Tax protestors and their obsession with the Federal Reserve

[Edgar]

Hello everyone. I've been a long time reader of Quatloos, and I just now decided to start posting.

To start, I have a question about a fairly common trend I've noticed not only from tax protestors/deniers, but from 9/11 truthers, sovereign citizens, gold bugs, and other assorted conspiracy theorists and fringe types.

What is it with many tax protestors and their obsession with the Federal Reserve?

I started noticing this as early as 2007, when I first learned about the concept of "tax protestors."

At that time, there was a whole bunch of tax protestor stuff being posted on various forums and on Digg (a then popular social news website) vaguely coinciding with the release of Aaron Russo's "America: Freedom to Fascism" as well as the 2008 presidential campaign of Ron Paul (a gold standard proponent who is certainly no fan of the Fed).

The posters would start threads with sensational claims like "There is no law requiring you to pay income tax!" or "Show the law to Ed and Elaine Brown and get a $1,000,000 reward!"
It was really odd that anyone would claim there was no income tax law, as I had certainly read about the Sixteenth Amendment. Some searching got me to the income tax law, namely 26 USC sections 1, 61, 63, 6012, and 6151. Aaron Russo and the Browns didn't search very hard, it would seem. Further searching brought me to Quatloos, Dan Evans' FAQ, and Jon Siegel's page (http://docs.law.gwu.edu/facweb/jsiegel/ ... omeTax.htm).

It also seemed to me that, if there were any semblance of reality to such a claim of being no income tax due to an oversight or something, Congress could easily pass something fixing that (perhaps they could call it the "Yes, Virginia, There Is An Income Tax" Act).

Inevitably, someone on these threads would respond to the person who gave the TP claims, "Well then don't drive on highways, eat inspected food, or use anything else that the tax funds." It was at this point that the original poster would respond with "That's funded with other taxes! The Grace Commission Report says that the income tax just pays interest to the Federal Reserve!" From that point it would devolve into a bunch of conspiracy-mongering about the Fed and fractional reserve banking and other such nonsense ("It's no more federal than Federal Express" was one of their favorite quotes to post).

I had no idea why they would bring up this stuff about the Federal Reserve, or what the income tax had to do with monetary policy. First, the Grace report doesn't say what they think it says. Even if the claim about the income tax paying only interest were true (which it's not), it would be irrelevant to the question of whether or not you have to pay the income tax. Still, I have noticed this obsession with the Federal Reserve come up time and time again with all sorts of tax protestors, as well as with other assorted fringe characters.

Why is this the case? Is it just a matter of people looking for a scapegoat for economic hardship or other problems in their life, or is there something else to explain this weird fixation?

[Famspear]

Welcome to Quatloos!

Before others weigh in on this phenomenon -- the connection between tax protesters and opposition to the Federal Reserve System -- I'll note that some of the earliest tax protester cases did indeed involve people who were also wacked out about the Federal Reserve System or banking generally.

As noted in Wikipedia, an early case was Lamb v. Commissioner. In that case, one of the taxpayer's arguments was that his income was not taxable because Federal Reserve notes were bogus and counterfeit under the Constitution. A losing argument, of course. See Lamb v. Commissioner, 32 T.C.M. (CCH) 305, T.C. Memo. 1973-71 (1973).

Another case from Wikipedia:

Also in 1973, a disbarred attorney named Jerome Daly lost an appeal on his conviction for willfully failing to file federal income tax returns. In rejecting Daly's appeal, the United States Court of Appeals for the Eighth Circuit noted that one of Daly's contentions involved his "seemingly incessant attack against the Federal Reserve System and monetary system of the United States. His apparent thesis is that the only 'Legal Tender Dollars' are those that contain a mixture of gold and silver and that only those dollars may be constitutionally taxed. This contention is clearly frivolous." United States v. Daly, 481 F.2d 28, 73-2 U.S. Tax Cas. (CCH) paragr. 9574 (8th Cir.) (per curiam), cert. denied, 414 U.S. 1064, 94 S. Ct. 571 (1973).

http://en.wikipedia.org/wiki/Tax_protes ... ted_States

[Famspear]

The infamous Arthur Porth was also one who mixed tax protester arguments with complaints about the Federal Reserve System.

