Paul Krugman and others point out that Geithner has been trying to artificially prop up asset prices, but that such a strategy cannot succeed. The stress tests were a total sham, with a pre-ordained passing grade for the banks. The government has allowed the giant banks to hide their liabilities and maintain dizzying amounts of leverage by using clever accounting gimmicks.

The Bank for International Settlements (BIS) slammed “the use of gimmicks and palliatives”, and said that anything other than letting asset prices fall to their true market value, increasing savings rates, and forcing companies to write off bad debts “will only make things worse”.

This is what Marc Faber and many other economists have said for years. But Bernanke and the other central bankers ignored BIS’ advice in 2007 and 2008, and they are still ignoring it today.

Instead, we are doing everything possible to prop up asset prices by trying to stimulate a new bubble by handing out trillions to the banks and allowing giant toxic debts to remain hidden on their books.

Fraudulent Accounting At Lehman

Recent court documents released online have detailed fraudulent accounting practices in the days prior to the collapse of Lehman Brothers. The documents also implicate the US Federal Reserve bank for possibly knowingly allowing these practices to go on.

Geithner and Bernanke have been busted for allowing Lehman to cook its books to try and hide its problems.

The New York Times notes:

The examiner, Anton R. Valukas, for the first time, laid out what the report characterized as “materially misleading” accounting gimmicks that Lehman used to mask the perilous state of its finances.

Lehman executives engaged in “actionable balance sheet manipulation” A large portion of the examiner’s report centers on the accounting maneuvers, known inside Lehman as “Repo 105.”

First used in 2001, long before the crisis struck, Repo 105 involved transactions that secretly moved billions of dollars off Lehman’s books at a time when the bank was under heavy scrutiny.

Huffington Post explains:

Senior officials failed to disclose key practices, opening them up to legal claims. The report concludes that the firm’s auditor, Ernst & Young, failed to meet “professional standards.”

The examiner also found that parties have claims to pursue against JPMorgan Chase and Citibank in connection with their behavior regarding the modification of agreements with Lehman and their increasing collateral demands in Lehman’s final days. These demands had a “direct impact” on Lehman’s diminishing liquidity — its cash on hand — which was a prime reason behind the firm’s demise.

There are colorable claims against Lehman’s external auditor Ernst & Young for, among other things, its failure to question and challenge improper or inadequate disclosures in those financial statements.

The examiner also notes that the issue giving rise to these potential claims was Lehman’s creative use of repurchase agreements, otherwise known as repo. These are agreements between financial firms that essentially act as loans for cash — one firm pledges collateral to another in exchange for cash with a promise that they’ll buy back that collateral.

The examiner said the sole function of Lehman’s use of repo was “balance sheet manipulation,” according to the report:

Although Repo 105 transactions may not have been inherently improper, there is a colorable claim that their sole function as employed by Lehman was balance sheet manipulation. Lehman’s own accounting personnel described Repo 105 transactions as an “accounting gimmick” and a “lazy way of managing the balance sheet as opposed to legitimately meeting balance sheet targets at quarter end.”

The reason for that, the report notes, was to lower Lehman’s leverage — a critical component of the firm’s credit rating.

In 2007-2008, Lehman knew that net leverage numbers were critical to the rating agencies and to counterparty confidence. Its ability to deleverage by selling assets was severely limited by the illiquidity and depressed prices of the assets it had accumulated.

Against this backdrop, Lehman turned to Repo 105 transactions to temporarily remove $50 billion of bad assets from its balance sheet at first and second quarter ends in 2008 so that it could report significantly lower net leverage numbers than in reality.

Lehman did so despite its understanding that none of its peers used similar accounting at that time to arrive at their leverage numbers, to which Lehman would be compared.

Lehman’s failure to disclose the use of an accounting device to significantly and temporarily lower leverage, at the same time that it affirmatively represented those “low” leverage numbers to investors as positive news, created a misleading portrayal of Lehman’s true financial health.

Colorable claims exist against the senior officers who were responsible for balance sheet management and financial disclosure, who signed and certified Lehman’s financial statements and who failed to disclose Lehman’s use and extent of Repo 105 transactions to manage its balance sheet.

In May 2008, a Lehman Senior Vice President, Matthew Lee, wrote a letter to management alleging accounting improprieties; in the course of investigating the allegations, Ernst & Young was advised by Lee on June 12, 2008 that Lehman had used $50 billion of Repo 105 transactions to temporarily move assets off balance sheet at quarter end.

The next day – on June 13, 2008 ‐ Ernst & Young met with the Lehman Board Audit Committee but did not advise it about Lee’s assertions, despite an express direction from the Committee to advise on all allegations raised by Lee.

