Harper’s Magazine fires off a broadside that has mainly, but not exclusively, been confined to the right wing: Barack Hoover Obama. The backside of the downturn, the part where states have to gut spending and raise taxes, and jobs are still very distant for most people, is generating a finally visible disquiet – while Obama is still personally popular, the public is not quite as confident of his economic policies. This disquiet could well be merely a wave in the normal back and forth of opinion, President Bush’s almost gravitational slide in the polls is not the norm for America politics, where most two term Presidents have an approval that resembles a suspension bridge, rather than a chopped down tree. But if there is unease over Obama, the Federal Reserve Chair Ben Bernanke has long since lost public faith:

Federal Reserve Chairman Ben Bernanke, on the other hand, holds a more tenuous position in public opinion than his immediate predecessor. Asked whether Obama should reappointment Bernanke as chairman when his term ends next year, 33 percent replied yes, 39 percent said no, and 28 percent weren’t sure.

This is down because Democrats, who approved of his performance earlier this year, have begun to desert him

Fed doubting, a staple of the libertarian right, and the fuel for Ron Paul’s appeals, is now spreading out into a broader mainstream, embodied by H.R. 1207, a bill he authored, to audit the Federal Reserve. What makes it interesting is that it has won broad support, and its most visible champion is a firebrand liberal, Representative Alan Grayson. The right and left wings of American politics have united in a suspicion of the Federal Reserve as the protector of a failed banking system. To understand how hated banks are in America right now, realize that worst customer service polls are regularly packed with two kinds of companies: banks and telecoms. And Abercrombie and Fitch, a retailer that seems to think it is in the phone business.

In this environment, Obama’s defense of the Federal Reserve, as the arbiter of "systematic risk" to the banking system, constitutes a certain use of political capital. But is his defense really true?

It wasn’t the Fed — where the — the (financial) regulations broke down here. And part of what we wanna do is to have somebody who’s accountable and clear when it comes to these large systemic firms that could potentially bring down the entire financial system…

An examination of the rules of the Federal Reserve, with respect to systematic risk, point in completely the opposite direction. This should not be a surprise: Greenspan openly argued for a "blow up-clean up" cycle, where asset bubbles were allowed to grow, and then explode, with the Fed cleaning up. Or, capitalism on the way up, socialism on the way down.

Consider, just to dip a ladle into a river of failure, the question of what has come to be called "counter-party risk." What made the banking crisis so virulent is that there was, virtually, one bank in the world, with different companies acting as front ends. Each owned so much of others, or invested so much in others, in no small part because finance has been where the profits have been, that the collapse of a few threatened to destroy the entire global system of payments. What does the Federal Reserve have to say about this? Let’s look at their own rules.

First, the Fed was a sleeping watch dog on the issue. Consider 12 CFR 206.3(3), which tells banks that they can rely on others to make the judgment about risk:

(3) A bank may rely on another party, such as a bank rating agency or the bank’s holding company, to assess the financial condition of or select a correspondent, provided that the bank’s board of directors has reviewed and approved the general assessment or selection criteria used by that party.

But these rating agencies are not subject to close Federal Reserve scrutiny. Literally anyone can start a rating agency. One of the drivers of this crisis was that rating agencies were blessing debt as "AAA" – which is to say, top investment grade – when they were shaking piles of derivatives.

And how much exposure can a bank have? Here is 12 CFR 206.4(a):

(a) Limits on credit exposure. (1) The policies and procedures on exposure established by a bank under §206.3(c) of this part shall limit a bank’s interday credit exposure to an individual correspondent to not more than 25 percent of the bank’s total capital, unless the bank can demonstrate that its correspondent is at least adequately capitalized, as defined in §206.5(a) of this part.

