Part 2: Deception and Abuse at the Fed...The Master of Garblements...Spinning Mountains into Molehills

Deception and Abuse at the Fed

by Robert Auerbach

Chapter 3 

The Master of Garblements 

The Road to High Office 

Far from being an enshrined oracle who issued garbled messages that were dissected for meaning around the world, Alan Greenspan began his career as an aspiring musician. After graduating from George Washington High School in New York City in 1943, he enrolled in the Juilliard School that summer to study the clarinet. Greenspan, who qualified for a scholarship, became a competent clarinetist and saxophone player. He was hired by the Henry Jerome swing band in 1944. Henry Jerome had attended the same high school as Greenspan, a decade earlier. Greenspan played in the band and handled its bookkeeping. He also enrolled at New York University in 1944.1 

Leonard Garment, who managed the band, would play a pivotal role in bringing Greenspan into the central government of the United States thirty years later. Garment became a lawyer and joined Richard Nixon’s law firm. He later recommended that President Nixon appoint Greenspan chairman of the Council of Economic Advisers. 

Greenspan realized that he was a competent musician, but not on a level with other musicians in the band. As a biographer noted: “Alan could either continue in music as a competent clarinetist and saxophonist who did a great job of preparing the group’s tax returns, or else he could move on to something he could really excel at.”2 If Greenspan had continued his musical career, he would not have achieved his prominence as the conscientious, capable leader of the world’s most powerful central bank. 

Greenspan had a peculiar skill at making important contacts. He was  affable, intelligent, somewhat aloof, and in possession of a sense of humor. His quiet, apparently reflective economic advice, later combined with his enshrined reputation, gave the impression of learned, thoughtful insights. He made important contacts throughout his career, both at his consulting firm and in the government. On the Washington scene, Greenspan showed up at cocktail parties, Gridiron Club dinners, private luncheons at major watering holes, etc., where he could make important contacts who would help him get good press.3 

Greenspan’s skill in presenting imprecise, sometimes near-meaningless, conflicting, yet learned-sounding views won him over-the-top adulation for his insights and abilities. In Maestro, his biography of Greenspan, Bob Woodward writes that Greenspan was described as a “math wiz” who “was always calculating probabilities.”4 The bar falls below “math wiz” when Woodward relates that Greenspan did not want to learn the modern statistics used by economists. The defense for the “maestro”’s lack of knowledge, according to Woodward: Greenspan knew that economists could end up addicted to such statistics. Woodward adds that Greenspan “would have been sucked in himself, but such study was not available when he was a student at New York University and Columbia in the 1940s and 1950s.”5 This leaves open the question described below of how Greenspan earned his PhD from New York University, in 1977. 

After he earned his master’s degree in 1950 from New York University’s School of Commerce, Greenspan continued his graduate studies at Columbia, where Arthur Burns was one of his professors. Greenspan’s views were importantly influenced by Burns: “Alan became more than just another one of Arthur Burns’s students; they became lifelong friends despite the gap of a generation in their ages. . . . As a young Ph.D. candidate in 1950, Alan idolized the older man and sought to emulate him in every way, even once briefly taking up the pipe, which Burns smoked incessantly.”6 

Greenspan left Columbia without completing the PhD program. He became a partner in a consulting firm with William Townsend in 1953. The firm, originally founded in 1929, was now named Townsend Greenspan and Company. When Townsend died, in 1958, Greenspan became the principal owner. The firm initially “consisted of five people—the two principals, two researchers, and a secretary, all crowded into a shabby office at 52 Wall Street.”7 As its business grew, the firm’s staff increased to approximately twelve people by the mid-1960s, and it moved several times to more auspicious offices in New York. 

In 1952, Greenspan joined a small circle of followers that gathered around Ayn Rand. He attended Saturday-night meetings in her Manhattan apartment. The group read drafts of sections of her forthcoming novel, Atlas Shrugged. She advocated a philosophy that opposed the modern welfare state and espoused self-interest as a guide for the optimal organization of society. Greenspan was not only a devoted follower of Rand, but also a frequent and active contributor to her anti-regulation and anti-government views. He was an ardent advocate for laissez-faire capitalism, a view holding that nearly all governmental activities and regulation are impediments to free markets and individual achievement. He advocated a return to the gold standard, which would eliminate the government’s discretionary control of the money supply—a little surprising for someone who was to become the nation’s most important regulator of the heavily regulated banking industry in a bureaucracy that had discretionary control over the nation’s money supply. 

Despite his strong beliefs against the wage and price controls that President Nixon had implemented, Greenspan accepted an appointment as chairman of the president’s Council of Economic Advisers in 1974, while Burns was serving as chairman of the Fed. Nixon resigned before Greenspan’s Senate confirmation. President Gerald R. Ford continued to support his confirmation against the strong objections of Senator William Proxmire, who became chairman of the Senate Banking Committee the following year. Proxmire questioned Greenspan’s appointment on the grounds that Greenspan was opposed to consumer-protection laws, antitrust laws, and governmental regulation of business. Proxmire said that Greenspan “has the almost incredible posture for an economic realist in these days of opposing the progressive income tax.”8 

One biographer tried to summarize some of Greenspan’s various views as of 2002, when Greenspan was leading the Fed: “King Alan was an unconventional economist by any measure. Part gold bug, part Austrian school free-market economist, part monetarist, with perhaps a dash of Keynesianism added for good measure, Alan had created his own school of economic theory that was fully understood only by himself.”9 

The conclusion that the views held by “King Alan” were “understood only by himself ” goes too far. More accurately, he was a nimble bureaucrat who was able to serve under and win praise from Democratic and Republican presidents. He was able to sound convincing both as an Ayn Rand follower, arguing for unregulated free markets, and as the nation’s most powerful regulator, defending nationalization of the Fed’s check-clearing system (see Chapter 7). Rand’s philosophy of adamantly rejecting governmental regulation did not appear to be merely a passing dalliance when Greenspan was young and impressionable. Greenspan invited Rand to his swearing in as President’s Ford’s chairman of the Council of Economic Advisors. Their relationship continued until her death, in 1982. 

“To Be Blunt about It, the President Has Lost Confidence in His Advisors’ Ability to Predict the Future” 

The Senate confirmed Greenspan. He began serving in 1974, the year after the U.S. entered a recession. The Ford administration and its chief economic adviser, Greenspan, focused on fighting inflation. This policy concentration brought into question the economic acumen of those who advised Ford. 

The recession that began in 1973 lasted sixteen months.10 The “official” unemployment rate (which underestimated unemployment) reached 9 percent, higher than the rate during any of the prior five recessions since World War II. Inflation also rose rapidly as a huge spike occurred in the prices of gasoline, fuel oil, and other energy goods.11 This rise in price was largely an external “tax” collected by foreign oil producers: oil prices tripled from 1973 to 1974, and then rose 30 percent over the next four years.12 

Three months after leaving his job as Ford’s press secretary, Jerald F. Terhorst criticized the advice given by Ford’s economists for fighting inflation while the country suffered a severe recession: “Ford relied heavily on the forecasts of his consultants, including Economic Council Chairman Alan Greenspan,” adding, “To be blunt about it, the President has lost confidence in his advisors’ ability to predict the future.”13 

The anti-inflation policy took a ludicrous turn when the Ford administration sought to fight it with lapel buttons and conferences. Ford organized “Whip Inflation Now” (WIN ) meetings across the country and at the White House, replete with WIN lapel buttons. Admonitions about buying less-expensive goods to slow inflation were not helpful, especially for those facing unemployment or already out on the street. It was not an entirely logical suggestion, since a sustained rise in the average price of less-expensive goods and services is also inflationary. 

The WIN conference at the White House and the lapel-button campaign during this severe recession were signs of detachment from reality.  This contribution to President Ford’s loss to Jimmy Carter in 1976 may not have been given sufficient emphasis. Ford’s pardoning of Nixon for alleged Watergate crimes, more easily understood and more politically damaging, receives more coverage.14

Greenspan’s Secret 

PhD Dissertation 

Greenspan returned to his consulting firm at the end of the Ford administration. He also returned to New York University, where he was awarded a PhD in 1977, the same year he left his position in the government. He submitted some papers in place of the usual PhD dissertation.15 Normally, a PhD dissertation in a field such as economics must be in a form sophisticated enough to be usable in research, must make a contribution to the existing body of knowledge, and must be original, unpublished work. When approved, the PhD candidate is normally required to supply a bound copy of the dissertation, which remains in the university’s library and is available for future researchers to consult. 

It was surprising to find Greenspan’s dissertation a secret. In his book about Greenspan, Justin Martin describes “a mild controversy” about the papers submitted: “The content totaled 176 pages and Greenspan gave it the prosaic title: ‘Papers on Economic Theory and Policy.’ Although the content was undoubtedly solid, this was not exactly groundbreaking academic level material, nor did the collection match the size and scope of the usual dissertation. For years after, Greenspan’s Ph.D. would remain steeped in a mild controversy. Critics questioned whether his work was sufficiently meritorious. And Greenspan didn’t help matters by requesting that NYU withhold from public view the collection of articles that comprised his Ph.D. work” (emphasis added).16 

As of 2004, the New York University library would not allow Greenspan’s dissertation papers to be seen by the public.17 On January 9, 2004, I made a telephone request to see them, and was informed on January 10 that the Greenspan dissertation papers are in a safe in the library and are not allowed to be made public. My further inquiries, to the president of New York University, John Sexton, elicited two replies from the provost, David McLaughlin, that were worthy of bureaucrats at the Fed. The last reply is shown in Figure 3-1. He indicates that NYU officials could not find it in the specified library. Also, he says that in the 1970s it was the policy to not place dissertations in the library. Evidently, he wanted me to believe that NYU business PhDs just took their dissertations home and put them in a drawer in case anyone inquired.18 

One possible argument for this secrecy is that Greenspan’s dissertation contains proprietary information that can never be made public. This argument resembles the one made by the Fed to block exposure, and even to deny the existence, of the transcripts of its meetings that it had hidden for seventeen years (see Chapter 6). 

