Transparency? You Don’t Need Transparency
This Bloomberg article is noting that the Federal Reserve is refusing to disclose information on $2,000,000,000,000 in emergency loans. And yes, that is trillions, not billions.
Nov. 10 (Bloomberg) — The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.
Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends far more than that in separate rescue programs that didn’t require approval by Congress, Americans have no idea where their money is going or what securities the banks are pledging in return.
So why might the Fed want to keep this all secret? Well to keep things from going to Hell in a Handbasket. Suppose the Fed comes out with a list of exactly who has borrowed what and the collateral that was used. These firms might then be seen as being in trouble that could cause even more problems. So the mindset at the Fed is: What you don’t know is good for you.
On the other hand there is a number of potential problems here that this policy can create. First, it insulates firms from their poor decision making. The idea of a competitive market is that if you make mistakes, especially on a systematic basis, then you will be beaten by your competitors and force out of business. This is typically viewed as a good thing in the long run since it means that the badly managed firms are not going to be sticking around to mis-allocate resources and so forth. Second, there is the principle agent problem. The principle in this case is the American taxpayer, and our agent is the Fed. In principle agent problems the problem is getting the agent to act in accord with the wishes of the principle. I think it is fair to say that Bernanke and Paulson might think that they know what is best for the American economy and ignore the desires/wishes of the American taxpayer. This could be good or it could be bad. Problem is we’ll have know way of knowing until much later when either most if not all of that money is either repaid…or lost.
Of course there are other issues as well. Note that I shifted from American taxpayer to American economy when discussing the principle agent problem. That was done intentionally. Now what is good for the economy is probably going to be good for taxpayers. However, there are distributional issues that would likely be ignored by Bernanke and Paulson. And when you are in a situation where you have a variety of market imperfections (asymmetrical information, externalities, public goods, etc.) then distributional issues can be important to the functioning of the economy. These issues are very complex and as smart as Bernanke is, I don’t think he can figure out exactly what the best course of action is. In the end, like the rest of us, he’ll have to make a guess.
Enjoy your bailout.