United States v. Porth, 426 F.2d 519 (10th Cir. 1970), at:

http://scholar.google.com/scholar_case? ... 83&scilh=0

and

Porth v. Templar, 453 F.2d 330 (10th Cir. 1971), at:

http://scholar.google.com/scholar_case? ... 35&scilh=0

The infamous Jerome Daly (see earlier post) was Porth's attorney in the first case. Daly was also involved in this one:

Hartman v. Commissioner, 65 T.C. 542 (1975), at:

http://scholar.google.com/scholar_case? ... 85&scilh=0

In some of the early cases, the reference in the court's opinion is pretty much to the effect that the wackadooster (oops, I mean the "patriot" taxpayer) is arguing that Federal Reserve notes are not money, or not income, blah, blah, etc., etc. Example:

United States v. Schmitz, 542 F.2d 782 (9th Cir. 1976) (per curiam), at:

http://scholar.google.com/scholar_case? ... 48&scilh=0

EDIT: To similar effect: United States v. Oaks, 527 F.2d 937 (9th Cir. 1975) (per curiam), at:

http://scholar.google.com/scholar_case? ... 88&scilh=0

[fortinbras]

from my compilation (revision in progress):

That Federal Reserve Notes (“FRNs”) are not money: In the Act to assure uniform value to the coins and currencies of the United States, usually identified by the cranks as “HJR 192", 73rd Congress, 1st session, chap. 48, 48 Stat 113, sec. 2, Congress expressly said: “All coins and currencies of the United States, including Federal Reserve Notes and circulating notes of Federal Reserve banks and national banking associations, heretofore or hereafter coined or issued, shall be legal tender for all debts, public and private, public charges, taxes, duties , and dues....” With very minor changes this provision is still in force as 31 USC sec 5103. However, despite their fascination and supposed intense study of HJR 192, some tax protesters and other try to pretend that FRNs are somehow not money.

Demos v. Kincheloe (ED Wash 1982) 563 F.Supp 30 (sounding as a civil rights claim); ditto (as a conspiracy claim) Koll v. Wayzata State Bank (8th Cir 1968) 397 F2d 124, 12 Fed.R.Serv.2d 37; similarly Zeissig v. US (1976) 211 Ct Claims 313; Ginter v. Southern (8th Cir 1979) 611 F2d 1226 cert.denied 446 US 967; Southard v. CIR (WD Okl 4/19/78) 42 AFTR2d 5502, 78 USTC 9507; (“It is well established that the aggregate powers granted to Congress by the Constitution include broad and comprehensive authority over revenue, finance, and currency. ... The Supreme Court has upheld congressional power to declare FRNs to be legal tender in satisfaction of debts.”) Richardson v. State of Utah, the Fourth Circuit Court, et al. (10th Cir 9/16/94) 36 F3d 1105(t); DeLaRosa v. Agents for International Monetary Fund (ED Cal 10/12/95) 76 AFTR2d 7134; US v. Greenstreet (ND Tex 1996) 912 F.Supp 224, 30 UCC Rptg Serv.2d 687; Juneau County v. Baritsky (Wisc.App 8/25/94) rev. denied (Wisc.Supm 12/14/94) 527 NW2d 335(t); DeJulis v. Alexander (D Wyo 1975) 393 F.Supp 823; Hartman v. Switzer (WD Penn 1974) 376 F.Supp 486; Bernhardt v. US [& CIR] (D Neb 7/23/76) 76 USTC 9618, 38 AFTR2d 5674; Nixon v. Phillipoff (ND IL 1985) 615 F.Supp 890 aff’d 787 F2d 596(t) (court referred to the Legal Tender Cases (1884) 110 US 421 which held that Art. I sec.8, cl.5 of the US Constitution gave Congress the authority “to coin money and regulate the value thereof” and this gave Congress exclusive authority to determine that Federal Reserve Notes are legal tender everywhere); ditto US v. Rifen (1978) 577 F2d 1111; ditto City of Colton v. Corbly (SDak 1982) 323 NW2d 138; ditto Spurgeon v. Franchise Tax Bd of California (1984) 160 Cal.App.3d 524, 206 Cal.Rptr 636; ditto Richardson v. Sullivan (10th Cir 6/18/93) 996 F2d 331(t) cert.den 510 US 1138; ditto Milam v. US (9th Cir 1974) 524 F2d 629; ditto (Congressional determination of FRNs as legal tender is conclusive on state and county govts and will not be challenged by the courts) Allen v. Craig (1977) 1 Kan.App.2d 301, 564 P2d 552; ditto State v. Dennis (Wis.App 12/13/83) 117 Wis.2d 782(t), 343 NW2d 830(t); ditto In re F.R. Dauberger (Calif. State Board of Equalization 3/31/82); ditto Vella v. McCammon (SD Texas 7/29/86) 59 AFTR2d 1064, 87 USTC 9467 (“these claims [that FRNs are not legal tender] are totally frivolous and without merit, and they have been summarily rejected by the courts.”); quoted in J.M. Ebert v. State (Tex.App 7/27/07); ditto (“The contention of illegality of paper money has been rejected by every federal and state appellate court that has considered it in the last 50 years.”) Walton v. Keim (Colo.App 1984) 694 P2d 1287; ditto Maxwell v. IRS (MD Tenn 6/24/09) 104 AFTR2d 5064 (“This is nonsense.”); ditto Rush v. Casco Bank & Trust Co. (Maine 1975) 348 A2d 237; ditto US v. K. Darcy (WD Wis 12/23/08).

