the rest, and glance thereupon.  There you will find the cause of this little mess.

Let's see, shall we count the ways (although I'm sure I'll miss some of them!)  I think so.

• Greenspan rubber-stamped a blatantly unlawful merger of Travelers and Citibank, then lobbied for the passage of Gramm-Leach-Bliley, retroactively making it legal.  That (bad) law was the first of the last line of nails in the coffin of bank regulation that had kept the system sound and functional for more than fifty years.
  
  

• Brooksley Born warned of the danger of an unregulated CDS market and was literally stomped into the ground by the rank derision of both Greenspan and Larry Summers.  She was right, they were wrong and this nonsense allowed the AIG mess to unfold - a mess that was effectively sanctioned by Greenspan and Summers.  Where are the apologies and corrections?  Missing - the obfuscation continues in this regard!
  
  

• Bernanke ran his "Depression Avoidance Playbook" to a "T" following the original subprime meltdown.  However, he has failed to explain how he can be excused for (1) claiming that house price appreciation was "a reflection of strong fundamentals" in light of the fact that it was driven by dangerous and even fraudulent lending, (2) the nation "was unlikely" to suffer a recession, and (3) failing to detect or get in front of any of the failures prior to them happening.  In fact, Bernanke and The Fed granted many Federal Reserve Policy Waivers (the infamous "23A" waivers) that in fact concentrated and increased risk while the crisis was unfolding. 
  
  
• The policies of The Fed were allegedly to "help lending"; in point of fact what Bernanke missed is that while he can provide all the printed money he wants he cannot control where it goes.  And "go" it went, right into oil and other commodities first in late 2008 and then again in the summer of 2009, causing not one but two doubles of oil prices off the bottom - first from $70 to $140 and then again this spring and summer from $35 to over $80.  This, despite demand collapsing for oil and refined products.
  
  
• In the same light this "flood of liquidity", instead of promoting economic growth, went into the stock market as well.  This has driven the S&P's P/E to one hundred and forty (as of 9/30/2009), a level never before seen in the history of the stock market, and on a historical valuation basis some seven times expected price/earnings value and more than double the previous high of approximately 60 (just before the Tech Bubble collapsed.)  Should the stock market correct to a "somewhat reasonable" P/E of 50, the S&P 500 would trade at 375!  Should it correct to a "more normal" P/E of 20, it would trade at 150!  Of course earnings could (and almost certainly will) improve, but even if they double this implies that "fair value" for the S&P 500 is something close to 300!  What are the societal and political implications of that collapse should it come, and how does Bernanke believe he can avoid mean reversion - when every other attempt to do so thus far has failed?  Bernanke has done nothing more than create more asset bubbles in a puerile attempt to avoid taking responsibility for the policy mistakes that led to this crisis in the first place.
  
  
• The Fed (along with the other regulators at the table) have been either willfully blind or intentionally complicit in the "valuation shams" of the last several years.  They, along with Congress, twisted FASB's arm into formally allowing what amounts to mythical accounting to be used to "value" assets.  This, along with willful and intentional blindness (or worse) toward the requirements of Prompt Corrective Action allowed large banks, of which The Fed is one of their primary regulators, to find themselves in a negative real asset position compared to liabilities - that is, on an accounting basis, bankrupt.  Rather than take the institutions into receivership The Fed along with other regulators have looked the other way and "recapitalized" these institutions with taxpayer money via what amounted to locking Congressional leaders in a room and pointing an economic gun at their heads.  This isn't the first time either - witness Citibank's history during the Latin American Debt Crisis, LTCM and other episodes.  By some accounts several of these institutions have been broke more than once and yet "saved" by this "regulatory forbearance."  The cost has been shoveled off to borrowers and the taxpayer generally.
  
  
• The Fed has arguably violated the black-letter law of Section 14 of The Federal Reserve Act.  Section 13(3) currently allows The Fed to make loans under "unusual and exigent circumstances" as it sees fit but nothing in Section 13(3) permits it to purchase assets by printing new bank reserves - that is, by printing money.  That function is controlled by Section 14, and a plain reading of that section does not disclose any legal authority to buy Fannie or Freddie paper, nor the assets of Bear Stearns and AIG.  Yet all of these programs were in fact put in place and continue to this day.
  
