GAO Audit of Federal Reserve No Bid Contracts Fails to Finger Geithner, Baxter, Dimon, Immelt and Friedman in Suspicious BlackRock Contract

Remember the Audit the Fed bill that was supposed to bring the financial system to its knees if Congress dared pass it? Remember the toothless, watered down version that finally made it into Dodd-Frank and at the time was itself controversial?

Pursuant to direction under Dodd-Frank, the Government Accountability Office today released a 266 page report detailing its findings after a review of the numerous emergency programs instituted by the Federal Reserve from 2008 to 2010. Among the many findings was that the bulk of over half billion dollars in service contracts were awarded without bid. While the report is a step in the right direction, its failure to mention the most suspicious contract (about which we know only because of Congressionally subpoenaed email records of the New York Fed), suggests the review was either facile or compromised. In other words, we cannot rely on even the simplest of half measures when it comes to providing Fed accountability.

Here is what the GAO wrote (all bolding and brackets are ours, throughout this post):

Reserve Banks Awarded Largest Contracts Noncompetitvely and Would Benefit From Additional Guidance on Seeking Competition

Although FRBNY awarded contracts both competitively and

noncompetitively for the emergency programs, the highest-value

contracts were awarded noncompetitively due to exigent circumstances.

FRBNY awarded almost two-thirds of its contracts noncompetitively,

which accounted for 79 percent of all vendor compensation (see fig. 4).

Eight of the 10 largest contracts were awarded noncompetitively. The

largest noncompetitive contract was valued at more than $108.4 million,

while the largest competitive contract was valued at $26.6 million.

Click image to enlarge.

Explaining the process by which FRBNY awarded contracts:

FRBNY awarded contracts in accordance with its acquisition policy, which

applied to all services associated with the emergency programs and

single-institution assistance. FRBNY is a private corporation created by

statute and is not subject to the FAR. Instead, FRBNY developed its own

acquisition policy, called Operating Bulletin 10.

Operating Bulletin 10 states that business areas may use noncompetitive

processes in special circumstances, such as when a service is available

from only one vendor or in exigent circumstances. FRBNY cited exigent

circumstances for the majority of the noncompetitive contract awards.78

Footnote 78 reads:

78 Of the noncompetitive contracts we reviewed, FRBNY awarded only three under the sole-source exception, when a service was available from only one vendor.

This fact will be key later on. Delving into the GAO's findings:

A guiding principle of the FAR, which applies to all executive agencies,

not to the Reserve Banks, is to ensure that agencies are able to deliver

the best value product or service in a timely manner while fulfilling

agencies’ policy objectives. Similarly, Operating Bulletin 10 provides a

framework for acquiring goods and services at the most favorable terms.

However, while the FAR requires certain activities for noncompetitive

awards and identifies specific steps to take, Operating Bulletin 10 does

not. Without similar guidance, FRBNY could be missing opportunities to enhance competition and provide the best value service in

noncompetitive awards. Examples of activities required or restricted by

the FAR include the following:

Soliciting multiple bids. The FAR requires contracting officers to solicit

as many offers as is practicable in the absence of full and open

competition.79 FRBNY officials stated that in noncompetitive

circumstances business areas are encouraged to collect a reasonable

number of competitive quotations and noted that, in at least some

cases, staff members contacted multiple vendors before awarding

contracts noncompetitively. However, FRBNY did not contact multiple

vendors before awarding some of the largest noncompetitive

emergency program and assistance contracts.80

Restrictions on contract duration and scope. Operating Bulletin 10

does not place any limits or restrictions on the duration of a

noncompetitive contract, nor does it require subsequent competition.