The argument that FRNs are not income or taxable is so thoroughly discredited that the court would not allow defendant to present supposed “monetary realist” to testify to that effect. US v. Tissi (8th Cir 1979) 601 F2d 372; ditto (use of Congressionally designated legal tender by the state govt in its transactions is not a state action contrary to the Constitution) Epperly v. State (Alaska 1982) 648 P2d 609; ditto Wikle v. City of Rapid City (SDak 1984) 347 NW2d 584; ditto Opinion of the Louisiana Atty-Gen, nr. 84-370 (1984); ditto 1984 Op. of the Ariz Atty-Gen 72 (1984, nr. I84-79, R84-83); ditto Opinion of the Texas Atty-Gen, nr GA-469 (2006); ditto D.K. Ferguson v. State Bd of Tax Comm’rs (Indiana Tax Ct 11/10/98); ditto (“Congress has exercised this power by ... the definition of FRNs as legal tender, 31 USC sec. 5103. ... There can therefore be no challenge to the legality of federal reserve notes. And we take judicial notice of the fact that FRNs are valued in dollars.”) US v. L.G. Anderson (10th Cir 1978) 584 F2d 369; ditto Gajewski v. CIR 1976) 67 Tax Ct 181 aff’d (8th Cir 1978) 578 F2d 1383; ditto Rush v. Casco Bank & Trust Co. (Maine 1975) 348 A2d 237; ditto Stephens v. State (1977) 239 Ga 446, 238 SE2d 29; ditto Rothacker v. Rockwall County Central Appraisal District (Tex.App 1985) 703 SW2d 235; ditto Maxwell v. IRS (MD Tenn 6/24/09) 104 AFTR2d 5064; ditto (perp questioned whether FRNs are “lawful money) Noah v. CIR (10th Cir 7/16/98) 153 F3d 727(t), 82 AFTR2d 5291, 98 USTC 50567; ditto (“His assertion is frivolous in the face of countless federal and state decisions holding that FRNs are legal tender and lawful money of the United States.”) State ex rel Goodwin v. Valentine (Ida.App 1985) 107 Ida 1033, 695 P2d 418; ditto Travis v. Gable (D.Ore 8/28/07); ditto Poe v. CIR, TC Memo 1983-12 (“It is well established that Federal Reserve Notes are lawful money even though not backed by gold or silver.”); ditto US v. Weninger (10th Cir ) 624 F2d 163 cert.den 449 US 1012; ditto (“It would appear impossible for a taxpayer to reasonably believe that Federal Reserve Notes are worthless and therefore that income received in that form does not have to be reported.”) US v. D.N. Moore (7th Cir. 1980) 627 F2d 830 at 833, 60 ALR-Fed 148 cert.den 450 US 916; ditto (Perp tried to evade liability for employer’s contribution to employees’ industrial insurance by re-calculating the employees’ salaries into “statutory dollars”, based on current London gold prices; “Arguments substantially similar ... have been uniformly rejected in both federal and state courts in recent years. Some courts describe the argument as specious and others as frivolous. [citing cases] .... It remains only for us to state that the US Congress is the only entity empowered to declare what shall be deemed legal tender. Congress has so declared. 31 USC sec 5103 provides that FRNs shall be legal tender for all debts and taxes. This unique and broad power of Congress to declare what shall be money and to regulate its value for all purposes has been constitutionally recognized.”) Trohimovich v. Director of Wash. Dept of Labor & Industries (1978) 21 Wash.App 243, 584 P2d 467 rev. denied (Wash.Supm. 1979) 91 Wash.2d 1013.

“It would appear impossible for a taxpayer to reasonably believe that Federal Reserve Notes are worthless and therefore that income received in that form does not have to be reported.” US v. D.N. Moore (7th Cir. 1980) 627 F2d 830, 60 ALR-Fed 148 cert.den 450 US 916; similarly US v. Snow (7th Cir. 1982) 670 F2d 749; similarly US v. Burton (ED Tex 1984) 575 F.Supp 320 remanded on other grounds 737 F2d 439.