Tyler Durden of Zero Hedge slammed the NY Fed saying:

There should be an immediate investigation into how many other banks are currently taking advantage of this artificial scheme to manipulate and misrepresent their cap ratio, and just why the New York Fed can claim it had no idea of this very critical component of the Shadow Economy.

Karl Denninger the Market Tickerguy called for prosectution in a recent blog post.

“Remember, The Feral Reserve is supposed to by the “uber-regulator” and the safety and soundness manager for the entire financial system. They did a great job, right? Well…”

“When the Examiner questioned Lehman executives and other witnesses about Lehman’s financial health and reporting, a recurrent theme in their responses was that Lehman gave full and complete financial information to Government agencies, and that the Government never raised significant objections or directed that Lehman take any corrective action.”

However the Examiner said:

Although various Government agencies had information that raised serious questions about Lehman’s reported liquidity and about the sufficiency of its capital and liquidity to withstand stress scenarios, the agencies generally limited their activities to collecting data and monitoring.

Essentially, they looked but didn’t act.

Stress Tests Were A Sham

After March 2008 when the SEC and FRBNY (Federal Reserve Bank of New York) began onsite daily monitoring of Lehman, the SEC deferred to the FRBNY to devise more rigorous stress-testing scenarios to test Lehman’s ability to withstand a run or potential run on the bank.

The FRBNY developed two new stress scenarios: “Bear Stearns” and “Bear Stearns Light.” Lehman failed both tests. The FRBNY then developed a new set of assumptions for an additional round of stress tests, which Lehman also failed.

However, Lehman ran stress tests of its own, modeled on similar assumptions, and passed. It does not appear that any agency required any action of Lehman in response to the results of the stress testing.

They ran two sets of stress tests and the firm failed both. Not satisfied with the results they then designed a third set, which the firm also failed.

Instead of applying any of these three, the FRBNY under command of Mr. Timothy Geithner, now our current Treasury Secretary (who reported directly to Ben Bernanke), took Lehman’s word that all was ok and took no further action.

In the spring of 2009 we were told that all the big banks ran “Stress Tests” of Geithner’s design. But Treasury didn’t actually run them and didn’t actually get and process the data – they told the banks to do so at their own discretion.

Lehman passed its own “internally computed” stress test but failed all three of the externally-computed ones.

The stress tests were a sham. With only one outcome being permissible: that Lehman pass. So after the Fed was unable to come up with an objective-looking stress test that Lehman could satisfy, they permitted Lehman to devise a test with low enough standards to give itself a clean bill of health.

The SEC inspection revealed significant problems at Lehman. The SEC found that Lehman’s Price Valuation Group was understaffed; and it found that Lehman’s asset pricing function was overly “process driven.” But the SEC did not release its findings or formally present them to Lehman prior to Lehman’s demise.

So The SEC knew of problems and they too did nothing.

While Geithner is implicated as being “concerned” about Lehman in the paper, the most-troubling part the narrative is here:

The challenge for the Government, and for troubled firms like Lehman, was to reduce risk exposure, and the act of reducing risk by selling assets could result in “collateral damage” by demonstrating weakness and exposing “air” in the marks.

The word Air is an apparent admission that FRBNY and Tim Geithner specifically knew that the marks that these banks were taking on their assets were materially and intentionally false.

All of the banks that have failed in 2009 had 25-40% discounts to their claimed balance sheet values when the marks are actually reduced to losses to the deposit fund by the FDIC!

1. Geithner, and presumably everyone under him, knew the marks on these assets were fictions months before Lehman failed, yet they intentionally concealed this fact from the market and took no action (nor did the SEC) to disclose this intentional misdirection.

2. The misdirection and false claims in this regard are almost certainly continuing today, as evidenced by the FDIC seizures literally on an every-week basis.

Who is Responsible?

What about Ben Bernanke? He maintains that primary responsibility lay with the SEC, he said:

“Our concern was about the financial system, and we knew the implications for the greater financial system would be catastrophic, and it was.”

Geithner and Bernanke’s strategies of covering up how bad things are, trying to paper over the severity of the problems of the financial giants by artificially inflating asset prices and allowing accounting tricks are doomed to failure.

Yves Smith of Naked Capitalism points out that Geithner must be fired and that a full audit of the Fed must be conducted:

The key revelation is that Lehman as of late 2007 was routinely using Repo transactions at the end of the quarter to mask how levered it truly was:

Lehman regularly increased its use of Repo 105 transactions in the days prior to reporting periods to reduce its publicly reported net leverage and balance sheet. Lehman’s periodic reports did not disclose the cash borrowing from the Repo 105 transaction – i.e., although Lehman had in effect borrowed tens of billions of dollars in these transactions, Lehman did not disclose the known obligation to repay the debt. Lehman used the cash from the Repo 105 transaction to pay down other liabilities, thereby reducing both the total liabilities and the total assets reported on its balance sheet and lowering its leverage ratios.