In contrast, the FAR generally limits the duration of contracts awarded

under “exigent circumstances” to the time necessary to meet the

unusual and compelling requirements and award a new contract using

competitive procedures, and such contracts may generally not exceed

1 year.81 FRBNY’s longest and most expensive contracts were

awarded noncompetitively and lasted more than 2 years and, in some

cases, could potentially last as long as 10 years.82 Some of these

contracts included distinct services that, while related, were needed at

different times and with different degrees of urgency. FRBNY officials

said that in some cases they think there would be limited benefits to

opening noncompetitive contracts to competition. FRBNY held

subsequent competitions for competitively awarded Agency MBS

program and TALF contracts when the terms of the programs

changed.

Justifying noncompetitive procedures. Operating Bulletin 10 requires

business areas to draft a memorandum that includes sufficient

documentation to justify the noncompetitive acquisition. However,

Operating Bulletin 10 does not provide guidance on what information

should be included in the memorandum. FRBNY justification

memoranda typically included background information on the

emergency program, vendor scope of work, vendor selection factors,

and an explanation of the special circumstances necessitating

noncompetitive awards. The memoranda did not typically identify

efforts made to promote competition, which the FAR requires.

Regarding Vendor Selection Criteria, the GAO makes a curious statement in the next paragraph:

FRBNY considered a number of factors when selecting vendors for both

competitive and noncompetitive contract awards, including a vendor’s

knowledge and expertise and ability to meet program requirements.

FRBNY also considered a vendor’s previous working relationship with

FRBNY or program participants as part of the selection criteria for

competitively and noncompetitively awarded contracts. FRBNY selected

vendors that had previous working relationships with FRBNY and the

program recipients so that it could leverage that familiarity to shorten the

vendor’s learning curve or ramp-up time. For example, FRBNY

noncompetitively selected BlackRock as the investment manager for

Maiden Lanes II and III because BlackRock had already evaluated the

underlying assets pursuant to an engagement with AIG prior to the

extension of credit by FRBNY.

These would constitute two of the three sole-source contracts mentioned in footnote 78, above. The appendixes disclose that BlackRock earned $24.1 million and $50.0 million for serving as the investment manager of Maiden Lane II and III, respectively.

BlackRock was also the investment manager for the original Maiden Lane portfolio that took on the toxic Bear Stearns assets. For serving as investment manager, it was paid $107.6 million in fees.

Recall that there are two bases upon which a no-bid contracts would be awarded: exigency or sole source, whereby there are no practical alternatives to a single service provider. The GAO report does not say on what basis the BlackRock Maiden Lane no-bid contract was awarded, but given the roughly three month window between the mid-March announcement of the new facility and the commencement of management by BlackRock in late June, it would be difficult to claim exigency. Also note the contract was not dated until September 9, 2008, several months later.

Thanks to the aforementioned subpoenaed emails of the NY Fed, we do in fact know that the BlackRock Maiden was sole-sourced. As we wrote in January, 2011:

[W]e'd like to know why BlackRock management of Maiden Lane I was sole sourced without a "clear reason", as is implied by the below email to FRBNY [then] Senior VP, Sarah Dahlgren, which we excerpt from the below document presented to Congress, with emphasis and brackets ours:

To Sarah Dahlgren/NY/FRS@FRS

Re: Sole Source

Spent some time with him [Tom Baxter, Jr., FRBNY GC] tonight. (He doesn't understand ML3, and I can't begin explain it either -- so don't needle him! -- and I am going to have [Paul] Whynott [FRBNY VP] spend some time with him tomorrow, BTW, you might touch base with Joyce [Hansen, FRBNY Deputy GC] about her reaction to Sunday's briefing; I think she had some concerns about how ML3 was presented to Geithner, which she expressed to Paul.) [Geithner] knew that Stephanie [Heller?, FRBNY Asst. GC] was handling the Blackrock contract -- he didn't express any concerns -- and I explained that, in contrast to MLI, we had a clear reason to sole source it this time (that they had already modeled, etc.). So, although I have no worries, yes, probably worth reviewing it with him [Geithner] before taking it to Tom."

It appears there was quite some consternation at the highest levels at the NY Fed about this contract award, yet no mention in the GAO report.