FRNs are legal tender, FRNs are the measure of value in our monetary system and are taxed at face value. Birkenstock v. CIR (7th Cir 1981) 646 F2d 1185; ditto Harrell v. CIR, TC Memo 1998-207 aff’d (7th Cir 8/19/99) 191 F3d 456(t), 84 AFTR2d 5752, 99 USTC 50810 (The Tax Court said “Petitioner’s most clearly stated explanation is that he was paid in FRNs, which are not lawful money and which are worthless. Yet, petitioner used the supposedly worthless FRNs to pay his expenses. We do not believe petitioner really thought that the FRNs were worthless.” and the Court of Appeals added, “he incants the standard tax protester mantra that ... the receipt of Federal Reserve Notes is not a taxable event. ... Harrell’s protestations that FRNs are exempt from taxation merits no discussion, other than to note that it, along with his ‘constitutional’ argument, warrants the imposition of sanctions” for frivolous pleadings [$2000 fine].); ditto US v. K. Darcy (WD Wis 12/23/08) (“The argument is one that has been made over and over again in federal and state courts without success. Its flaws are obvious and numerous. Presumably the defendant used her ‘worthless securities’ [i.e., FRNs] to pay tuition, to buy textbooks and cover her living expenses. ... She never address that point or explains why, if FRNs are truly worthless, she would have any objection to turning over $48,489 in such notes to the govt, which is all that the govt is requesting.”); ditto State ex rel Goodwin v. Valentine (Ida.App 1985) 107 Ida 1033, 695 P2d 418; ditto US v. R.F. Kennedy (D No.Dak 11/3/05) 233 FRD 530, 97 AFTR2d 311; ditto (argument that FRNs “cannot be lawful money” has already “been addressed and rejected by numerous courts.”) L.Boyce [Fisher] v. County of Williamson (Tex.App 1/17/02); ditto Noah v. CIR (10th Cir 7/16/98) 153 F3d 727(t), 82 AFTR2d 5291, 98 USTC 50567; ditto US v. K. Darcy (W.D.Wis 12/23/08); ditto Poe v. CIR, TC Memo 1983-12 (“It is well established that Federal Reserve Notes are lawful money even though not backed by gold or silver.”); ditto (tax dodger argued that since “98% of FRNs are bogus” he did not have to report or pay taxes on them) US v. Davenport (7th Cir 1987) 824 F2d 1511; “There can therefore be no challenge to the legality of FRNs. And we take judicial notice of the fact that FRNs are valued in dollars.” In re W.J. Walton (Bankr., ND Ohio 1987) 77 B.R 617; “The argument that the only ‘lawful money’ of the United States consists of gold or silver coins and not Federal Reserve Notes has been rejected by the federal courts.” Love v. Baldwin United Mortgage Co. (1983) 168 Ga.App 361, 308 SE2d 857; for example, minor (non-precious) coins such as nickels have been recognized as lawful money. Black v. State (1904) 46 Tex.Crim 107, 79 SW 311; ditto Barddell v. State (1906) 144 Alab. 54, 39 So. 974; in an old case not only FRNs but national bank notes (at a time when neither was identified in statutes as legal tender) were categorized as lawful money, nor, having identified the denominations of the paper currency, was any further evidence required to establish its value. State v. Elliott (1921) 110 Kan 40, 202 Pac 847. “A majority of the courts, when asked to determine whether Federal Reserve Notes constitute legal tender for the payment of debts and taxes, have concluded that Federal Reserve Notes are legal tender and lawful money of the United States. ... Consistent with the majority of the courts presented with this question, and in view of the tacit approval evidenced by the United States Supreme Court by refusing certiorari of those rulings when review has been requested, we hold that Federal Reserve Notes are lawful money.” Herald v. State (1984) 107 Ida 640, 691 P2d 1255 at 1257 (citing numerous cases).

[Gregg]

Hi! Welcome to Quatloos!

Long ago I worked for one of the Federal Reserve Banks, and when the lawyers and practicing accountants start talking about this stuff I'm at best an educated layman but when the Fed comes up I like to consider myself something of an expert.

The Daly case argues pretty much the anti-lawful money argument, they tried only real money was taxable, now they say real money is not taxable, and their money is real, non taxable money because they said a secret incantation over it when they stamped it with red ink.... not much to do with the Fed but someone brought it up.

