From Whom Is the Fed Independent? To Whom Is It Accountable?

Published in The Federalist Society.

The Federal Reserve and its supporters constantly declare that the Fed is and should be “independent.” Whether it is or should be independent of the elected President of the United States is once again a hot issue—as it has been numerous times before in history. Whether the President can fire the Fed Chairman is now a particularly debated question. A more fundamental question is whether any agency of the federal government—including the central bank—can in our constitutional republic be an independent power subject only to itself.

The constitutional bedrock of American government, and of American political philosophy, is that all parts of the government are subject to checks and balances from other parts. This must apply to the Fed as well as to all other government entities. Should one immensely powerful part of the government, the Fed, be exempt from the essential principle of checks and balances? The answer is no. But we have to specify from whom the Fed is independent and to whom it is accountable.

My conclusion is that the Fed is and should be independent of the President, but that the Fed is and should be accountable to (thus not independent of) the Congress.

Congress and the Fed

The Congress is without question the possessor of the Constitutional Money Power: “To coin money [and] regulate the value thereof.” The Congress also possesses the Taxing Power: “To lay and collect taxes.” The Fed is a critical part of both and thus is subject to Congress. We must include taxation because the inflation the Fed creates is in fact a tax; it takes the people’s purchasing power and transfers it to the government.

In addition, the Fed is now running massive losses. As April 2025 ends, the Fed’s accumulated operating losses have reached the astonishing amount of $227 billion. Besides far exceeding the Fed’s capital and rendering it technically insolvent, these losses are a growing hit to the taxpayers. They increase the federal deficit and increase the national debt—both key congressional responsibilities. The Fed has on top of this a more than $1 trillion market value loss on its investments. Imposing these losses and this risk on the government’s finances should by itself sink any claim that the Fed should be completely independent, especially when the Fed has manipulated its accounting in embarrassingly dubious fashion to hide its resulting negative capital.

Further, we must consider that the Fed’s monetary policy is in essence an attempt at central planning and price fixing, using changing and debatable theories and data reflecting the past, with inevitable political effects. There is no data on the future. Neither the Fed nor anybody else has the knowledge of the future which would be required to “manage the economy.” The Fed’s efforts—no matter how much intelligence, data from the past, and good intentions are applied—share with all tries at government central planning the impossibility of the requisite knowledge, as demonstrated by Ludwig von Mises and Friedrich Hayek.

As one notable example, the Fed could not know what the results would be of its unprecedented monetizing of $8 trillion in long-term Treasury debt and 30-year fixed-rate mortgages. As it turned out, this included stoking a new house price bubble. This bloating of its balance sheet by “quantitative easing” was accurately described by former Fed Chairman Ben Bernanke as “a gamble.”

The Fed does not and cannot know what the results of such gambles will be; it is flying by the seat of its pants.

Likewise, neither the Fed nor anybody else can know—but can only guess about—what the celebrated “neutral rate of interest” is or will be. That this theoretical neutral rate is called “r-star” gave rise to this brilliant and honest aphorism of Fed Chairman Jerome Powell: “We are navigating by the stars under cloudy skies.”

While flying by the seat of your pants, gambling with trillions of taxpayer dollars, and navigating by the stars under cloudy skies, how can you claim you should be independent? In my view, you can’t. Accountability to the Congress is required.

Turning to political philosophy, we should recall the conclusions of the congressional study, The Federal Reserve After Fifty Years, published in 1964 under the leadership of Wright Patman, then Chairman of the House Committee on Banking and Currency:

“An independent central bank is essentially undemocratic.”

“Americans have been against ideas and institutions which smack of government by philosopher kings.”

“To the extent that the [Federal Reserve] Board operates autonomously, it would seem to run counter to another principle of our constitutional order—that of the accountability of power.”

These conclusions seem to me correct.

The President and the Fed

It is natural that the President and his Treasury Department should want to control the Fed, since that would give them the power to keep spending money when they are in deficit, by having the Fed print it up and lend it to the Treasury. Presidents of both parties have often wanted lower, or at least not higher, interest rates for political purposes, including financing wars and winning elections, and they have used their influence with the Fed accordingly.

The Treasury Department of course likes lower interest rates on government securities, which reduce the cost of the debt it issues and reduce the amount of new borrowing needed to pay the interest on the old debt. To make the executive the boss of the Fed is to make the borrower the boss of the lender.

Nonetheless, for extended times in Federal Reserve history, especially during major wars and economic emergencies, the Fed has been subservient to the Treasury Department. This began when the Fed was three years old with the American entry into the First World War in 1917. During these times, the Fed devoted itself loyally to financing the government’s deficits as needed. It did so most recently during the Covid-19 economic crisis of 2020-21. Will the Fed repeat this performance in the future? Given a war or emergency big enough, it will.

Historically, under master politician Franklin Roosevelt, “The Treasury controlled most decisions,” and the Federal Reserve “was in the backseat,” according to Allan Meltzer’s magisterial A History of the Federal Reserve. Also during this period, the Treasury took every ounce of the Fed’s gold and never gave any back.

The intense dispute between President Truman and his Treasury Department, on one side, and the Fed, on the other, resulted in the President telling Thomas McCabe, the Fed Chairman, that the Fed was doing “exactly what Mr. Stalin wants.” He then criticized and induced McCabe to resign (bitterly) and chose a new Fed Chairman, William McChesney Martin, who he thought would be loyal. But Martin did not do what Truman wanted; Truman called him to his face a “traitor.” Martin stayed on as Fed Chairman for 19 years.

President Lyndon Johnson had a memorable dispute with the Fed. “How can I run the country and the government if . . . Bill Martin is going to run his own economy?” the furious President demanded. Martin traveled to Johnson’s Texas ranch to discuss the issue, where it is said that Johnson physically pushed the proper Martin around the living room, shouting at him. Quite a scene to picture.

We come to the interesting discussions between President Nixon and Fed Chairman Arthur Burns. Meltzer writes, “Ample evidence . . . supports the claim that President Nixon urged Burns to follow a very expansive policy and that Burns agreed to do it.” Wittily and cynically, Nixon said he hoped that the independent Fed Chairman would independently decide to agree with the President. Burns is said to have remarked with fine irony, “We dare not exercise our independence for fear of losing it.”

The Fed is always in a web of presidential and financial politics. President Trump’s pressure on Fed Chairman Jerome Powell, however extreme the language, repeats an historical tension.

In Sum

We can safely predict that this natural tension between the President and the Fed will continue as far as we can imagine. It reflects the fact that the Fed is constitutionally accountable to the Congress, not to the President.

The Fed remains at all times a creature of Congress—if Congress exerts its authority. If Congress has the will, it can instruct, redirect, restructure, or even abolish the Fed. In addition, as the then-President of the New York Fed testified at Wright Patman’s hearings, “Obviously the Congress that set us up has the authority to review our actions at any time they want to, and in any way they want to.” Should Congress audit the Fed? Of course—and on an ongoing basis.

Moreover, I believe that each of the congressional banking committees should have a subcommittee devoted exclusively to the Federal Reserve and central banking issues.

Discussions of Fed independence often focus on the need to prevent the executive from overrunning the central bank. But American citizens consistent with our Constitution should demand that such a powerful government agency be accountable to the people’s representatives in Congress.

BPInsights: April 19, 2025

Published in the Bank Policy Institute.

The panel also featured Yale Professor Gary Gorton and Mises Institute Senior Fellow Alex Pollock, who critiqued the inability of regulators to differentiate between minor risks and systemic threats.

Congress Should Never Have Created Fannie Or The GSEs

Published in Forbes.

As a result, Congress and three consecutive administrations have allowed the GSEs to remain in conservatorship. And as a recent Law and Liberty article by Alex Pollock and Ed Pinto points out, the GSEs remain insolvent.

The Sound of Five Thousand Banks Collapsing

Published by the Civitas Institute.

From 1921 to 1929, 5,711 U.S. banks went broke. That is an average of 635 failures per year, or about 12 per week for a period lasting nine years, all in a decade that elsewhere featured the 1920s boom.

——

Acting as the lender of last resort to banks by making them collateralized loans from its “Discount Window” was a principal reason for the creation of the Federal Reserve in 1913.  It is still a key function, although at present, loans to banks represent only 0.06% of the Fed’s assets.  Nonetheless, it is a capability that has proven very handy in the many financial crises of the Fed’s career so far.  

With the passage of the Federal Reserve Act, many hoped that the new Federal Reserve Banks would make future financial crises impossible. William G. McAdoo, for example, the Secretary of the Treasury at the time—and therefore, under the original act, automatically the Chairman of the Federal Reserve Board—had this excessively optimistic prediction:

The opening of [the Fed] marks a new era…[It] will give such stability to the banking business that the extreme fluctuations in interest rates and available credits which have characterized banking in the past will be destroyed permanently.

Only one decade later, the still young Fed was facing the failure of thousands of banks, principally smaller banks across the country's agricultural regions. To be specific, from 1921 to 1929, 5,711 U.S. banks went broke. That is an average of 635 failures per year, or about 12 per week for a period lasting nine years, all in a decade that elsewhere featured the 1920s boom.