In follow up posts, we will document the full email chain from which the above was excerpted, explore just exactly how the NY Fed's Acquisition Policy (Operating Bulletin Number 10) implicates some of the country's top bankers in this no-bid contract scandal, discuss the GAO's findings of failure in conflicts of interest disclosure, and the GAO's own failure to follow its Congressional mandate under Dodd-Frank.

Krugman Gets it Right With Gold

Everyone seems to be making fun of Paul Krugman, who's out on the NY Times oped page today, suggesting the run-up in gold might be due to Goldline's advertising on Glenn Beck show. Both Bob Wenzel and Bob Murphy have added their two cents.

Krugman concludes:

Market prices almost always tell you something useful. But sometimes what they tell you is that there’s a marketing scam in progress.

I'm afraid I have to side with Krugman on this one as I think he's on to something. In fact, should demand ever falter for the Treasury's notes and bills, I suggest the Fed simply purchase airtime on its behalf on the Glenn Beck show.

Call it QE Beck, a truly patriotic marketing scam.

Sorry MMTers, the Economy Doesn't Exist and GDP is Bogus

The other day, a practitioner of Modern Monetary Theory (MMT), Robert Koerner, called for a sythesis between MMT and Austrian Economics. Robert Wenzel, at EPJ Central, provided an Austrian rebuttal here, which provoked an interesting discussion in the comments. Unfortunately, this appears to be part of a trend, in which the bogus constructs of MMT are passed off as somehow part of Austrian economics, which they are most definitely not. This post will demonstrate that MMT is simply a justification for the broken and irreparable status quo, but with a novel face.

Friend of EPJ, Robert Murphy, provides some background and criticism of its foundations, here*. To say that so-called MMTers come to some rather unconventional conclusions is understated, and something from which they do not run. For instance, Murphy writes, "if the federal government runs a budget surplus, then by simple accounting the private sector can't save."

However, at its heart, MMT appears to be based on accounting identities derived from national income accounting methods, which are themselves based upon imperfect abstractions. These are the same familiar equations [sadly] taught in nearly every economic intro course:

GDP = C + I + G + (X — M)

and

GDP = C + S + T

Austrian economist, Frank Shostack, tears apart GDP and its foundations here (emphasis mine):

To gain insight into the state of an economy, most people rely on a statistic called Gross Domestic Product (GDP). The GDP framework looks at the value of final goods and services produced during a particular time interval, usually a quarter or a year. This statistic is constructed in accordance with the view that what drives an economy is not the production of wealth but rather its consumption. What matters here is demand for final goods and services. Since consumer outlays are the largest part of overall demand, it is commonly held that consumer demand sets in motion economic growth.

By focusing exclusively on final goods and services, the GDP framework lapses into a world of fantasy wherein goods emerge because of people's desires. This is in total disregard to the facts of reality (that is, the issue of whether such desires can be accommodated). All that matters in this view is the demand for goods, which in turn will give rise almost immediately to their supply. Because the supply of goods is taken for granted, this framework completely ignores the whole issue of the various stages of production that precede the emergence of the final good.

In the real world, it is not enough to have demand for goods: one must have the means to accommodate people's desires. Means—i.e., various intermediate goods that are required in the production of final goods—are not readily available; they have to be produced. Thus, in order to manufacture a car, there is a need for coal that will be employed in the production of steel, which in turn will be employed to manufacture an array of tools. These in turn are used to produce other tools and machinery and so on, until we reach the final stage of the production of a car. The harmonious interaction of the various stages of production results in the final product.

The GDP framework gives the impression that it is not the activities of individuals that produce goods and services, but something else outside these activities called the "economy." However, at no stage does the so-called "economy" have a life of its own independent of individuals. The so-called economy is a metaphor—it doesn't exist.