Shifting the Tax 

Burden to Lower Incomes 

As an adviser to Ronald Reagan and a private-sector consultant, Greenspan generally supported the large tax cuts pushed by the Reagan administration in 1981, although he gave priority to lowering inflation.19 The tax cuts lowered the top tax rates on increases in income from 70 to 50 percent and reduced other tax rates on increases in income by 23 percent.20 These tax-rate deductions went into effect over the next three years. Many people agreed that the previous rates had been too high, even confiscatory, and had impaired investment and economic growth. The tax reduction was followed by a large and growing, actual and projected, budget deficit.21 

As early as 1981, doom-and-gloom projections, including one forecasting an imminent collapse, were issued regarding the funds available for Social Security pensions. Greenspan was appointed by Reagan to be chairman of a bipartisan commission to save Social Security (National Commission on Social Security Reform, 1981–1983).22 Greenspan received praise for achieving a compromise solution in a crisis atmosphere. As the measure passed the Senate, it was reported that the changes would “assure the solvency of the Social Security for the next 75 years.”23 

A primary part of the Greenspan Commission’s solution was an increase in the payroll tax rate over a phase-in period. The combined employee employer payroll taxes (Social Security plus Medicare taxes) were raised 15 percent to 15.3 percent of wages for 1990 (still in effect in 2007). The tax fell only on lower incomes, $35,800 or less in 1984 ($97,500 in 2007). 

The final plan has resulted in more funds being collected than are paid out every year thus far, imposing a larger than necessary tax increase on lower incomes. The tax helped finance other governmental spending, such as the wars in Afghanistan and Iraq. The payroll-tax increases combined with the Reagan tax cut have substantially shifted the tax burden to those with lower incomes.24 

Twenty-two years after the commission claimed it had “saved” Social Security for seventy-five years, Greenspan advocated an additional tax redistribution plan to save Social Security. Greenspan answered a question about the effects of taxes on the distribution of income in what was called his last appearance before the House Banking Committee, on July 21, 2005. Asked if tax cuts should provide more relief to the middle class, he said that as Fed chairman he looked only at the production effects of tax reduction (stimulating economic activity) and not at the effect on different income groups. Then he sermonized on his purity regarding this issue by saying the matter of who benefits from tax cuts must be decided by Congress; he would stay clear of that consideration. He ended with an aside that tarnished his purity a bit: he had always favored not taxing dividends. That sounds very much as though he has always advocated measures that affect income distribution, a necessary result of nearly all tax changes.25 

Charles Keating and the Most Expensive Financial-Institution Failure in U.S. History 

Greenspan continued his consulting business. He was retained in 1984 by Charles H. Keating, Jr., the head of Lincoln Savings and Loan in California. Lincoln’s collapse in 1989 was the most expensive financial-institution failure in U.S. history, costing more than $3 billion. Lincoln was a corrupt enterprise that stripped away many thousands of older people’s savings. Instead of placing their funds in insured savings accounts, as many depositors expected, Lincoln used the funds to buy uninsured bonds from a real estate company, American Continental Corporation (ACC), which Keating operated. He had used ACC to buy Lincoln. He bought ACC with the proceeds of “junk bonds” (high-interest-paying bonds with lower credit ratings) sold by Michael Milken. Both Milken and Keating would serve time in prison. Criminal charges against Keating were later dismissed. 

Lurid stories of how Lincoln misled these customers, costing them their life savings when Lincoln collapsed, were finally brought out in a San Francisco field hearing by House Banking chairman Gonzalez in January 1989. 

Keating’s attempt to keep Lincoln from failing included hiring a number of economists and a very prominent consultant who had been chairman of the Council of Economic Advisers. Alan Greenspan lobbied for Lincoln to obtain an exemption from the 10 percent limit on what were called “direct investments.” The primary assets of savings and loans were  home mortgages. If the 10 percent limit was lifted, more of the depositors’ funds could be put in other investments. 

Many of the savings and loans were insolvent and terminal. The income from the lower-interest mortgages they had sold in the 1970s failed to cover the cost of attracting new money in the higher-interest 1980s. The federal government refused to close the insolvent savings and loans. It would have had to use government-guaranteed deposit insurance to pay depositors. The government even passed legislation allowing phony assets to be put on the books at fake prices to make it look as if the firms were solvent.26 Meanwhile, unsavory practices dominated much of the industry. Many of those who controlled the terminal and near-terminal S&Ls placed high-risk bets on speculative investments, and some made phony investments for personal gain. Eventually there were many criminal convictions. 

Keating sent his distinguished, influential consultant, Alan Greenspan, to Congress to lobby senators for an exemption to the 10 percent limit. The expense statement from Townsend-Greenspan and Company, shown in Figure 3-2, details Greenspan’s bill for his trip to Washington, D.C., on December 17, 1984, including his retainer of $25,000. Greenspan was scheduled to meet Keating’s principal lobbyist, James Grogan, who would accompany him. Their schedule included meetings with the chairman of Senate Banking, Edwin Jacob “Jake” Garn (R-UT); Danny Wall, the committee’s chief of staff, who would take over as director of the governmental regulatory board for S&Ls; and Senators John Glenn (D-OH) and Alan Cranston (D-CA). These last two senators would become part of the Keating Five, a group of senators who met with regulators to induce them to lay off of Keating.27 Keating was generous with campaign contributions and in-kind payments. 

Greenspan was also paid to write a letter on Keating’s behalf. In 1985, he wrote to the governmental regulator, painting a picture of Lincoln management as “seasoned and expert” and as having “restored the association [i.e., Lincoln] to a vibrant and healthy state, with a strong net worth position, largely through the expert selection of sound and profitable direct investments.” The bouquet of flowery praise included a final orchid: “Finally, I believe that denial of the permission Lincoln seeks would work a serious and unfair hardship on an association that has, through its skill and expertise, transformed itself into a financially strong institution that presents no foreseeable risk” (emphasis added).28 

In Maestro, Woodward reports that Greenspan was “alternatively embarrassed, forthright and defensive” when Senator John McCain (R-AZ, 

one of the Keating Five) cited Greenspan’s “prior endorsement” of Lincoln Savings and Loan. Greenspan reportedly said: “I was wrong about Lincoln. I was wrong about what they would ultimately do and the problems they would ultimately face.” Despite these embarrassments, Woodward describes Greenspan’s “private” excuse: “Privately, Greenspan believed he would do it the same way again, given the information he had in 1985. When he reviewed Keating’s balance sheets, he found them both quite impressive and fiscally sound. Keating had done nothing wrong at that point, or if he had, it wasn’t detectable. Greenspan just hadn’t anticipated that Keating would turn out to be a scoundrel.”29

This private excuse does not fly, according to an expert who states that information contradicting Greenspan’s rosy predictions was available to Greenspan in 1985. Professor William K. Black was former deputy director of the Federal Savings and Loan Insurance Corporation and senior deputy chief counsel for the Office of Thrift Supervision in San Francisco.30 He investigated Lincoln Savings and ACC. According to Black: 

Greenspan’s letter was the principal basis for Lincoln Savings application to engage in direct investments roughly four times as large as the threshold. The Bank Board [Federal Home Loan Bank Board] adopted the direct investment rule on the basis of evidence showing that such assets caused unusually large losses in the new wave of failures . . . Mr. Greenspan’s conclusions were not supported by the record of Keating’s management of ACC (a failing home builder) or Lincoln Savings (a failing S&L). I researched and drafted the memorandum recommending that the Bank Board reject Mr. Keating’s application. My research on ACC’s performance was based on information available to Mr. Greenspan in February 1985. I reviewed ACC’s securities filings. They revealed that ACC was very poorly run. It had experienced serious losses because it produced homes that consumers did not want to buy due to poor design and flawed homes that suffered water damage and led to a series of lawsuits. As a result, ACC had ceased producing homes in all but one market (AZ). Mr. Greenspan’s claim that ACC had a long track record of successful management was refuted by ACC’s own securities law disclosures. Note that Mr. Greenspan cites no factual support for his bare assertions.31 

The $3 billion collapse of Lincoln became part of the huge bailout of savings and loans that cost the nation’s taxpayers between $150 and $170 billion, 2.5 to 3 percent of the goods and services produced in the United States in 1993.32 

Greenspan’s Dire Warnings 

about Recession in 1989 

A few months before Greenspan was nominated by President Reagan to be the new Fed chairman, Greenspan “sketched an outline of his brand of laissez-faire conservatism April 8 [1987] in a brief interview intended for use in a coming CBS television documentary.”33 The producers wanted to hear from the former chairman of the Council of Economic Advisers. After his nomination in June 1987, the network decided to play the interview on Sunday’s Face the Nation. Concerning the next recession, Greenspan said that recessions always occur—“it’s just a matter of when.” He guessed the next one might be in 1989, and to a large extent the Greenspan Fed’s policies would bring that guess to fruition in 1990. Greenspan sounded an alarm about the U.S. economy: if saving and investment did not increase, “we are going to fade from the scene as a huge superpower eventually.”34 

Greenspan’s dire warning about investment was spectacularly wrong during the next decade, which saw an explosive increase in investment in digital information technology. Failing to specify a specific time and hiding behind the word “eventually” made his prediction immune to contradiction, sort of like a horoscope. 