This now almost entirely forgotten banking bust, and the Federal Reserve Banks’ widespread use of the Discount Window during it, are instructively recounted and analyzed by Mark Carlson in his new book, The Young Fed—The Banking Crises of the 1920s and the Making of a Lender of Last Resort. The book reviews both colorful specific cases and the fundamental ideas involved. Calson makes it clear that the Federal Reserve Banks and Board officers were well aware of and thought carefully about the tensions and trade-offs inherent in their lender of last resort activities.

These include the systemic problem of having many banks in trouble at the same time, the problems of the moral hazard induced by central bank lending, distinguishing illiquidity from insolvency in the time pressure and uncertainty of a crisis, a banker’s first loyalty to depositors vs. the central bank’s shifting losses to depositors, and the central bank itself taking credit risk.

Thus, the book is both an interesting history and an exploration of some core concepts in banking and central banking.

Hundreds or Thousands of Banks in Trouble at the Same Time

As Carlson writes, “the disruptive effects of bank failures are particularly relevant when many banks are in trouble at the same time.” At that point, “the sudden liquidation of all assets of the troubled financial institutions would be disastrous.” Yes, all the troubled banks cannot sell their assets simultaneously when their lenders and depositors want their money back.  

An old Washington friend of mine once asked, “If a good pilot can in an emergency land a jet plane in the Hudson River like Captain Sullenberger did, why can’t we handle financial crises better?” I replied, “To get the analogy right, you would have to picture landing a hundred crippled jets in the Hudson River together.”

“In the 1920s,” says Carlson, “the troubles in the banking system were also widespread… Congress leaned heavily on the Federal Reserve to support the banks.” The book suggests that the new Federal Reserve did well under the 1920s circumstances. The Fed “experienced a large number of successes when providing emergency funds to banks,” Carlson observes, but “other banks failed with discount window loans outstanding, which put the Federal Reserve in uncomfortable situations.”

Why were so many banks in trouble at the same time? The root cause was the First World War, as war was often the key factor in big financial events. As Carlson explains, the “Great War” created a huge agricultural boom in the U.S., and the boom set up the bust. Because of the war, “prices of agricultural commodities soared globally. U.S. farmers bought more land, planted more crops, and raised more livestock amid expectations that the boom would last.... A significant proportion of the expansion was financed through borrowing. … The price of farmland rose notably. … To purchase the increasingly expensive land…farmers needed to borrow.” Whether they needed to or not, many did. So did land speculators.

Then: “the collapse was as dramatic as the run-up had been. … Foreclosures [and bank failures] surged.” Across vast swaths of the country, an agricultural banking crisis descended.  

Moral Hazard

In the 1920s, the Fed was fully aware that being ready to support troubled banks could induce more banking risk—the problem of “moral hazard.” This is the well-known general risk management problem in which saving people whenever they get in trouble makes them more prone to risky behavior.  

Carlson writes, “The greater availability of the discount window…meant that managers and shareholders had more incentives to take liquidity risks.” He quotes the Federal Reserve Bank of Dallas in 1927: “Those extensions of credit simply serve to create further opportunities to make the same mistakes of judgement and to further prosecute the same unsound policies.”  

The moral hazard dilemma of central banking, apparent 100 years ago and, indeed,100 years before that, will always be with us.

Distinguishing Illiquidity from Insolvency in the Pressure of the Crisis

In theory, lenders of last resort should address the problem of illiquidity, where the troubled bank is short of cash but the real value of its assets still exceeds the claims of its depositors and lenders. Thus, in theory, central banks should lend only to solvent borrowers. But to paraphrase Yogi Berra, in theory, illiquidity is different from insolvency, but in practice it often isn’t.  

In Carlson’s more scholarly language:

A lender of last resort will often find it difficult to fully determine the extent to which the need for support is the result of insolvency versus illiquidity. …The experiences of the Federal Reserve in the 1920s highlight that in some cases it will be impossible to determine whether a bank is solvent at the time it requests funds.

In short, the lender of last resort suffered in the 1920s, and in crises, it will always suffer a “fog of financial crisis”—just like generals in Carl von Clausewitz’s celebrated “fog of war.” It is inevitably very difficult to know what is really going on and how big the losses will be.

The Banker’s First Loyalty vs. Shifting Losses to Depositors

The 1920s Fed was clear about classic banking ethics. Carlson quotes the Federal Reserve Bank of Chicago as “firmly of the opinion that the prime obligations of any bank are—first, to its depositors; second, to the stockholders; and third, to its borrowers.”  Does the current Fed say anything that clear?

The Federal Reserve Bank of San Francisco agreed: “A bank’s first obligation is to its depositors. No course should be followed which jeopardizes a bank’s ability to pay its depositors according to the agreed terms.  A bank’s second obligation is to its shareholders, to those who have placed their investment funds in charge of the directors and officers”; the borrowers were an also-ran.

Yet the Fed of the time knew that by acting as lender of last resort, which meant (and means today) taking all the best assets of the troubled bank as collateral to protect itself, the central bank was pushing losses to the remaining depositors. “Reserve Banks officials were aware,” Carlson writes, “that lending to support a troubled bank could end up allowing some depositors to withdraw funds while leaving the remaining depositors in a worse position.” I would change that “could end up” to “ends up.”

Carlson continues, “The depositors that did not withdraw would only be repaid from the poorer assets of the bank; that would likely mean that their losses would be worse than if the Federal Reserve had not provided a loan.”  

The Federal Reserve Bank of San Francisco wrote in the 1920s that discount window lending should not “invade the rights of depositors by inequitable preferences to Federal Reserve Banks.” But it inevitably does.

With the advent of national deposit insurance in the 1930s, depositors as claimants on the failed bank’s assets were largely replaced by the Federal Deposit Insurance Corporation. The problem then became the Fed’s shifting losses to the FDIC. This was an important debate at the time of the FDIC Improvement Act of 1991, and it remains an unavoidable dilemma if the Fed can take the best available collateral at any time.

Credit Risk for the Fed

Today, the Fed tries to avoid taking any credit risk. It now gets the U.S. Treasury to take the credit risk as junior to it in various clever designs, like the “variable interest entities” formed for the 2008 bailouts. But we learn from the book that the Federal Reserve Banks actually suffered some credit losses on their Discount Window lending in the 1920s. That meant the borrowing commercial banks failed, and then the Fed’s collateral was insufficient to repay the borrowing. The combined Fed had credit losses of $1.1 million, $1.3 million, and $1.4 million in 1923, 1924, and 1925, respectively.

One hundred years later, in the 2020s, the Fed has zero credit losses but massive losses on interest rate risk. The aggregate losses arising from its interest rate mismatch are $225 billion as of March 27, 2025, and it has a hitherto unimaginable mark to market loss of over $1 trillion.  One wonders what the Federal Reserve officers of the 1920s would have thought of that!

I conclude with three vivid images from the book:

Getting Bank Directors’ Attention

Carlson observes that the Federal Reserve Banks in the 1920s sometimes required personal guarantees from the borrowing bank’s board of directors’ members for Discount Window loans.  When I related this to a friend, who is a successful bank’s Chairman of the Board, he replied, “That would get the directors attention!”  I’m sure it did then and would today.

Mission to Havana

In 1926, there was a bank panic in Cuba involving American banks there, and more paper currency was needed to meet withdrawals. Carlson tells us that the Federal Reserve Bank of Atlanta “scrambled to assemble the cash and ship it to Cuba. … Atlanta assembled a special three-car train with right-of-way privileges to rapidly make the journey from Atlanta through Florida all the way to Key West.  The train left from Atlanta late Saturday afternoon bearing the currency [and] Atlanta staff and guards.  [In] Key West, the money was transferred to the gunboat Cuba…. The gunboat reached Havana harbor at 2:00 a.m. on Monday, whereupon a military guard escorted the currency…[allowing] delivery to the banks before their 9:00 a.m. opening. …and the panic subsided. … Federal Reserve officials received significant praise from the Cuban government.”

The Fed as cattle rancher

“In addition to the losses,” Calson writes, “dealing with the collateral could sometimes cause considerable headaches.” The Federal Reserve Bank of Dallas “ended up owning a substantial amount of cattle after defaults by both banks and ranchers. … Efforts to sell them had a meaningful impact on the local market prices… there were a number of complaints from the local cattlemen’s associations.”  A 1925 memo from Dallas described the “challenges of managing several hundred head of cattle acquired from failing banks in New Mexico.”  This seems a good parting vision for Carlson’s insightful study of the early Federal Reserve wrestling with a systemic agricultural banking crisis.

Overall, The Young Fed is a book well worth reading for students of banking, central banking, and the evolution of financial ideas and institutions.

The Federal Reserve’s Accounting for Its Own Losses Is Emerging as an Embarrassment That Only Congress Can Fix

Published in The New York Sun.

America’s central bank fails to account for its own red ink the way it requires of the banks it regulates.

A basic principle of accounting is that net operating losses are subtracted from retained earnings and thus from capital. If the losses are big enough, capital goes negative, your liabilities exceed your assets, and you are technically insolvent. The Federal Reserve requires all the banks it regulates to follow this principle.

Remarkably, though, the Federal Reserve proclaims itself exempted from this basic — and obvious — arithmetic. Exempted by whom? By itself. This is an embarrassment. It is also a conflict of interest and a temptation for a money-losing entity to have control of its own accounting rules.

