If You Can't Explain it, You Can't Regulate it

Imagine if government officials who controlled some crucial aspect of our lives, say the war in Afghanistan, spoke about it in public only in another language.

Greek, say.

Only those who understood Greek would be able to talk about it or ask questions.

Now imagine that those who controlled the policy were unelected, appointed by a mysterious group of Greek-speaking weapons manufacturers whose business would benefit from the war.

Got it?

That’s about what we have in the U.S. Federal Reserve, a quasi-government agency that speaks in its own language, whose members are appointed by banks, and are not accountable to anybody else.

And the Federal Reserve is very, very important, never more so than right now, when it’s conducting a trillion-dollar bailout of the financial industry, largely in secret.

Business reporters used to joke how the former chairman of the Fed, Alan Greenspan, was a mysterious oracle who spoke in gobbledygook nobody could understand called “fedspeak” – on purpose.

We do understand this: Greenspan favored complete deregulation of the financial system, believing at the time that businesses would do good by doing well.

There was also a classic anecdote about the famously cigar-smoking fed chair before Greenspan, Paul Volcker, who took a dim view of public accountability. In response to a reporter’s question, he responded, through a haze of smoke: “We did what we did, we didn’t do what we didn’t do, and the result was what happened.”

Since the Fed’s starring role in the bailout and the Obama administration’s continuing reliance on it to engineer the economy, the agency has come under increasing scrutiny.

At the center of the controversy is President Obama’s Treasury secretary, Timothy Geithner, who in his previous job as head of the New York office of the Fed was a key player in the bailout drama last year. In that role, critics say he was too cozy with the banks and financial institutions he was supposed to be overseeing.

In particular, critics have been questioning why Geithner allowed a backdoor bailout on favorable terms for financial institutions’ risky mortgage investing, which had been insured by AIG. When those investments went sour when the housing bubble burst, Geithner approved billions in bailout funds to flow through AIG to the financial institutions, including Goldman-Sachs, without forcing them to take any losses, which would be the usual approach even if the government was determined to soften the blow of those bad investments.

So the Fed has presented an increasingly larger target for public anger over the bank bailout, bonuses, and financial sector recovery while Main Street stays mired in economic misery.

Attacking the Fed was a key aspect of the tea baggers’ protests earlier this summer. Ron Paul, the Republican libertarian Texas congressman and unsuccessful presidential candidate, has long advocated abolishing the Fed.

But the notion of getting tough on the Fed has crossed ideological lines in the wake of the financial meltdown.

In his legislative effort to audit the Fed, which is exempt from congressional audit now, Paul has been joined by liberal flamethrower Alan Grayson, D-Florida – and more than 300 other members of Congress. In addition, a number of economists and labor leaders are also favoring bringing the Fed under closer scrutiny and greater public accountability.

Meanwhile, the Obama administration, which has promised a more transparent financial system, rejects any greater accountability for the Fed. The administration is joined in opposition by those masters of fedspeak, former Fed chairs Greenspan and Volcker.

Not surprisingly, the Fed’s role is also at the heart of the congressional debate over how to reform the financial system. Sen. Chris Dodd, the Connecticut Democrat who heads the Senate Finance Committee, is facing a tough re-election battle. Though he has been an ally of the financial industry status quo in the past, Dodd has offered a massive reform proposal that is at odds with the Obama administration and the House’s less ambitious reform proposals.

As part of his proposal, Dodd wants strip the Fed some of its key authority to regulate how financial institutions handle risk.

Meanwhile, the Fed’s authority to conduct business in secret as usual is also being challenged in court. Bloomberg News has filed a Freedom of Information Act lawsuit seeking to learn which financial institutions have taken advantage of the Fed’s generosity as part of the bailout. The Fed’s lawyers contend that the Fed is not covered by FOIA, and not surprisingly, that disclosure would touch off a run on the banks and undermine the Fed’s “ability to perform important statutory function at a time of economic upheaval.”

Bloomberg is scheduled to respond next month, and a hearing is scheduled in the lawsuit in January.

The Fed’s arguments are basically a variation of the arguments we heard after Congress defeated the initial bailout proposal last year: Give us the money or we’re taking the economy down – all the way down. Now the Fed argues, Do it our way or we’re taking the economy down.

It’s time for the fear-mongering, the secrecy and the arrogance to stop. Policies that can only be pursued in the dark, without withstanding the harsh light and messy atmosphere of public debate, are unsound policies. It’s time for us to tell the Fed, and the bankers, that we can no longer afford their back-room dealings and mumbo-jumbo.

The congressional bailout watchdog, Elizabeth Warren, proposed a new rule for the financial industry the other day: “If you can’t explain it, you can’t sell it.”

I would propose a similar rule for regulators and the Fed: “If you can’t explain it in broad daylight, you can’t regulate it.”