  
• Who is the real holder of all the Treasuries in "Caribbean Banking Centers"?  You don't actually expect me to believe that little islands like Antigua and Grand Cayman have the sovereign wealth to support holding nearly two hundred billion dollars of Treasuries, do you?  Is that a vehicle by which back-door monetization can (and has) taken place?  Germany, with a real economy and government, by contrast holds a mere $55 billion dollars, and even Russia (and Hong Kong!) have only $121 billion.
  
  

The Fed has promoted and in fact still is promoting through policy action the lie that credit can expand "forever" at a rate that exceeds GDP.  This is mathematically impossible and Bernanke knows it.  I do not accept that he is ignorant of this fact as he is clearly an intelligent man and in addition is a credentialed Professor with an advanced degree - therefore, I must conclude that this is not an error but rather an intentional lie.  It is, in fact, the big lie upon which all others rest, and yet as I have repeatedly pointed out the mathematical facts are not subject to dispute.  To recap, here's the graph:

And to recap on the averages:

GDP growth from the early 1950s onward has been 6.818% annually, debt growth 8.777%, for a spread of 1.959%.

From 1990 onward, GDP grew at 5.396%, debt at 7.907%, for a spread of 2.511%.

From 2000 onward GDP grew at 5.225%, debt at 8.495%, for a spread of 3.270%.

The spread is increasing and the chart above shows that mathematically it is inevitable that you WILL reach the point where debt service cannot be maintained so long as the spread either is maintained or increases.  This is the essence of the "Ponzi Finance Indicator" that I have posted before, to wit:

All of this data is from The Fed's own Z1 release and the BEA's GDP series.  

You can't argue with your own data!

The outcome of these policies is not in question, as that is a matter of mathematics.

Mathematics that The Fed has willfully and wantonly ignored.

Congress must put a stop to it before the economy and monetary system collapses - not due to "oversight" of The Fed, but rather due to The Fed's own policies, obfuscation and willful disregard of mathematics.

"Does The Federal Reserve try to manipulate the stock market?"

"No Sir, not that I'm aware of."

Oh really Mr. Lawyer?

Oct. 19 (Bloomberg) -- Bank of America Corp. signed off on its government-assisted purchase of Merrill Lynch & Co. after U.S. regulators assured the deal should boost the shares, e- mails from two bank finance executives showed. Instead, the shares collapsed.

"The chairman of the Federal Reserve indicated it would be structured in a manner such that BAC stock should go up when announced,” Chief Financial Officer Joe Price said in a Dec. 29 e-mail to top executives of the Charlotte, North Carolina-based bank, including Chief Executive Officer Kenneth D. Lewis.

The shares instead collapsed, but that's not the point. 

The question was whether The Fed has ever attempted to manipulate the stock market, and this email clearly says that indeed, they have done exactly that.

What is the penalty for perjury in front of Congress?

Kudos to Zerohedge and Jim Bianco on this one.

The Fed has repeatedly claimed they would not monetize the debt, as has Tim Geithner.  Two videos:

And then this one (9 minutes into it)

That's pretty clear.

So how does this get explained?

These would be Fannie securities, which, I remind you, are not guaranteed by any agency of the US Government, nor are they full faith and credit obligations of same; they all bear a disclaimer substantially identical to this on the prospectus:

So what did The Fed do?  A half hour later, this:

Uh huh.  The same Fannie's that were sold a half-hour before.

Now I want to reproduce Section 14 of The Federal Reserve act once again (the salient portion):

Purchase and Sale of Obligations of United States, States, Counties, etc., and of Foreign Governments

(b)

1. To buy and sell, at home or abroad, bonds and notes of the United States, bonds issued under the provisions of subsection (c) of section 4 of the Home Owners' Loan Act of 1933, as amended, and having maturities from date of purchase of not exceeding six months, and bills, notes, revenue bonds, and warrants with a maturity from date of purchase of not exceeding six months, issued in anticipation of the collection of taxes or in anticipation of the receipt of assured revenues by any State, county, district, political subdivision, or municipality in the continental United States, including irrigation, drainage and reclamation districts, and obligations of, or fully guaranteed as to principal and interest by, a foreign government or agency thereof, such purchases to be made in accordance with rules and regulations prescribed by the Board of Governors of the Federal Reserve System. Notwithstanding any other provision of this chapter, any bonds, notes, or other obligations which are direct obligations of the United States or which are fully guaranteed by the United States as to the principal and interest may be bought and sold without regard to maturities but only in the open market.
2. To buy and sell in the open market, under the direction and regulations of the Federal Open Market Committee, any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States.