The losses of the Federal Reserve since they started in 2022 are so big — $226 billion so far — that they have wiped out all the central bank’s retained earnings, which it calls “surplus,” and all its paid-in capital, five times over. Here is what the simple arithmetic adds up to:

The Federal Reserve’s accumulated losses are $226 billion. Retained earnings (“surplus”) are 7 billion. Subtract that to get retained earnings of negative $219 billion. Subtract paid in capital of $37 billion. That leaves actual capital of negative $182 billion. It’s simple and straightforward.

It means that the United States Federal Reserve has lost all its retained earnings and all the capital that its stockholders — private commercial banks — invested in it, and then lost $182 billion more. Nonetheless, the Fed publishes a balance sheet that shows positive capital of $44 billion.

How can that be? Well, it’s a great thing, if you are losing an ocean of money, to set your own accounting rules so you can avoid the effect of the losses on your capital. To do that, the Federal Reserve books its losses as an asset. It manages to keep a straight face with central banking dignity while it explains that its losses are a so-called “deferred asset.”

Most newspapers dutifully repeat this, but anyone who passed Accounting 101 knows that it’s nonsense. In accounting terms, the losses are a $226 billion debit which should go to reduce retained earnings, but instead is hiding out in a more than dubious asset account.

You may wonder how this can happen when the Fed’s balance sheet is audited by an independent accountant (currently KPMG). As the auditors make clear every year, they do not examine the Fed’s books according to Generally Accepted Accounting Principles, but instead follow rules devised by the Fed.

To our particular point, they follow the “deferred asset” rule the Fed made up for itself in 2011 when it realized it might have unprecedented losses and wished to obscure their effect. It has turned out that the losses and the obscuring are far greater than the Federal Reserve expected and continue to get bigger every month.

Fed representatives argue that negative net worth in a paper money-printing central bank doesn’t matter and that no one will care if the Fed is technically insolvent. They may be right, even though the Fed’s losses are borne by America’s taxpayers and increase the government’s budget deficit and the national debt.

If, in any event, the Fed is convinced that no one cares, why would it bother to hide the true capital and call into question its accounting probity? If you are the greatest central bank in the world, the least you can do is keep accurate books. The Fed should report the true capital number.

The Congress has oversight authority and responsibility for all aspects of the Federal Reserve, including its accounting. I believe Congress should investigate the Fed’s accounting and then direct the Fed in legislation how it wishes the books to be kept. The governments of other countries certainly do this.

The governing statute of the Swiss National Bank, its central bank, requires the SNB to mark its investments to market and reflect the results in its profit and loss statement and its capital. If the Fed had been required to do this, its reported capital at year end 2024 would have been negative $1.2 trillion.

The Bank of Canada is required by the Bank of Canada Act to follow generally accepted accounting principles, which in Canada means International Financial Reporting Standards. As these are applied, the Bank of Canada has been reporting that it has negative net worth — as it does.

Congress could fix the Fed’s wayward accounting by instructing the Federal Accounting Standards Advisory Board, which issues official accounting standards for government entities, to develop accounting standards for the Federal Reserve.

It could also authorize the Government Accountability Office, the government’s chief auditor, to audit the books of the Fed in accordance with such standards. No government entity, especially one with losses counted in hundreds of billions of dollars, should be writing its own accounting rules.

Not Another Free Lunch

Published in Law & Liberty with Edward J. Pinto.

Don’t let Fannie and Freddie turn back into GSEs.

Once again, we have efforts to release Fannie Mae and Freddie Mac from the conservatorship of the Federal Housing Finance Agency in which they have been confined for nearly 17 years—ever since the US Treasury did a 100 percent bailout of their creditors in 2008. Pros and cons are hotly debated relative to the proposed release of the twins that continue to rank among the largest systemically important financial institutions in the world.

The ongoing conservatorship means that the government has total control over these huge government-backed mortgage enterprises, with $7.7 trillion in combined assets. Since the bailout, the government has also been by far the biggest equity investor in them. Although they are often still called “GSEs” (“Government-Sponsored Enterprises”), in fact, while they are in conservatorship, they are not GSEs, but something very different: Government-Owned and Government-Controlled Enterprises. The proposed “release” transaction would give private shareholders control instead. Unfortunately, this could turn Fannie and Freddie back into GSEs, which would be a grievous mistake.

The US Treasury owns all the senior preferred stock of Fannie and Freddie; this stock has a combined liquidation preference of $341 billion as of December 31, 2024. This is more than twice their combined total book equity. In other words, not counting the government’s investment, Fannie and Freddie are deeply insolvent, and have been since 2008.

In addition, the Treasury owns warrants that give it the right to acquire new stock so that it owns up to 79.9 percent of Fannie and Freddie’s common stock for a minuscule exercise price. (The specific exercise price of the warrants is one-thousandth of one cent per share.) Exercising these warrants could give the Treasury a large profit, but they expire in September 2028, during the term of the current Trump administration. This gives the Treasury a duty to realize their value before they expire. Treasury could sell the warrants, exercise them, and then sell the stock, or exercise them and simply hold the stock along with the senior preferred stock.

To retire the government’s preferred and common equity stake would require a refinancing of massive scale, or a taxpayer gift from the US Treasury of tens of billions of dollars to Fannie and Freddie, or both.

The conventional narrative is that an exit from conservatorship would be a “privatization” and Fannie and Freddie would again become “private” companies. It is not the case. To be a GSE means that you have private shareholders, but you also have a free government guarantee of your obligations. As long as Fannie and Freddie have that free government guarantee, they will not be private companies, even if private shareholders own them.

As GSEs before 2008, the companies always enjoyed such a hugely valuable but free government guarantee. Because they did, no private company could successfully compete with them, and they were never private companies themselves. As our colleague Peter Wallison explained in his book, Hidden in Plain Sight, they were an unhealthy mix of socialized government risk and private profit.

The Essence of a GSE

Former Democratic Congressman J. J. Pickle of Texas pointedly summarized the GSEs: “The risk is 99% public and the profit is 100% private.” It was always said that the government guarantee of the GSEs was only “implicit,” but it was and is nonetheless fully and unquestionably real. This was definitively demonstrated by the Treasury’s $190 billion bailout of Fannie and Freddie in 2008, and the simultaneous creation of explicit government credit commitments during conservatorship. The bailout completely protected all of Fannie and Freddie’s creditors, even egregiously including the investors in their theoretically risk-absorbing subordinated debt. Creditors of GSEs are always saved by the government, and everybody knows it. The global sales of their securities and the credibility of the sponsoring government depend on it. To paraphrase the memorable words of a MasterCard commercial, what is the value of a free, unconditional, irrevocable, ever-greening line of credit from a sovereign creditor to an insolvent debtor? “Priceless,” the commercial said, but we calculate in the last section below the significant price that Fannie and Freddie should have to pay.

J. J. Pickle’s insight again fully applies to the new Fannie and Freddie “release” proposals and the ongoing debates of 2025. It displays the financial essence of a GSE: the immense value of the free government guarantee is a gift to the private shareholders, with little benefit to first-time homebuyers, as research has demonstrated. This obviously bad idea nonetheless has been supported by many politicians in the past. In their perennial search for a free lunch, they should not make the same mistake again.

The current debates must confront the fact that an ongoing government guarantee for Fannie and Freddie is an indispensable part of any “release” transaction. These fundamental questions and answers make that clear:

Question: Is Fannie and Freddie’s business model sustainable without a government guarantee?

Answer: No. Their business, their size in the bond market, their leverage, their access to credit risk-averse global investors, and their claim to lower mortgage interest rates all entirely depend on the government guarantee.

Question: As a practical business matter, can Fannie and Freddie exit conservatorship without the government guarantee?

Answer: No. The government guarantee would be always critical to their credit standing, but even more so immediately after their release from conservatorship.

Question: Could the government get out of its guarantee, even if it wanted to?

Answer: No. The government is locked in because Fannie and Freddie are “To Big to Fail” (TBTF), just like the largest banks. Indeed at $7.7 trillion and growing they are Far Too Big to Fail (FTBTF, we might say). No matter what the government may claim, the market will believe they are in fact guaranteed and the market will be correct.

Since no “release” deal is possible without a government guarantee, we arrive at this essential question:

Should Fannie and Freddie’s government guarantee be a free guarantee?

Answer: No. In line with Pickle’s point, public risk should not be turned into private profit. The government, and hence the taxpayers, should be fully and fairly remunerated for the risk and the cost of their massive guarantee. This will require legislation and Congress must make sure it is part of any “release” transaction.

Therefore, we must determine what the price of the government guarantee should be.

How Much Should a “Released” Fannie and Freddie Pay for Their Government Guarantee?

There are two components of the fee Fannie and Freddie should pay the Treasury for its guarantee. The total fee should be the same whether the guarantee is “implicit” or explicit, because it is equally real in both cases. These components are Risk and Current Cost.

The “Risk Fee” is today’s price for the possibility of having to cover future losses with future bailouts.

The “Current Cost to Treasury Borrowings Fee” is the offset for how much Fannie and Freddie cost the Treasury and the taxpayers by making Treasury notes and bonds more expensive. Higher interest rates for the Treasury on its own debt result from the competition that Fannie and Freddie’s massive $7 trillion in mortgage-backed securities create for investors who want US government credit.

The fee paid by Fannie and Freddie should be the sum of these two.