The Stock Market Crash 

and Missing Fed Records 

Almost immediately after Greenspan became chairman of the Fed, in August 1987, he was confronted by a stock-market crash. Stock-market prices reached their peak in August, and then fell by 22.6 percent in one day, October 19, 1987. The Greenspan Fed may have correctly handled the liquidity problems associated with the crash. The cautionary word “may” is appropriate because the Fed reported to Congress that transcripts of eight consecutive FOMC telephone conference calls following the crash were missing (those for October 21, 22, 23, 26, 27, 28, 29, and 30). 

What did the individual FOMC members advise during this period? Did their individual views reflect skill in conducting the Fed’s operations? Seven years later, the Greenspan Fed, under pressure from a Gonzalez investigation and a series of hearings, sent the list of FOMC conference-call transcripts (shown in Figure 3-3) to Gonzalez. The list includes a notification of the missing transcripts.35 45 

It is important for taxpayers as well as future Fed officials to know the actions and deliberations of individual members of the FOMC during this crisis. With the vote of at least five governors and its own emergency declaration, the Fed can lend billions of dollars of funds to brokerages and other private sector businesses under the Fed’s emergency powers (Section 13-3 of the Federal Reserve Act). All these FOMC records missing from the same time period suggests a deliberate omission by the Greenspan Fed, an omission that shields this twelve-member committee from accountability during a critical period. 

After a rapid stock-price recovery following the crash, the Greenspan Fed decided to fight rising inflation, despite Greenspan’s prior prediction about a likely recession in 1989.36 The Fed fired its monetary shotgun, pushing up interest rates and rapidly contracting the nation’s money supply. The Volcker Fed had successfully fought inflation in this way, but at the cost of a double-dip recession. Volcker had fought a more rapid and more sustained inflation. Now, in 1988 and 1989, the Greenspan Fed overreacted. It fired the shotgun at a smaller target, and the economy dropped into a recession in 1990 and 1991, undermining President George H. W. Bush’s reelection bid. The president’s popularity dived from the high levels achieved following the victory in the first Gulf War. Like the economic policies attributed to former President Gerald Ford when Greenspan was chairman of his Council of Economic Advisers, George H. W. Bush’s economic policies seemed out of touch with reality. 

Economic Expansion, a Speculative Bubble in Stock Prices, and Deification 

The implementation of new advances in digital information technologies, including the Internet, together with bursting optimism about the future produced a dramatic boom in investment and output in the 1990s. The excitement over the new technologies also caused a speculative bubble in stock prices in the last half of the 1990s. The nation’s economic guru and sage, Greenspan, was praised unto deification for overseeing the expanding economy and the surging stock market and for keeping the rise in the prices of goods and services—inflation—low from 1992 until the end of the decade. 

Many world events helped hold prices in check while Fed policy in the 1990s and early 2000s was on a roller-coaster ride. (More about the Fed’s erratic monetary policy can be found in Chapter 11.) Prices were affected by competition from low-cost foreign goods and services. Huge foreign currency crises and recessions affected prices. None of this seemed to diminish the praise for the wizard behind the curtain until the U.S. stock market began to crash in March 2000. 

A reviewer of Stephen K. Beckner’s Back from the Brink: The Greenspan Years (1996) noted in the Financial Times: “It has become axiomatic that the softly spoken Mr. Greenspan is the real architect of the US economy’s formidable strength today. . . . It was only Mr. Greenspan’s foresight and remarkable surefootedness that averted a series of events that could have sent the entire economy tumbling over the edge. In his introduction, Mr. Beckner paints a lurid picture of the nightmare scenario that might have happened [after the stock market crash in 1987]—financial collapse, bankruptcies, and mass unemployment.” The review notes, somewhat cheekily, that after Greenspan was nominated by “Bush and Clinton, Presidents of rather different political views . . . saving the US economy from collapse must have seemed like a piece of cake.” The reviewer concludes that the chairman was “widely called without a hint of hyperbole, the most powerful man in the world,” adding, “Mr. Greenspan has already inspired a number of biographies, mostly of a hagiographical nature. But none goes quite so far as this one.”37 Hagiographies are biographies of saints. 

In Maestro (2000), Woodward concluded: “Each of us is a character in the nation’s great economic soap opera; Greenspan is both director and producer,” noting as well that “Greenspan’s policy of expanding openness and transparency has done more than merely increase the Fed’s accountability.”38 

The claim of openness and transparency was far from reality, at least as shown by the evidence turned up in Gonzalez-led congressional investigations of the Greenspan Fed. Although some of the problems presented in this book were unavailable at the time, that evidence included Greenspan’s signed replies to attempts at more transparency in 1992 and 1993, his comments on FOMC transcripts, the Fed’s seventeen-year lie about the sham burial of its records, the shredding of source transcripts, and the failed attempt, engineered by Greenspan in 1993, to mislead Congress about the seventeen years of transcripts. This record evidently did not affect Woodward’s assessment. Woodward and, later, a researcher called me when they were preparing Maestro; I offered my assistance and provided some material. 

Perhaps Greenspan’s speech on December 5, 1996, at the American Enterprise Institute for Public Policy Research helped propagate his personal myth. Greenspan declared his support for transparency at the Fed: “If we are to maintain the confidence of the American people, it is vitally important that, excepting the certain areas where premature release of information could frustrate our legislated mission, the Fed must be as transparent as any agency of government. It cannot be acceptable in a democratic society that a group of unelected individuals are vested with important responsibilities, without being open to full public scrutiny and accountability” (emphasis added).39 This was the same year in which unedited transcripts of Fed meetings were being destroyed, as authorized by a Greenspan engineered unrecorded vote. This effective feint toward transparency deceived a receptive audience that could not hear the shredders humming at the Fed. 

In Maestro, Woodward wrote: “Some day, in some form, the economic boom will end. Someone, an authoritative voice, is going to have to tell us the party is over . . . Who is responsible?” He asked his question just a few months too soon. The party ended when the stock market began its crash in March 2000, which was followed by a recession that ended in late 2001, which was followed by an anemic job-loss recovery. Three million jobs had been lost by 2003.40 

President George W. Bush, running for reelection in May 2004, nominated Greenspan for a fifth four-year term as Fed chairman, saying that Greenspan’s policies had “helped unleash the potential of American workers and entrepreneurs.”41

The Chairman Testifies From 1995 to 1998, the small hearing room (222, known as the “three deuces”) at the Rayburn House Office Building was used to house some of the press waiting to cover the semiannual testimony of Fed chairman Greenspan on monetary policy in the main House chambers. These semiannual reports were required by law. The reporters were not allowed to use the telephone or leave the room after receiving a copy of Greenspan’s speech to read in advance. There was an armed guard at the door, as there was in the other room containing other members of the press, who followed a similar ritual. Shortly before 10:00 A.M., when Greenspan began to speak, they were allowed to leave to rush to the toilet, to the hearings, or to call in their summary of the speech, which was immediately made public. This ritual may have evoked a bit of the Stockholm syndrome as the captives began to revere their Fed jailer, who held the key to the telephones and the toilets. 

The hearings were impressive media events, with members of the press at tables along one wall, flashbulbs blinking from a swarm of still photographers crouched in front of the chairman at the beginning of the hearings, and TV cameras; the camera directly in front of the chairman was remotely controlled from the outside hallway. The Fed chairman sat alone behind a microphone, his staff contingent behind him in the first row of public seating. The committee members sauntered in slowly and sat in the tiered rows of seats behind continuous, long mahogany desks with spaced microphones. Members sat in order of seniority, starting with the longest tenured member, who was placed next to the committee chair (not always the longest-serving member of the committee). The chairman sat top-row center. The number of members on the committee from each party was supposed to reflect the division in the full House of Representatives, but that was open to sometimes-heated negotiation between minority-party members and the House leadership. Lower rows contained members with less tenure. The newest members, whom one House Banking chairman referred to as the “babies,” sat in the lower rows. 

The committee has grown, reaching nearly seventy members in 2001. Before the hearing began, the Fed Chairman would go forward to speak briefly with some of the members, especially the chairman and the longest-tenured member of the minority party, the ranking member. Hearings began with opening statements from members. Because of the size of House Banking, senior members were often the only ones allowed to make opening statements. Some opening statements amounted to little more than bouquets of congratulations for the chairman; others were hard-hitting presentations of economic problems, which only infrequently could be remedied by policies over which the Fed had jurisdiction. 

