This document summarizes the arguments presented during a congressional hearing on H.R. 1207, a bill that would audit the Federal Reserve. Supporters argue that the Fed's secrecy is unnecessary and that its actions are already politicized. They claim taxpayers deserve transparency given the trillions loaned. Opponents argue auditing would undermine the Fed's independence and ability to effectively conduct monetary policy. They say the Fed is already transparent and accountable within legal limits. The document also discusses the Fed's role in bailouts and lending to foreign governments and central banks.

1. Adam Kirby
Issues in Public Policy
Professor Doty
December 12th, 2011
Should the Federal Reserve be Audited?
A Monetary Policy Analysis
Issue Overview
The Federal Reserve System plays a prominent role in not only the
U.S. economy, but the global economy as well. The Humphrey-Hawkins
Full Employment Act of 1978 extended the Fed’s responsibilities over
price stability and interest rates to include in its mandate the goal of full
employment. With the collapse of the housing market in 2007 and the
credit crisis that followed, the Federal Reserve began taking
extraordinary actions to intervene in the global economy in the attempt
to induce banks to lend to consumers again, as well as to stabilize
financial markets around the world. For the first time, Americans began
to pay attention to monetary policy. Many people grew very concerned
following the passing of the Troubled Asset Relief Program [TARP] in
ECON 3310 "1

2. spite of overwhelming objections, with TARP funds being utilized to
infuse banks with capital rather than the stated purpose, which was to
buy toxic assets. Americans were worried following the collapse of
housing prices and the appearance that free market principles were
being abandoned with the “too big to fail” institutions receiving bailouts
in spite of their malinvestment. For the first time, the newfound interest
in the Federal Reserve inspired many questions regarding the monetary
policy decisions of the central bank, not only concerning the banks
which received emergency lending in the wake of the Great Panic of
2007, but also the Fed’s lending to foreign governments and their central
banks. The Federal Reserve Act of 1913 excludes many details regarding
the Fed’s decisions in these matters.
The new public debate over monetary policy has facilitated an
unprecedented support for legislation designed to bring more oversight
to the Federal Reserve System, which, after all, is a private consortium of
banks with a government chartered monopoly over the issuance of
currency and credit. House Resolution 1207, introduced by
Congressman Ron Paul in February of 2009, entitled the Federal
ECON 3310 "2

3. Reserve Transparency Act, received 320 cosponsors, an unprecedented
bipartisan support for legislation of its kind. During the House Financial
Services Committee hearings regarding H.R. 1207, the matter of
transparency and the Fed’s prerogative to be independent of politics
were thoroughly debated.
The Federal Reserve’s General Counsel, Scott G. Alvarez, testified
on behalf of the Fed, and maintained the position that in order for the
Federal Reserve to be effective, the policy discourse carried out by the
board of governors must remain free from scrutiny. Alvarez also went on
to state that for lending facilities to be completely open to the public
would create market stigma, which might dissuade firms from
approaching the Fed for help in fear that the market might misinterpret
the activity as a sign of the institution’s weakness. Alvarez maintains that
Fed secrecy is necessary in order to keep interest rates favorable and in
order to fight inflation.
In opposition, Thomas Woods of the Ludwig von Mises Institute,
countered that the Federal Reserve’s activities are already politicized in
the sense that the Fed chairman serves at the pleasure of the President of
ECON 3310 "3

4. the United States and that a monetary policy which is economically
sound might not be put forth by a chairman receiving pressure from the
executive branch in connection to a monetary crisis. Woods also points
out that H.R. 1207 does not alter the Fed’s current abilities, but merely
“opens the books”. He advises the committee that a watered down
version to H.R. 1207 will merely stoke the public’s curiosity to an even
greater degree. Taxpayers are the involuntary underwriters of every
policy decision that the Federal Reserve makes, and are entitled to more
complete disclosure.
Summary of the “Yes” Position
Thomas Woods, in responding to questions by Congressman Paul,
illustrated the fact that the arguments by economists that the Fed’s
secrecy is necessary to prevent inflation and higher interest rates rings
hollow; the current immunity from scrutiny which the Fed enjoys did not
enable the central bank to prevent the asset bubble in the housing
market. This market distortion breaks the credibility of the argument
ECON 3310 "4