Considering the Risk Fee, we suggest that a close, relevant analogy is what the largest, TBTF banks have to pay the Federal Deposit Insurance Corporation (FDIC) for the implicit total government guarantee these banks receive. Like Fannie and Freddie, the real guarantee is for all the obligations of the TBTF bank; it is not just for the smaller amount of the formally guaranteed “insured deposits.”

Correspondingly and correctly, these banks are assessed FDIC fees on their total liabilities, not just the insured deposits. Likewise, Fannie and Freddie’s fee should be assessed on their total liabilities, or $7.6 trillion as of year-end 2024.

Unfortunately, we cannot see what the TBTF banks pay the FDIC, because although banks report FDIC premiums on their Call Reports, the FDIC removes them from the published version and keeps the numbers secret. But we can estimate an appropriate Risk Fee by analogy to the FDIC standards.

Fannie and Freddie certainly qualify as large and complex companies. As shown in the FDIC’s table of “Total Base Assessment Rates,” the corresponding “Initial Base Assessment Rate” for “Large & Highly Complex Institutions” is 5 to 32 basis points per year (a basis point is one-hundredth of 1 percent, or 0.01 percent). Multiplying this by $7.6 trillion in liabilities suggests a range for the Risk Fee for the combined Fannie and Freddie of $3.8 billion to $24 billion per year.

Where would Fannie and Freddie fall in the FDIC’s Large and Highly Complex range? Their risk is entirely concentrated in real estate credit, and their capital ratios are very low. Congress should ask the FDIC what it would hypothetically charge Fannie and Freddie to insure their liabilities. Congress might also ask Warren Buffett what price Berkshire Hathaway would charge for providing such insurance.

In the meantime, suppose as a starting point that with their concentrated real estate risk and little capital, Fannie and Freddie were 25 percent of the way from minimum to maximum, or about 12 basis points per year. That would be a Risk Fee of $9 billion per year, or about 25 percent of their combined 2024 pre-tax profits of $36 billion.

We present this estimate as a starting point for further discussion and analysis. But it is certain that the right Risk Fee is not zero.

Without doubt, the presence of trillions of dollars of Fannie and Freddie mortgage-backed securities in the market, competing with the US Treasury’s own debt for purchase by credit-risk averse investors, drives up the cost of Treasury debt and thereby increases the government’s deficits.

How much does this competition cost the Treasury? The answer is: a lot—an estimated 10 to 15 basis points on its $27.7 trillion of marketable debt, or from $29 billion to $43 billion a year. Over ten years, this imposes a $290 billion to $430 billion additional cost on the Treasury, without even compounding interest.

The estimate of the cost to the Treasury is from a February 2025 update by Amanda Dial, Edward Pinto, and Tobias Peter that uses the Federal Reserve’s own estimates of the effect on Treasury debt yields of the Fed’s “QE” (Quantitative Easing) purchases of MBS, adjusting for current outstandings, relative proportions and conditions. The fundamental insight is that if the Fed’s taking MBS out of the market lowers the cost of Treasury’s term debt by a certain amount, putting that many MBS into the market will increase it by the same amount.

Taking the increased Treasury cost of $29 to $43 billion caused by Fannie and Freddie’s government-guaranteed MBS, and dividing this cost by their $7.6 trillion in liabilities suggests that Fannie and Freddie are enjoying a taxpayer subsidy of 38 to 57 basis points a year on their liabilities.

Let us take the middle of that range: 48 basis points. A Current Cost to Treasury Borrowings Fee of 48 basis points would just offset the increased cost Fannie and Freddie impose on the Treasury. That fee assessed on Fannie and Freddie’s $7.6 trillion in liabilities would be $36 billion, or 100 percent of Fannie and Freddie’s pre-tax profits. In short, the subsidy from the Treasury equals the totality of Fannie and Freddie’s profits.

The Total Fee

Adding the two components together gives us the total fee that Fannie and Freddie should pay the Treasury for their government guarantee:

On $7.6 trillion in liabilities, that would be $46 billion or 128 percent of their pretax profit. While others may have their own lower estimates, any legitimate Total Fee would constitute a significant portion of Fannie and Freddie’s pretax profit.* Needless to say, the private shareholders, present or future, would not like this outcome!

All these numbers speak to one truth: the essence of a GSE is to convert a free government guarantee and public risk into private profit. That should not happen again. Fannie and Freddie should pay for their government guarantee at a fair rate. If they can’t do that, they must remain stuck in the government. They should not be allowed to turn back into GSEs. Peter Wallison and Congressman Pickle, you were both so right!

* Supporters of Fannie and Freddie’s privatization would try to give them every benefit of the doubt. So, let’s take the lowest estimate of Current Cost to Treasury Borrowings Fee or 38 basis points and generously divide that in half—call it 19 basis points. In addition, suppose we drop the 12 basis point Risk Fee to 9 basis points, only 15 percent of the way from the minimum to the maximum on the FDIC’s “large and highly complex” range. The result is that, at the very least, Fannie and Freddie should pay 28 basis points or $21 billion per year for their government guarantee, which is still 58 percent of their pretax profit.

April 17: The Great Debate: How to Modernize Financial Regulation and Create Economic Stability in a Digital Age

See the event information here.

Join George Mason University’s (GMU) Center for Assurance Research and Engineering (CARE), the Financial Technology & Cybersecurity Center (Center), GMU’s School of Business, and a host of experts for a wide ranging discussion of what a financial regulatory structure equipped to deal with the realities of today’s financial services sector should look like.

The Great Debate:  How to Modernize Financial Regulation and Create Economic Stability in a Digital Age

Co-Chairs:

Dr. Jean-Pierre Auffret
Director, Research Partnerships, Costello College of Business, George Mason University; Director, Center for Assurance Research and Engineering (CARE), College of Engineering & Computing, George Mason

Thomas P. Vartanian
Executive Director of the Financial Technology & Cybersecurity Center
Author, 200 Years of American Financial Panics, Crashes, Recessions and Depressions, And the Technology That Will Change It All; The Unhackable Internet: How Rebuilding Cyberspace Can Create Real Security and Prevent Financial Collapse

Agenda:

8:30 – 8:40 a.m. Welcome and Overview

8:40 – 9:10 a.m. Why Don’t We See Financial Sector Crises Coming & How Do We Make Supervision Work Better?

Keynote Remarks:
Elizabeth McCaul
Former Member Supervisory Board, European Central Bank
Former Chair, New York State Banking Board and Superintendent of Banks

9:10 – 10:10 a.m. Panel:

Greg Baer
President & CEO, Bank Policy Institute
Gary Gorton
Professor Emeritus of Management & Finance
Yale School of Management
Author, Misunderstanding Financial Crises: Why we don’t see them coming
Elizabeth McCaul
Alex Pollock
Senior Fellow, Mises Institute

10:10 – 10:35 a.m. In Person Exclusive: Faculty Donut Networking Break
featuring Elizabeth McCaul, William Isaac, Randal Quarles

10:35 – 11:25 a.m. Time to Regulate Cryptocurrency? Investments, Money or Both?

John Reed Stark
John Reed Stark Consulting LLC
Former Chief, SEC Office of Internet Enforcement
Coy Garrison
Partner, Steptoe LLP
Former Counsel to SEC Commissioner Hester Peirce

11:25 a.m. – 12:25 p.m. Regulation of Nonbank Financial Institutions and FinTechs

Michele Alt
Co-Founder and Managing Director, Klaros Group
Dan Swislow
Director of Policy and Government Affairs, Mercury
Caitlin Long
Founder & CEO, Custodia Bank

12:25 – 1:40 p.m. Buffet Lunch

12:40 – 1:20 p.m. Fireside Chat

Randal Quarles
Chairman & Founder, The Cynosure Group
Former Vice Chair for Supervision, Federal Reserve Board
Thomas Vartanian

1:40 – 2:40 p.m. Building a New Regulatory Model

Elizabeth McCaul
Todd Zywicki
George Mason University Foundation Professor of Law
George Mason University, Antonin Scalia Law School

[Additional panelist to be announced]
2:40 – 3:05 p.m. In Person Exclusive: Faculty Donut Networking Break
featuring Robert Ledig, Elizabeth McCaul, Todd Zywicki

3:05 – 3:40 p.m. Rethinking Deposit Insurance – Uninsured Deposits and other Threats to Financial Stability

Keynote Remarks:
William Isaac
Chairman, Secura/Isaac Group
Former Chairman FDIC

3:40 – 4:30 p.m. Panel:

Robert Ledig
Managing Director, Financial Technology & Cybersecurity Center
Alison Touhey
SVP, Bank Funding Policy, American Bankers Association
Richard Wald
Vice Chairman, Emigrant Bank

4:30 – 5:15 p.m. Leveraging AI to Improve Financial Regulation

Jo Ann Barefoot
CEO & Cofounder at Alliance for Innovative Regulation
Author, The case for placing AI at the heart of digitally robust financial regulation
Dr. Jon Danielsson
Director of the Systemic Risk Centre, London School of Economics
Author, The Illusion of Control: Why Financial Crises Happen and What We Can (and Can’t) Do About It

[Additional panelist to be announced]
5:15 – 5:30 pm Wrap Up

No Funding from The Fed for the CFPB

Published in The Wall Street Journal,

Chris Dodd and Barney Frank point out that the Consumer Financial Protection Bureau was brought into being by proper legislative action in 2010 ("Trump Harms Consumers by Weakening the CFPB," op-ed, March 13). They leave out, however, that the act was approved on a mostly party-line vote when the Democratic Party had majorities in both the House and Senate.