Following in the style of Burns, Greenspan read his long opening statements in a muffled monotone, the naive perception of a learned professor’s style. They were laden with prolific economic background material, sounding like products of the large staff of economists that assist each Fed chairman. The statement might touch on many aspects of the economy but would not zero in on the effects of Fed policy. Extensive analysis of the success or failure of previous Fed policies was generally omitted. The average predictions of FOMC members about future economic activity, inflation, and employment were required to be presented. There was little or no explanation of the accuracy of previous or present observations, or of how they were related to past or future Fed policy. The result was frequently an excessively qualified mush that tasted delicious to the Fedwatchers industry, which baked them into a variety of delicious pastries. 

Questions about the Fed’s views of current conditions and its expected policies had to be extracted from a rapid reading of the chairman’s statements and associated material, sometimes supplied to members and staff only thirty minutes before the hearing. 

When the chairman stopped droning and looked forward in silence, the Banking Committee chairman would thank him for his presentation. Then came questions from members, many fewer of whom were generally present now than at the beginning of the hearing. Near the end of the hearing, the public audience had often nearly vanished, several times leaving only a visiting grade-school class on a tour of the Capitol. 

Although Greenspan would assume the erudite style used by Burns, he did not adopt the same magisterial condescension when answering members’ questions. Greenspan’s qualified answers contained nuggets of information that fell somewhere around the question. Questions directly affecting Fed policies or operations were sometimes treated with perceptible irritation, although other subjects were discussed cordially. It was often difficult to extract a distinct reply without digging into the analysis Greenspan had offered, and this was a more rigorous style of questioning than most legislators cared to undertake or, in House Banking, could pursue in the five minutes each was allotted. Occasionally members would yield their time to another member in order to facilitate continuity via follow-up questions. These members paid a price when they forfeited TV coverage of their questioning or praising the nation’s guru. 

Greenspan often appeared to be going in opposite directions on partisan issues so that he would not appear to be stepping on anyone’s toes, especially the toes belonging to the president. Sometimes he tripped on a contentious issue. 

He opposed big deficits in 2004, which he would rather not see, but thought they were sometimes necessary during the presidency of George W. Bush, whose major economic policies emphasized income tax reductions, which contributed to larger budget deficits. He stepped on the third rail in 2005 when his sage advice included Social Security payments, over which the Fed has no jurisdiction. Senate minority leader Harry Reid (D-NV, majority leader in 2007) called Greenspan “one of the biggest political hacks we have in Washington” after a Greenspan garblement that supported President Bush’s plan to put part of taxpayers’ Social Security contributions in private accounts.42 At the same time, Greenspan continued to oppose the huge budget deficits that the privatization plan would produce. Greenspan preferred dealing with the growing deficits by cutting Social Security benefits.43 

Playing Congress and the Public 

At congressional appearances, Greenspan could resort to the irrelevant detour to consume the time allotted to a legislator. With the help of Fed officials and the Fed’s experienced staff, Greenspan even planned such a diversion strategy. This is shown by his statements during a 1993 conference call to FOMC members. The Fed had been in a nearly two-year fight against Gonzalez’s efforts to impose greater transparency on it. Now the Fed governors and Fed Bank presidents feared being called en masse to testify. Some FOMC members turned to Greenspan for his expert assistance in producing detours away from questions. Robert McTeer, president of the Dallas Fed Bank, said: “I’m not questioning the views; [my concern] is just the way it’s going to look to the people [watching] C-Span, I guess.” Richard Syron, president of the Boston Fed Bank, added: “I don’t know how to do it, but if there is a way, along the lines of what Bob said, of trying to raise in our testimony something about the economy, or even finding a segue between the importance of what we’re doing and the [unintelligible] in some of our regions or something else to try to get somewhat off the defensive, it’s worth thinking about. I’m not sure it’s possible.”44 

Greenspan replied by explaining how to play committee members with a detour: “Well, that’s not a bad idea, Dick, because remember: Aside from Gonzalez and a few other planted questions, this [Banking] Committee is not focused on this issue. In fact the one thing that’s pretty clear is that there is a spectacular lack of interest in that Committee for these hearings. And it should be quite easy to say: And by the way, this reminds me of an incident in 1936 in Sacramento or something like that” (emphasis added).45 

Another technique used by Greenspan to announce Fed policy was to use a ridiculously opaque, garbled message conveying little or no information. A bit of deception, contradiction, or falsehood in a well-written announcement might draw some criticism, but if the entire message is a big garblement, it may well go unquestioned. It is difficult to dispute an entire message that is total nonsense, especially if it is decorated with erudite jargon. 

The jumbled FOMC announcement in May 2003 was interpreted as a very important message, signaling the Greenspan Fed’s concern with the possibility of deflation (falling average prices of goods and services). The Greenspan Fed thought this was a terrible condition, although this was a radical change from Greenspan’s prior support for zero inflation, which would require falling prices much of the time. 

The muddled announcement contained contradictory statements: “over time” things should get better, “over the next few quarters” things should stay about the same, and for the “foreseeable future” things should get worse: 

Release Date: May 6, 2003 

For immediate release 

The Federal Open Market Committee decided to keep its target for the federal funds rate unchanged at 1-¼ percent. 

Recent readings on production and employment, though mostly reflecting decisions made before the conclusion of hostilities [the second Iraq war], have proven disappointing. However, the ebbing of geopolitical tensions has rolled back oil prices, bolstered consumer confidence, and strengthened debt and equity markets. These developments, along with the accommodative stance of monetary policy and ongoing growth in productivity, should foster an improving economic climate over time. 

Although the timing and extent of that improvement remain uncertain, the Committee perceives that over the next few quarters the upside and downside risks to the attainment of sustainable growth are roughly equal. In contrast, over the same period, the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level. The Committee believes that, taken together, the balance of risks to achieving its goals [presumably to achieving full employment and price stability, as it is directed to do under 1946 legislation] is weighted toward weakness over the foreseeable future. 

Voting for the FOMC monetary policy action were Alan Greenspan, Chairman; William J. McDonough, Vice Chairman; Ben S. Bernanke; Susan S. Bies; J. Alfred Broaddus, Jr.; Roger W. Ferguson, Jr.; Edward M. Gramlich; Jack Guynn; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; and Robert T. Parry.46 (emphasis added) 

Former Fed governor Laurence Meyer wrote in his interesting book that when the FOMC said “foreseeable future,” as in this press release, it “was described as an ‘elastic’ concept, a period of time that depended on circumstances.”47 That ambiguity about time periods intensifies this garblement. 

This important press release issued at a critical time may appear to be the work of intellectually challenged people. In fact, there were well qualified intelligent people in this group who were simply following their leader. They adopted Greenspan’s long record of success in public relations by using “what he calls ‘constructive ambiguity.’ ”48 

As Meyer wrote in his book about his experiences as a Fed governor, the code words used in Fed messages can be tweaked in various ways to improve their usefulness to the Fed in signaling the public.49 These techniques, so beneficial to the health of the Fed-watchers industry, played a game with Congress, the public, and the press. 

Meyer was perplexed by a public statement proposed by Greenspan at an FOMC meeting in July 1996. Meyer wondered what it had to do with the discussion of policy that he and other FOMC members had just concluded. The proposed public statement contained the following garblement: “In the context of the Committee’s long-run objectives for price stability and sustainable economic growth, and giving careful consideration to economic, financial and monetary developments, slightly greater reserve restraint or slightly lesser reserve restraint would be acceptable in the intermeeting period.”50 Meyer wrote: “As I listened [to the chairman’s proposed directive for the committee to vote on] I wondered what that statement had to do with the discussion we had just concluded,” adding, “these decisions [at the FOMC meeting] were in the message but concealed by code.”51 Except for one dissent on policy grounds, the FOMC members approved Greenspan’s garblement. 

Meyer also found that another statement prepared by Greenspan and his staff before the discussion at a FOMC meeting “did not reflect a shred of the discussion just concluded.”52 This kind of manipulation by Greenspan bothered Meyer, who wrote: “The fact that the statements were prepared by the Chairman without any real input from the Committee created a degree of tension over the matter that never diminished during my term.”53 

These examples of high-handed manipulation by Greenspan apparently “created a degree of tension” but not much else. Meyer relates that during his term (June 1996 to January 2002), “no governor dissented in the vote at an FOMC meeting.”54 Thus, they were apparently tense but cowed. Meyer relates that there were occasional dissents by the Fed Bank presidents. He says that three dissents would have been seen as “open revolt with the Chairman’s leadership” and would have been “disruptive.” Meyer adds that he differed on occasion with the chairman but never dissented. Thus, behind the garblements, code words, and cowering, the public was shown unity. This had not been true at the Board of Governors meetings during Volcker’s tenure as Fed chairman. The so-called “gang of four” won a vote on February 24, 1986, at a Board of Governors meeting, 4–3, with Volcker on the losing side. 