By lumping the values of final goods and services together, government statisticians concretize the fiction of an economy by means of the GDP statistic. By regarding the economy as something that exists in the real world, mainstream economists reach a bizarre conclusion that what is good for individuals might not be good for the economy, and vice versa. Since the economy cannot have a life of its own without individuals, obviously what is good for individuals cannot be bad for the economy.

The GDP framework cannot tell us whether final goods and services that were produced during a particular period of time are a reflection of real wealth expansion, or a reflection of capital consumption.

For instance, if a government embarks on the building of a pyramid, which adds absolutely nothing to the well-being of individuals, the GDP framework will regard this as economic growth. In reality, however, the building of the pyramid will divert real funding from wealth-generating activities, thereby stifling the production of wealth.

Because the GDP framework completely disregards the intermediate stages of production, it can be of little help in the assessment of boom-bust cycles. It is little wonder then that mainstream economists are forced to conclude that recessions are a response to a sudden fall in consumer spending. Consequently, it is quite logical within the GDP framework to advocate loose monetary policies to revive the "economy."

The whole idea of GDP gives the impression that there is such a thing as the national output. In the real world, however, wealth is produced by someone and belongs to somebody. In other words, goods and services are not produced in totality and supervised by one supreme leader. This in turn means that the entire concept of GDP is devoid of any basis in reality. It is an empty concept.

Quoting the Austrian masters on the fallacy of national accounting:

According to Mises the whole idea that one can establish the value of the national output is somewhat far-fetched:

The attempt to determine in money the wealth of a nation or the whole mankind are as childish as the mystic efforts to solve the riddles of the universe by worrying about the dimension of the pyramid of Cheops.

Furthermore,

If a business calculation values a supply of potatoes at $100, the idea is that it will be possible to sell it or replace it against this sum. If a whole entrepreneurial unit is estimated at $1,000,000 it means that one expects to sell it for this amount the businessman can convert his property into money, but a nation cannot.

In addition to all these issues, there are serious problems regarding the calculation of the GDP statistic. To calculate a total, several things must be added together. To add things together, they must have some unit in common. It is not possible to add refrigerators to cars and shirts to obtain the total of final goods. Since the total real output cannot be meaningfully defined, obviously it cannot be quantified.

To solve this problem, economists employ total monetary expenditure on goods which they divide by an average price of those goods. There is, however, a serious problem with this. What is price? It is the rate of exchange between goods established in a transaction between two individuals at a particular place and a particular point in time. The price, or the rate of exchange of one good in terms of another, is the amount of the other good divided by the amount of the first. In the money economy, price will be the amount of money divided by the amount of the first good.

Suppose two transactions were conducted. In the first transaction, one TV set is exchanged for $1,000. In the second transaction, one shirt is exchanged for $40. The price or the rate of exchange in the first transaction is $1000/1TV set. The price in the second transaction is $40/1shirt. In order to calculate the average price, we must add these two ratios and divide them by 2. However, $1000/1TV set cannot be added to $40/1shirt, implying that it is not possible to establish an average price.

It is interesting to note that in commodity markets, prices are quoted as Dollars/barrel of oil, Dollars/ounce of gold, Dollars/tonne of copper, etc. Obviously, it wouldn't make much sense to establish an average of these prices. On this Rothbard wrote, "Thus, any concept of average price level involves adding or multiplying quantities of completely different units of goods, such as butter, hats, sugar, etc., and is therefore meaningless and illegitimate."

More on the fallacy of average price level, and getting to the heart of the matter (that GDP is simply a tool of coercion for the ruling class):

The employment of various sophisticated methods to calculate the average price level cannot bypass the essential issue that it is not possible to establish an average price of various goods and services. Accordingly, various price indices that government statisticians compute are simply arbitrary numbers. If price deflators are meaningless, however, so is the real GDP statistic.

So what are we to make out of the periodical pronouncements that the economy, as depicted by real GDP, grew by a particular percentage? All we can say is that this percentage has nothing to do with real economic growth and that it most likely mirrors the pace of monetary pumping.