Perhaps knowing that their control was fleeting, the drafters attempted to restrict future Congresses from controlling the agency’s finances. They did so by stipulating that the CFPB would be funded out of the combined earnings of the Federal Reserve—at the time a safe bet, considering the central bank had been profitable for nearly 100 years. As long as that remained the case, lawmakers would be deprived of their essential power of appropriation.

But the Fed ceased to have any combined earnings in late 2022, and it has since racked up massive losses. So long as those persist, there are no earnings that can be used to fund the CFPB legally under the terms of the Dodd-Frank Act. When the CFPB now wants to ask for funding, it should have to go to the Congress and ask for appropriations—exactly as it should’ve been in the first place.

Alex J. Pollock
Mises Institute
Lake Forest, Ill.

A 2025 Review of the Governance, Mission, and Independence of the Federal Reserve

Hosted by the Federalist Society.

The Federal Reserve’s governance has captured the attention of Congress, the Administration, and the media. President Trump’s executive order on independent agency accountability specifically requires the Federal Reserve’s supervision and regulation function to coordinate with the White House, while the House Financial Services Committee has constituted a new task force to study the Fed’s monetary policy function, among other things. This legislative and presidential attention to considering Fed reform follows supervisory failures associated with Silicon Valley Bank, concerns around de-banking, and the Fed’s massive losses associated with its last round of quantitative easing. 

This webinar will discuss potential reform to the Fed’s governance as well as the purpose and scope of the Fed’s independence. It will feature a keynote address from Representative Frank Lucas—Chair of the House’s Task Force on Monetary Policy, Treasury Market Resilience, and Economic Prosperity—as well as remarks from panelists Professor Christina Skinner (The Wharton School), Don Kohn (Brookings Institution), and Alex Pollock (Mises Institute). Andrew Olmem (Mayer Brown) will moderate.

The Golden Road Out of the Debt Crisis

Published in The New York Sun.

America has a chance to introduce into its monetary system a role for the gold that’s already owned by the government.

The value of a dollar has sunk to a new low, less than 1/3,000th of an ounce of gold. Yet according to a woefully outmoded American law, the federal government must account for its more than 8,100 tons of gold at a completely irrelevant valuation set more than 50 years ago, when the dollar’s value was much higher — about 1/42nd of an ounce.

That outdated number stems from the precise language of the 1973 Act to Amend the Par Value Modification Act, still in force, legally stipulating that the gold value of the dollar is fixed at “forty-two and two-ninths dollars per fine troy ounce.” In other words, the law values the dollar at 1/42.22nd of an ounce of gold.

Yet in the gold market, the dollar is fetching less than a 3,000th of an ounce — another way of saying that gold is trading at more than $3,000 per ounce, about 71 times the statutory price. In other words, the statutory price is less than 2 percent of the market price. How does this antique artifact survive?

Whatever was the case in 1973 when Congress reduced the legal value of the dollar — to 1/42.22nd of an ounce of gold, from 1/38th of an ounce — for us in 2025, after a further half-century of depreciation of American paper money, the statutory price makes no sense at all.

It comes from a law passed 52 years ago in a different world of political finance. Why hasn’t it been updated with a more realistic relationship between gold and the dollar?

Gold’s value in terms of the dollar, having dropped to a 3,000th of an ounce from a 42.22nd of an ounce, has gone up by about 7,000 percent from the statutory price. That means in terms of gold, the value of the dollar has plunged by more than 98 percent.

In accounting terms, this means that the Treasury has what amounts to a giant capital gain on the gold it owns. Although the gain is unrecognized on the government’s books, it has already happened and is already real.

At a market price of $3,000 per ounce, this capital gain, in round numbers, amounts to $2,958 per ounce on the Treasury’s 261.5 million ounces of gold. That translates, theoretically at least, into a total unrealized profit of about $773 billion. That is a big enough number to get anybody’s attention, and for any Secretary of the Treasury to think about.

When Treasury Secretary Bessent recently said, “We're going to monetize the asset side of the U.S. balance sheet for the American people,” many financial commentators immediately thought of the Treasury’s gold and how it might be turned into a big realized gain and spendable cash. This can certainly be done, but not in any case until Congress amends the official dollar value set by the 1973 act.

The possibilities are important for the fundamental theory and politics of money, because they would reintroduce some monetary role for gold a half-century after America led the world into its current inflationary, pure paper money system in 1971. That was when President Nixon ordered the Treasury to default on the international commitment of the United States to redeem dollars for gold.

Suppose that Congress brought the official price of gold up to reality. The Treasury would immediately realize a $773 billion gain on the government’s books. To turn the gain into cash it would not have to sell any gold, but could borrow against it.

For example, the Treasury could issue gold bonds, as it did historically, and as monetary theorist Judy Shelton, in her book “Good as Gold,” has suggested it do again. (The Treasury would have to overcome the issue of having defaulted on its former gold bonds in 1933.)

With a more radical return to historical practice, the Treasury could issue gold-backed currency in competition with Federal Reserve notes. This, though, would take further controversial legislation.

Much simpler and more direct would be for the Treasury to issue Gold Certificates, which are already authorized by the Gold Reserve Act of 1934, but now would be based on the current value of its gold. The profit on the gold could then be easily monetized by depositing these certificates in the Federal Reserve, which would correspondingly credit the deposit account of the Treasury with the Fed. Voila! Money ready to spend without issuing more Treasury bonds.

As Paul Kupiec and I have previously pointed out, this would be an efficient way to create interim financing for any future debt ceiling crisis.

We should certainly bring the finances of the United States current with the reality of the vast rise of the value of its gold with respect to the dollar and the vast fall of the value of the dollar with respect to gold. At the same time, we could open our monetary theory and practice up to a renewed monetary role for gold.

To do so, Congress could immediately amend the Par Value Modification Act by enacting a "Gold Value Modification Act of 2025" that deletes the former official price of "forty-two and two-ninths dollars," and replaces it by "the fair market value of gold as certified by the Secretary of the Treasury."

The U.S. debates what to do about Fannie and Freddie, after their 17 years in government conservatorship

Published in Spring 2025 Housing Finance International Regional round up: news from around the globe

For international observers to understand the U.S. housing finance system, they must understand Fannie Mae and Freddie Mac. To understand Fannie and Freddie, they must understand how huge and how completely intertwined with the government these giant mortgage finance companies are.

As for huge, between them, Fannie and Freddie have US$ 7.7 trillion in assets – that is “trillion” with a T. This is composed of $4.3 trillion for Fannie and $3.4 trillion for Freddie.[1] They are by far the most important factors in the $14 trillion U.S. residential mortgage system and the main thing that makes the U.S. system unique in the world.

As for intertwined, Fannie and Freddie still have some private shareholders, but they are primarily owned by the U.S. Treasury Department, which as of December 31, 2024 holds senior preferred stock in them with a liquidation preference of $341 billion, or about 2.5 times their combined book equity. In other words, without this government investment, Fannie and Freddie would be insolvent. As part of the Treasury’s bailout of Fannie and Freddie in 2008, they were put in and remain in government conservatorship, which means subject to total government control.

In addition, also arising from the bailout, the Treasury owns warrants giving it the right to purchase at the exercise price of one-thousandth of a cent per share – that is, to get basically for free – enough new shares to give the Treasury a 79.9% share of the common stock of both companies. Why 79.9%? Because at 80%, the government would have to consolidate Fannie and Freddie’s debt on its books, a bookkeeping outcome the Treasury does not like.

Exercising the warrants could give the Treasury a large profit, but the warrants expire in September 2028 – during the term of the current Trump administration. This creates a duty for the Treasury Department to do something to realize their value before they expire. The Treasury could sell the warrants, exercise the warrants and then sell the stock, or exercise the warrants and simply hold the common stock, just as it holds the senior preferred stock.

Some people view the expiration date of the warrants as an incentive to release Fannie and Freddie from their 17-year long conservatorship to some new status. The arrival of the Trump administration has started new debates about what should happen next.

An essential question in these debates, one which cannot be avoided, is the nature of the government guarantee that Fannie and Freddie will get in the future. In my opinion, there is no possible outcome that does not involve a government guarantee. With this in mind, we consider the essence of Fannie and Freddie and the historical evolution which brought the U.S. mortgage system to this complex problem in political finance.

Fannie and Freddie are thinly capitalized, even with the massive government investment in them. They have a combined $7.5 trillion in liabilities and bear more than half the mortgage credit risk of the whole country. This unwise concentration of risk is possible because every penny of it is effectively guaranteed by the Treasury. Investors in Fannie and Freddie’s obligations don’t have to worry about Fannie and Freddie’s high leverage or anything else about their financial risk – Fannie and Freddie’s mortgage-backed securities can be sold and traded by Wall Street firms all over the world based on the credit of the U.S. government and potential taxes on the American people.

Fannie started life in 1938 as simply a part of the government. Its debt was government debt and any profits it made accrued ultimately to the Treasury.

Thirty years later, in 1968, in a gigantic blunder in government finance, Fannie was turned into a “government-sponsored enterprise” (GSE). This was done to get a bookkeeping result: to get the debt of Fannie off the government books, as President Lyndon Johnson’s budget deficits ballooned.