Greenspan’s positions were frequently not well defined or supported, and his vague descriptions left open a nearly free range of interpretations, something like an inkblot test. In The Quotations of Chairman Greenspan: Words from the Man Who Can Shake the World, Larry Kahaner records the following four headlines that appeared after Greenspan answered reporters questions during a banking conference in Seattle in 2000: 

“Greenspan Sees Chance of Recession,” New York Times 

“Recession Is Unlikely, Greenspan Concludes,” Washington Post 

“Recession Risk Up, Greenspan Concludes,” Baltimore Sun 

“Fed Chairman Doesn’t See Recession on the Horizon,” Wall Street Journal ”55 

Kahaner records six additional headlines showing that Greenspan’s mystique was only nourished by the continued, seemingly inconsistent interpretations of his message thirteen days later: 

“Greenspan Predicts ‘Modest’ Recession,” Idaho Statesman 

“Greenspan: Little Risk of Recession,” USA Today “Greenspan Hints at Interest Rate Cut,” Nashville Banner 

“Interest Rate Cut Not on Horizon,” Los Angeles Daily News 

“Greenspan Hints Fed May Cut Interest Rates,” Washington Post 

“Greenspan: Uncertainty Abounds,” Manchester (N.H.) Union Leader 

Fed chairmen speak publicly under important constraints, as do all governmental officials. Governmental officials should not panic the public with dire economic pronouncements unless absolutely necessary. Fed chairmen, whose every utterances are thoroughly examined by the Fedwatchers industry, should not make statements that could cause depositors to run to their banks for their money. Fed chairmen cannot even visit a bank without causing great uncertainty about the bank. 

Opaque and garbled statements about the policies and operations of the Fed and the state of the economy were a technique that helped Greenspan retain his position as Fed chairman through four administrations. This technique has also played a role in Greenspan’s enshrinement as oracle and sage. The Fed chairman’s garblements, evasions, and deceptions not only stoked mistaken praise for the undecipherable coded announcements, but also hid accountability, increased the value of inside information to the favored few, and added to economic uncertainty. 

Rather than having to try to nail the chairman’s custard pies to the wall or to react to the public utterances of the other eighteen Fed governors and Fed Bank presidents, the public should be allowed to read transcripts of FOMC meetings in a timely manner—no more than sixty days later. The transcripts should be lightly edited in cooperation with professional archivists from the National Archives and Records Administration, and the source records should never be destroyed. 

Greenspan’s Garblements Live 

on at the Bernanke Fed 

When Ben Bernanke succeeded Greenspan as Fed chairman, in 2006, there was hope that this capable professor would lead the Fed into a new era: one in which meaningful reports would be released to the public, and the timely release of FOMC transcripts would become a reality. Instead, the Bernanke Fed has carried on the Greenspan tradition of garblements, as evidenced by an FOMC press release in the fall of 2006. It issued a prizewinning garblement seven months after Bernanke assumed leadership, one that only the Fed-watchers industry could admire: 

Readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.56 (emphasis added)

Chapter 4 

Spinning Mountains into Molehills 

The Fed’s reactions to problems, especially by its chairman, provide striking public relations lessons on how to avoid significant public recriminations and accountability and to limit meaningful remedies. Greenspan trivialized mountains and deftly swept what he painted as molehills under the Fed’s lumpy rug. He was called upon to deal with many problems, including nearly $500,000 stolen from the Fed’s cash and vault areas—and this official amount is an underestimate; revolving-door relations between Fed bank examiners and the banks they examine; the exposure of faulty examinations of a foreign bank in Atlanta through which $5.5 billion was sent to Saddam Hussein, part of what a federal judge found to be active U.S. support for Iraq in the 1980s; meals, gifts, and sports tickets for Fed officials and examiners from banks they examine; and the Fed’s bypass of the congressional appropriation process by making loans to foreign countries and by “warehousing” funds to take them off the Treasury’s books. 

Embezzling Fed Money and 

Falsifying Accounting Records 

The Fed vault facilities are a crucial part of the nation’s payment system and should be a national-security priority requiring full accountability to Congress. The Fed Banks contain uncirculated currency and coin transferred from the Bureau of Engraving and Printing. They also receive cash from banks throughout the country. 

When troubling information about problems in the cash departments at some Fed Banks reached Congressman Gonzalez, he ordered an investigation in 1996. He utilized his staff and a team of auditors from the General Accounting Office (renamed the Government Accountability Office in 2004). The GAO is the legislative entity that inspects and audits governmental operations. 

After requesting information from Greenspan about several major embezzlements, Gonzalez received an astounding admission of embezzlements from Fed vaults. On December 5, 1996, Greenspan replied to Gonzalez about the cash record-keeping and embezzlements from a number of the Fed’s vault facilities. Greenspan attempted to reduce the importance of the thefts by comparing the amount stolen to the huge number and amount of bills the Fed handled (but failed to mention any underlying problems that the identified embezzlements revealed): 

During the ten year time frame from 1987–1996, the Federal Reserve Banks received and processed $2.7 trillion or 201 billion notes. During this time the Reserve Banks identified 21 instances of thefts or suspected thefts by Reserve Bank employees from Federal Reserve operations. The aggregate amount taken was $498,000. The large part of that amount involved two cases totaling $377,000, which have been reported in the press and which you referred to in your press release of October 1. Of the total dollars taken in all incidents approximately $279,000 was recovered and an additional $116,000 is subject to future restitution to the Federal Reserve by court order. Assuming full restitution, the net loss will be approximately $103,000.1 

The Banking Committees that have oversight authority should have been fully notified about these thefts and the remedies that were being used to reduce or eliminate the embezzlements. Gonzalez issued an extensive press release citing the GAO study and Greenspan’s information about thefts of cash by Fed employees: “Chairman Greenspan has informed me that Fed employees have lifted nearly $500,000 from the Fed’s own vaults in the last ten years.”2 

Both of the larger amounts reported stolen were in connection with the processing of worn-out currency, which is destroyed. One of these employees worked at the Boston Fed Bank. A press account stated the defendant “pled guilty last summer to one-count charging him with embezzlement and theft from the Federal Reserve Bank of Boston.” The defendant’s lawyer explained to the judge “how the defendant managed to Spinning Mountains into Molehills � 57 embezzle $70,000 from the Federal Reserve Bank of Boston, one of the most heavily guarded financial institutions in the country. According to the prosecutor,” the defendant “was employed as a senior Payroll Teller and also as an Overnight Payroll Teller in the Cash Services Department of the Federal Reserve Bank in 1993, when he devised his scheme to embezzle $70,000 in cash from the Bank. During the first half of 1993,” while the defendant “was working as a member of a so called ‘Currency Verification and Destruction Team,’ ” the defendant “managed to remove $70,000 in unfit United States currency which had been hole-punched and earmarked for destruction.” The defendant “then held on to this so called ‘canceled’ currency until September of 1993 when he brought it back into the Bank and attempted to switch it for $70,000 in good United States currency, while working as an Overnight Payroll Teller.” The defendant “attempted the switch in the following manner. On the evening of September 28, 1993,” the defendant “removed $70,000 in good United States currency from a $100,000 bundle of currency in his cash drawer, ‘sandwiched’ the canceled currency in between the remaining $30,000 in good currency, re-bundled the bills together, and then spilled some sort of liquid on the bundle. [He then] submitted the bundle of currency to the Bank’s Destruction Unit for cancellation and destruction, claiming it was unfit. . . . an alert member of the Bank’s Destruction Unit discovered the $70,000 in unfit currency . . . mingled in the bundle. The case was investigated by Special Agents of the United States Secret Service.”3 The employee could have received up to thirty years in prison and $1 million in fines. The defendant received a sentence of four months incarceration to be followed by a period of community confinement and a thirty-two month term of supervised release. 

Another employee who entered a guilty plea worked at a branch of a Fed Bank and stole currency there over a reported two-year period. The total amount of discrepancies, also found in the currency-destruction operation, was $267,000, of which approximately $100,000 remained in the employee’s bank account and $49,236 was recovered during a search of the employee’s home, pursuant to a search warrant.4 As Greenspan reported: The “employee stole currency during processing and falsified documentation regarding the total number of notes destroyed.” The troubling part of this episode was that the theft was not detected by the Fed’s security system. Greenspan added: “The FBI notified Bank management of a suspicious currency transactions report filed by a local commercial bank on an account holder, the Bank’s employee.”5 The employee was sentenced to twelve months and one day in prison, the first six months to be served in a community-correction component and the remaining sentence in a prerelease component that might be called a halfway house. Confinement in a halfway house where residents may not go out at night might be especially frustrating if there was substantial stolen money that was not recovered. Again, the maximum sentence that could have been imposed was thirty years imprisonment and a fine of $1 million. 

The fact that the Fed was unable to detect this currency theft that occurred over a two-year period is one reason to suspect that the officially reported amount of money stolen by Fed employees from the Fed’s vaults may be substantially understated. 

There are other reasons for this conclusion. Gonzalez received information—and a subsequent investigation in 1996 substantiated—grossly improper record-keeping and management-directed falsification of records at the Fed Bank branch in Los Angeles. The GAO indicated that any other Fed facilities using this type of accounting would also be suspect. Evidence included a Cash Services Department memo stating that for several months they would be “backing into” their numbers, which means they were to be arbitrarily changed to bring about an accounting balance. Gonzalez said, “The [Los Angeles Fed Branch Bank] reports were not just wrong, they were falsified at the direction of management. I want to know who is responsible and why.”6 

Gonzalez requested a GAO investigation, and the results indicted some outrageous practices for a central bank holding a large part the nation’s supply of currency. The GAO findings were published as Federal Reserve Banks: Inaccurate Reporting of Currency at the Los Angeles Branch.7 The accounting problems reported by the GAO indicated that the Fed’s cash records and accountant controls were seriously flawed and incomplete. There was a severe security problem in the non-secure manner in which the Fed Bank staff was allowed access to the general ledger of the bank, the primary record of account. The GAO team could “not find evidence that anyone at the Bank reviewed the general ledger for unposted transactions,” so “certain staff could make unauthorized adjustments that could go undetected.” The GAO found troubling the manner in which an $8 million mistake was handled.8 The GAO team also found that the general ledger of the LA Branch Bank could not identity the reasons for its being out of balance. These are very serious internal security breaches for handling and storing the immense amount of currency and coin—$80 billion a year at that time in this one facility—entrusted to the nation’s central bank.9 

The problems uncovered reminded me of a past incident at the same LA Branch Bank, a branch of the San Francisco Fed Bank, which had seemed troubling. As a professor at the University of California, I had taken my MBA students on a tour of the LA Branch Bank. During the tour of the check-processing and cash departments, the initial impression was of a well-run operation with many guards, video cameras, and locked doors. 