Lehman was engaging in blatant misreporting, treating these “repos”, in which a bank still shows them on its balance sheet as sold but with the obligation to repurchase, as sales. Note that at the time analysts and others kept probing at the seeming miracle of Lehman’s deleveraging in a difficult market.

The Examiner questioned Lehman executives and other witnesses about Lehman’s financial health and reporting, a recurrent theme in their responses was that Lehman gave full and complete financial information to Government agencies, and that the Government never raised significant objections or directed that Lehman take any corrective action.

So even though Lehman dressed up its accounts for the great unwashed public, it did not try to fool the authorities. Its games playing was in full view to those charted with protecting investors and the financial system.

The SEC handed assessing Lehman over to the Fed, which under direction of Tim Geitner bent over backwards to give it a clean bill of health.

Lehman type accounting, in other words, is being institutionalized, with the active support from senior government officials.

Geithner must go. He is not fit to serve as Treasury secretary.

And the time is overdue for a full audit of the Fed, and in particular the New York Fed, from the start of the Bear crisis through and including all the retrades of the AIG bailout.

If Geithner is not replaced by someone who will actually try to fix things instead of just covering up for the big banks shenanigans, and if the Fed is not audited so that the air can be cleared, it will almost certainly spell doom for America. Ending up being a crisis much worse than the Great Depression.

Credits to Washington’s Blog, Zero Hedge, Market Ticker, and Naked Capitalism , and Huffington Post

Edited by MJ Harris

Video Summary

In this week’s much anticipated State of the Union address, President Obama again demonstrated his poor understanding of the fundamental problems that confront our nation. By following the advice of the same people who helped guide our economy to the precipice of total collapse, Obama now threatens to push it over the edge.

Notwithstanding his well crafted lip service regarding future spending restraint, the essence of his current program is for more government spending and larger deficits. For all his talk about job creation, his policies will further burden those who might otherwise create those jobs with higher taxes and more regulation. While he did call for tax cuts for the middle class and offered what amounts to bailouts for those struggling to repay student loans, such cuts do nothing to promote growth in the near term and will add to the deficits in the long term.

The President spoke optimistically about the future, but in reality there is little evidence to support such an upbeat outlook. He began his speech by assuring us that the worst of the storm had passed. General Custer may have said something similar when the first wave of Indian attacks ebbed at Little Big Horn.

While Obama did have some harsh words for Wall Street (not exactly a courageous political stance), he leveled no criticism at the Federal Reserve or other government agencies that had financed and guaranteed all the ridiculous real estate speculation that precipitated the crash. And while he at least conceded that the prosperity of the last decade was based on illusions, he continued to endorse the very policies that produced the mirage in the first place.

To lead us back to brighter days, he articulated a vision of a centrally planned recovery, where clean energy and a Soviet style five-year plan to double our exports would make our economy preeminent once more. He fails to understand that the only reason our economy rose to the top in the first place is that the government left it alone.

In the words of the Spanish philosopher George Santayana, “Those who cannot learn from history are doomed to repeat it.” Since our President cannot even learn from the mistakes of his immediate predecessor, to say nothing of those he made himself while in the Senate or during his first year as president, we are surely doomed to repeat them, perhaps more quickly than Santayana could have imagined.

Rather than tightening the reins on the reckless monetary policy that undermined our savings, diminished our industrial output, inflated asset bubbles, and led to reckless speculation on Wall Street and excess consumption on Main Street, we are loosing them further. Rather than repealing regulations that distort markets and create moral hazards, we are adding new ones that do more of the same. Rather than cutting government spending to reduce the burden it places on our economy, we are increasing both the amount of the spending and the size of the burden. Rather than making government smaller so that the private sector can grow, we are making government bigger and forcing the private sector to shrink. Rather than paying off our debts we are taking on even more. Rather than encouraging people to save we are enticing them to spend. Rather than creating jobs, we are merely creating unemployment benefits.

As a result, instead of seeding the soil for a real recovery we are setting the stage for a prolonged depression.

Last week, in the name of protecting the little guy from Wall Street, the House passed HR 4173 to increase the little guy’s false sense of security in the financial system. This mammoth piece of legislation would massively increase government regulation and oversight in the banking industry under the misguided reasoning that more government could have stopped faulty lending practices, when in actuality it caused them. This bill would also greatly increase the powers of the Federal Reserve, which too many in Congress still see as savior rather than perpetrator in this mess.