Again, note the prospectus.  It explicitly disclaims such a full faith and credit guarantee.  Further, Fannie Mae (formally Federal National Mortgage Association) is a shareholder owned corporation chartered by Congress in 1968 explicitly lacking any such full faith and credit guarantee.

Claims that Fannie is a government "agency" from a legal perspective are, from everything I can determine, factually false. 

Fannie was originally chartered in 1938 as a government agency under FDR's "New Deal".  However, in 1968 Fannie was converted into a private shareholder-owned District of Columbia corporation in order to remove its activity from the federal balance sheet, and the prospectuses issued were required to have the legal disclaimer of agency status and full faith and credit added to them.

More to the point, US Code Title 12, Section 1717 says:

(B) The other such separated portion shall be a body corporate to be known as Federal National Mortgage Association (hereinafter referred to as the “corporation”), which shall retain the assets and liabilities acquired and incurred under sections 1718 and 1719 of this title prior to such date. The corporation shall have succession until dissolved by Act of Congress. It shall maintain its principal office in the District of Columbia or the metropolitan area thereof and shall be deemed, for purposes of jurisdiction and venue in civil actions, to be a District of Columbia corporation.

Now if you can somehow come up with Fannie being a government "Agency" (when the black-letter law says it is a District of Columbia corporation) then you win the "Rabbit out of a hat" award.

You might also make the claim that this purchase was "open market", and I'm sure that The Fed will claim it is.  Whether they first told certain dealers they were going to make that purchase is a further question, but as you can see, it is (or should be anyway) immaterial as Fannie Mae is not a government agency, but rather a  shareholder-owned District of Columbia corporation and thus their paper should be ineligible for purchase by The Fed anyway.

Indeed, USC Title 12, Chapter 13, SubIII Sec 1716b makes clear that the partition that took place in 1968 leaves Ginnie Mae as a government agency, while splitting Fannie off as a private corporation.

So, this leaves me with the same question I've had before and adds a few more, specifically:

• Under what authority is The Fed buying this paper at all, given the rather clear declaration that Fannie Mae is a private corporation and not a government agency, and in addition its paper does not bear the requisite full-faith-and-credit guarantee?
  
  
• Did The Fed tell the "lead managers" they were going to buy this paper prior to its sale, thereby allowing these dealers to purchase and then roll over this paper at a "guaranteed profit"?
  
  
• Assuming that some tortured claim can be made that Fannie is an "Agency" (despite what certainly looks to be clear proof to the contrary) how does The Fed (and Treasury) square the claim that "The Fed will not monetize (the) debt" with the fact that it literally announced this purchase thirty minutes after the offering? 
  
  
• Again, if the claim that Fannie is an "Agency" can somehow be made, how is this scheme of announcing a purchase a mere 30 minutes after the sale a true "open market" operation and not a charade and shell game to get around The Fed's stricture preventing direct purchase?

The world, however, is voting already - with its feet.  The dollar is sinking fast as our government refuses to enforce the law and whether Geithner and Bernanke claim they are not monetizing debt traders and governments know they're lying.

Bernanke's gambit is that the devaluation he is engineering will remain controlled.  Unfortunately he has managed to produce yet another asset bubble, this time in stocks which (for the S&P) are trading at an outrageous 122 times earnings on the last quarter's (2Q 2009) earnings.

This sort of parabolic pricing move (from the bottom in March of this year), of course, is unlikely to hold up.  Consider that while P/Es have reached 60 during bear market "rollovers" in the past, they have never seen valuations like this in the history of the US market.  Never mind Treasuries, with the IRX (13 week T-bill) pricing at a vast six (yes, six) basis points of yield as of the close today.

These levels are dramatically and ridiculously unsustainable.  The only reason to loan the government money for 13 weeks for a near-zero cost (six basis points is six cents per $100 annualized) is because you either believe massive and outrageous deflation is about to strike or you fear that a near-literal end of the world in other financial assets is shortly upon us.  Yet this general level of yield on the IRX has persisted since late last year, with the "recent high" reaching a vast 33 basis points in January.

Meanwhile Gold is skyrocketing - yet another "no confidence" vote.