The students entered a large paper-check sorting room. It contained many rows of long mechanical sorting machines. Stacks of paper checks were placed in one end of the machines, which read the magnetic coding across the bottom of the checks and then carried each check to the slot for the Fed Bank that served the private-sector bank on which the check was drawn. Mutilated checks that could not be mechanically read were sent to employees at the end of the room, who entered the codes manually. This was part of the Fed’s paper-check-clearing operations. The machines were not running, and there were no employees working at the time the students were in the room. One of the Fed managers explained that every day the Fed balanced the books with a $10 error tolerance limit. That was a good accounting control, he inferred, given the millions of checks processed each day. Just after the manager finished this statement, one of the students found a $5,000 check on the floor under one of the machines. He interrupted the presentation and asked the Fed manager how they could balance to within $10 if they overlooked this $5,000 check. The students laughed.10 

The response was much more direct and forthright than the nearly constant diversions received from Fed officials while I assisted in investigating Fed operations as a House Banking staff economist. The Fed manager thanked the students for finding the check. Yes, they had made a mistake. 

The response to the GAO audit of the LA Branch Bank some years later was very different but typical. The Fed’s long-winded reply did not give forthright answers to the main concerns that the GAO investigators found: deliberate accounting errors and a poor system.11 Where were the direct admissions of the problems found by the GAO team and the specific actions in other Fed banks that may have used similar accounting practices? Where was a complete statement of corrections for the mess that was found? What has happened to the Fed officials who ordered the accounting records to be forced? 

The Fed Board of Governors had responded to the Gonzalez-GAO investigation by sending a large team to count the money in the vault, a huge  task: “The Board’s Washington D.C.–based financial examiners performed a 100 percent count of the currency and coin holdings of the Branch, with the assistance of the San Francisco internal audit function. . . . A total of forty examiners and auditors were used to conduct the examination. . . . The Branch’s vault was sealed on Friday afternoon, September 6, [1996,] and the count continued through Monday morning, September 9. This special examination was conducted in accordance with generally accepted auditing standards.”12 The people sent by the Board presumably found little missing, since it was reported that the count agreed with the bank records under the vague phrase “generally accepted auditing standards” (GAAS). Nothing might be missing if the GAAS records were “properly adjusted,” as in the deliberate falsification of the accounting records or if the type of embezzlements described above at two Fed facilities had been used. 

Blame the Press and 

Trivialize Corrupt Accounting 

At his Senate confirmation hearing on July 26, 1996, before Senate Banking chairman Alphonse D’Amato, Greenspan blamed the press for overstating the problem: “Unfortunately, the press coverage of this matter, in our judgment, has significantly overstated the problem.” That seemed odd, since there was very little coverage, although coming from such a revered source for the Fed-watchers industry, it might have chilled any further coverage. There would be little press coverage of that part of Greenspan’s statement. One reporter noted, “Greenspan also brushed aside criticism of the Los Angles branch of the San Francisco Fed regional bank for misreporting certain money supply data.” He quoted Greenspan as saying, “No taxpayer money has been lost. No key decision-making has been compromised.”13 

Greenspan added that the LA Branch Bank had already discovered some problems and “was in the process of resolving them before Representative Gonzalez began his inquiry.” How inconvenient that they were bothered by an investigation of what they now called “some problems.” Why didn’t they inform Gonzalez, his staff, and the GAO staff who were actively investigating those problems? Did any officials permanently “leave” in connection with the finding that a LA Branch Bank official ordered some cash reports to be forced into balance by deceptive entries? What responsibility does the chain of command have, and where does the buck stop? 

Greenspan did not read the part of his submitted written statement in which he said that a small error, described as $178 million, had occurred at the LA vault facility, noting that it did not significantly matter because “at worst there would have been slight errors in forecasting currency demand, which could have caused a slight increase to the Federal Reserve’s order to the Treasury to print new currency.” He also did not discuss the widespread bookkeeping problems uncovered in the cash department by both the GAO and Gonzalez’s investigation. 

Meals, Gifts, and Sports 

Tickets for Fed Officials 

Fed Bank personnel examine the large private-sector bank companies in New York, some of which exceed $1 trillion dollars in assets. These banks have deposits insured by the federal government, so the collapse of one of them would require a huge bailout by U.S. taxpayers and cause massive collateral damage to banks around the country with interbank deposits in these New York banks. The task of examining these large banks with any precision is enormous. One thing should not be a problem: avoiding a conflict of interest by refusing gifts, free meals, or any form of remuneration from the regulated banks. 

On April 22, 1993, Chairman Gonzalez wrote to E. Gerald Corrigan, president of the New York Fed: “I have recently received reports that both lower and higher level employees of the New York Federal Reserve Bank have engaged in the following activities with officials of private banks. The practice includes socializing with foreign and domestic bankers, accepting meals at expensive restaurants and accepting gifts from bankers.”14 On May 18, 1993, Corrigan replied: “In order to seek to comply with your request in a manner that was timely and not unduly disruptive to the workforce at the Bank, and that would avoid creating an accusatory atmosphere, we have inquired of 65 officers of the Bank . . . to determine if we could find any evidence supporting the allegations in your letter.” Corrigan said the “review has not disclosed evidence of widespread socializing by Bank personnel with foreign or domestic bankers, where the costs are paid by the bankers alleged in the reports you received.”15 

He then wrote about a “limited number” of regulated-bank-paid meals for officers of the Fed Bank and a “literal handful” of tickets to sporting events, but no sign of free gifts of the type Gonzalez had mentioned. Corrigan assured Gonzalez that “the Bank has always prided itself on its independence of judgment and maintenance of high ethical standards,” and that “in the context of the overall review of our policies described below, we will carefully consider whether any modifications of our policies in this area seem warranted.”16 

Anyone familiar with Gonzalez knew that you could not brush him off with platitudes and the casual response that the Fed would look into things to see if any changes should be made. Gonzalez shot back within a week (May 24, 1993): “You say to avoid an ‘accusatory atmosphere’ you limited your inquiry to 65 [of the 174] officers of the New York Federal Reserve Bank. I think there would be an accusatory atmosphere if you ignored legitimate allegations and lost the trust of United States citizens in their central bank.” Gonzalez sharply disagreed with Corrigan that meals paid for by Fed-regulated banks were within bank guidelines because the Fed employees were conducting “bank business.” He also disliked the characterizations of the complaints as “anonymous allegations”: “It would have been inappropriate for me to release the names of those who made these complaints.”17 

Two months later, Corrigan ended his twenty-five-year career with the Federal Reserve System: he left his position at the New York Fed on July 18, 1993, before the end of his term. On January 3, 1994, he became a senior executive at Goldman Sachs. 

William McDonough, the newly appointed president of the New York Fed, made some suggestions to the House Banking Committee that no gifts or meals should be accepted from regulated banks. On May 27, 1994, he informed Gonzalez that he was instituting a “Uniform Code of Conduct.” This twenty-two-page document contained many provisions to ensure that Fed employees received no monetary advantages from regulated banks. Only gifts with a “de minimis” (trifling) value could be accepted, and only under special circumstances, such as being a “benefit available to the general public.”18 A Fed Bank employee “who ceases to be employed by the Bank should not contact the Bank concerning a particular matter in which he or she participated while employed at the Bank.”19 The rules were to be adopted by all twelve Fed Banks. Since 1998, when Gonzalez left Congress, there has apparently been no congressional oversight to determine if the provisions of this “Uniform Code of Conduct,” which are critical to the unbiased, ethical regulation and examination of the nation’s financial system, are being strictly observed throughout the Fed. 

McDonough’s work on the ethics code was a valuable service for better government. He was appointed chairman of the Public Company Accounting Oversight Board in April 2003. This board was created to avoid  accounting scandals at private-sector corporations, the kind that became public after the huge stock-market decline began in March 2000. 

Greenspan Spins the Revolving 

Door for Bank Examiners 

Examining banks is an immense challenge that relies on examiners who earn considerably less than the officials of the banks they are examining.20 There are excellent examiners whose primary objective is a career dedicated to serving the public interest and not to soliciting or accepting gifts or employment from the regulated banks. 