As a rule, the more money created by the central bank and the banking sector, the larger the monetary spending will be. This in turn means that the rate of growth of what is labeled as the real economy will closely mirror rises in money supply.

So it is no wonder that in the GDP framework, the central bank can cause real economic growth, and most economists who slavishly follow this framework believe that this is so. Much so-called economic research produces "scientific support" for popular views that, by means of monetary pumping, the central bank can grow the economy. It is overlooked by all these studies that no other conclusion can be reached once it is realized that GDP is a close relative of the money stock.

One is tempted to ask, why it is necessary to know the growth of the so-called "economy"? What purpose can this type of information serve? In a free unhampered economy, this type of information would be of little use to entrepreneurs. The only indicator that any entrepreneur relies upon is profit and loss. How can the information that the so-called "economy" grew by 4 percent in a particular period help an entrepreneur make profit?

What an entrepreneur requires is not general information but rather specific information regarding the demand for his specific product, or products. The entrepreneur himself has to establish his own network of information concerning a particular venture.

Things are quite different, however, when the government and the central bank tamper with businesses. Under these conditions, no businessman can ignore the GDP statistic since the government and the central bank react to this statistic by means of fiscal and monetary policies. Likewise, participants in financial markets closely follow the GDP statistic in order to assess the likely responses of the central bank.

The entire army of economists is busy guessing whether the central bank will lower, or raise, interest rates. Moreover, to provide a rationale for all this, a new form of economics labeled macroeconomics was invented. Needless to say, this type of economics doesn’t deal with the real world but rather with a nonexistent entity called the economy.

By means of the GDP framework, government and central bank officials generate the impression that they can navigate the economy. According to this myth, the "economy" is expected to follow the growth path outlined by omniscient officials. Thus whenever the rate of growth slips to below the outlined growth path, officials are expected to give the "economy" a suitable push. Conversely, whenever the "economy" is growing too fast, the officials are expected to step in to cool off the "economy's" rate of growth.

The powerful conclusion:

If the effect of these policies were confined only to the GDP statistic then the whole exercise would be harmless. However, these policies tamper with activities of wealth producers and thereby undermine people's well-being. To take a particular instance, by acting to make the nonexistent entity the "economy" more efficient, U.S. government officials are busy destroying a major wealth generator—Microsoft. Likewise, by means of monetary pumping and interest rate manipulations, the Federal Reserve doesn't help generate more prosperity, but rather sets in motion a "stronger GDP" and the consequent menace of the boom-bust cycle—i.e., economic impoverishment.

We can thus conclude that the GDP framework is an empty abstraction devoid of any link to the real world. Notwithstanding this, the GDP framework is in big demand by governments and central bank officials since it provides justification for their interference with businesses. It also provides an illusory frame of reference to assess the performance of government officials.

Bob Roddis writes in the comments in Wenzel's post about MMT's intellectual heritage:

Never forget that MMT godfather Abba Ptachya Lerner’s magnum opus was “The Economics of Control”:

Chapter l. INTRODUCTION. THE CONTROLLED ECONOMY

The fundamental aim of socialism is not the abolition of private property but the extension of democracy. This is obscured by dogmas of the right and of the left. The benefits of both the capitalist economy and the collectivist economy can be reaped in the controlled economy.

And again, in a subsequent comment:

More things I have dug up on MMT…

1. Abba Lerner was a longtime economic Stalinist. He writes in the preface to “The Economics of Control” that he was long resistant to the any “free market” analysis but finally he thanks Joan Robinson for getting him to overcome his prejudices against “Mr. Keynes great advancement in economic understanding”. Great. A Stalinist tempered with some Keynesianism. That’ll work, right? This is their starting point and helps explain how they can be so joyous when they explain “The government is not revenue constrained!!! [how cool is that??]”

