http://www.campaignforliberty.com/blog.php?view=30047
"This article by U.S. News and World Report's Rick Newman is bad enough. He repeats the usual nonsense about "deregulation," and (of course) assures us that "of all the villains responsible for the Great Economic Wipeout, the Federal Reserve is pretty far down the list."- Thomas E. Woods

http://articles.moneycentral.msn.com/Investing/Extra/a-better-way-t...
All right, so no one is surprised that U.S. News instinctively parrots the Establishment line. But now read National Review Online on the Fed (ht: LRC blog). How many Establishment cliches can they cram into a single article? It is absolutely unbelievable (as is their low-IQ claim that Ron Paul favors "disbanding the military" [!]).

Every line of this editorial reads like it came from a Fed press release. One looks in vain for even a shred of intellectual curiosity, the tiniest inkling that the world might be a teensy weensy bit more complicated and interesting than the conventional view -- which NRO adopts hook, line, and sinker -- will allow. Seriously, am I reading The New Republic? Is there even a difference anymore? Pro-Fed, pro-empire, pro-bailout, anti-Ron Paul -- the left-neocons and right-neocons sure have a lot in common.

All gone is the Mises/Hayek view (remember when National Review editors knew who those men were and what they thought about these matters?) that criticized central banking for its destabilizing interventions into the free market. Instead, we read about the wondrous wizards who keep inflation at bay and smooth out the business cycle. Yes, there are people who still believe this -- people who actually think of themselves as supporters of the free market! -- even in 2009.

It's certainly behind members of Congress who deregulated the banks in 1999, allowing once-staid institutions to gamble recklessly. Then there are notorious CEOs such as Martin Sullivan of American International Group (AIG, news, msgs), Angelo Mozilo of Countrywide Financial and Richard Fuld of Lehman Brothers, whose greed and hubris wrecked their companies. Crooked mortgage brokers, rapacious Wall Street traders and millions of irresponsible homeowners were key supporting actors in the revolting drama, too.

The Federal Reserve made one unambiguous mistake: It kept interest rates too low for too long after the 2001 recession, in the forlorn belief that Wall Street money hounds would exercise restraint instead of getting drunk on cheap money and heading to the casino.

The Fed also could have spotted the housing bubble sooner than it did and acted more quickly to deflate it. And once the financial system was in full meltdown in 2008, the Fed arguably could have done a better job managing the collateral damage.

But the punishment proposed by critics of the Fed is far out of proportion to the crime. Fed basher Rep. Ron Paul, a Texas Republican, wants to conduct regular audits of the Fed, allow Congress to get involved in decisions on monetary policy and eventually eliminate the Fed altogether -- as if politicians would be better economic stewards than the Fed's gray-suited bankers.

Democratic Sen. Chris Dodd of Connecticut, chairman of the Senate Banking Committee, wants to strip the Fed of its power to regulate banks, entrusting those duties to some other agency that would presumably do a better job because . . . it's not the Fed.

As Congress debates how to reregulate the financial industry, the next few months could be the most fateful for the Fed since it was revamped in the 1930s.

Video: Bernanke pushes back on audits

The Fed certainly needs several reforms, and Chairman Ben Bernanke has proposed a few good ones himself. But wholesale overhaul, political meddling and burden-shifting to some other agency seem like overkill.

Some better ideas come from the recent report on the AIG bailout by Neil Barofsky, the special inspector general auditing the Treasury Department's bailout regime. The AIG bailout was effectively a joint venture by Treasury and the Fed, and Barofsky did his report to answer one of the most unsettling questions of the entire fiasco: Why did AIG use taxpayer money to redeem billions of dollars in contracts with trading partners like Goldman Sachs (GS, news, msgs), Merrill Lynch and four other sophisticated banks -- at full value, with no discounts mandated by AIG's financial distress?

Barofsky's analysis offers sharp insights into what works well at the Fed and what doesn't. The report highlights a number of mistakes, but it also depicts Fed officials in Washington and New York working diligently and sincerely to prevent a catastrophe that the federal government hadn't anticipated and wasn't structured to handle. For one thing, AIG was an insurance company regulated mostly by state insurance commissioners. Neither the Fed nor the Treasury exercised any official oversight of the company.

In September 2008, when it became clear that AIG was on the verge of failing, the Fed tried to organize a group of private banks to bail out AIG, as Wall Street has done before. But the private banks, worried that they'd lose money at a time of crisis when they needed it most, essentially chickened out, leaving the Fed to either step in or let AIG fail.
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Lehman Brothers had just collapsed, the financial markets were in a free fall and Fed economists feared a 1930s-style financial seizure if such a huge conglomerate went down -- a judgment that seems generally sound more than a year later. So the Fed crafted a hasty AIG takeover plan involving an $85 billion loan to the company, following some of the guidelines the private bankers had come up with and leaving other important details to be worked out later.