5. against a General Accounting Office [GAO] audit of the Fed’s policy.
Woods points out that the idea that technocrats can better address
monetary policy than regular people through their elected government is
an antiquated point of view made untenable by the dire circumstances
which have occurred since 2007. It is true that during boom times, the
relative prosperity outweighs the costs of the Fed’s policy. But when a
bust occurs, it becomes difficult not to associate the resultant
unemployment and price distortions with the policies of the Federal
Reserve.
Woods argues that Congress has a moral obligation to keep tabs on
its various creations. The Fed has made trillions of dollars of loans to its
various recipients around the world since the Great Panic of 2007
began. Woods argues, “There is no good reason for the American people
not to know the details of loans to foreign governments. In a free society
this is what people have come to expect.” The opposition the HR 1207
claim the importance of Fed independence. Woods points out that the
Federal Reserve chairman is appointed by the president, and serves at his
pleasure. The chairman will, in the interests of his career, accommodate
ECON 3310 "5

6. the president with loose monetary policy. Woods says, “It is not likely
that a Fed chair will doggedly adhere to economic principles” when the
president’s political life is on the line.
Speaking to the issue of politicization, Woods claims that monetary
policy of late is highly politicized, pointing out that the American people
do not believe that the bailouts occurred for their benefit, and not for the
political purposes of supporting special interests. 99% of the public
opposed the bailouts, and yet Congress and the Senate passed TARP
anyway, completely undermining the American people. For the Fed to
say that they are independent of the political process just does not reflect
reality. Woods claims that 75% of the American people want an audit of
the Federal Reserve. They do not want a watered down version. Settling
for a watered down version will only raise the question, “What is the Fed
hiding?”
Woods concluded his opening statement by saying, “It’s plain that
an audit is coming. It’s in the Fed’s best interest to cooperate and allow
the audit to occur.” Woods points out that thus far, the Fed has tried, as
ECON 3310 "6

7. demonstrated by the frequent appearances of Chairman Ben Bernanke
before the Congress, to urge the American people to quit meddling in its
affairs and to let the technocrats handle all matters regarding money and
credit.
Summary of the “No” Position
Scott G. Alvarez, General Counsel for the Federal Reserve, began
his testimony by pointing out that the Fed is already accountable to the
public and committed to maximum transparency in accordance with its
responsibilities under the original Act, and the subsequent Humphrey-
Hawkins Act. Scott says that in light of the extraordinary events of late,
the Fed recognizes the need for additional transparency and has
increased disclosure of its asset purchasing programs, which is detailed
on the Federal Reserve’s website: “The Federal Reserve has initiated
detailed monthly reports on liquidity programs including types of
borrowers,” Alvarez claims. He went on to further state that the Fed is
already subject to GAO audits across a wide range of activities, and in
ECON 3310 "7

8. 2009, 14 audits were carried out, including enforcement of consumer
protection laws. Alvarez continued: “The GAO can already audit
emergency credit facilities, including the Term Asset Backed Loan
Facility in association with TARP.”
The Fed believes that H.R. 1207 would see an erosion of its
independence. In the original Federal Reserve Act, Congress gave the
Fed monetary policy independence within a public accountability
framework over open market and discount window operations. “This
independence was for good reason,” adds Alvarez. Monetary policy
independence tends to yield a policy which best promotes price stability
and economic growth. HR 1207 would undermine confidence in
monetary policy and create fear that policy judgments would be subject
to political consideration. H.R. 1207 would have an impact on interest
rates, with an audit possibly raising rates prematurely. It could reduce the
effectiveness of borrowing programs by increasing fear of stigma in a
firm’s having to come to the Fed for help, and cause the market to lose
confidence in the forward path of monetary policy. In response to a
statement made by Congressman Jeb Hensarling that initial borrowing
ECON 3310 "8

9. from the Fed in the wake of the recent crisis saw price support in the
markets, Alvarez stated that the market attitude has changed over time,
and that lending services from the Fed are becoming a “red letter”.
Alvarez claims that most borrowers are in fact not troubled, but are
merely attempting to provide greater liquidity to the market than they
have the resources to provide on their own. It is the Fed’s position that
the public will misinterpret discount window borrowing as sign of
trouble when it is not the case, thus creating market stigma.
Additional Arguments
Several other key points were illuminated during the testimony in
consideration of H.R. 1207. Congressman Bill Foster brought up the
issue of archiving, stating that “It is a good policy objective to have the
eyes of history on the decisions that are being made.” He asked
Counselor Alvarez about the specific policies of the Federal Reserve
regarding making available for historians not only the minutes of Federal
Open Market Committee meetings (which become available to the
ECON 3310 "9

