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Saturday, September 19, 2009

The Federal Reserve and Conflict of Interest

The Federal Reserve is among the most misunderstood organizations in our societies. For instance, most don't even know that it's privately owned. The folks that own the Fed are bankers themselves. In fact, it's the main names in the banking and financial services system: Goldman Sachs, Chasen, Wells Fargo, etc. The share of the Fed that each bank has is determined by the individual size of the bank. In other words, the larger the bank, the larger its share in ownership in the Fed. Then, each year each bank gets a dividend paid out from the Fed based on its share of the Federal Reserve ownership.

The Federal Reserve system is made up of twelve governors, and each is a political appointee. The Federal Reserve has two specific responsibilities: control the money supply and regulate the banking system.

Now, let's think about that for a minute. If the Fed is owned by the major players of the Federal Reserve, isn't there a natural conflict of interest in it regulating the banks. Isn't that what you'd call the fox guarding hen house.

Then, there's the Fed's ability to control the money supply. The Fed does this by buying and selling securities. Overwhelmingly, the Federal Reserve buys and sells U.S. Treasury bonds. In fact, the Federal Reserve has its preferred bond traders. It goes to these traders when it wants to buy and sell U.S. Treasury bonds.

There's no evidence that the Fed tips off its owners when its about to buy or sell a lot of U.S. Treasury bonds overtly. Yet, banks like Chase, Goldman, etc. are tipped off either way. They have traders on the floor. Heck, for all we know, it's their traders that are the ones that the Fed goes to. In any case, Chase, Goldman et al know the Fed is making major purchase or sales long before the average person. Overt or not, that's not a free market but a rigged system. The banks that own the Fed know before everyone else when they make a move. If the average person got their hands on this information, that would be insider trading. In the case of Goldman, Chase, etc. it's the way business is done.

Now, while the Fed usually only trades in U.S. Treasury bonds, knowing what the Fed is doing provides a massive advantage over the average investor. Worst of all, the Fed has this power because the initial act that created it, the Federal Reserve Act of 1913. That act moved the power to create money from the Congress, where it was in the Constitution, and moved it to the Federal Reserve. Since an audit has never been done of the Federal Reserve, we, the citizens, don't know just how much money its created since its own creation in 1913. It's a totally non transparent process. We don't however know if its owners know just how much money its created.

So, the banking system that the Federal Reserve is supposed to regulate is likely in a position to know more than the public at large. The conflicts, in effect, are numerous.

1 comment:

Anonymous said...

Hey Mike. Here are the lists of traders: what the Fed calls “primary dealers”.

Primary Dealers List
Primary Dealers List – changes

These are the dealers who enjoy the seignorage of all new money origination done by the Federal Reserve. In other words they enjoy the income received by the creation of money. Instead of paying that income directly to the US Treasury, they pay it to these dealers. They may end up with portfolio losses before they realize real economic gains beyond the financial markets (in which case someone else gains from their losses), but they enjoy the special privilege of the income from the injection of new money into the system.

BTW, the etymology of “seignorage” arises from “seigneur” who was the lord of the manor, since the lord of the manor enjoyed the power of seignorage by divine right. So one way to think of these primary dealers is as our lingering vestigial feudal lords. Hopefully they won't also try to demand their divinely granted Droit de seigneur (aka Jus primae noctis). I would hate to have sloppy seconds after Henry Paulson from Goldman Sachs on my wedding night. :-)