Every taxpayer has a stake in these examinations, since banks hold government-insured deposits, which are ultimately a liability of the U.S. taxpayers. House Banking chairman Gonzalez had guided legislation to resolve the massive savings and loan debacle in the 1980s and early 1990s. This legislation sought to install better examination methods. He had reason to believe that some bank examiners had conflicts of interest or worse because of a “revolving door syndrome,” in which examiners could be working for the Fed one day and then for a Fed-regulated bank the next. Gonzalez asked Greenspan to institute a one-year waiting period before former Fed bank examiners could accept a job with a regulated bank.21 

Greenspan responded with a contradictory answer and a blunt refusal. He said the Fed did not routinely keep records of its bank examiners’ later employment; he instead relied on the “collective memories of the Fed Reserve officials” for this information. They could only remember “one half of one percent” of Fed bank examiners taking jobs at banks they had examined in the last five years. So it was not a significant problem according to this misty survey.22 After thus minimizing the trouble, Greenspan noted that the revolving door has “numerous benefits” and that it was not “uncommon” for examiners to accept a job at the Fed in order to obtain a job at a bank: “We should note that it is not uncommon for examiners, given their skills, knowledge and experience, to accept employment in the banking industry; moreover, it is not unusual for many of those who enter our employ as examiners to have plans to become bankers over time. Such transitions are considered both positive and natural. Numerous benefits have been derived, by both regulators and bankers, from examiners taking employment at banking institutions.”23 

Greenspan also cited a federal law and Fed policy guidelines that do not prohibit examiners from seeking or negotiating employment “as long as the examiner does not participate in an examination or supervisory matter once negotiations have begun” (emphasis added). Examiners can send a “mass distribution of resumes” (a phrase used by the Fed’s general counsel) even to regulated banks being examined. If employment negotiations begin with a bank official at the bank the Fed examiner is examining, Greenspan stated, the examiner is “prohibited from any further supervisory matters concerning that institution.”24 

Thus, the revolving door was protected, and a required arm’s-length relationship between Fed bank examiners and banks being examined was jeopardized. According to Greenspan, the revolving door was common and beneficial, even though the “collective memories” of Fed officials did not remember it revolving very much. Gonzalez’s inquiries indicated mismanagement or worse of the bank-examination functions of the nation’s central bank. 

The Intelligence Reform and Terrorism Prevention Act of 2004 did install a one-year postemployment restriction limited to “certain senior examiners” employed by federal regulators of depository institutions, including the Federal Reserve Banks.25 

Billions to Saddam Hussein 

On November 9, 1993, several federal marshals brought a prisoner, Christopher Drogoul, into my office at the Rayburn House Office Building. The marshals removed the manacles, and Drogoul took off his jumpsuit and changed into a shirt, tie, and business suit. He immediately looked like the manager of the Atlanta branch of Banca Nazionale del Lavoro, a government-owned Italian bank—which was, in fact, his former position. 

According to a press account, Drogoul had come to testify about “a scheme prosecutors said he masterminded that funneled $5.5 billion in loans to Iraq’s Hussein though BNL’s Atlanta operation. Some of the loans allegedly were used to build up Iraq’s military and nuclear arsenals in the years preceding the first Gulf War.”26 Drogoul’s “‘off book’ BN L-Atlanta funding to Iraq began in 1986 as financing for products under” programs overseen by the Department of Agriculture, which allegedly authorized the loans.27 Since Drogoul told the committee he was merely a tool in an ambitious scheme by the United States, Italy, Britain, and Germany to secretly arm Iraq in its 1980–1988 war with Iran, his testimony was politically contentious and unproven. He was sentenced in November 1993 to thirty-seven months in prison; he had served twenty months while awaiting his sentencing hearing. 

U.S. District Judge Ernest Tidwell found that the United States had actively supported Iraq in the 1980s by providing it with government guaranteed loans, even though it was not creditworthy. The judge said such policies “clearly facilitated criminal conduct.”28 

Gonzalez was drawn to Drogoul’s answer about the Fed examiner who had visited his Atlanta operation: 

At the November 9, 1993 Banking Committee hearing I asked Christopher Drogoul, the convicted official of the Banca Nazionale Del Lavoro agency branch in Atlanta Georgia, how the Federal Reserve Bank examiners could miss billions of dollars of illegal loans, most of which ended up in the hands of Hussein. 

Mr. Drogoul stated: 

The task of the Fed [bank examiner] was simply to confirm that the State of Georgia audit revealed no major problems. And thus, their audit of BNL usually consisted of a one or two-day review of the state of Georgia’s preliminary results, followed by a cup of espresso in the manager’s office. 

The Federal Reserve bank examiner’s friendly chat and cup of espresso in the manager’s office at BNL is symbolic of a collegial atmosphere that may very well get in the way of proper supervision and regulation.29 

Surely the Fed examiners should have realized whether billions of dollars were flowing to Iraq from this tiny branch of an Italian bank. Given its substantial powers and its obligation to examine and regulate foreign banks, the Fed’s bank examiners should provide thorough examinations of these banks, something more than perusing a state examiner’s papers.30

Unauthorized Loans to Mexico 

The power given to Congress to appropriate federal governmental funds is specified in the Constitution: “No money shall be drawn from the Treasury but in consequence of appropriations made by law” (article 1, section 9). Nevertheless, since 1962 the FOMC has voted to lend money to foreign countries and has also, in recent decades, voted to “warehouse” funds for the U.S. Treasury so that the Treasury could avoid limits on the funds available to it from congressional authorization. 

Some of the members of the Board of Governors called attention to FOMC votes that could “be subject to being viewed as perhaps circumventing the Congress.” They brought their concerns directly to Greenspan in then-secret FOMC meetings. W. Lee Hoskins, president of the St. Louis Fed, told Fed officials in 1989: 

And it seems to me that over time, given I think what the paper pointed out that Mexico needs $3 to $5 billion per year for the next several years, with the drying up of private resources I think we could expect more of this kind of activity. The concern is that we would be subject to being viewed as perhaps circumventing Congress by working more closely with Administrations down the road on this kind of activity. In that sense, I don’t think it’s appropriate to continue those kinds of relationships because I think it risks the political independence of this body to some extent. (emphasis added)31 

J. Alfred Broaddus, Jr., president of the Richmond Fed, objected to making a loan to Mexico in 1994. He warned Greenspan at an FOMC meeting: “So, it seems clear to me that any loan to Mexico in the current circumstances in essence would be a fiscal action of the U.S. government. And fiscal actions—expenditures of the government—are supposed to be authorized by Congress and Congress is supposed to appropriate the funds. So, whatever the general merits may be of making loans to Mexico, I don’t think we should be involved without explicit Congressional authorization, Mr. Chairman. So, I would oppose an increase in the swap line.”32 (The “swap line” is the general name given to the Fed’s so-called “reciprocal currency transactions.”) 

Governor Wayne Angell called attention to violations of Congress’s appropriation power when the FOMC discussed “warehousing” currency for the U.S. Treasury. The Treasury, an executive-branch department, must obtain congressional approval for most of its budget.33 Warehousing allows it to keep funds off the books and to purchase assets that exceed its authorized budget. At an FOMC meeting in 1990 at which the warehousing of more than $40 billion in foreign currency was being discussed, Angell gave a stern warning: 

I believe the Constitution gives the Congress of the United States the power to appropriate. I believe for us to do warehousing, which in a sense removes from Congress this appropriations power, is at best a [legally] risky proposition. . . . It eliminates the necessity for the Treasury to go to the Congress to get an appropriation, [and] I can’t do that [i.e., approve more warehousing] as a matter of principle until the courts tell me that we can. . . . I do not believe that members of the Appropriations Committee understand this issue. I do not think that they know their appropriations power is being subverted by our warehousing agreement.34 

Angell was worried that someone outside the Fed might cause political trouble: “And I believe that in that atmosphere at some point in time this is apt to become a political issue. And if it becomes a political issue, I believe it is incumbent upon us to protect the Federal Reserve’s position, which is not to go around the congressional appropriation that other warehousing would tend to do” (emphasis added).35 

As shown in a 1992 letter (see Figure 4-1), Greenspan told Secretary of the Treasury Nicholas Brady how eager the Fed was “to increase the size of the warehousing facility in the future, as has happened in the past, beyond its present $5 billion. I would strongly support an increase under a wide variety of possible circumstances.” 

The warehousing arrangement with the Treasury was increased to $20 billion in 1995 in connection with a “Mexican financial assistance package,” but was reduced to $5 billion in 1999.36 Two Fed economists reported that warehousing arrangements have been controversial since “about 1978” because they provide the Treasury “with additional funding that circumvents the congressional appropriations process and statutory limits on Federal borrowing.”37 

Thus, these warnings from Fed governors to Greenspan and other FOMC members—that by warehousing, the Fed would be circumventing the constitutional powers given Congress—produced little effect, with one possible exception. The warnings may have added some enthusiasm for a secret unrecorded vote of FOMC members to destroy three years of their source records in the 1990s, when a Fed loan to Mexico was authorized. An FOMC transcript from 1997 indicates the ease of the Greenspan Fed in circumventing the appropriation process: 

Mr. Broaddus. A point of clarification, Mr. Chairman. The authority for the warehousing is in the first vote, right? 

Mr. Truman. Yes, the authority to enter into a warehousing transaction is in the first vote. 

Mr. Broaddus. Okay. 

Chairman Greenspan. Is that satisfactory to everybody? Would somebody like to move the first vote on the warehousing transaction agreement? 

Mr. Truman. Mr. Chairman, President Minehan has a question. 

Ms. Minehan. Just one small question: When we ratcheted up the amount of the warehousing authority in the late 1980s, what was the proximate cause for that? The Brady policy? 

