“Subpoena the Fed?”

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).


January 27, 2010

On our website, under Special Reports, you will find the letter of Congressman Darrell Issa, http://www.cumber.com/content/Special/Towns012610.pdf, requesting the subpoena of documents from the Federal Reserve. We want to offer some very quick thoughts in the heat of politics now casting a major pall over financial markets and economic decisions.

This is a week filled with politics on a collision course with financial markets and economics. Bernanke is likely to be reconfirmed as Fed Chairman by a US Senate vote with the narrowest of margins. There will be a cloud over the Fed for some “extended period” of time.

Fed policy will need to be understood and must be continuously examined. The Fed is engaged in a creative development of its policy implementation apparatus. We have written about this many times, and we will not delve into those nuances here.

Unfortunately, the Fed has failed in communication. It may get a passing grade for policy and it may get support for prompt and strategic action after Lehman and AIG. However, it does not get good grades for the early pre-Lehman period of this evolving financial crisis.

Remember, the first Fed primary dealer to fail was Countrywide. It was merged with another primary dealer, Bank of America. The second primary dealer casualty was Bear Stearns. It was merged with primary dealer JP Morgan Chase. Merrill Lynch was a primary dealer that was also merged with another primary dealer, Bank of America. All this activity involving primary dealers occurred in the early phase of the financial crisis, under Chairman Bernanke’s supervision. More importantly, it also occurred while Tim Geithner was president of the Federal Reserve Bank of New York.

In the Congress, in the country at large, on Main Street and on Wall Street, we now witness witch hunting over Geithner and Bernanke. It is important to distinguish between them.

Bernanke is a respected academic. He did not come in with a cloud of ethical questions over his head when he took office as a Federal Governor, as an economic advisor to the President, and as Fed Chairman. Disagreements with Bernanke occurred in the realm of policy making. Some argue he is a creative savior who avoided a Great Depression. Others argue he did not have the forecasting proficiency to see the crisis coming.

The arguments in all cases are about policy making and professional economic skill. So far, no one has been able to produce a smoking gun that impugns Bernanke’s character. That is the reason Bernanke will survive the political firestorm and be confirmed by the Senate for another term as Chairman.

Revelations about Geithner’s taxes damaged his character when they were revealed. Additional revelations about the behavior of New York Fed board members provided fuel for the Geithner critics. For the last year, as Treasury Secretary, Geithner has operated under this cloud of embarrassment. In addition, a number of his proposals reached an ignominious end. PPIP is a good example.

Now we are engaged in a detailed examination involving the role of the Federal Reserve and the specific role of Secretary Geithner, targeting payments made by AIG. We have learned that there were internal memos examining one course of Fed action and that there were subsequent reversals. We have learned that memos were not revealed and that certain documents and information were placed under a sealed agreement involving the SEC and others.

This episode of secrecy in American financial history hangs over financial markets and our economy. It continues to rain poison like a toxic cloud.

Now we have a Congressional request to subpoena documents. We have an inquiry to gain transparency that was not forthcoming from the Federal Reserve or Treasury. That transparency and full revelation of all hidden elements is now absolutely essential. We cannot obtain full meaningful financial reform in the US without it. Financial markets need the truth in order to properly discount America’s economic and financial future.

The narrative of this crisis must be accurately written. If Secretary Timothy Geithner becomes a political casualty in the process, so be it.

David R. Kotok, Chairman and Chief Investment Officer

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