Bernanke may be able to threaten dire consequences if The Fed is audited and he may be able to baffle Congressmen and Senators to the point that they will not call him on his raw monetization of debt along with what appear to be clearly-unlawful purchases, but he cannot stop the rest of the world from judging his actions.

That judgment is being rendered, and the consequence is being reflected in both gold and the dollar.  Should Bernanke lose control of his charade, an outcome that appears increasingly likely, the outcome for markets in the US will be unbelievably chaotic - and undesirable.  If you think last fall into the spring was bad, you've seen nothing yet.  A disorderly dollar move would force interest rates higher across the board immediately, it would cause an immediate crash in the stock market, and it would cut off federal deficit spending - immediately - forcing repudiation of most government entitlement programs and half the military budget. 

There are rumblings from The Fed that it is searching for a "scapegoat" in that it sees a potential "fiscal crisis" on the horizon.  This "concern" is insanely misplaced.  The crisis is of Bernanke's own making; by literally monetizing the entire second quarter net Treasury issuance Bernanke has ratified the spending policies of the administration while at the same time ratifying the making of unsound, unsustainable and fraudulent loans that Barney Frank and the rest of Congress is also approving of:

Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee, said in an interview that the defaults were, in essence, worth it.

“I don’t think it’s a bad thing that the bad loans occurred,” he said. “It was an effort to keep prices from falling too fast. That’s a policy.”

Got that Ben?  You're ratifying the intentional making of bad loans as a policy of the government.  Worse, the borrowers know they can't afford the houses:

“I knew in my heart I could not really afford the house, but they gave it to me anyway,” said Mr. Fullenkamp, 22. “I thought, ‘Wow, I’m surprised I pulled that off.’ ”

That's right - the people are pulling a scam, they know it, and you're enabling and powering it forward.

These risks are real and Congress, and the people, must not ignore them. 

Anyone who claims that we have a "strong dollar" policy when we in fact have Congress sanctioning and promoting the intentional making of bad loans and then monetizing them to avoid having to recognize the defaults is literally insane.  Such a policy is nothing more than Weimar-style printing of money and currency debasement as a formal policy of The United States Government, and if it continues it will lead to a dollar, stock market and government funding collapse.

I have promised a treatise on the proper regulation of liquidity in the economy from a perspective of avoiding both speculative credit bubbles and deflationary credit collapses.

There have also been those who disagree with my definition of "money."  I will therefore remove that term entirely, since "money" connotes different things to different people and we'll go through the definitions again:

• Asset: An item that has value of some varying amount of stability.  Examples are a stand of trees, a stack of sawn and finished lumber, a bushel of corn, a house, a car, a CNC machine and a computer.
  
  
• Currency: An abstraction of a collection of assets, also of varying value against those assets.  Often used as a medium of exchange between parties who wish to exchange one asset for another, and sometimes used as an abstracted store of value.  Examples include federal reserve notes and quarter coins.  Some forms of currency are officially backed or mandated for certain uses, but not all.
  
  
• Credit: A further abstraction of currency, but generally fungible with currency in commerce.  When brought into existence backed by an asset, credit is "hard" or "secured"; when not, credit is "speculative" or "unsecured."  Credit always, in some form, requires payment of interest.
  
  
• Interest: The amount one pays for the use of credit, usually (but not always) denominated as a percentage.  The elements of interest are the risk of failure to pay, the risk of debasement of the unit credit is denominated in, the scarcity of credit and the demand for profit on the lending transaction.
  
  
• Liquidity: The amount of currency and credit in an economic system that is available for deployment (that is, is not committed to some other purpose) at any given point in time.

From this we can determine certain relationships:

• The greater the system liquidity the lower the rate of interest, all other things being equal.  That is, the more "free and uncommitted" currency and/or credit is available, the less will be charged for its use in recognition that credit follows the classic economic supply/demand curve.
  
  
• The greater the interest charged the less deployment of credit will take place, and the greater the preference to use credit for productive purposes.  As the cost of credit rises its use for speculative or consumptive purposes becomes less desirable compared to saving the funds required prior to their expenditure.  Likewise, the lower the cost of credit the more likely it will be used to pull forward demand (consume) or speculate.
  

It is generally-accepted that significant inflation or deflation are undesirable. 