Why Tax Protesters despise the Fed is understandable though. It's a complicated setup of a very complicated system of an insanely complicated process. As such, it lends itself to being misunderstood even by those with the best intent, but when those who are a little conspiracy theory bent start writing about it on the internet among other like minded people it reaches a critical mass of stupid quickly. Toss in the ones who are spinning conspiracy for a profit who deliberately distort it (and any politician however mainstream who climbs the ramparts to start screaming "audit the Fed" I count among these) and add a little bit of the internet, and you get....well, Ron Paul.

But just to give a few debunks out of thousands which space and time prohibits, here are a few things I'll say about the Fed that are actually true, you can look it up!

The "Fed" most people refer to is actually "The Federal Reserve Board of Governors" a government agency whose members are appointed by the President, approved by the Senate and whose budget is fully funded by the private Federal Reserve Banks, The Federal Open Market Committee and the 12 Federal Reserve Banks.

The Federal Reserve Banks are private corporations. They are not owned by secret rich foreigners, the Queen, or the Rothschild family. They are in fact owned by the member banks in their region who buy special stock that gives them theoretical equity but the traditional rights of a shareholder are different and more limited than other private corporations. The stock does pay a dividend every year of 6% of the invested equity and that is the only profit of the Federal Reserve System going to anyone but the Treasury of the United States.

The FOMC controls (in theory) the size of the Money Supply by either buying US Government bonds on the Open Market (paying cash and increasing the Money Supply) or selling those securities (receiving cash and retiring it, reducing the Money Supply) The FOMC is not allowed to buy new issue securities directly from the Treasury which would be directly affecting the debt of the United States, they can only buy these securities on the open market which means that they are just transferring current debt from public to semi-public debt, held by the Fed which pays the dividends ultimately back the Treasury and in a minor side benefit actually reduces the deficit, if just a little bit. The important part about buying on the open market is that it affects the money supply by either putting out cash or retiring it, and it does not create any new government debt. If they hadn't bought it the interest would have been paid to a private holder.
In general the FOMC is restricted by law to buying ONLY Government Securities, but in fact, as demonstrated in 2007-2008 if the Board of Governors wants to do something, they can find a way to legally do it. I almost believe Ben Bernacke has the power suspend the law of gravity.
This, like most of this post is a HUGE GENERALIZATION of the larger concept. If you want to go deeper into FOMC operations, theory and such, get a Masters in Finance and/or Economics and come see me, it's complicated even for me to discuss and while I'll talk to anyone who is genuinely curious I've talked to enough who are just looking for an answer they like that I've tired of it and avoid that when I can.

The whole shebang makes a profit, every year. They pay first the Member banks their 6%, pay the entire system's bills and what's left is paid to, wait for it....The Treasury of the United States. The only way the Queen gets a cut is if she has some Savings Bonds she wants to sell.

The Fed was founded for among other reasons the fact that the US Economy had gotten too big for private bankers to smooth out cyclical ups and downs in activity and money supply. A triggering event on this theme was the panic of 1907 when JP Morgan and some of his friends put together a package to prevent a recession or other consequences. The public, led largely by small business owners and farmers, demanded the end to a system where a few large banks and rich bankers controlled the economy. (gee, that sounds familiar, don't it?) People demanded some system to regulate banks.

I'm gonna paste a Wiki thing here because I'm lazy....

The Board of Governors of the Federal Reserve System, the Federal Reserve banks, and the individual member banks undergo regular audits by the GAO and an outside auditor. GAO audits are limited and do not cover "most of the Fed’s monetary policy actions or decisions, including discount window lending (direct loans to financial institutions), open-market operations and any other transactions made under the direction of the Federal Open Market Committee" ...[nor may the GAO audit] "dealings with foreign governments and other central banks." [82] Various statutory changes, including the Federal Reserve Transparency Act, have been proposed to broaden the scope of the audits.

The big part is to tell Ron Paul and such to STFU, at least until we get to audit Congress. The part in red is what they are technically screaming about and if you look at it, those are policy things, not "where did the cash go" things and as such are really none of Congress's business, as a matter of law. One reason the Fed is independent of, well, everyone not a deity, is so they can make those decisions based on whether its a good idea as opposed to will it garner a few votes.
Congress was never intended to be able to threaten, coerce or influence the Fed in any way, and whether you like or understand that or not, every night when you say your prayers thank someone for that fact. Any elected official in charge of the Central Bank is about as twisted as North Korea being on the UN Commission for Human Rights.
This stuff is insanely complicated, lets leave it to people who have spent their entire adult lives studying it, not the whore who got the most votes in West Virginia and has been doing so longer than anyone else on the committee.