Mr. Truman. That was a period when we and the Treasury were doing quite a lot of intervention in the markets. The Treasury essentially ran out of dollars in the Exchange Stabilization Fund. We warehoused Figure 4-1. some of their foreign currencies to provide them with dollars so that they could participate with us in foreign exchange operations. 

Ms. Minehan. Thank you. 

Chairman Greenspan. Would somebody like to move the warehousing agreement? 

Vice Chairman Mcdonough. I move the warehousing agreement, Mr. Chairman. 

Chairman Greenspan. Seconded? 

Mr. Kelley. Second. 

Chairman Greenspan. Without objection. The next item on the agenda is boilerplate; it is the report of examination of the System Open Market Account—38 

Lending Money to Foreign 

Countries, Deceptively 

The conditions leading to the Fed’s internal authorization for foreign-loan activities began in 1961 in connection with the U.S. government’s gold policy. The government agreed to buy gold from foreigners (or to sell it to them) for thirty-five dollars a troy ounce.39 This system, which regulated the issuance of money to foreigners, was the external part of a system known as the gold standard. A full gold standard would have applied to all money issued by the U.S. government: all currency would have been redeemable for gold. 

The price of gold rose above thirty-five dollars an ounce in London in October 1960, and this price increase threatened the gold-standard system. As long as gold could be bought from the U.S. Treasury for thirtyfive dollars an ounce and sold in London for forty dollars an ounce, U.S. dollars would flood into the Treasury to buy, and perhaps exhaust, its supply of gold. The outflow of investment funds from the U.S. in response to the London price of gold was called the “London gold rush.” An official of the Bank of England warned that these events threatened “the whole structure of the exchange relationships in the western world.”40 The Kennedy administration sought to “defend the dollar” and preserve its value in terms of gold. The management of the value of the dollar in international trade, as well as the price of gold, was under the jurisdiction of the Treasury. It used a special fund, the Exchange Stabilization Fund, to support its interventions in the foreign currency markets. This fund did not have enough money to effectively operate in the foreign-exchange markets. The Secretary of the Treasury, Douglas Dillon (1961–1965), warned against complacency, saying that the situation was “still ticklish.” 

Then the Fed, with its “unlimited pocketbook,” entered the picture. At the inaugural meeting of the Organization for Economic Cooperation and Development, in April 1961, the U.S. team included the Fed chairman, William McChesney Martin. It became apparent early in the following year why the Fed was drawn into the international exchange problems surrounding the gold standard: As Fed Governor J. L. Robertson said (according to paraphrased transcripts) it had an “unlimited pocketbook”: “Mr. Robertson inquired as to the advantages seen—aside from the Federal Reserve’s ‘unlimited pocketbook’—in having two agencies [the Treasury and the Fed] operating in this field instead of one, and Mr. [Charles A.] Coombs replied that he did not think there were any.”41 The need to evade congressional budgetary authority was admitted to be the basic reason for the establishment of the fund for foreign-exchange currency intervention at the Federal Reserve.42 Robertson told the FOMC members that he opposed the operation in foreign currencies “on legal, practical, and policy grounds because it seemed to him that the only basis for the entrance of the Federal Reserve into this field would be to supplement the resources of the Stabilization Fund and because the program was being undertaken without specific congressional approval.”43 

Fed chairman Martin developed a peculiar, contradictory rationale to justify the absence of a request for formal authorization from Congress in 1962: although the Fed had received favorable opinions from its own and the administration’s lawyers, it did not know exactly what it was doing, so it would not know what to ask Congress to authorize. If it truly did not know what it was doing, the pleasing approvals from the lawyers should have been suspect. This disingenuous sophistry was part of a plan to keep Congress uninformed about the Fed’s circumvention of its constitutional authority to appropriate money.44 

Still, Fed officials, mindful that someone in Congress might inquire about why it had not been notified, developed a plan to notify Congress and the public without meaningfully informing them. Public notification came from Alfred Hayes, president of the New York Fed, who referred in a speech to the possibility of the Fed undertaking foreign-currency operations. 

Congressional notification consisted of a reference by Fed chairman Martin in a nine-page single-spaced statement at the meeting of the Joint Economic Committee (JEC) of Congress on January 30, 1962. This committee has no authorization to vote on legislation. Normally, it would be expected that new operations would be presented before the Banking Committees, which have legislative and oversight authority for the Fed. 

Martin told the JEC members that the New York Fed, acting as an agent for the Treasury, had used the Exchange Stabilization Fund for operations not previously undertaken since World War II: “As one step in such cooperation [with the Treasury], the System is now prepared in principle and accordance with its present statutory authority to consider holding for its own account varying amounts of foreign convertible securities . . . [for] the primary purpose of helping to safeguard the international position of the dollar against speculative forays of funds.”45 

Alert congressman Richard Bolling (D-MO) asked Martin to explain what he meant by “As one step in such cooperation, the System is now prepared in principle and in accordance.” Martin replied that the Fed was not anxious to engage in this activity, and that the Treasury had experimented with foreign-exchange operations in a small way in March. Then he added: “What we are aiming at is to keep the speculators from unseating us.”46 This warning of a nebulous attack by “speculators” produced the desired effect, quashing questions about the Fed’s grant of new powers to itself. Bolling asked one cautious question: “But I want to know what you do, within the bounds of what you should or should not say.”47 Martin replied with a short explanation of reciprocal currency transactions. That was the last question, despite the presence of Senator Paul Douglas (D-IL), a renowned economist. The Fed could breathe easy. It had cleverly notified Congress in a vague, incomplete, deceptive way that produced little immediate scrutiny. This was an early example of a Fed garblement. 

The gold-standard system was completely abandoned by the United States in 1971 when the Nixon administration closed the “gold window” at the Treasury. Even though this eliminated the right to buy the Treasury’s gold, and Martin’s rationale for the Fed’s foreign-exchange activity—to keep the “speculators from unseating us”—thus no longer applied, the Fed’s reciprocal currency transactions and loan facility lived on. 

Spinning Fed Loans to Foreign 

Countries into the Mist 

Thirty-two years later, in 1994, Greenspan referred to a 1962 House Banking hearing at which Henry Gonzalez had been present. As part of the Fed’s claim to have the authority to carry on its foreign-exchange operations without congressional authority, Greenspan said that no one  seriously objected in 1962, and that Gonzalez was there. That was incorrect. Gonzalez sent Greenspan a letter indicating that seven months after Martin had talked to the Joint Economic Committee, Congressman Henry Reuss had objected at that hearing, although further discussion was cut off by the committee chair: “I must serve notice on you right now that I consider this an usurpation of the powers of Congress. I don’t think you are authorized to do this at all, and you give only vaguest generalizations about what kind of arrangements you are going to make with foreign Central Banks” (emphasis added).48 

After reading this history of the Fed’s deceitful announcement of its “foreign exchange network,” the reader may appreciate Greenspan’s 1994 denial that the Fed made loans to foreign countries.49 Greenspan said that the Fed and the Treasury “are unique among the monetary authorities of major industrial countries in the frequency and detail in our public reports on foreign exchange operations.”50 Greenspan went on to explain part of the Fed’s international currency operations called “swap drawings.”51 Greenspan said that the Fed “always seeks to assure that there are reasonable prospects of prompt repayment,” and that “all drawings on this network have been repaid in full.”52 If swaps are not loans, why worry about repayment? 

The Fed probably participated in swaps or loans with Mexico in 1976, 1982–1983, 1986, and 1988, and authorized a loan to Mexico in the 1990s as well.53 The discussion at the FOMC meetings in the mid-1990s was about a loan to Mexico. Since they were involved in discussions about the collateral, they surely knew it was a loan. The mid-1990s multilateral loan facilities of $12 billion, in which the Fed participated, were clearly loans. The foreign and domestic governmental lenders that participated as well as the recipient knew this. FOMC members were worried about the collateral, which would include revenue from Mexico’s oil industry. Although the Mexican peso crisis was ameliorated when the Fed authorized the loan, giving the New York Fed Bank the authority to extend it, the FOMC nonetheless authorized it without congressional approval. 

Greenspan as well as former Fed chairman Martin were spinning foreign loans into a mist, and few will recognize them as foreign loans once they are labeled swaps. They are a liability of the U.S. government and the taxpayers.54 Greenspan suggested that Congress never complained.55 Case closed, without the bother of further congressional authorization for the Fed’s loans to foreign countries and the warehousing of foreign currencies held by the Treasury. It does not follow that foreign-exchange operations of the Fed are bad  policy. The central bank should be authorized to intervene in foreign exchange markets as long as there are appropriate checks and balances for governmental expenditures. This oversight can be done in a timely manner by the chairmen and ranking members of the House and Senate Banking Committees, provided they have high security clearances. They should have all records of these loans (including source FOMC transcripts) before the loans are made. They have the authority to introduce legislation if they think this self-authorized power by the Fed is being abused. 

Foreign loans affect not only the federal budget, properly calculated, but also foreign policy. They may prop up the international value of the currency of a foreign government to assist its officials in their reelection. The political effects of Fed loans to assist the party in power apply to some Fed swaps or loans made to Mexico, especially those made immediately before an election in that country. Unelected Fed officials should not bypass congressional budget authority without timely checks and balances from Congress.

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Valuable Secrets and the Return of Greenspan’s “Prophetic Touch”