Fed’s Alvarez Says Audits Could Lead to Higher Rates (Update1)

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Sept. 25 (Bloomberg) -- Federal Reserve General Counsel Scott Alvarez said audits of monetary policy by the U.S. Congress could lead to higher interest rates and reduced confidence in central bank policy.

Congressional audits of monetary policy could “cause the markets and the public to lose confidence in the independence of the judgments of the Federal Reserve,” Alvarez told the House Financial Services Committee today in response to a question from Representative Dennis Moore, a Kansas Democrat. Alvarez said in his prepared remarks the audits would probably “chill” the central bank’s discussions on interest rates.

Fed Chairman Ben S. Bernanke and his colleagues are trying to persuade lawmakers not to pass legislation sponsored by Representative Ron Paul of Texas that would repeal the central bank’s immunity to audits of monetary policy. Fed officials used emergency powers to protect creditors of Bear Stearns Cos. and American International Group Inc. during the financial crisis, prompting congressional scrutiny.

“We don’t want to give the rest of the world or, more important, domestic investors the impression that we are somehow in a formal way injecting Congress into the setting of monetary policy,” said Representative Barney Frank, a Massachusetts Democrat and chairman of the committee. “That could have a very destabilizing effect.”

Frank added that “a lot needs to be done” on Fed transparency and said that Congress can accomplish that without interfering with the independence of monetary policy decisions.

Remove Exemptions

Paul’s legislation would remove Fed exemptions from audits in four areas: transactions with foreign central banks; deliberations on monetary policy matters, including discount- window operations; transactions made under the direction of the Federal Open Market Committee; and communications and discussions between the Board, the reserve banks and staff.

Frank said he supports a delay in making some Fed information public, such as the securities it buys and sells, so it doesn’t have a “direct market effect.” Alvarez told Frank that the Fed is “giving serious consideration” to that idea and would be “happy to work with you on it.”

In an interview after the hearing, Paul said the audit powers in the bill may be altered to delay by three to six months releasing information on FOMC actions. The legislation is likely to be included in a broader Democratic package of financial-regulation changes in the House, he said.

‘Gentleman’s Agreement’

“It’s a gentleman’s agreement” with Frank, Paul said, adding that Frank fulfilled an earlier agreement to hold a hearing. “That doesn’t mean it will happen in the Senate,” even as prospects in the upper chamber are improving, Paul said.

In the hearing, Paul told Alvarez that the Fed had “failed” to stabilize interest rates, prices and employment, according to its mandate. “What we need is more oversight and more transparency rather than more authority to the Federal Reserve,” Paul said.

Alvarez said GAO audits of discount-window lending could reduce the effectiveness of “these facilities in promoting financial stability, maximum employment, and price stability.” The legislation could also “disrupt” the Fed’s relationships with foreign central banks, he said.

“Monetary policy independence prevents governments from succumbing to the temptation to use the central bank to fund budget deficits,” Alvarez said in his prepared testimony. “Financial markets likely would see the grant of audit authority to the GAO with respect to monetary policy as undermining the Federal Reserve’s independence.”

The legislation has 295 sponsors in the House, including every Republican member, Rachel Mills, a spokeswoman for Paul, said in an e-mail yesterday.

The Fed is facing other challenges by Congress, including a proposal to strip the central bank of its rule-writing power on some consumer financial products.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net

Last Updated: September 25, 2009 14:25 EDT
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