To be a “GSE” means you have private shareholders, but you also have a free government guarantee of your debt. It was constantly claimed that this GSE guarantee was only “implicit.” Nonetheless, it was and is fully real. This was demonstrated by the $190 billion Treasury bailout of Fannie and Freddie in 2008. That bailout completely protected all their creditors, even – egregiously – holders of subordinated debt. Creditors of GSEs are always saved by the government, and everybody knows it.

In Fannie’s original 1938 form, the risk was public and the profit was public. In the GSE form, as Congressman J. J. Pickle of Texas sardonically observed in 1992, “The risk is 99% public and the profit is 100% private.”

Pickle’s point fully applies to the new Fannie and Freddie debates of 2025. The financial essence of a GSE is that the huge value of the free government guarantee is a gift to the private shareholders. This is obviously a bad idea, but a great many politicians have been convinced to support it. Might they be again?

Congress chartered Freddie to join Fannie as another GSE in 1971. The two became in time an exceptionally profitable dominating duopoly with soaring prices for their stock, because no private firm can compete with the free government guarantee of a GSE. They both, but especially Fannie, developed remarkable arrogance and Fannie was widely feared for its bully-boy tactics and political clout.

As the Book of Proverbs tells us, “Pride goeth before destruction and a haughty spirit before a fall.” As the housing bubble collapsed in 2008, Fannie and Freddie, having greatly expanded in bad loans, had their fall and their humiliation. The price of their stocks went down 99%. The Treasury bailed out all their creditors, foreign and domestic, and Fannie and Freddie, under complete government control, sent their profits to the Treasury. They had ceased to be GSEs and had been turned into “GOGCEs”: Government-Owned and Government-Controlled Enterprises. This is what they remain at present.

As GOGCEs, Fannie and Freddie now pay for their government guarantee by giving the Treasury all their profit in the form of increased value of the Treasury’s senior preferred stock. Should they be turned back into GSEs and again given their government guarantee for free?

Supporters of the idea claim this would be a “privatization.” But Fannie and Freddie would not be private companies if they once again had a free government guarantee and if once again “the risk was 99% public and the profit was 100% private.” This would not be a privatization, but a “re-GSEification” with the value of the government guarantee as a gift to the private shareholders. You can easily see why private shareholders would love this idea – and why taxpayers should not.

You can also easily see the required solution to this problem: in any proposed exit from conservatorship, Fannie and Freddie should pay an ongoing fair price to the Treasury for the guarantee which makes their business possible.

Setting that price is an unavoidable requirement in the Fannie and Freddie debates. Based on the model of U.S. deposit insurance for the largest banks, the price should be assessed on Fannie and Freddie’s total liabilities. Based on U.S. deposit insurance finances,[2] I estimate the minimum fee would be about 8 basis points (0.08%) per year. That would now cost Fannie and Freddie together about $6 billion per year – not expensive at all for the essential factor that allows their trillions in obligations to be easily sold and traded all over the world.

The fundamental principle is that Fannie and Freddie should never again get a free government guarantee.

[1] Fannie Mae and Freddie Mac Form 10-K filings, December 31, 2024.

[2] Federal Deposit Insurance Corporation, Annual Report 2023.

April 17: GMU: The Great Debate: How to Modernize Financial Regulation and Create Economic Stability in a Digital Age

Click here to register and learn more abut the event.

Join George Mason University’s (GMU) Center for Assurance Research and Engineering (CARE), the Financial Technology & Cybersecurity Center (Center), the Donald G. Costello College of Business, and a host of experts for a wide ranging discussion of what a financial regulatory structure equipped to deal with the realities of today’s financial services sector should look like.

-=-=-=-=-=-

The Great Debate:  How to Modernize Financial Regulation and Create Economic Stability in a Digital Age

Co-Chairs:

Dr. Jean-Pierre Auffret
Director, Research Partnerships, Costello College of Business, George Mason University; Director, Center for Assurance Research and Engineering (CARE), College of Engineering & Computing, George Mason

Thomas P. Vartanian
Executive Director of the Financial Technology & Cybersecurity Center
Author, 200 Years of American Financial Panics, Crashes, Recessions and Depressions, And the Technology That Will Change It All; The Unhackable Internet: How Rebuilding Cyberspace Can Create Real Security and Prevent Financial Collapse

LOCATION

In-person and Online

Van Metre Hall, George Mason University, Fairfax Drive, Arlington, VA, USA

DATE & TIME

Thursday April 17th 2025
8:30 AM - 5:30 PM

_______________

9:10 – 10:10 a.m. Panel:

Greg Baer
President & CEO, Bank Policy Institute
Gary Gorton
Professor Emeritus of Management & Finance
Yale School of Management
Author, Misunderstanding Financial Crises: Why we don’t see them coming
Elizabeth McCaul
Alex Pollock
Senior Fellow, Mises Institute
Author, Finance and Philosophy--Why We're Always Surprised

Click here to register and learn more abut the event.

Mortgage Markets and Crony Capitalism

Published by the Mises Institute.

America’s residential mortgage market is mostly controlled by government. Ryan McMaken and Alex Pollock talk about how government corporations like Fannie Mae are fueling America’s housing affordability crisis.  

Listen to the episode here.

Debate Is Buzzing Over Whether Fannie and Freddie Are Ready To Be Released From Conservatorship

Only if, our columnist says, they are fully shorn of any free guarantees by the government.

Published in The New York Sun.

The arrival of the new Trump Administration has revived debates about releasing Fannie Mae and Freddie Mac from the conservatorship and total government control which came with their bailout by the U.S. Treasury in 2008, nearly 17 years ago. What should happen next is a major financial system issue, since Fannie and Freddie are giant firms, with combined assets of more than $7.7 trillion.  

The most important factor in the “release” decision is seldom mentioned: Should the future Fannie and Freddie, as in their pre-bailout past, get a free government guarantee of all their obligations, now totaling $7.5 trillion? In other words, should Fannie and Freddie’s shareholders get a taxpayer subsidy of billions of dollars a year? The answer is that this costly mistake of the past should not be repeated.

Fannie started life in 1938 as a straightforward part of the government. Its debt was government debt and any profits it made accrued ultimately to the Treasury.

In a strategic blunder in government finance, Fannie was turned into a “government-sponsored enterprise” (GSE) in 1968 to achieve a bookkeeping result: to get its debt off the government’s books as President Lyndon Johnson’s deficits ballooned.  

A GSE is a corporation with private shareholders but also a free government guarantee of its debt. This guarantee is only “implicit,” it was always said, but it is fully real, as demonstrated by the 2008 bailout that fully protected all creditors, even subordinated debt holders. Creditors of GSEs are always saved by the government.

The financial essence of a GSE is that the massive value of the free government guarantee is a gift to the private shareholders. 

Freddie joined Fannie as another GSE in 1971. The two became in time an exceptionally profitable dominating duopoly, since no private firm can compete with the free guarantee of a GSE. They both, but especially Fannie, developed remarkable arrogance and Fannie was widely feared for its bully-boy tactics.  

As the Book of Proverbs tells us, “Pride goeth before destruction and a haughty spirit before a fall.” As the housing bubble collapsed in 2008, Fannie and Freddie had their fall, having invested excessively in bad loans. Then came their bailout and government conservatorship. From being GSEs, they were turned into “GOGCEs”: Government-Owned and Government-Controlled Enterprises. That is what they remain at present, not GSEs.

This has meant their government guarantee is no longer free, because in effect, they pay for it as part of giving the Treasury all their net profits in the form of increased value of the Treasury’s bailout senior preferred stock. The value of the Treasury’s preferred stock in Fannie and Freddie is now up to $334 billion from its original $190 billion. 

In addition, the Treasury owns warrants with the right to acquire at the exercise price of one-thousandth of a cent per share new common shares of Fannie and Freddie giving Treasury a 79.9% ownership of the common. Why 79.9%? Bookkeeping again. At 80%, the government would have to consolidate Fannie and Freddie’s debt on its books.

These warrants expire in September 2028—during the term of the current Trump administration. This creates a Treasury duty to do something before they expire. For example, Treasury could exercise its warrants, which has virtually no cost, and simply hold the new shares.

But some people view this expiration date as an incentive to free Fannie and Freddie from their long conservatorship by what they claim would be a “privatization.” But it would not be a privatization and Fannie and Freddie would not be private companies if they once again got a free government guarantee.  

Such a deal would simply be turning them back into GSEs, with the value of the government guarantee as a gift to the private shareholders. You can easily see why the private shareholders of Fannie and Freddie like this idea and why the taxpayers should not.

In any proposed exit from conservatorship, Fannie and Freddie should pay a fair price to the Treasury for the very real government guarantee that makes their business possible.

Setting that price would involve spirited discussions. Based on the model of deposit insurance for the largest banks, a fair price should be assessed on Fannie and Freddie’s total liabilities and might be about 8 basis points (0.08%) per year. That would now cost Fannie and Freddie about $6 billion per year— not expensive at all for what allows their trillions in obligations to be easily sold and traded all over the world, no matter how risky Fannie and Freddie themselves may be.

The essential principle is that Fannie and Freddie should never again get a free government guarantee.

Government's Role in Central Banking - Playing with Fire

Featuring interviews with Ron Paul, Tom DiLorenzo, Joseph Salerno, Mark Thornton, Jim Grant, Alex Pollock, and Jonathan Newman, Playing with Fire explains what the Fed is, where it came from, and why it is so dangerous. Perhaps most importantly of all, Playing with Fire shows why we need to end the Fed altogether. Watch the full film here: https://bit.ly/4hh2pBB

Countries Don’t Go Broke. Governments Do.

