The Federal Reserve lead response to the acute phase of the Great Financial Crisis was based on deceit.  The entire narrative used to justify bailing out the banks and the subsequent passage of the Dodd-Frank Act was a lie.

Allow me to give one small example of our lying central bankers in action.  This example is the abomination known as the Supervisory Capital Assessment Program (aka, stress tests).

On May 7, 2009, in his role as Chairman of the Fed, Mr. Bernanke issued a statement about the financial condition of the 19 largest bank holding companies in the US.  He observed,

These examinations were not tests of solvency; we knew already that all these institutions meet regulatory capital standards. Rather, the assessment program was a forward-looking, “what-if” exercise intended to help supervisors gauge the extent of the additional capital buffer necessary to keep these institutions strongly capitalized and lending, even if the economy performs worse than expected between now and the end of next year.

His observation is pure deceit.  Notice how he says the stress tests were not tests of solvency, but rather were tests of banks meeting regulatory capital standards.  This is very important because bank capital is an easily manipulated accounting construct.

There are several ways bank capital is manipulated by regulators so banks always meet regulatory capital standards.  Here are two of the most obvious.  Regulators suspend mark to market (this was done with the subprime securities).  Regulators let banks engage in “pretend and extend” (bankers pretend over-indebted borrowers can repay their existing loans by extending additional credit to cover interest and principal repayments;  note: this creates zombie borrowers).

Mr. Bernanke then goes on to say a goal of the assessment was to gauge the need for more capital to keep the banks lending.  This is complete BS.  Banks don’t turn on and off their lending function based on an easily manipulated accounting construct.  Banks don’t need capital to lend.  They need a borrower who is willing to accept the terms they are willing to lend at.

These two examples of deceit pale in comparison to Mr. Bernanke’s greatest deceit in his statement.

The results released today should provide considerable comfort to investors and the public. … our government, through the Treasury Department, stands ready to provide whatever additional capital may be necessary to ensure that our banking system is able to navigate a challenging economic downturn.

Here is the Chairman of the Federal Reserve committing the US taxpayer to put up as much money as is necessary to keep the largest 19 banks in the US in business.  He has no authority to promise unlimited funding!  The Treasury Department had a $750 billion cap on what it could give the banks before having to go back to Congress.  Does anyone think Congress would have given more funding to keep this particular collection of misbehaving banks in business? But here is Mr. Bernanke taking it upon himself to commit Congress.

Of course, his statement did provide considerable comfort to investors (including bankers).  Mr. Bernanke confirmed they would be protected from any losses and it would be the taxpayers who were responsible for the losses.

As Matt Taibbi put it

What’s critical here is not that investors actually buy the Fed’s bullshit accounting – all they have to do is believe the government will backstop [the banks] either way, healthy or not. “Clearly, the Fed wanted [them] to attract new investors,” observed Bloomberg, “and those who put fresh capital into [the banks] this week believe the government won’t let [them] die.”

Through behavior like this, the government has turned the entire financial system into a kind of vast confidence game – a Ponzi-like scam in which the value of just about everything in the system is inflated because of the widespread belief that the government will step in to prevent losses.

On August 8, 2013, Mr. Bernanke gave a little noticed speech on the stress tests.  I say little noticed because anyone who reads the speech will realize he a) brags about lying in 2009 and b) says the Fed is lying every year about the stress test results because it doesn’t have the necessary information.

He begins by saying

In retrospect, the SCAP stands out for me as one of the critical turning points in the financial crisis. It provided anxious investors with something they craved: credible information about prospective losses at banks.

Since the tests were not tests of solvency, how could the tests have provided investors with credible information about prospective losses at the banks?  The tests didn’t provide credible information about the losses.  It provided information about “who” would be responsible for the losses.  As noted above, investors understood Mr. Bernanke’s promise the taxpayer would pick up the losses.

Mr. Bernanke then goes on to say

The original SCAP was supervisors’ first attempt to produce comprehensive and simultaneous estimates of the financial conditions of the nation’s largest banking firms, and the required data and analytical methods were developed under great time pressure. Of necessity, when projecting losses and revenues under alternative SCAP scenarios, supervisors relied on the firms’ own estimates as a starting point. Although we scrutinized and questioned the firms’ estimates and made significant adjustments based on our own analysis, for that inaugural round of stress tests, it was not possible to produce completely independent estimates.

However, over the past four years, considerable progress has been made in data collection and in the development of independent supervisory models. For our most recent supervisory stress tests, we collected and analyzed loan- and account-level data on more than two-thirds of the $4.2 trillion in accrual loans and leases projected to be held by the 18 firms we evaluated this year. Those detailed data include borrower, loan, and collateral information on more than 350 million domestic retail loans, including credit cards and mortgages, and more than 200,000 commercial loans. … These ongoing efforts are bringing us close to the point at which we will be able to estimate, in a fully independent way, how each firm’s loss, revenue, and capital ratio would likely respond in any specified scenario.

Shorter, every year the Fed lies about the banks’ financial condition.  We know this because Mr. Bernanke acknowledges the Fed doesn’t have the data necessary to independently run its own tests.

It is simply the continuation of the policy Matt Taibbi described as

the government allowing unhealthy banks to not only call themselves healthy, but to get the government to endorse their claims. Projecting an image of soundness was, to the government, more important than disclosing the truth.

If a government wants to ruin its legitimacy, it lies.  It lies in just the way Mr. Bernanke brags about doing.

As regular readers know, FDR said the government should never be in the position of recommending an investment (this is what the stress tests do by saying the banks can withstand financial armageddon).  Instead, the government is suppose to ensure disclosure of all the necessary information so market participants can make a fully informed investment decision.  In the case of the banks, as Mr. Bernanke points out, this information is each bank’s current exposure details.  With this data, market participants can run their own stress tests.

Every year when the stress tests results are announced, I observe the only way the results are credible is if the banks disclose their current exposure details and the market confirms the results.  Of course, the Fed doesn’t push for or mandate this type of disclosure.  Which leads to the obvious conclusion the Fed is still lying about the health of the Too Big to Fail banks.

If the Fed is willing to lie about the condition of the banks, what else is it lying about?