Dodd Paved Path to Financial Crisis

Today it was revealed that the moral hazard which led to the financial crisis was created by none other than Senator Chris Dodd. In the early 1990’s the Democrat from Connecticut authored a bill which removed a ban on financial speculation using loans from the Federal Reserve.

On the day before Thanksgiving in 1991, the U.S. Senate voted to vastly expand the emergency powers of the Federal Reserve…The critical language was contained in a single, somewhat inscrutable sentence, and the only public explanation was offered during a final debate that began with a reminder that senators had airplanes to catch. Yet, in removing a long-standing prohibition on loans that supported financial speculation, the provision effectively allowed the Fed for the first time to lend money to Wall Street during a crisis.

…Did investment banks take greater risks in the past two decades because they knew the Fed could rescue them? The 1991 legislation, authored by Sen. Christopher J. Dodd (D-Conn.), was requested by Goldman Sachs and other Wall Street firms in the wake of the 1987 market crisis, and it would save some of them a generation later.

Dodd, at the time chairman of the securities subcommittee of the Senate Banking, Housing and Urban Affairs Committee, agreed to insert the language into a bill whose primary purpose was to reform the Federal Deposit Insurance Corp., which guarantees commercial bank deposits.

Since that time Wall Street has operated under the assumption that if its risk taking ever led to a financial emergency it would be bailed out by the Fed. That time came in March of last year when the Fed put Dodd’s law into use by handing JP Morgan $29 billion to buy out Bear Stearns.

In less than a year’s time, the Fed and Wall street drove $2 trillion through Dodd’s loophole. They became so comfortable with their emergency powers that they stopped disclosing the details of what firms were receiving the no interest loans. The Fed ended up acquiring more assets than the total amount of treasuries held by the remainder of the world combined.

U.S. taxpayers need to know the risks behind the Federal Reserve’s $2 trillion in lending to financial institutions because the public is now an “involuntary investor” in the nation’s banks, according to a court filing by Bloomberg LP.

The Fed refuses to name the borrowers, the amounts of loans or assets banks put up as collateral under 11 programs, arguing that doing so might set off a run by depositors and unsettle shareholders. Bloomberg, the New York-based company majority- owned by Mayor Michael Bloomberg, sued Nov. 7 under the Freedom of Information Act on behalf of its Bloomberg News unit. It made the new filing yesterday.

When questioned by Congress the Federal Reserve Inspector General claimed that she lacked the authority to audit the Fed’s member banks.

A bill to give the Government Accountability Office (GAO) the authority to audit the Fed has been cosponsored by more than half of Republicans in the House.

The Fed’s open market operations are not at all neutral in allocating credit. The Fed creates new balances out of thin air and uses those new balances to purchase Treasury bills from banks. Thus the banking sector is the first to get the use of the new money created in these bank balances. As this new money circulates through the economy, prices rise, and individuals further down the chain experience a higher cost of living before their salaries rise.

The bill now sits in the Financial Services Committee where its prospects of moving forward are dim. Committee chairman Barney Frank is a longtime lackey of the Fed whom he is actually trying to give more power to.

Barney Frank, the powerful US lawmaker who chairs the House financial services committee, on Thursday called for Congress to consider authorising the Federal Reserve to broaden its powers and act as a ¨financial services risk regulator”.

Foreign countries have become spooked by the expansion in the money supply and are increasingly resistant to buying US bonds.

The Obama administration needs to raise $2 trillion this year to cover the fiscal stimulus plan and the bank bail-outs. It has to fund $900bn by September.

“The dynamic is just getting overwhelming,” said RBC Capital Markets.

…It is not clear where the capital will come from to cover global bond issues. Asian central banks and Mid-East oil exporters have cut back on their purchases of US and European bonds as reserve accumulation slows. Russia has slashed its holding by a third to support growth at home. Even Japan’s state pension fund has become a net seller of bonds for the first time this year the country’s population ages.

Inflation is showing up in commodities prices where oil has already risen more than 70% this year. The extra capital may be flowing in thanks to Dodd’s financial speculation loophole.

U.S. crude oil inventories are at their highest levels in almost two decades, and demand has fallen to a 10-year low, but crude oil prices have climbed more than 70 percent since mid-January to a six-month high of $62.04 on Wednesday.

…Big Wall Street banks such as Goldman Sachs & Co., Morgan Stanley and others are able to sidestep the regulations that limit investments in commodities such as oil, and they’re investing on behalf of pension funds, endowments, hedge funds and other big institutional investors, in part as a hedge against rising inflation.

These investors now far outnumber big fuel consumers such as airlines and trucking companies, which try to protect themselves against price swings, and they’re betting that the economy eventually will rebound, that the Obama administration’s spending policies and Federal Reserve actions will trigger inflation – or both – and that oil prices will rise.

This is the latest in a series of scandals surrounding Dodd who was already under fire from his dealings with Countrywide and AIG.

Political sharks are smelling blood and the line of challengers against the Connecticut Senator continues to grow. Former Air Force officer Merrick Alpert will look to bruise up Dodd in the Democrat primary race. On the Republican side former Congressman Rob Simmons and state Senator Sam Caligiuri will duel for the honor of removing Dodd from office. Also considering a run is financial analyst and commentator Peter Schiff.