Published by the Mises Institute:

The United States is not immune to this, but remains relatively insulated—for now—thanks to the fact that the dollar is in greater demand than sterling, and therefore so is US debt. I asked Mises Institute Senior Fellow Alex Pollock about Dalio‘s comment, and Pollock replied with an important point about whether or not “countries” go broke: 

Ray Dalio is certainly right to highlight the issue of sovereign defaults.  Based on the FT‘s article, I have already ordered a copy of Dalio’s forthcoming How Countries Go Broke.  

I do want to object to the book’s title, however. It is not countries, but governments, which overborrow and go broke.  The debtor is the government.  The government is quite distinct from the country, although in common parlance the two are often confused.  It is the government of the United States, for example, not the country, which defaulted five times on its debt between being unable to pay interest on time in 1814 and reneging on its solemn commitment to redeem dollars for gold in 1971.  These five defaults do not count the failure to pay its debt by the Confederate government, defaults by a number of individual U.S. state governments, or the historic bankruptcies of the governments of the City of Detroit and the Commonwealth of Puerto Rico.

Monetary Policy That Holds the Fed Accountable

Published by the Cato Institute.

The so‐called dual mandate calls for the Fed to achieve both price stability and maximum employment. Now that the Fed has also become responsible for guarding against financial instability, it really operates under an even broader mandate.[2]

2. The Fed Is as Poor at Knowing the Future as Everybody Else, Before the US House of Representatives Subcommittee on Monetary Policy and Trade of the Committee on Financial Services, 113th Cong., 1st Sess. (September 11, 2013)(testimony of Alex Pollock).

How Can the Federal Reserve Pay Dividends to Its Shareholders When It Has No Profits?

Published in The New York Sun.

Although the Federal Reserve is — and thinks of itself as — part of the government, 100 percent of the $37 billion in paid-in stock of its twelve component Federal Reserve Banks is owned by private shareholders. This was part of the political compromise of the original 1913 Federal Reserve Act.

The shareholders are the commercial banks that are the members of the respective Federal Reserve Banks. Remarkably, these private shareholders are getting dividends from the Reserve Banks even when the combined Fed has no profits, no saved up past profits (retained earnings), and hugely negative actual capital.  Any private bank which tried to pay dividends under these circumstances would be sternly prohibited by the Fed from doing so.

For the first nine months of 2024, the Federal Reserve Banks in the aggregate paid more than $1.2 billion in dividends to their shareholders. Yet at the same time, they together posted losses totaling $63 billion.  On an annualized basis, they are paying dividends of $1.7 billion, for a dividend yield of about 4.5 percent, while losing about $80 billion, with negative retained earnings and capital.  How is that possible — or ethical — one might wonder.

The Fed’s performance on this score was even more remarkable in 2023.  For that year, the combined federal reserve banks paid $1.5 billion in dividends to the shareholders, while losing the nearly unimaginable sum of $114 billion.  That was a loss of 2.6 times the total capital they claim to have. 

The Fed’s officers and energetic public relations efforts assert that for the Fed, having negative capital, i.e. being technically insolvent, doesn’t matter.  Even were that true, how could it justify paying dividends when there are no profits, past or present, with which to pay them.

As of January 1, 2025, the combined FRBs have accumulated losses of $216 billion from losing money in every single month since October 2022.  In proper and obvious accounting, one subtracts losses from retained earnings. That is ineluctable. The Fed, though,  does not do this.  It wishes one to believe instead that its vast accumulated losses are an asset, opaquely called a “deferred asset,” so it can show positive capital on its balance sheet.

What do they take us for? It is easy to understand why the Fed does not want its financial statements to subtract its $216 billion in losses from its stated $7 billion in retained earnings: because then it would have to show that its actual retained earnings are negative $209 billion. Which they are.  

Further subtracting that $209 billion from the total paid-in capital of $37 billion, the Fed would then have to show the world that its actual capital is negative $172 billion.  Which it is. If the Fed really believes that its technical insolvency doesn’t matter, why is it intent on hiding the numbers?

Turning to the individual FRBs, as of January 1, 2025, ten of the twelve have negative retained earnings and negative capital, being thus technically insolvent.  They should not be paying any dividends. Yet two FRBs, Atlanta and St. Louis, could. It might seem odd to have two FRBs paying dividends and ten not, but it accurately reflects the regional logic of the system as designed in 1913.

The Federal Reserve Bank of New York is far and away the biggest and most important FRB, with the most clout.  Its assets equal those of all the other eleven FRBs put together.  Its accumulated losses are bigger than all the others put together.  

Properly subtracting the New York FRB’s $131 billion in accumulated losses from its retained earnings of $2 billion gives it actual retained earnings of a negative $129 billion. This easily wipes out its paid-in capital of $13 billion and leaves an actual capital of negative $116 billion. The members of the New York FRB lead the parade of Fed stockholders who should not be receiving any current dividends. 

Curiously, the Federal Reserve Act stipulates that Fed dividends are cumulative.  Thus, if not paid, they would still have to be accrued as a liability and paid out of the profits of some future time before the American Treasury gets paid anything from those profits.  Fed losses do matter. They increase the federal deficit and increase the national debt. Fed dividends when the Fed has no profits increase the deficit and debt further.

It would be salutary for FRB stockholders to learn that they do have some skin in the game as equity investors and that when there are no profits, no retained earnings, and no capital, there will also be no dividends paid.

Caution warranted on Strategic Bitcoin Reserve

Published by the Competitive Enterprise Institute:

At a recent price of Bitcoin of $100,000, the purchase prescribed by this bill would cost the government $100 billion. But there’s more. Paul Kupiec and Alex Pollock – scholars respectively of the American Enterprise Institute and the Mises Institute — point out in The Hill that if this purchase were made by the Federal Reserve, the Fed would have to borrow money for this purchase at current interest rates, which are now above 4 percent. That means that over 20 years, the Fed’s operating cash losses could come to “more than 100 percent of the investment.”

A Calm Analysis of the Panic of 2008

Published in Law & Liberty.

It makes sense that the 2008 bailouts inspired a lot of emotion, rhetoric, and hyperbole. Hundreds of billions of dollars had just been lost, the government was rescuing arguably undeserving institutions and their creditors, and the financial system seemed to be wavering on the edge of an abyss. Sixteen years after the panic, though, Todd Sheets manages to stay calm, analytical, and generally convincing in his new book discussing the Great Housing Bubble, its causes, its acceleration, its collapse, and the costly aftermath. 2008: What Really Happened dispassionately reviews the actions of key parts of the US government that were central to creating each stage of the bubble and bust over a decade.

In the early 2000s, Sheets tells us, he “had a growing concern that the Fed’s cheap-money policies were destined to end badly.” Then came the first financial crisis of the then-new twenty-first century. This disaster, we should remember, arrived shortly after we were assured by leading central bankers that we had landed safely in a new age of “The Great Moderation.” In fact, we landed in a great overleveraged price collapse.

In economics, the future is unknowable, we are usually confused by the present, and we can easily misinterpret the past. Sheets believes that “historical review reveals … a lengthy delay from an economic crisis to an understanding of what really happened.” He tells us that the book is a result of deciding, while reflecting on the crisis, that “I was confused about big-picture economic matters I had long taken for granted and realized it was time for a new self-study program … focused on financial history.”

Five Phases of the Bubble

Sheets’ study has resulted in an instructive historical framework for understanding the development from growing boom to colossal bust. He proposes five principal stages:

1. The pre-Bubble era, pre-1998: This era is now 26 years, or a whole generation, away from today. Sheets emphasizes the long historical period when average house price increases approximately tracked general inflation. “In the century preceding the housing bubble, house prices more or less tracked inflation,” he writes, “increases in real house prices were negligible.” He believes this is historical normalcy. One might argue that the average real increase in US house prices had been more like 1 percent per year (as I did at the time in graphing the Bubble’s departure from the trend), but that does not alter the fundamental shift involved.

2. Liftoff, 1998–2001: “Beginning in 1998, housing prices suddenly departed from these long-term historical trends,” Sheets notes. In other words, the Bubble starts inflating ten years before the final panic. “Real home prices suddenly begin to increase at an average annual rate of 4.7% during Liftoff.” Why did they? We will discuss below Sheets’ proposals for the principal cause of each phase.

3. Acceleration, 2002–2005: In this phase, “the rate of real home price appreciation began to accelerate even more rapidly”—it “shot up again, to an average annual rate of 8.3%, reaching a peak of 10.4% in 2005.” Remember that Sheets is always dealing always in real price increases—those on top of the general rate of inflation. At this point, it seemed to many people that buying houses with the maximum amount of mortgage debt was a sure-fire winning bet. From 1998 to 2006, Sheets calculates that in real terms, house prices “appreciated over 10 X the level of cumulative appreciation in the 100 years before the bubble.”

4. Deceleration, 2006: “The rate of increase in real house prices slowed dramatically” in the transition year of the inflation turning into deflation of the bubble.