I'm starting to rant, and skating close to the "no politics" thin ice, so I'll quit for now and respond as the thread develops.

[wserra]

Why Tax Protesters despise the Fed is understandable though. It's a complicated setup of a very complicated system of an insanely complicated process. As such, it lends itself to being misunderstood even by those with the best intent, but when those who are a little conspiracy theory bent start writing about it on the internet among other like minded people it reaches a critical mass of stupid quickly. Toss in the ones who are spinning conspiracy for a profit who deliberately distort it (and any politician however mainstream who climbs the ramparts to start screaming "audit the Fed" I count among these) and add a little bit of the internet, and you get....well, Ron Paul.

IMHO that's very well said, and explains the phenomenon about as well as it's possible to explain the irrational.

[LPC]

The Board of Governors of the Federal Reserve System, the Federal Reserve banks, and the individual member banks undergo regular audits by the GAO and an outside auditor. GAO audits are limited and do not cover "most of the Fed’s monetary policy actions or decisions, including discount window lending (direct loans to financial institutions), open-market operations and any other transactions made under the direction of the Federal Open Market Committee" ...[nor may the GAO audit] "dealings with foreign governments and other central banks."

The big part is to tell Ron Paul and such to STFU, at least until we get to audit Congress. The part in red is what they are technically screaming about and if you look at it, those are policy things, not "where did the cash go" things and as such are really none of Congress's business, as a matter of law.

I'm not an accountant, but the things in red are also things that I don't think would be covered by what I consider to be an "audit" in the usual sense of the word.

My understanding of an audit is that it really only covers two things:

1. Do the financial statements of the organization accurately portray the changes in financial position of the organization? This means things like whether the assets are really there and whether the liabilities are really owed, and whether the income and expense statements are accurate.

2. Are there proper financial controls in place? This means things like reducing opportunities for theft and mistake, but also means things like making sure that financial and operational decisions are being made by the right people, and in accordance with law.

The things in red are policy matters and not financial reporting matters. For an audit of the Federal Reserve Board to question how (or why) monetary policy is made would be like an audit of GM raising questions about why GM is still making so many SUVs, and why they haven't made cars more fuel efficient. Those might or might not be valid questions, but they're not part of the audit function.

[JamesVincent]

One of the things that struck me with all the "audit the Fed" screaming I've heard over the years is this: a. would you understand what the audit tells you? b. would you see what the audit finds? and c. what makes you think it will change your point of view. All the people calling for it would be out of the loop if and when it does happen and would, more then likely, not understand what it says and it wouldnt change their mind anyway. One of the biggest problems we have nowadays is that even if we did have the most corrupt government since Nero the people calling for change have no real clue how government should work and so are fixated on things that either don't matter and have no real clue on what should change. Like Gregg said it takes an economist whos been trained or schooled in the Federal Reserve system to understand how the interactions work, how many of them are in the audit crowd?

[wserra]

BTW, Edgar, as others have said, welcome to Quatloos. You don't work for the SEC, do you? Because if you did, your name would be in all caps, and you would thus be a legal fiction.

[Pottapaug1938]

I don't think that the TPers and the anti-Fed crowd care whether or not they COULD understand an audit even if one were presented to them. What they want is a justification for taking up the valuable time of Congress with endless hearings about the evil machinations of the Fed, and a source of quotes to be misunderstood and mined for their blogs, newsletters and forums about what an unalloyed evil the Fed is.

[notorial dissent]

I'll throw my 2 1/2 cents worth in.

In my experience, it mostly comes down to the ones yelling the loudest are the ones who haven't mastered their own bank accounts, and never will, and yet are yelling about wanting an audit/explanation of something that is so many magnitudes of complicated above that as to not be comparable. That and they have to have something to blame for their problems, and the Fed is easier to blame than their own staggering ignorance.

[Famspear]

My understanding of an audit is that it really only covers two things:

1. Do the financial statements of the organization accurately portray the changes in financial position of the organization? This means things like whether the assets are really there and whether the liabilities are really owed, and whether the income and expense statements are accurate.

2. Are there proper financial controls in place? This means things like reducing opportunities for theft and mistake, but also means things like making sure that financial and operational decisions are being made by the right people, and in accordance with law.

The things in red are policy matters and not financial reporting matters. For an audit of the Federal Reserve Board to question how (or why) monetary policy is made would be like an audit of GM raising questions about why GM is still making so many SUVs, and why they haven't made cars more fuel efficient. Those might or might not be valid questions, but they're not part of the audit function.