During significant inflation goods become more expensive relative to incomes.  If there is sufficient labor pricing power to force coupling of these price increases back to wages, then a wage-price spiral ensues and can quickly get out of control, since labor is the predominant cost for most businesses.  If there is insufficient labor pricing power to force coupling of price increases then the standard of living degrades for the citizens, in severe cases sufficiently to force a material part of the population into abject poverty.

Significant deflationary events, on the other hand, bankrupt debtors as the real value of the currency used to pay their debts rises rapidly.  This can quickly overwhelm their ability to pay, even when that debt was acquired for legitimate productive purpose.  When these entities fail they discharge workers, forcing contraction of GDP which can in turn lead to further insolvencies as purchasing power declines in the population.  This too can become self-reinforcing and lead to significant economic dislocation.

It is often claimed that "hard money" is a natural check and balance on the tendency of fiat currency regimes to "run away" into an inflationary mess as a means of "printing" out of sovereign debt.  The alternative, however (hard money), has a many-hundred-year history of causing forced inflationary and deflationary spikes that are extremely harmful to the economic climate of any nation, as is shown by the following chart found on Wikipedia:

The inflationary and deflationary spikes are caused by the nature of "hard currency"; once dug out of the ground gold, for example, is not destroyed.  When innovations in productivity outrun the ability to provision new currency reserves deflation ensues as the mining rate cannot keep up - the resulting deflation causes business and personal bankruptcies.  This in turn causes a contraction in GDP but that cannot be balanced with a withdrawal of the currency base since it already exists!  The result is a punishing swing between severe bouts of inflation and deflation; this is unacceptable.

Yet the history of our fiat money regime as practiced to date, while perhaps "better" in terms of violence, certainly isn't in terms of bias, which is clearly inflationary, all the time.

Why?

Simple: Given the proclivity of "choice" the monetary authorities will always choose to try to paper over their friend's mistakes!  This requires inflation, not deflation.

Unfortunately such "papering over" ultimately leads to either a Weimar-style collapse or the utter destitution of huge percentage of the population, dependent only on whether wage-price coupling can occur.  As inflation is a "silent tax", so long as it does not happen too suddenly people tend to react much as a boiled frog - that is, they don't realize what's going on until they're cooked!

There are two competing issues - if you permit debt to rise faster than GDP over an extended period of time you will inevitably get a "runaway" condition and deflationary credit collapse.  This occurs because of the mathematical reality of exponential ("compound growth") functions and no amount of tampering can change it if these relationships are maintained.  The following chart demonstrates this phenomena:

But regulating liquidity and thereby preventing this outcome and what is otherwise a mathematically-certain outcome can be done through a ministerial process.  Let's go back to one of the charts I recently introduced - the Market Ticker Ponzi Finance Indicator:

This indicator is simply the arithmetic difference in growth rates between GDP and systemic credit outstanding.  If this indicator is positive then GDP is growing faster than (or shrinking slower than) credit in the system.  If it is negative the opposite is the case.

When the indicator is positive systemic stability in terms of debt coverage is improving, and likewise it is deteriorating when negative.

Since the goal of liquidity regulation is to maintain systemic balance in debt coverage the mandate to be provided as a matter of law to whatever entity regulates liquidity in the monetary system is simple: The Ponzi Finance Indicator must be slightly positive.

Implementation of this mandate is relatively simple, in that excursions beyond a modest negative value (e.g. -1%) denote severe monetary imbalances and produce asset bubbles.  The 1990s Asset bubble in Internet Stocks was produced by the severe imbalance in credit and GDP growth in the mid 1980s that The Fed refused to correct, and the Housing Bubble was produced by the continuation of that imbalance from the late 1990s forward.  The Fed's current policy, indeed, has spawned yet another asset bubble, this time in stocks which are trading at a completely preposterous 140 P/E ratio as of the end of September 2009, or roughly ten times the historical "fair" valuation.  While many will argue that this is an unfair computation given the negative earnings from last year the fact remains that these negative earnings were real; even on a "current" basis of the second quarter alone the P/E is 122.  This bubble, like all others, will burst with disastrous consequences.

The solution to this problem is to place system liquidity regulation under a ministerial regime that is respondent only to the Ponzi Finance indicator (and to further mandate that GDP be honestly reported, as distortions in GDP will of course lead to improper adjustments), both as a matter of law.  This will result in credit tightening on an automatic basis as long as credit growth is exceeding economic growth - that is, so long as market actors are using credit not for investment but rather to engage in ponzi-style consumption measured simply by the objective on-balance results of credit and output rates of change.