5. Crash, 2007-2012: Home mortgage debt had by now become much more important to the US economy than before, surging strikingly, as Sheet’s table of mortgage debt as a percent of GDP shows:

A lot of people had made a lot of money on the way up, but any potential mortgage debt losses now had a much bigger potential negative impact than before. How much bigger? We were about to discover. Then, “beginning in 2007, real house prices declined … eventually falling about one-third.” Indeed, house prices fell for six years, until 2012. Between 1998 and 2012 we thus approximated the biblical seven fat years followed by seven lean years. There were vast losses to go around, defaults, failures, continuing bad surprises, and a constant cry for government bailouts, as inevitably happens in financial crises.

Sheets helpfully divides Phase 5, the Crash, into four component stages. For many of us, he reenergizes memories that may have been fading by now, and for those younger without the memories, provides a concise primer. Thus:

5(a) Awareness, June 2007-October 2007: “Hedge funds managed by Bear Stearns and BNP Paribas that were heavily concentrated in US home mortgages announced significant write-downs.” Oh-oh, but there was still much uncertainty about the implications for wider problems. “The markets still had no idea of just how precipitously housing prices would fall.” The Federal Reserve embarrassingly and mistakenly opined that the problems were “contained.” The stock market rose until October 2007. Showing some earlier awareness of looming problems, in March 2007 the American Enterprise Institute had a conference on “Implications of a Deflating Bubble,” which I chaired. We were pessimistic, but not pessimistic enough.

5(b) Stress, November 2007-August 2008: “A steady procession of substantial mortgage-related write-downs and losses were announced by a wide swath of financial institutions.” Two of my own favorite quotations from this time epitomize the growing chaos. “Hank,” the chairman of Goldman Sachs told the Secretary of the Treasury, Henry Paulson, “it is worse than any of us imagined.” And as Paulson himself summed it up: “We had no choice but to fly by the seat of our pants, making it up as we went along.”

In July 2008, “the Fed invoked special emergency provisions that enabled it to supply bailout financing” to Fannie Mae and Freddie Mac, the dominant mortgage companies. Fannie and Freddie are called “GSEs,” or government-sponsored enterprises. Their creditors believed, even though the government denied it, that “government-sponsored” really meant “government-guaranteed.” The creditors were correct. In the same July, “President Bush signed a bipartisan measure to provide additional funds” to Fannie and Freddie. These two former titans of the mortgage market, the global bond market, and US politics were tottering. But Sheets stresses a key idea: “Markets found additional reassurance in the idea that federal authorities would continue to intervene,” as they did when Fannie and Freddie went broke but were supported by the US Treasury in early September. In a financial crisis, the universal cry becomes “Give me a government guarantee!”

5(c) Panic, September 2008-February 2009: The Treasury and the Fed provided government guarantees and bailed out the creditors of Bear Stearns, Fannie Mae, and Freddie Mac. But on September 15, 2008, “the authorities unexpectedly allowed Lehman Brothers to fail.” Whereupon “the money markets lurched into a state of panic,” their confidence in bailouts punctured. As Sheets relates, this was followed by a series of additional, giant government guarantees and bailouts to try to stem the panic.

5(d) Recovery, March 2009-forward: “What the [panicked] short-term financing markets were looking for,” Sheets concludes, “was unconditional assurance that none of the remaining critical institutions—Citigroup, Merrill Lynch, or Bank of America—would become the next ‘Lehman surprise.’ The final bailout package for these critical institutions was announced in mid-January of 2009.” In 2009 bank funding markets stabilized and the stock market recovered. That is where Sheets’ history concludes, but we should remember that house prices did not finally stop falling until 2012, and the Fed’s abnormally low interest rates resulting from the Crash continued for another decade—through the financial crisis of 2020 and until 2022. But that is another story.

What were the fundamental causes of the ten-year drama of the housing bubble and its end in disaster? “A plausible theory of causation must explain the sudden onset and the distinct phases of the bubble,” Sheets sensibly argues, thus that different phases had different main causes. As he identifies the principal cause of each phase, it turns out that the US government, in various manifestations, is the prime culprit.

“The Liftoff phase of the bubble in 1998 was triggered by the rapid expansion undertaken by Fannie Mae and Freddie Mac,” Sheets concludes. The timing fits: “The sudden acceleration of GSE growth coincided with the onset of the housing bubble.” And the magnitudes: “88% of the excess growth in mortgages outstanding relative to the Base Period originated from the GSEs.”

Fannie and Freddie could have so much impact because they were the dominant competitors, had key advantages granted by the Congress, had deep political influence and allies—but most importantly—operated with a government guarantee. This was only “perceived” and “implied” it was said, but it was nonetheless entirely real. That enabled their debt obligations to be sold readily around the world, as they set out to and did expand rapidly, notably in riskier types of mortgages, seeking political favor as well as more business.

Fannie and Freddie’s rapid expansion was linked to the push of the Clinton Administration to expand homeownership through “innovative” (i.e. risky) mortgages. This was a perfect combination of factors to launch a housing bubble. Sheets correctly observes that Fannie and Freddie’s role was “aided and abetted by federal housing policy.”

He sympathetically discusses Franklin Raines, Fannie’s CEO from 1999–2004, whose “move back to Fannie Mae coincided almost exactly with the onset of the housing bubble.” This section should also have considered James Johnson, CEO from 1991–1998, the real architect of Fannie’s risky, politicized expansion. Both of them combined politics at the highest level in the Democratic Party with housing finance, a combination which produced, as Sheets says, “just the opposite of what was intended.”

Sheets’ conclusions are consistent with those of Peter Wallison’s exhaustive study, Hidden in Plain Sight, which states, “There is compelling evidence that the financial crisis was the result of the government’s own housing policies.” So that no one misses the point, Sheets reiterates, “We can safely conclude that the Liftoff phase of the housing bubble was caused by the GSEs, with the support of the federal government.”

In the acceleration phase, Sheets writes that “the Federal Reserve became the driving force behind the further escalation of real housing price appreciation” by suppressing interest rates to extremely low levels, including negative real interest rates. This made mortgage borrowing seem much cheaper, especially as borrowers shifted to adjustable-rate mortgages.

“The Fed dramatically lowered short-term interest rates in order to deal with the collapse of the Internet stock bubble in 2000 and then held rates at historically low levels. … The Fed pushed the real fed funds rate down to an average of minus 0.6% during the Acceleration phase.” And “Where did the stimulus go? Into housing.”

Sheets notes that after the Internet stock bubble burst in 2000, the Fed lowered short-term interest rates and held them at historic lows. That stimulus, he says, went into housing. I call this the “Greenspan Gamble,” after the famous Fed chairman of the time, who was then admired as “the Maestro” for his timely monetary expansions. As Sheets says, the Fed ended up with the housing bubble instead—which cost Greenspan his “Maestro” title.

After the Fed started increasing rates again in 2005–2006, the housing bubble decelerated, and then collapsed in 2007. House prices started to go down instead of up, the start of the six-year fall. Subprime mortgage defaults went up. Specialized subprime mortgage lenders went broke. The problems spread to leading, household-name financial institutions. In the fourth quarter of 2007, “Citigroup, Bank of America, and Wachovia announced steep profit declines due to mortgage write-downs, … Merrill Lynch announced the largest quarterly loss in the firm’s history, … Citigroup revealed [huge] pending write-downs … [and there was] the steady drumbeat of massive mortgage write-downs, historic losses, and jettisoned CEOs”—all this showed the bust had arrived, just as it had so many times before in financial history, and it kept getting worse.

When Fannie and Freddie went down in September 2008, it provided an affirmative answer to the prescient question posed by Thomas Stanton way back in his 1991 book, A State of Risk: “Will government-sponsored enterprises be the next financial crisis?” That took the crash to the brink of its panic stage. As discussed above, the panic began when the funding market’s expectation that Lehman Brothers would be bailed out by the government was surprisingly disappointed. Peak fear with peak bailouts followed.

Sheets believes this no-bailout decision for Lehman was a colossal mistake, describing the date of Lehman’s bankruptcy as “a day that will forever live in financial infamy.” He provides a summary of internal government debates leading up to the failure, considers the argument that the Treasury and the Fed had no authority to provide a bailout, and finds it unconvincing: “I believe that they could have chosen to bail out Lehman if given sufficient political backing, and that such a step would have averted the Panic stage of the crisis.”

Wallison relates that the decision seems to have originated as a negotiating position of Treasury Secretary Henry Paulsen, who explained that he thought “we should emphasize publicly that there could be no government money … this was the only way to get the best price.” Paulsen also “declared that he didn’t want to be known as ‘Mr. Bailout.’” Wallison is a former general counsel of the Treasury Department and thinks, like Sheets, that authority to rescue Lehman was available: “Paulsen and [Fed chairman] Bernanke … telling the media and Congress that the government didn’t have the legal authority to rescue Lehman … was false.”

What would have followed if there had been a bailout of Lehman, since the deflation of the housing bubble would still have continued? That is a great counterfactual issue for speculation.

2008: What Really Happened ends a good read with two radical thoughts about politically privileged institutions:

Given the understanding of the bubble set forth here, the keys to preventing a similar crisis in the future are relatively straightforward: Eliminate the role of the GSEs in the national housing markets. Eliminate or dramatically curtail the ability of the Federal Reserve to inflate asset bubbles.

Great proposals, with which I fully agree. But Sheets, like the rest of us, does not expect them ever to happen, so he does expect, and so do I, that we will get more bubbles and busts.