Hey, for a statement from (ahem... clearing my throat) a non-accountant, that's a pretty good description.



In the United States, an audit by a certified public accountant in conformity with "Generally Accepted Auditing Standards" promulgated by the Auditing Standards Board of the American Institute of Certified Public Accountants involves the gathering of evidence about five classifications of assertions embodied in financial statements. Those classifications are:

1. Existence or occurrence. Do the assets and liabilities show on the balance sheet as of the close of business on a given date actually exist at that date? Did the transactions reflected in the statement of operations (income statement), etc., during a given period of time actually occur during that period?

2. Completeness. Are all the transactions and accounts that should be presented in the financial statements actually included therein?

3. Rights and obligations. Do the assets shown in the financial statements actually represent rights of the entity for which the financial statement is prepared as of the applicable date? Do the liabilities shown in those statements actually reflect obligations of that entity as of that date?

4. Valuation or allocation. Have the assets, liabilities, revenues and expenses been included in the financial statements at appropriate amounts? ("What is the appropriate amount" is a subject, the explanation of which could fill volumes.)

5. Presentation and disclosure. Are the components of the financial statements properly classifed? Properly described? Properly disclosed? Is there enough information in the statements for a reasonably knowledgeable investor to make rational economic decisions about the entity?

In the U.S., the term "generally accepted auditing standards" (GAAS) should not be confused with "generally accepted accounting principles" (GAAP). GAAS consists of the standards that CPAs follow in performing an audit. GAAP consists of the "financial accounting" standards -- standards for the financial statements themselves. I understand that we're moving in the direction of international financial accounting standards, but I don't follow this kind of thing, much any more, as I don't perform audits or even prepare unaudited financial statements. Taxation is a lot more fun.

The term "audit" itself of course means different things in different contexts. For example, an "audit" by a CPA firm of the annual financial statements of ExxonMobil is not the same as an IRS "audit" (examination) of a taxpayer's tax returns. Many times people split hairs on terminology; this thing here is an "audit", but that thing over there is an "examination".

EDIT: Regarding Dan's point 2 above, on internal control: Generally, in addition to the audit report on the conformity of the financial statements to the financial accounting and reporting standards (whether they be GAAP or some other set of standards), the CPA also issues a report on internal control. In the olden days, this report was confidential - it went only to the internal people, the top management of the entity that was being audited. After Enron and Sarbanes Oxley and all that about ten years ago (which was long after I had already moved over to a tax practice), I haven't been keeping up with many of the changes in the rules on reporting on internal control. I suspect that the rules vary depending on whether the entity under audit is a publicly traded company or not.

EDIT 2: By the way, in U.S. accounting terminology, a federal or state tax return is not a "financial statement" in the sense that this term is used by CPAs.

[Burnaby49]

Re LPC's understanding of "audit". The Canadian Auditor General, the authority that audits Canadian government accounts, does as LPC stipulates, pure financial audits. However the Auditor General also confirms that the government departments keep within their mandates as stipulated by parliament and does overall program reviews to ensure government programs are being carried out as authorized. I assume your GAO does the same.

[Quixote]

In the tax denier/sovereign citizen universe, there are no coincidences, just conspiracies. The sixteenth amendment was ratified in 1913 and the Federal Reserve was created in 1913. Tax deniers don't understand either of them, so they must have a sinister connection.

[Gregg]

I'll throw my 2 1/2 cents worth in.

In my experience, it mostly comes down to the ones yelling the loudest are the ones who haven't mastered their own bank accounts, and never will, and yet are yelling about wanting an audit/explanation of something that is so many magnitudes of complicated above that as to not be comparable. That and they have to have something to blame for their problems, and the Fed is easier to blame than their own staggering ignorance.

On that point, I'll agree. One thing that I often see the ignorant screaming about is "The Fed loaned XXX bank YYY TRILLION !!!" which, might be technically true but shows a misunderstanding of how the discount window works and a way that it was never intended to work but does.