Under the circumstances, there's probably no way such a complex, chaotic bailout could have gone smoothly, but in retrospect, the Fed made a couple of big mistakes it probably could have avoided.

The first mistake, according to Barofsky, was assuming the private bailout would go through and failing to develop a contingency plan in case the Fed got stuck with AIG. That's one reason the terms of the bailout had to be reworked two months later, as AIG was running out of money once again.
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By then, it was clear that stabilizing the company required the redemption of some big contracts with Goldman and the other trading partners. In bankruptcy or conservatorship, those partners would have become creditors fighting to get back a fraction of the value of the contracts, perhaps less than 50%. But AIG and its overseers from the Fed bought out those contracts at 100 cents on the dollar, a sweetheart deal that some have characterized as a "backdoor bailout" for Goldman, Merrill and Bank of America (BAC, news, msgs) -- which had already received separate bailout loans from the government -- and 13 other companies.

Altogether, the payouts added up to a staggering $62 billion in taxpayer funds.

Fed officials in New York tried meekly to get a better deal, but the trading partners argued that they'd be violating a fiduciary obligation to their own shareholders if they voluntarily gave up cash they were due. That's valid. The Fed ended up in an awful spot with no leverage to negotiate, ethical conflicts between its role as a regulator and as a sudden participant in private financial deals and legal questions over some of the tactics that would have been needed to force the partners to accept a discount. So the Fed gave in and redeemed the contracts at full value.

From the Fed's perspective, two months after its first attempt at an AIG bailout, that may have been a prudent move, since by then there was no practical alternative. But the Fed also showed a deaf ear -- perhaps two deaf ears -- when it came to the way it committed billions in taxpayer dollars. The bailouts that taxpayers knew about were already becoming unpopular by November 2008, and the Fed was effectively conducting additional bailouts with little or no oversight.

The Fed compounded that problem by refusing to identify the 16 banks AIG had bought out, creating the impression that the Fed and the firms it was rescuing were not subject to the usual rules governing the spending of taxpayer money. In March 2009, Fed Vice Chairman Donald Kohn told a Senate committee that "giving the names would undermine the stability of the company (AIG) and could have serious knock-on effects to the rest of the financial markets."

That was around the time that the controversy over the AIG bonuses exploded, revealing yet another instance where the Fed had neither the political judgment nor the regulatory tools to rein in something taxpayers clearly regarded as heinous.

Under intense pressure, AIG, with Fed backing, finally revealed the 16 trading partners it had bought out. "The sky did not fall," writes Barofsky in his report. "The now familiar argument from government officials about the dire consequences of basic transparency . . . does not withstand scrutiny."

Fed critics have cited Barofsky's report as evidence supporting whatever agenda they happen to be pushing with regard to the Fed. But Barofsky depicts neither corruption nor incompetence at the Fed, and his report is anything but an indictment of the central bank. Instead, he describes an institution that made some mistakes while doing a job that no other organization had responsibility for, wanted to do or was able to do.

The Fed typically operates with a degree of secrecy for good reason: If its usual dealings with banks were instantaneously made public, there'd be a frenzy of trading and possible bank runs to exploit or take advantage of the information. But extending that modus operandi to the AIG bailout backfired, because AIG became a one-of-a-kind lightning rod that required the most prompt and thorough public disclosure possible.
What must be done
The Barofsky report doesn't call for specific reforms, but it's easy to infer a few things that must be done.

First, there is no question that we need a structured and effective way to take over huge, linchpin companies like AIG without forcing some branch of the government to stumble through an ad hoc bailout like the Fed did with AIG. It probably doesn't matter whether that authority ends up with the Fed or another competent agency, like the FDIC, but what does matter is making sure there's a road map for taking over these "too big to fail" companies and dismantling them if necessary without having to appease trading partners, creditors, politicians or anybody else.

The Fed can also stand to be more transparent, along the lines that Ron Paul has suggested. Allowing members of Congress to meddle with monetary policy would be a disaster likely to generate more political interference in the economy when we need less. But the Fed could provide more detail about its activities, especially the extraordinary interventions it has undertaken over the past two years.

Thanks to the Bear Stearns and AIG bailouts, for example, the Fed is now sitting on billions in "toxic assets" it took over as part of those deals. The Fed should issue regular reports on when the government is likely to get its money back, rather than stonewalling and forcing other agencies to do it.
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The Fed has also proved that it's bad at politics. So it should either submit to more political oversight or stay out of affairs like the AIG bailout that are inherently political. In Washington, it's always good to have astute political antennae, but it's also shrewd to stick to your knitting and let somebody else handle can't-win problems.

Bernanke wants a strong Fed that is the nation's pre-eminent regulator of the banking system. But he would probably sleep better without any more AIGs or other nightmares.