The Fed as the New Global Aristocracy: Walker Todd

In this issue of The Institutional Risk Analyst, we ask a question that ought to be top of mind for all Americans - namely whether the US government and particularly the Federal Reserve System should be bailing out the Old Man of Europe once again. And to help us answer that question, we went to the nation's leading expert on the constitutionality of the role currently being played by the Fed, Walker Todd.

A resident of Cleveland, OH, Walker served as counsel to the discount window at the Federal Reserve Bank of New York in the 1980s when IRA co-founder Chris Whalen worked as an applications analyst in the same institution. Todd later fled the moral vacuum created inside the central bank by then NY Fed President E. Gerald Corrigan to work at the Cleveland Fed. He was eventually driven out of the central bank entirely by the forces of relativism that have controlled the Fed ever since. Todd now works as a scholar at the American Institute for Economic Research (AIER).

But before we dive into this important discussion, we need to announce a couple of changes at IRA. First we held our annual shareholders meeting last week and Dennis Santiago was elected Chairman & CEO of Lord Whalen LLC, the parent of Institutional Risk Analytics. If you need information about any IRA tools and services, please contact Dennis or Diana Waters.

IRA co-founder Chris Whalen was elected Vice Chairman of Lord, Whalen LLC. He is leaving his duties as head of sales and business development at IRA to take a position as Senior Managing Director of Tangent Capital Partners in New York. Chris will be focusing on investment management and advisory opportunities at Tangent, as described by Bill Alden in the New York Times, but he will continue to edit The Institutional Risk Analyst. Suffice to say it is time to put some of IRA's analytics tools to work in a live risk environment.

Many readers of The IRA have asked us in the past several months if we despair for the future of the United States and the economic system built upon the much abused dollar. The short answer is no; we at IRA are bullish on the United States, in part because the very democratic freedom that allows Americans to commit acts of libertine stupidity is also our greatest strength.

No matter how much gold is stored in the central banks of the nations of the old world such as China, Russia and the European Union, these nations are not democratic. No amount of monetary rectitude will offset the fact that the peoples of the old world are not free to act, either in political or economic terms. In this regard, see the critical review of the new book by Jim Rickards, "Currency Wars: The Making of the Next Global Crisis," written by Chris Whalen on The Big Picture.

The key point to be made about the Fed swaps lines to EU central banks is not financial but rather political. Phil Izzo of The Wall Street Journal noted on November 30, 2011 that "since the Fed isn't lending to banks directly, the risk is essentially nonexistent," a point that is only true if the central banks on the other side of the swap still exist a year from now. But hold that thought.

The US government has bailed out Old Man Europe three times in the past century and more. Prior to the start of WWI in 1913, the allied nations led by the UK borrowed heavily from the US, both directly from banks and through commercial credits underwritten by the new federal reserve system. At the end of the conflict, the victorious European nations defaulted on their debts to the US government even as they extracted unfair financial reparations from defeated Germany, extortionate outflows that would eventually create the macabre path for the political rise of Adolph Hitler.

In WWII the allied nations of Europe again led by the UK borrowed heavily from the US government. And again the victorious nations of western Europe defaulted on their financial obligations to the people of the US. This avoidance of the financial obligations by the nations of Europe to the US is on top of the vast human sacrifice made by American soldiers and their families in that conflict.

After WWII, the allied nations of Europe were broke and the US once again subsidized them via the Marshall Plan and various related mechanisms intended to rebuild Europe and, later, engage in a Cold War against the Soviet Union. One of the key points that needs to be made is that in neither WWI nor WWII were the entrenched economic and political elites in Western Europe disturbed. After WWII the leadership of the US military actively organized the very same corporations and business leaders that had financed and supplied Hitler's blitzkrieg to fight the war against godless communism.

With no turning of the economic soil in Europe after the two great wars and Cold War, it should be no surprise that growth and employment in what is today the Eurozone has slowly ebbed. Keep in mind that while the US required the nations of Europe to undertake the experiment we now call the EU as a condition of financial support under the Marshall Plan, the Americans did not require significant restructuring nor the breakup of the old industrial groups. There are still numbers tattooed into the leather seats of every Mercedes Benz that rolls off the assembly line.

Thus our earlier comment about the chief effect of the Fed's generosity via the swap lines being political. By providing financing to the bankrupt nations of Europe, the Fed is interfering in the internal political affairs of foreign nations. Whether the Fed is repaid or not is a minor issue compared to the political and social damage done to the people of Europe by depriving them of the democratic opportunity to "throw the rascals out," to use the well-worn American phrase.

Like most economists, the people who run the Fed today have no more sense about the political impact of foreign intervention than they do about the domestic political impact of bailing out large banks. In each case, the Fed's economic decision to leave existing corporate and political structures in place has tremendously damaging effects on the political life of all the nations concerned.