10. public after five years) but also some of the less formal communications,
such as e-mail exchanges between Fed officials and other memoranda
issued internally which are not a part of official meetings. Alvarez
responded that some confidential exchanges can and will never be made
public, and that it is ultimately the responsibility of the Federal Reserve’s
archivist makes the ultimate decision regarding what information is
considered historically relevant and thus worthy of archival, and what
merits destruction. Although the exchange between Alvarez and Foster
did not proceed further, the obvious implication here is that the Fed
appears to have complete latitude with regard to its own record keeping
process, and that there is nothing to prevent the Fed from destroying any
documents which are technical violations of the law or which might be
of a politically sensitive nature.
In response to Congressman Emanuel Cleaver’s concerns
regarding the “end run” around the American people which occurred
after TARP was signed into law, where the funds had been used to
directly infuse funds into the largest institutions in contravention of its
supposed purpose, Alvarez responded that since the economy was
ECON 3310 "10

11. struggling in 2008, banking confidence needed to be restored. Instead of
using the TARP as it was originally sold as a means of buying up toxic
assets, the Treasury department used it for the purpose of managing
market expectations. Even though the money is being repaid with
interest, this deviation speaks directly to the heart of the issue of
monetary policy: can the Fed possibly maintain the moral high ground
and support markets at the same time?
An interesting highlight of this issue comes to us from author
David Wessel’s historical account of the Great Panic, In Fed We Trust. In
it there are several references to the discord between sound economic
policy and expectations management. When The FOMC would meet to
discuss the issue of interest rate changes, often times Fed governors
disagreed fundamentally on the technical decision that had to be made.
But rather than vote their principles, the governors knew ultimately that
the market would interpret their dissent as an indication that the Federal
Reserve did not have control over the economy. To use Wessel’s words,
“...central banking is equal parts substance and theater - what the Fed
ECON 3310 "11

12. does with interest rates and whether it looks to be calm and in
control” (Wessel, p. 146.) are of equal importance to policy making.
The other issue highlighted by Wessel is that once the Fed makes a
loan to an institution, it does not have control over how the funds are
utilized. In quoting economist Stephen Cecchetti, Wessel points out that
“‘Central banks have great tools for getting funds into the banking
system, but they have no mechanism for distributing it to the places
where it needs to go.’” (Wessel, p. 137.) Part of the Fed’s difficulties can
be clearly seen by the instances of banks sitting on large tracts of
liquidity which the Fed provided for the purposes of getting banks to
lend again, but the expectations of those firms dominate the policy
objectives of the Federal Reserve, to the point where it almost seems like
no lending, and by extension, no further taxpayer exposure to liabilities,
should have occurred in the first place.
In the most heated portion of Alvarez’s testimony, he was
challenged by Congressman Brad Sherman on the Fed’s use of section
1303 of the Federal Reserve Act, which gives the Fed the function of
ECON 3310 "12

13. “lender of last resort.” Sherman’s main concern was for the security of
the collateral which the Fed was willing to accept from institutions in
need of service at the discount window. He asked Alvarez if the Fed was
required by law to ensure that collateral for loans under section 1303 had
to be 100% secured. Alvarez responded that so long as the Fed felt it
would be repaid in full, there was no legal restriction on lending
practices to troubled firms.
Sherman was exasperated, claiming that “we have an agency
which can make high risk loans - at least a 51% chance of being repaid -
without any scrutiny as to how secure they are.” The picture painted is
one of great latitude by the Federal Reserve to accommodate banks, but
very little in the way of legal restraints against risky policy decisions,
which ultimately are guaranteed by the American taxpayers.
Congressman Ron Paul brought forth the issue of lending to
international institutions, which he claims is the aspect of H.R. 1207’s
implications which worry the Federal Reserve the most. Paul asserts that
foreign banking agreements have much of the characteristics of treaties,
ECON 3310 "13

14. which are exclusively the purview the United States Senate.
Congressman Randy Neugebauer pointed out also, that the United
States is currently borrowing fifty cents on every dollar it spends. The
international transactions occurring between the Fed and the European
Central Bank could include stipulations that Europe then turn around
and invest liquidity in U.S. treasuries. This undermines European
sovereignty as well as creates a new source of easy money for the U.S.
government, thus leading to greater deficits, and more debt. It should be
pointed out that for Americans to conduct foreign relations without the
advice and consent of the Senate is a violation of the Logan Act of
1799, which states clearly:
Any citizen of the United States, wherever he may be, who, without
authority of the United States, directly or indirectly commences or carries
on any correspondence or intercourse with any foreign government or any
officer or agent thereof, ... in relation to any disputes or controversies with
the United States, or to defeat the measures of the United States, shall be
fined under this title or imprisoned not more than three years, or both.
ECON 3310 "14