Such a change in policy measure will put a permanent stop to the policy of "bailing out" financial institutions through lowering interest rates at the precise time when they have engaged in Ponzi-style financial maneuvers, creating unsustainable credit.  It is precisely this cycle - the political demand to "cover bad bets" made through Ponzi-style financial manipulation, that ultimately, if left unchecked, leads to deflationary credit collapses or even destruction of a nation's currency.

Fiat currency can work, but to do so the liquidity supply must be constrained such that credit growth is never allowed to outpace GDP.  Simple sixth-grade mathematics prove this to be the case, and also prove that when this stricture is violated disaster will strike - we are left only to argue over how long we have before it occurs.

Those who argue otherwise, whether on the public or private stage, are committing fraud upon the public and must be held to account for their criminal acts.

Back when Lehman went under I wrote a couple of Tickers in which I referenced short-term lines that the NY Fed had open at the time of the collapse, and was wondering what the devil happened to them.

It appears that there was more than just what was "announced" out, however, and that some of that money might have been subject to improper "preference" as Lehman entered bankruptcy:

Billing records filed with the court show the examiner is investigating an issue that has angered many of Lehman's creditors: how the Federal Reserve and the New York Fed -- which lent Lehman $46 billion in cash and securities before its bankruptcy filing last September -- were paid promptly and in full, while tens of billions of dollars in other debts were left to be sorted out in court. It remains unclear when and how much Lehman creditors will be repaid.

Ah.  Now that's a problem, but from my view there are two issues here - the bankruptcy law issue and a potentially-illegal "preference" payment, and then there is the part that the WSJ isn't talking about:

Why didn't the NY Fed and Federal Reserve simply seize the collateral they had posted from Lehman for those "loans" and liquidate it?

Remember folks, we are repeatedly told by The Fed that all loans they make are backed by sufficient collateral to prevent loss and are "haircut" to provide them with a margin against potential loss.

If this is in fact true then there was no reason for The NY Fed or Federal Reserve to receive any sort of "preference" payment (unlawful though such a payment would be), as the proper and expected thing to do is simply to seize the collateral they have possession of and sell it!

As such there are only two reasonable explanations for The NY Fed's behavior:

• They didn't actually have collateral for those loans, in which case Bernanke is a damned liar, The Fed has been handing out money in violation of the law requiring proper collateral and haircuts, and the next question becomes "how many other times has The Fed done this and are they still doing it?"

or

• The collateral they took was insufficient to cover the loan(s) balance, in which case Bernanke is also a damned liar, in that The Fed, contrary to The Federal Reserve Act and thus the law was effectively issuing unsecured loans.  (Was that "collateral" worthless CDOs, as just one possibility?)

Of course there is another possibility: The Fed simply doesn't give a damn about what the law says when it comes to preference and established US legal procedure, and neither did the people running Lehman at the time - that is, they believed they could simply do whatever they wanted, preference rules be damned.

But that latter explanation doesn't make a lot of sense.  If you have sufficient security in the form of posted collateral and have actual possession of it (electronic or otherwise) in accordance with the law requiring same there is no reason to play this sort of game - simply sell the collateral and recover your money.

Whatever the truth this is just one more reason why we need a full and complete audit of The Federal Reserve.

Given this little disclosure yesterday my curiosity related to the circumstances surrounding Bear Stearns credit line with the NY Fed is heightened considerably.  As I have noted on multiple occasions that line was unexpectedly yanked as we went into the weekend where Bear ultimately failed.  This act was the proximate cause of their forced merger and near-total destruction of the value held by Bear Stearns' shareholders, and we have never had a cogent explanation for that action; indeed, any such line of inquiry has been met with stony silence.

If, as required by Section 13 of The Federal Reserve Act, the loans made to Bear were properly secured by collateral, there was no reason for The NY Fed to yank those lines on what amounted to essentially zero notice, as had Bear defaulted they could have (once again) simply seized and sold the collateral.

But that line was yanked, which leads to the same two questions that I have related to Lehman's credit line in relationship to Bear Stearns.

Lawlessness, or even the appearance of lawlessness, is unacceptable in any government-linked agency, and we the people have a right to know what is happening with our money.

Audit The Fed!