Federal Reserve & Interest Rates

This month the Internal Revenue Service released its “Dirty Dozen” list for the top tax scams of the year. The list includes both scams that cheat individuals out of their money through various deceptive tactics, and ones that cheat the government out of money with erroneous tax claims.

Here is the list:

1. Phishing. This is when fake emails sent by scammers posing as banks or companies are used to steal money from bank accounts and credit cards.

2. Fake Economic Stimulus rebates. Con artists are tricking individuals into revealing personal financial information online through email or through a phone call by posing as an IRS agent. (The stimulus is automatic, there is no reason for the IRS to call or email you.)

3. Frivolous Arguments. These are myths about tax laws including erroneous ideas like “filing tax is optional,” or “tips don’t count as income.” A complete list of these false arguments is available on taxes.banks.com.

4. Fuel Tax Credit Scams. Individuals who are not entitled to the fuel tax credit have tried to claim it.
5. Hiding Income Offshore. It is illegal to try to avoid paying taxes by keeping money in another country.

6. Abusive Retirement Plans. The IRS is cracking down on individuals who try to deposit more than the allowed annual contribution to avoid taxes.

7. Zero Wages. Phony wage reports that reduce the amount of tax owed using falsified W-2 and 1099 forms.

8. False Claims and for Refund and Abatement. Requests for tax abatements using Form 843, even though no taxes were previously paid.

9. Tax Preparation Fraud. Individuals pose as tax professionals and promise huge returns. They encourage false claims, and often take substantial portions of promised returns.

10. Disguised Corporate Ownership. Hiding business ownership and concealing or underreporting income (money laundering) is a serious offense. Terrorist funding is sometimes accomplished in this manner.

11. Misuse of Trusts. Some promise that taxes will be lower if funds and assets are transferred into a trust, yet not all trusts offer tax benefits.

12. Abuse of Charitable Organizations and Deductions. This is the misuse of tax-exempt organizations, donors controlling the use of contributions, and private tuition payments disguised as donations for tax benefit.

United States Treasury Secretary Henry M. Paulson made a statement on Federal Reserve regulations on Wednesday, March 26, 2008 at the US Chamber of Congress. He expressed the need to slightly reform the lending practices of the Federal Reserve, urging more transparency and more informed lending decisions.

Secretary Paulson discussed the discount window operations of the Federal Reserve. The discount window offers a cash flow supply for commercial banks and allows the Federal Reserve to increase market liquidity. The Secretary suggested a few minor tweaks in the more recent lending to non-depository institutions that have access to the discount window on a temporary basis.

Secretary Paulson stated:

I believe a few constructive steps would enable the Federal Reserve to protect its balance sheet, and ultimately protect U.S. taxpayers….The Fed should describe eligible institutions, articulate the situations in which funds will be made available, and the magnitude and pricing structure for the funds. The TAF process is a good model for a structure that would provide relevant information to the marketplace.

…The Federal Reserve should have the information about these institutions it deems necessary for making informed lending decisions…We suggest that the Federal Reserve, the SEC, and the CFTC continue their work of building a robust cooperative framework… These regulators should consider whether a more formalized working agreement should be entered into to reflect these events.

With this added information flow, the Federal Reserve will be better positioned to consider market stability issues like liquidity provisioning and the interconnectedness of financial institutions. The Federal Reserve’s participation could also allow for broader consideration of market stability issues by the SEC and the CFTC. This collaborative process will necessarily have a strong focus on liquidity and funding issues.

The combination of these steps should provide the Federal Reserve with a structure and the information that it would need to make liquidity backstop loans during periods of market instability to non-banks.

It seems what Paulson is basically trying to say is that the Federal Reserve would be able to handle liquidity and funding issues better if they were not standing alone. More open communications with the Securities and Exchange Commission and the Commodity Futures Trading Commission would protect taxpayers and avoid moral hazard. Moral hazard in this situation is basically when banks have incentive to take higher risks because they know that the Federal Reserve will insure them or bail them out.

Tuesday, the Federal Reserve announced the results of Monday’s $50 billion Term Auction Facility (TAF).  This is the eighth TAF since the program was initiated back in December 2007.  The total amount that has been awarded as short-term loans to bidding banks is $260 billion.  This is an ongoing program that will continue until credit liquidity is stabilized.

Over $88 billion in bids were submitted on Monday, with $50 billion worth approved.  The stop-out rate for these 28-day credits (set to settle tomorrow, March 27th) is 2.615%.  This is the lowest rate the Federal Reserve has offered since the TAFs began.  There were 88 participants in the propositions.

The lending was initiated in December as part of the Federal Reserve’s effort to stop the effects of the credit crunch stemming from the sub-prime mortgage crisis.  Increase the liquidity in banks allows them the ability to lend to businesses and individuals for homes, cars, equipment and expansion.  The country thrives on credit, so it is extremely important to have increased flexibility in lending because the system cannot function with tight credit conditions.  That is why the Term Auction Facility was created.

The European Central Bank is taking similar actions.  Banks in need of cash flow were awarded a total of just over $77 billion in short-term loans.

We are undeniably suffering from major economic slowdown in this country. Some economists say that we are in recession, but the overall word is that this is just a slowdown.  Data suggests that there is definitely a slowdown, and whether or not we call this a recession is a matter of semantics.  Many are still not willing to call our situation a recession, while some have said that we have been in a recession for several months already.

Regardless of terminology, the economy has slowed down considerably, and there is a risk of it getting worse. If it gets worse, more will begin to say that we are officially in recession.  The Federal Reserve is not ready to call it that, and they are making as many moves as possible to avoid it, including Term Auction Facilities.  Hopefully, the TAFs will keep credit loose enough to keep credit conditions from becoming to tight.