Subject: Should we fire the Fed?

Baltimore – (TFN): All eyes and ears are on the Fed this week. With Bernanke in New York discussing potential new bubbles and the New York Fed getting heat for overpaying AIG’s many creditors, investors are having a tough time knowing exactly who to follow.

For those of you who hold up the “Fire the Fed” signs, move over. I am thinking about joining your camp.

First, the real bad stuff. According to Neil Barofsky, TARP’s special inspector general, New York’s Fed (under the leadership of Tim Geithner) failed to use its leverage as the top-banking regulator to tell AIG’s lenders to take less than they were owed.

Instead of taking an across-the-board “haircut” as Obama and Pelosi told us we all should, finance giants like Goldman Sachs, Merrill Lynch and Societe Generale said they want 100% of what they were owed.

The only holdout, UBS, said it would be willing to take 98%. But after tough looks from the guys from across the table, that offer was quickly rescinded.

According to Barofsky, the move cost the country billions of dollars and much, much more in confidence for the nation’s banking cops.

Thanks, Tim!

With that bit of news in today’s headlines, it is tough to find the confidence in some of the Fed’s latest plans to help pull the country from financial failure.

As the nation slowly recovers from last fall’s economic collapse, Bernanke and his troops at the Fed are now facing the difficult task of unwinding massive expansionary policies.

One trick discussed today is shortening the length of emergency loans from 90 days to just 24 days starting in January. It’s a pretty mundane move that will have little tangible effect on the markets.

But what could have a much larger impact, with much less transparency, is Bernanke’s recent discussion of paying interest on the reserves banks place with the Fed.

A popular move with many overseas central banks, the interest rates paid on reserves helps to establish a rate floor that regulators can gradually increase without raising overall interest rates.

Essentially, the move is a way of mopping up excessive liquidity without draining or lowering the water in a much larger pool of lending capital.

Like many things, the idea sounds great on paper, but so did letting the Fed negotiate with AIG’s trading partners and we now know how much that cost us.

Let’s face it. The markets like transparency and predictability. Anything less gives us what Friedrich Hayek called “malinvestment.”

As the Fed gets more and more creative in its efforts to boost the economy without creating deadly bubbles, transparency will go out the window.

Toss in growing political pressure from the folks from Washington and one thing is certain.

Anything the Fed does will cost you and I more money.