2. In 1980, two years before he died, Abba Lerner (1903-1982) was dabbling in the following price control system based upon this article by David Colander, a co-author of a 1980 book with Lerner:

Lerner found the implications of sellers’ inflation so important that, beginning in the 1960s, he changed his research program to center on finding cures for sellers’ inflation. Initially he toyed with various administrative wage and price control policies, but he found those lacking and soon gave them up. He replaced them, first, with a tax based incomes policy and ultimately, a market based[??!!!] incomes policy in which property rights in prices are set and individuals have to buy the right to change prices from others who change their price in the opposite direction. It was this idea that formed the basis of our market [???!!!!] anti inflation (MAP) book. (Lerner and Colander 1980) Under MAP, rights in value added prices would be tradable so that any firm wanting to change its nominal price would have to make a trade with another firm that wanted to change its nominal price in the opposite direction. Thus, by law, the average price level would be constant but relative prices would be free to change [@page 12]

http://tinyurl.com/4rfk3jk

So, we now know enough about MMT to know that Abba Lerner wrote a book in 1980 proposing a ghastly and barbaric Rube Goldberg system where one would be precluded from raising (setting) one’s one prices without trading the right to do so with somebody else under penalty of statist law. But I thought the MMTers could cure inflation just by changing the tax code. Hmmm.

And it was Keynes, himself, in collaboration with a few other economists and statisticians at the beginning of World War II, who invented the national accounting constructs that would give rise to GNP and GDP. All for the purpose of justifying a protracted, expensive war. Writes Judo Cuyvers in the Economic Journal:

The elaboration of national economic accounts and detailed national income estimates is generally considered to be a direct result of Keynes's emphasis on the main macroeconomic determinants of employment and aggregate demand.

Scholars have repeatedly stressed Keynes's impact in the course of the first few years of the Second World War, or have pointed to Colin Clark's pioneering calculations during the 1930s. However, as we shall show in the following pages, it was at the very beginning of the Second World War, not in 1937 nor in 1941, that British national income accounting entered a critical phase. Determined to convince the authorities and public opinion of the necessity of financing the war effort properly, Keynes immediately set himself the task of elaborating a proposal based on statistical evidence. It was during the period between Octboer-November 1939 and February 1940, when Keynes was working on his December 1939 article in this JOURNAL and subsequently on his pamphlet How to Pay for the War, in close statistical collaboration with Erwin Rothbarth, that the first double-entry national accounts were developed and the still very crude accounting and estimation procedures became essential steps in economic policy making.

In true Ministry of Truth fashion, decades of Keynesian and related indoctrination continues to facilitate and propagate the lie that the banking system is somehow not regulated enough--too free market. As Tom Woods recently wrote:

She likewise thinks the banking system is pretty close to a free market – after all, hasn’t she seen news reports about bank "deregulation"? To the contrary, the banking system is perhaps the least free-market sector of the entire economy. The whole system is overseen by the government-created Federal Reserve System, which presides over a system-wide cartel. It involves monopolistic legal tender laws, a monopoly of the note issue, artificial disabilities on other media of exchange apart from the depreciating dollar, and various forms of bailout guarantees. For a sense of what a free market in banking would actually look like, read Murray N. Rothbard’s The Mystery of Banking.

Even if we ignore MMT's dubious historical origins and assume beneficent intent, it's important that Austrian economics not be conflated with MMT and the work of its practitioners, such as Wray, Mosler*, Aureback, Mitchell, Fullwiler. Why make the distinction? As governments and economies fail around the world, there is and will be increasing demand for alternatives. MMT ensures the status quo ante. It's simply another system for central planning and price fixing. And prices matter, as I wrote last November:

Though it's possible we will eventually transition to a new Ponzi (which is in the works), the case for optimism can be made that a better informed public with no prospects for a future bailout will rebuild a system in which prices are given the respect they deserve.

* EPJ Regular, Taylor Conant, produced a series of critiques of Warren Mosler's book called "Seven Deadly Frauds of Economic Policy", which itself is based upon MMT.