That’s right, a bank can have up to one quarter of it’s risk in one place. Except it can have even more if the counterpart meets the supposedly higher standards of 206.5(a). What is this higher standard? Put down your drink before you read this, I don’t want to be responsible for ruined keyboards:

(a) Adequately capitalized correspondents.1 For the purpose of this part, a correspondent is considered adequately capitalized if the correspondent has:
(1) A total risk-based capital ratio, as defined in paragraph (e)(1) of this section, of 8.0 percent or greater;
(2) A Tier 1 risk-based capital ratio, as defined in paragraph (e)(2) of this section, of 4.0 percent or greater;
(3) A leverage ratio, as defined in paragraph (e)(3) of this section, of 4.0 percent or greater.

That is to say, leverage of 25 to 1 is safe enough that a bank can have more than a quarter of it’s capital exposed to it. Is it any wonder that when the "Great Unravelling," as Krugman called it, began, there was no tendency to equilibrium in the system? To say that the Fed did not fail can’t be supported by a close reading of the rules. And Tier 1 capital, when the rules were drafted, were not subject to special scrutiny, that is in the proposal that Obama is presenting.

Over at baseline scenario, Simon Johnson is more than merely skeptical of the draft, presenting bullet points, none of them positive, and coming to the following bottom line:

But based on what we see so far, there is little reason to be encouraged. The reform process appears to be have been captured at an early stage – by design the lobbyists were let into the executive branch’s working, so we don’t even get to have a transparent debate or to hear specious arguments about why we really need big banks.

Johnson does not have a political ax to grind, and has, in fact, a relatively long record as a relatively moderate voice in the banking world. Rather than being a firebreather, he’s been part of the system. Which makes his insider’s critique all that much more scathing.

While it can be argued where the ultimate power for regulation should be, the facts are fairly clear that the Federal Reserve was not fighting against the tide of deregulation, which still has a loud and well-funded astroturf-roots, based out of the University of Chicago. Instead, the regulations it promulgated allowed for exactly the kind of "Christmas Tree" wiring that made the entire structure catch fire, and which is being propped up by an explosion of the Fed’s balance sheet. How can systematic risk be reduced by putting the power in the hands of an institution that nakedly told Congress to go pound sand when the House Banking Committee asks for specific numbers? An institution that probably could not survive an audit? Whose Inspector-General, as Rep. Grayson discovered when he questioned her in the video above, didn’t think it was worth looking into why the Fed let Lehman Brothers fail?

The Federal Reserve is more to blame than most regulatory agencies, and has no better a track record than the others which were charged with overseeing the financial system, with the exception of the SEC, which was turned into everything but a brothel for lobbyists. It might be that the Federal Reserve will be where this regulation ends up, but it will not occur by giving a free pass to an institution that thought that a bank was perfectly safe taking other people’s word about where to put money, and which could put all of its eggs into three or four heavily leveraged baskets.

Fiscal policy, and monetary policy, are, in the end, the same thing. The Federal Reserve’s expansion of power is the Congress’ diminution of power. The money the Fed creates is money that the Congress cannot allocate. The money the Fed taxes by either inflation or stagnation is money the Congress cannot tax. The Federal Reserve acts under a grant of power from Congress, and for ends which Congress is, expressly in the constitution, responsible. It does not take a Central Bank conspiracy theorist to see that this particular central bank is being elevated for reasons that go beyond policy, and that the legislative branch can, should, and ought to exercise the Madisonian option to assert its prerogatives more forcefully, or realize that it will be very hard to get them back. For a generation the Congress was content to be infantile: let the Fed take the blame for the economy, and parcel up the pie into small pieces. That system has started a Depression, which may yet become longer and deeper. It would be irresponsible not to act.

Related posts:

1. Bill Black is Right: Federal Reserve = Oversight FAIL
2. Barney Frank: Committee to Hold Hearings on the Federal Reserve Transparency Act
3. Fourteen More Cosponsors Join Alan Grayson, Sign On to Federal Reserve Transparency Act
4. Rep. Raul Grijalva Joins Alan Grayson, Cosponsors Federal Reserve Transparency Act
5. John Dean: Is Boies/Olson’s Federal Anti-Prop 8 Filing A Risk?