The Problem With Federal Reserve Transparency

Last week, the Federal Reserve lost a lawsuit. As a result, it is required to disclose the details of loans in some of its lending programs. Currently, this information is kept secret, and the Fed insists it must remain that way. As a result, the Fed is expected to appeal the case. It has already requested a delay on enforcement of the court order. After all, once the cat is out of the bag, it's not really possible to put it back in. I think the question at hand is a difficult one. I've got mixed feelings on which side is right.

First, what's the Fed's argument for keeping this information secret? Bloomberg explains the Fed's reasoning given to the judge, Loretta Preska:

Preska's Aug. 24 ruling rejected the Fed's argument that the records should remain private because they are trade secrets and would scare customers into pulling their deposits.

The trade secret argument seems a bit of a stretch. Are there really banks out there claiming that the secret to their success is getting loans from the Federal Reserve? That seems highly unlikely.

The other argument, however, is relevant and important. I see it as the crux of the Fed's case. Let's imagine your bank needed an emergency loan from the Federal Reserve. Currently, you'd never find out, since it's secret. But if the Fed ultimately loses the case, then imagine if its emergency loan balance listing by bank became published daily for public consumption. You could see your bank on there. That might, and probably should, cause some alarm to those banks' customers.

The Fed's argument is essentially that disclosing this information will cause bank panics. Ignorance is bliss. If people never find out about these loans, then assuming the bank pays it back, everything will turn out fine. Why scare the public for no reason?

I get that argument. I'm even sympathetic to it. It still bothers me. I don't need to know if my bank got a loan from Goldman Sachs, but since the Fed is a lender of last resort, that means something much different. As a shareholder of the bank, I'd probably want this information too.

Maybe an analogy would be if you're in a crowded movie theater, and there's a small fire in the concession stand outside. The movie theater employees are pretty sure they can put it out with the fire extinguisher they have. Should they first alert the theater of the fire? Panic and mayhem may ensue, but I'd lean towards wanting to know -- even if they think they can put the fire out.

Another difficulty is related to the Fed being a quasi-public institution. As a result, the public should rightly demand more transparency. What if, for example, it was found that over the past twenty years, some bank accounted for 25 percent of the Fed's emergency loans? That would seem very suspicious. Right now, no one but the Fed would ever know.

Finally, this ruling would also weaken the strength of the Fed's ability to stabilize the financial markets in a broad sense -- even beyond the bank panics it could cause. If banks know that everyone will find out when they obtain emergency loans from the Fed, they will be less likely to do so. That might seem good on some level, but it could cause them to prefer a less stable situation than they would have if they got the loan. In some cases, banks might just decide to go ahead and fail rather than request a Fed loan, because a bank run would cause the same result anyway.

I'm really torn on this one. If anyone out there has a strong belief one way or the other that can shed some light on the right answer, feel free to share as a comment.