Banks have to balance out the books every day. Banks have a hard solid number they calculate every day of their capital, reserves, and loans outstanding, among others. On any given day a bank should have some 'extra' capital reserves just as a safety net. And at one time not so long ago, the arithmetic involved was done by hand with big old desktop calculators. You wanted to have a big cushion in case the number changed more than you thought it was going to.
Now, a problem with this is, if you have $50 billion in unused reserves at the end of the day, in theory you have lost the income on that excess liquidity had it been loaned out at interest. Banks did what they could to get close to that figure, but the amount of unused capital added up to quite a bit.
Sometimes, for many reasons, a bank would end the day with too little capital... very bad. But, to fix it you could go the the Fed's discount window and borrow what you needed overnight. Once upon a time doing so was considered a little bit extreme, not a little embarrassing and a sign that someone wasn't keeping up with the business. In my lifetime it would not be unusual for the Controller or even President of a regional sized bank to lose his job for having to go to the discount window a few times.
Important point, ALL Discount Window loans are overnight. If you needed it again the next day, it was a different loan. Technically, if you needed to borrow $1 million for 3 days, you borrowed $3 million. See where I'm going with this?
So, are banks now so bad that they have to borrow all the time? Absolutely not. A bunch of quants at some of the bigger banks (BofA was the first to make a habit of it) figured out that the Discount Window was cheaper than their nominal cost of capital, and as such, from a strictly numbers point of view, it made more sense to figure out how close to your reserves you are every day, and then figure out how much you were able to borrow from the Fed @ the Discount Rate, and how much you could make if you could find someone to borrow it from YOU at a higher rate. The only penalty for going to the Discount Window was the stigma of having done so, and show a bunch of bankers how much money they're leaving on the table and they tend to lose their modesty at some amount.
Before long, and fast computers and technology played a big part, banks were figuring out how much the Fed would lend them every day, and taking pretty much all of what was available, using the funds to buy overnight commercial paper and stuff like it. So now, the banks were deliberately taking out the maximum amount every night. It's now not shameful to go to the Discount Window and failure to do so is a sign that you might be a little slow, or having trouble finding places to borrow from you. All this excess liquidity increased the money supply AND increased the velocity of the money supply, both steps that increased economic activity and were more or less good for the overall good. It also ruined a whole lot of models used to gauge money supply movement, btw.

But the point is, all of the big banks borrow a, compared to their net worth, small amount every single day. In the greater scheme of things it's not a significant amount of money. But when a bank borrows a billion a day for 30 days, well, on the books it shows up as the bank borrowed $30 billion dollars, and if you don't know the mechanics involved, well, it looks like a staggering amount. What bothers me about it is the first time I saw a sensationalist headline about it, the person quoted in the story demanding some action was a member of the Senate Banking Committee, who if he didn't know any better is scary in itself and if he did was lying through his teeth to get the crazies to come out.

In the end, it's about the same as someone making $50,000 a year having a credit card with a $1,000 balance over a year, and someone yelling that a guy earning $50,000 borrowed a third of a million dollars last year.....

[Gregg]

In the tax denier/sovereign citizen universe, there are no coincidences, just conspiracies. The sixteenth amendment was ratified in 1913 and the Federal Reserve was created in 1913. Tax deniers don't understand either of them, so they must have a sinister connection.

And believe it or not, both were part of a larger conspiracy, and the 19th Amendment was part of it, too. The conspiracy was Prohibition. The income tax was needed to replace the tax on spirits, women's suffrage was seen as a way to get more dry voters eligible and the Federal Reserve Bill was important in getting farmers to support it.

[JamesVincent]

So, in the interest of brevity, if a bank was a little less then flush, after making a high amount of loans, they could borrow against the Federal Reserve for a cheaper rate and bring themselves back up. And now, because someone figured out they could, they go ahead and borrow anyway to be able to push higher loan amounts or push higher paying investments. Close?

[Gregg]

So, in the interest of brevity, if a bank was a little less then flush, after making a high amount of loans, they could borrow against the Federal Reserve for a cheaper rate and bring themselves back up. And now, because someone figured out they could, they go ahead and borrow anyway to be able to push higher loan amounts or push higher paying investments. Close?

Dead on!

[notorial dissent]

Gregg, thank you. That was probably the clearest and most concise explanation of what the discount window is all about I've seen since the bad old days when i got schooled on it when I was working at the bank, and in those days, it was the option of last resort.

Second point, about the way borrowing is figured, is the other thing that is misconstrued and misunderstood, mostly intentionally.

[Gregg]

You're more than welcome.

I have to say, I think it's a dangerous practice. Someday a BIG bank is going to make a mistake that is going to result in them having to exceed their limit. When that happens, the Fed will bail them out to tide them over, but it could lead to a series of events that might, well, who knows what it will be but I doubt it will be good. The Fed back in the day was called "The lender of last resort" for a reason. What the banks are doing now is kind of like a person who gets a credit card "just in case" and before long is maxed out on it. And that's when "just in case" tends to happen.

Just my opinion.