15. Finally, in his testimony, Tom Woods articulated the fact that bad
decisions are made when information is missing:
When you have secrecy you have a missing information problem. More
irrational decisions take place with secrecy. Decisions are easier to make
when information is clear.
The Fed claims that the markets will become stressed if monetary
policy is exposed to the public, whereas, Woods is claiming that better
decisions will be made in light of a GAO audit. The wording is key here,
because a market which responds to more thorough information might
rightfully contract. It would be appropriate for such a contraction if
firms and households determined that it was not an ideal time to borrow,
due to Fed activity. This would have economic benefits in the long run,
but given the possible short run instability which might occur as a result,
the Fed feels that they are only trying to faithfully adhere to their
mandate, and thus cannot allow transparency if a short term disturbance
might appear to reveal policy failure. The question the American people
need to ask is whether there should be a role for the government to play
in managing market expectations through the Federal Reserve.
ECON 3310 "15

16. Summary of the Taxpayer’s Position
The Federal Reserve is not a public institution, as the American
people assume it to be. It is a private bank, with local commercial banks
owning its shares, which is a requisite for being a part of the Federal
Reserve System. With the announcement in October, 2011 that the
Federal Reserve would extend its lending facilities to Europe on an
unlimited basis further enflames the issue of oversight of the central
bank. In an article written for The New American, Charles Scaliger points
out a scenario which opens the door for possible hyperinflation:
And what if the ECB and the entire EU falls apart as a result of the
debt crisis (which cannot and will not be solved by printing money)? Italy
and Spain are faltering, and Greece has all but been given permission to
default. A Greek default would likely trigger defaults in Ireland and
Portugal for starters, events which by themselves could cause the entire EU
to unravel. What then will happen to all of those loaned dollars which the
ECB has promised to repay?
ECON 3310 "16

17. The Federal Reserve has not adequately explained its contingency
for this, even though it has broken with its own precedent by openly
announcing the establishment of the currency swap lines with European
institutions.
The issue of transparency at the Federal Reserve is not dying
down. At some point, the political consequences to the Fed and to the
Congress will be overshadowed by the consequences of a global
economic crisis. The American people want to have a conversation
about the morality of central banking. They want to discuss the Fed’s
record in controlling interest rates. At the conclusion of his testimony,
Woods mentioned the Nobel Prize award to F.A. Hayek in his
demonstrating that interest rates are not arbitrary. Woods ended by
issuing a stark warning to the American people regard the consequences
of attempting to second guess the market: “If you set interest rates
artificially you open up prospect for massive malinvestment by
consumers and investors.” The collapse of the housing market as a result
of a decade of Federal Reserve interest rate policy would tend to bear
out this point of view.
ECON 3310 "17

18. Issue Summary
The Federal Reserve already makes available a variety of aspects
of its operations to the public via its website and through the frequent
appearances before Congress by the Federal Reserve chairman. The
ability of the Federal Reserve to fulfill its dual mandate of price stability
and maximum employment is ostensibly contingent upon it’s liberty to
conduct policy discourse and execute decisions without the scrutiny and
second guessing of Congress. According to Fed officials, to mandate
greater transparency would make markets unstable and could possibly
lead to premature changes in interest rates, as well as destabilization of
the job market.
But, the American people as a culture expect transparency from
government. The recent outcome of the TARP program and other
government interventions in the market in the wake of the Great Panic
demonstrated a deep disconnect between the wishes of the American
people and the attitudes and policy decisions of government. The
American people have an unprecedented interest in monetary policy as a
ECON 3310 "18

19. result, and are only made more curious and committed to more fully
expose monetary policy with the resistance of the Federal Reserve to a
comprehensive GAO audit. There is no moral justification for
maintaining secrecy when the American people will ultimately bear the
responsibility of any monetary policy decisions being made, for better or
for worse, especially if the decisions lead to inflation, unstable interest
rates, and unemployment. The current economic conditions in 2011
reinforce this sentiment.
ECON 3310 "19

20. Works cited:
1. In Fed We Trust: Ben Bernanke’s War on the Great Panic. Wessel, David.
(New York: Three Rivers Press, 2010.)
2. Federal Reserve to Bail Out European Banks (Again!), by Charles Scaliger.
The New American, Friday, Sept. 16th, 2011. http://
thenewamerican.com/economy/sectors-mainmenu- 46/9011-federal-
reserve-to-bail-out-european-banks-again.
ECON 3310 "20