Financial crisis causes Congress to cringe

Congress doesn‘t know much about history, as evident by its recent approach to the U.S. financial crisis.

Most Americans are ill-informed about how the U.S. financial market is structured and operated on a daily basis. Unfortunately, Congress seems just as clueless, even though it was instrumental in creating the financial institution at the center of controversy in the bailout of corporate entities (like AIG), in addition to the two failed mortgage giants, Fannie Mae and Freddie Mac. In short, Congress has failed its history lesson and thus is doomed to repeat the mistakes of the past.

The New York Times reported today that members of Congress were “stunned” when they received information about the depth of severity of America’s financial crisis from Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry M. Paulson Jr.

“When you listened to him describe it you gulped,” said Senator Charles E. Schumer, Democrat of New York.

As Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the Banking, Housing and Urban Affairs Committee, put it Friday morning on the ABC program “Good Morning America,” the congressional leaders were told “that we’re literally maybe days away from a complete meltdown of our financial system, with all the implications here at home and globally.”

Mr. Schumer added, “History was sort of hanging over it, like this was a moment.”

When Mr. Schumer described the meeting as “somber,” Mr. Dodd cut in. “Somber doesn’t begin to justify the words,” he said. “We have never heard language like this.”

Financial concerns undermine investors’ confidence

The major market bailout by the so-called “government of the United States” is yet another attempt to calm the fears of investors — fears that drive the stock market down. Over and over again we hear the mantra that the success of the stock market — and indeed, the U.S. economy at large — is predicated upon the faith, belief and confidence investors have in the financial system.

What IS the Federal Reserve?

For starters, the Federal Reserve is not the Federal Government. It is an institution created by Congress that operates within the boundaries of government, yet independent from it. Confused? You’re in good company..

Did Congress create a new government? Did it create a new branch of government? Did it create an entity that is independent of the law and the government itself?

The Fed is a creation of the legislative branch as an independent entity working within legislative boundaries; it is not the government itself nor answers to a single individual in the government, including the president. It was given power as an independent entity that reports to Congress. But neither the executive branch nor any individual member of Congress can exert power over this entity. Although presidents appoint the Board of Governors of the Federal Reserve (7 leaders who each serve 14 years once appointed), Congress as a whole body is the only authority that may exert its legislative power over the Fed by passing new laws that impact the Federal Reserve (See FAQ about the Fed).

Why is the Fed and the U.S. Treasury Dept. linked?

Over time, the Federal Reserve has become a partner with the executive branch because the Federal Reserve purchases Treasury Securities from the Department of the Treasury (which exists within the executive branch of government). In the early 1920s, Fed President Benjamin Strong made large purchases of Treasury Securities, according to the Fed’s history section of its Web site … although the Fed doesn’t explain what was used for a valued monetary exchange.

History reveals a similar picture to the one we see today, of extreme financial volatility in the early 1930s that resulted in the formation of new government entities with broad sweeping regulatory authority and the ability of the Federal Reserve to gamble with the wealth of the U.S. on the open global market. The Banking Act of 1933 (aka Glass-Steagall Act) mandated Treasury Securities be put up as collateral in exchange for Federal Reserve Notes. But Congress didn’t stop there. It also placed the Fed as a regulatory oversight authority over all bank holding companies (any entity owning more than one bank). And President Franklin Delano Roosevelt sealed the fate of American capitalism that same year by repealing all gold and silver certificates, thus ending all metalic monetary systems in the United States.

The government’s financial scheme

So, the result was the Fed providing the Treasury Department with its Federal Reserve Notes while the Treasury put up securities against these notes. But the notes were mere paper. Of what value was this paper that the Treasury Department would offer its securities as collateral against the notes? With gold and silver taken away as valued monetary commodities, what valued commodity backed the notes issued by the Federal Reserve?

The result of the Federal Reserve’s open market purchasing of U.S. Treasury Securities, and Congress requiring such securities to be used as collateral against borrowing from the Federal Reserve, is that the U.S. citizenry went into debt to the Federal Reserve. The irony is that the Fed is a concocted creation of Congress, erected in order to regulate the national banks which, in turn, it created … which, in turn, preyed upon the citizens.

Banks’ predatory lending practices

Ironically, banks were accused of using predatory lending practices to write bad loans. Where was the Fed? Congress created the Fed as the de-centralized central bank of the U.S., complete with powers of oversight over all banks in the nation. Yet, it was the Fed and the Bush administration that protected banks during a battle with all 50 states in 2003 when the practice of extending new “creative” loans to citizens who could not afford such debt reached a zenith. But the banks had no worries. Both Fannie Mae and Freddie Mac were buying up all the debt as fast as they could. Of course, that made Fannie and Freddie both hugely powerful and volatile — a dangerous combination.

Fannie Mae and Freddie Mac take the fall

Then Fannie and Freddie fell. And no one was big enough to bail them out except the government itself … meaning the entirety of the U.S. citizenry. Fannie and Freddie purchased tons of bad debt loans made by the banking industry, which is regulated by the Fed. Thus, the Fed created the mortgage industry meltdown. Congress’ other two creations — Fannie and Freddie — bought the bad loans (with what money? I don’t know).

The Treasury (executive branch of government) then bought up those bad loans by taking over Fannie Mae and Freddie Mac, the two institutions designed to guarantee the loans being made by banks and other lending institutions.

Thus, Fannie and Freddie bought the bad loans being made by the bad banks, making Fannie and Freddie grow substantially large. The incredible bursting of the bad debt bubble burst the ballooning growth of Fannie and Freddie, only to reveal that these Congress-created catastrophies were worth only as much as the loans that had been purchased from the banks, which was worthless.

The defaulting on loans and foreclosures on homes became the story for the media. But the story behind that story is that Fannie Mae and Freddie Mac found themselves in the same predicament of the homeowners who lost their homes. Both entities were broke, having bought up worthless stock.

Domino theory

The Treasury Department stepped in to buy two worthless organizations and prop them up with U.S. taxpayer dollars. The result was predictable. The U.S. Treasury would need a bailout of its own, thus calling on the Federal Reserve to intervene as numerous companies that depended on the loans coming due, which Fannie and Freddie had no way of paying, began to fall like dominoes. And the U.S. Treasury could not absorb the two behemoths Fannie and Freddie and then continue to extend its saving grace to every big company that was in some way also hugely impacted by the crisis. The U.S. government itself was hugely indebted as well.

FOR SALE: United States

Today, the Fed is reluctant to continue the process of bailouts because it already is owed so much of the future wealth of the American people that it can only lose by participating in extending the timeline of loans and by flooding the financial infrastructure with more dollars to bailout companies in need, thus sending the value of the dollar plummeting. When the value of the dollar plummets, the power of the Federal Reserve in the world market, where it operates, diminishes. After all, the Fed bought up America’s wealth with worthless paper (Hmmm … does that make the U.S. a paper tiger?).

Now, America is asking the Fed for help, hoping to borrow today against some of its future wealth. But where did the Fed gets its wealth to loan? From the same source that is asking for help today, the U.S. government. It’s a vicious circle, that when explained to Congress, sent shivers of fear throughout its chambers.

Thus, America, as a nation, is declining in financial power worldwide. As an answer to the decline, Congress has come up with a so-called new approach: create yet another authoritative entity!

It is apparent that Congress failed its history lesson.

Posted on September 20th, 2008 by MikeGreen
Filed under: The Economy

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