In the case of the US, does anyone think that Barack Obama would be seeking a second term as POTUS had the largest banks been restructured by free market forces? The US housing sector would already be recovering, in part because the political shock wave of restructuring would have forced Congress to act long ago. Bank America and Citigroup would have been broken up and sold to new investors, and the US economy would be growing again without fiscal stimulus.

Likewise without the Fed's swap lines, Angela Merkel in Germany and Nicholas Sarkozy in France would have preceded Italian premier Silvio Berlusconi out the political door more than a year ago. Instead the very same entrenched corporate elites that have led Europe down the road to economic hell for the past half century are now clients of Ben Bernanke and the Federal Reserve Board.

When Bernanke, Treasury Secretary Tim Geithner and their trained puppet Mitt Romney talk about how the Fed just had to save the financial system via bailouts for zombie banks, they never admit that the chief beneficiaries of these actions were American politicians. This all brings us to our discussion with Walker Todd.

The IRA: A House committee is planning hearings this week on the legality of the Fed swap lines. What is your view of this issue?

Todd: First you should see my Superior Court brief in the Four Farmers' Case (2001).

The IRA: This was an interesting case that of course the media ignored. The petitioners, a group of four farmers residing in Colorado, New Mexico, and Kansas, brought an action against the United States for an injunction against farm foreclosures until parity pricing principles, declared to be the underlying law of U.S. agriculture in 1933 and never repealed or suspended, were enforced in the United States.

Todd: Precisely. Similar issues are at stake in the case of the Fed swap lines to the EU. The Constitution clearly and squarely prohibits a congressional delegation of the power to create monetary claims against the United States. What else is a swap agreement, after all? The Congress cannot allow claims to be created permanently to an entity not subject to congressional (a) appropriations or (b) review. Now tell me about the ECB and other central banks.

The IRA: No, you tell us. Are the Fed swap lines a violation of the US Constitution?

Todd: Yes. The Fed, whose liabilities have the explicit full faith and credit of the United States and thus should be subject to congressional review, currently is letting the ECB create "unlimited amount" claims against the Fed. What happened to the long-established principle of 50-50 sharing of swap liabilities between the Fed and the Treasury/ESF?

The IRA: Once upon the time, the Treasury did pretend to care about the distinction between fiscal expenditures and monetary emissions from the central bank.

Todd: The term of the loans at least is limited, although the Fed now is extending the stuff out a little more than a year.

The IRA: So what is the basic issue? Accountability?

Todd: Yes. When you report back to me that Congress is willing to haul a European banker, let alone a senior Fed or Treasury official, before a hearing and to ask him or her reaming-out questions about how the swap line credits were used, then and only then will I believe that Congress is serious about getting on top of this issue.

The IRA: Has Congress or the Supreme Court ever addressed this issue?

Todd: The Supreme Court case that should be reviewed is Hampton v. US (1928). Beyond that, I currently have no reason to believe that anyone in Congress is serious about taking on or reforming the Federal Reserve Board. Why should anyone volunteer to be guillotined in defense of a principle that no one in Congress will defend?

The IRA: Why indeed. But we do suspect that there is a rising tide of Americans who do care about such issues. The success of Newt Gingrich in attacking the better financed and organized Romney campaign certainly suggests that Americans do care about such distinctions. How should Congress impeach Bernanke and the other Fed governors for their reckless foreign intervention?

Todd: The principle is roughly as follows and it's all constitutional; the contrary is not. Claims against the full faith and credit of the United States have to be approved by Congress. Otherwise, the people are subjected to whatever noble class Congress deigns to enshrine. Tocqueville wrote, in his "Old Regime and the Revolution" (1851), that the fatal wound to the French constitutional body politic was administered when Charles VII (15th century) agreed with the nobles that he would have the right to impose direct taxation on the people unilaterally as long as he did not tax the nobles.

The IRA: So Bernanke and company are the new nobility, imposing a tax on US taxpayers via an illegal expenditure and, indirectly via inflation?

Todd: Don't unlimited Fed swap lines for Europe and general favoritism toward corporations (especially banks, and foreign banks at that) smack mightily of that tone and flavor?

The IRA: Yes they do.

Todd: Bankers and corporations generally, constitutionally are supposed to have no better standing before Congress, the Supreme Court, or God Almighty than the average Joe taxpayer from Peoria, Illinois. A clause in the Constitution explicitly prohibits the creation of a noble class.

The IRA: So by bailing out the large banks and foreign governments of the EU, Bernanke is elevating these corporate entities to the level of "too big to fail" and thus above that of the US citizens?

Todd: Yes. Until and unless Congress and/or the Supreme Court manage to behave accordingly, I have no reason to gainsay Robert Heilbroner's great summary of the US economy: "Imagine a series of tribute trains moving slowly from the Heartland toward Washington and New York." In the question you have posed, I would add, "And toward Frankfurt."