With the world's attention focused on the debate over the debt ceiling in the US, some rather startling evidence released by the non-partisan Government Accountability Office attached to the US Congress went relatively unnoticed. That evidence indicated that the amounts outlaid by the US Federal Reserve to deal with the financial crisis of 2007-08 amounted to a whopping $16 trillion, or well in excess of the US economy's GDP of $14.5 trillion in 2010. The near crisis that resulted from the debt ceiling debate was because of the conditions that were being imposed to increase the cap on public debt accumulated over years from $14.3 trillion to $16.4 trillion. The Fed bail out compares favourably even with these figures. It is clear, therefore, that huge money was delivered to the largest firms in the financial system in the short period between December 2007 and June 2010. That money was given out at near-zero per cent interest rates. Some of it is still to be returned and sounds more like a grant rather than a loan.

These figures are now in the public domain because of an amendment to the Frank-Dodd Wall Street Reform Act, introduced by Senators Ron Paul and Alan Grayson, and pursued by others such as the independent and more radical Bernie Sanders from Vermont. That amendment required the Government Accountability Office, an investigative arm of Congress, to undertake a full-scale audit of the Fed's activities. The report based on that audit was released on July 21 this year.

The numbers involved made this a bombshell. Towards the end of 2010, once again ordered by Congress on the basis of the Frank-Dodd financial reform bill, the United Sates Federal Reserve had dumped on its website details of around 21,000 lending transactions it undertook to deal with the crisis that engulfed the financial system and threatened a collapse comparable with the Great Depression. That evidence had shown that through multiple programmes referred to with confusing acronyms the Fed had launched a massive bailout. But those figures had suggested that the size of the Fed's intervention, though massive, totalled just $3.3 billion or less than a quarter of US Gross Domestic Product in 2010. That was far below the $16 trillion figure which has emerged as a result of the GAO's audit.

Much of this lending was against “toxic assets” as collateral, which was worthless inasmuch as there was no market for them. This possibly explains why the Fed had to take on this responsibility. Operating through the Federal Reserve's emergency lending powers allowed the system to bypass Congressional scrutiny, which was crucial given the opposition from sections of Congress even to the much smaller TARP or troubled assets relief programme valued at $800 billion. Thus the Wall Street-Treasury nexus that crafted the rescue seems to have consciously chosen the Federal Reserve as the main fire-fighting agent rather than other government bodies.

It was noteworthy that though in principle the Federal Reserve is responsible for providing liquidity to the banking system it regulates, a large amount of emergency Fed financing went to firms in the shadow banking system. Investment banks like Bear Stearns, Morgan Stanley and even the failed Lehman borrowed from the Fed. Even Goldman Sachs that had claimed that it had navigated the crisis without government support was reported to have received $814 billion from the Fed. Different firms received different sums from the $16 trillion trove: $2.5 trillion went to Citigroup, while Morgan Stanley received $2.04 trillion and the Royal Bank of Scotland and Deutsche Bank, a German bank, shared about a trillion.

What has angered some is that the Federal Reserve was not just supporting US financial firms that were on the verge of failure but a host of foreign entities that had been exposed to toxic assets generated in the US. Beneficiaries of the bail out were not just large financial firms and corporations in the US, but also banks and corporations outside the US. Barclays and the Royal Bank of Scotland from UK, UBS from Switzerland, Deutsche Bank from Germany, Dexia from Belgium and a host of other European banks had been bailed out with Federal Reserve funding. Saving the US financial system seems to have required saving foreign firms entangled with that system.

But this is not the only facet giving rise to anger. As Bernie Sanders's website notes, the GAO audit found “that the Fed lacks a comprehensive system to deal with conflicts of interest, despite the serious potential for abuse. In fact, according to the report, the Fed provided conflict of interest waivers to employees and private contractors so they could keep investments in the same financial institutions and corporations that were given emergency loans. For example, the CEO of JP Morgan Chase served on the New York Fed's board of directors at the same time that his bank received more than $390 billion in financial assistance from the Fed. Moreover, JP Morgan Chase served as one of the clearing banks for the Fed's emergency lending programs.” And in a shocking instance of conflict of interest “on Sept. 19, 2008, William Dudley, who is now the New York Fed president, was granted a waiver to let him keep investments in AIG and General Electric at the same time AIG and GE were given bailout funds.”

Finally, the GAO audit found that the Federal Reserve outsourced its emergency lending programmes to private contractors, s like JP Morgan Chase, Morgan Stanley, and Wells Fargo, many of whom were beneficiaries of the loans provided.

The massive size of the bail-out and the way in which it was implemented no doubt explains the secrecy that surrounded the bail-out and the decision to use the Federal Reserve to avoid public scrutiny. That the Fed could be used in this fashion makes nonsense of the theory that the Federal Reserve and central banks generally can be independent and impeccable managers of money and finance.

The use of the Fed to bypass scrutiny and finance a huge bail-out of irresponsible and often manipulative financial firms is inviting criticism also because not enough has been done to restore the real economy to health and support those who have had to bear the consequences of the unemployment resulting from the recession induced by the financial crisis. On the other hand Wall Street firms and some of the banks are back in the times of good profits and fat bonuses. The GAO's report, therefore, revives the view that Main Street has had to pay the price for Wall Street's misbehaviour, but the government has bailed out the latter while the former still remains in crisis. "The Federal Reserve must be reformed to serve the needs of working families, not just CEOs on Wall Street," says Sanders.

* This article was originally published in the newspaper 'The Hindu' and is available at http://www.thehindu.com/business/Economy/article2324652.ece

August 08, 2011.