As the debate continues over the wisdom or lack thereof of Congress having given Treasury Secretary Paulson a blank check to keep Fannie and Freddie afloat over the next 18 months, a point that seems largely overlooked is that there was only one realistic alternative. Either Congress could explicitly provide a financial backstop such as the one just enacted, or the Federal Reserve could later ride to the rescue a la Bear Stearns should the need arise. After all, there is widespread agreement that Fannie and Freddie are too big, and at the moment too important, to fail, and that taxpayers are ultimately on the hook.
What also has received surprisingly little attention is that when the Treasury received this authority, the federal budget was hit with a charge of $25 billion—CBO’s estimate of the prospective cost of assistance. But if the Fed had provided the equivalent protection with a wink and a nod, the budget cost would be zero.
Why does this matter? Budget estimates, flawed though they may be, are important because the budget process makes lawmakers accountable for the obligations they incur. When Congress has to acknowledge that protecting Fannie and Freddie costs real money, they have greater incentive, and more political cover, to put a limit on such obligations in the future.
Furthermore, when a Federal Reserve rescue looks free but a bailout by Treasury costs billions of dollars, there is a natural tendency to leave it to Ben. Not only does this sacrifice accountability and transparency, it also could have a detrimental effect on the Fed’s ability going forward to meet their primary mission of conducting responsible monetary policy.
In fact the Federal Reserve System has been kept largely outside of the budget process for good reason. It is widely recognized that credible monetary policy, and in particular the ability to fight inflation by raising interest rates, requires a central bank with enough financial independence to insulate it from legislative meddling. Regular disclosures by the Fed on monetary policy and the banking system are used to provide adequate information to the public outside of the budget process.
With the Fed’s entry on an unprecedented scale into the emergency financial guarantee business, the routine disclosures of the past are no longer adequate. In fact, distressingly little has been revealed about the cost of these new obligations: The Fed was silent on the full value of the guarantees it provided to entice JP Morgan Chase to acquire Bear Stearns, and it seems not to report on the cost associated with accepting billions in risky collateral through the Term Auction Facility. For the sake of good policy, and to ensure their future independence, it is time for the Fed to give us meaningful numbers on the value of the protection they are providing, and to do it soon.