One silver lining is that the amendment to audit the Fed is still attached to the bill, and if it survives the Senate, the Fed will no longer operate in secrecy. If any version of HR 4173 becomes law, the Fed will be intervening and bailing out more rather than less, as it will gain enormous new powers in addition to those it already has. Whatever happens, the Fed and its defenders have seen that people are becoming very wary of its methods of operation, and many are downright angry at its very existence. Never again will the Fed be immune from the scrutiny of its critics. This is very positive.

Because of legal tender laws that force acceptance of the dollar, the Fed has absolute power over the currency. This absolute power is leading to the absolute corruption of our currency. The money supply has doubled in the last year or so, which is extremely dangerous. The banks seem to be hoarding liquidity now but once these dollars make their way into the economy, hyperinflation and economic chaos will be a real possibility.

Every time hyperinflation rips through an economy, the middle class gets completely wiped out. It is very alarming to watch the purchasing power of an entire life savings reduced to that of a few pennies. Those savings represent years of real labor, real time, effort and sacrifice exchanged for corruptible pieces of paper that politicians and bankers can destroy at whim.

Legal tender laws force the people to become subject to this risk for the benefit of the rulers. Artificial demand for currency allows the authorities to create arbitrary amounts of it to pay for wasteful projects, like frivolous wars and an ever-expanding public sector. This saps the private economy of jobs and purchasing power, yet the temptation proves too great for politicians, time and time again. Our government is no different. Although our dollar has taken nearly a century to lose 98f its purchasing power, the fact that we are all obliged to participate in this slow burn of the economy on pain of imprisonment is anathema to the principles of liberty.

I introduced the Free Competition in Currency Act last week to free the people from these governmental threats. HR 4248 would repeal legal tender laws, prohibit taxation on certain coins and bullion, and repeal certain laws related to coinage. The prospect of people turning away from the dollar towards alternate currencies should provide incentive for Congress to regain control of the dollar and halt its downward spiral. Restoring soundness to the dollar will remove the government’s ability and incentive to inflate the currency and keep us from launching unconstitutional wars that burden our economy to excess. With a sound currency, everyone is better off, not just those who control the monetary system.

www.House.gov/Paul

“A bald man with a gray beard and tired eyes is sitting in his oversize Washington office, talking about the economy. He doesn’t have a commanding presence. He isn’t a mesmerizing speaker. He has none of the look-at-me swagger or listen-to-me charisma so common among men with oversize Washington offices. His arguments aren’t partisan or ideological; they’re methodical, grounded in data and the latest academic literature. When he doesn’t know something, he doesn’t bluster or bluff. He’s professorial, which makes sense, because he spent most of his career as a professor.”

“He is not, in other words, a typical Beltway power broker. He’s shy. He doesn’t do the D.C. dinner-party circuit; he prefers to eat at home with his wife, who still makes him do the dishes and take out the trash. Then they do crosswords or read. Because Ben Bernanke is a nerd.”

Yes good ol’ Benjamin Bernanke, with the power to bring the world to it’s knees and his love of dropping bags of money out of helicopters, he’s just your everyday guy who goes home to his loving wife, eats a TV dinner and does the crosswords before lights out. He’s just like you and me.

Day after day Ben is hard at work printing money and holding down those interest rates down to zero for months on end. Despite all of that power, does he let it go to his head? No, good ol’ Ben always remembers to take care of his friends. Because where would we be today without those who are “Too Big To Fail”, and it certainly wouldn’t be Christmas without “Tiny Timothy Geithner”.

Despite the Federal Reserve’s ultimate desire to be independent from Washington Bernanke still makes the time to meet with his friend Treasury Secretary Tim Geithner every week; during the Bush Administration, when Geithner served as head of the New York Fed, he was essentially Bernanke’s Ambassador to Wall Street.

Professor Bernanke of Princeton was a leading scholar of the Great Depression. He knew how the passive Fed of the 1930s helped create the calamity — through its stubborn refusal to expand the money supply and its tragic lack of imagination and experimentation. Chairman Bernanke of Washington was determined not to be the Fed chairman who presided over Depression 2.0. So when turbulence in U.S. housing markets metastasized into the worst global financial crisis in more than 75 years, he conjured up trillions of new dollars and blasted them into the economy; engineered massive public rescues of failing private companies; ratcheted down interest rates to zero; lent to mutual funds, hedge funds, foreign banks, investment banks, manufacturers, insurers and other borrowers who had never dreamed of receiving Fed cash; jump-started stalled credit markets in everything from car loans to corporate paper; revolutionized housing finance with a breathtaking shopping spree for mortgage bonds; blew up the Fed’s balance sheet to three times its previous size; and generally transformed the staid arena of central banking into a stage for desperate improvisation. He didn’t just reshape U.S. monetary policy; he led an effort to save the world economy.

Bernanke has saved the United States from the correction and single handedly avoided the catastrophe of a bubble burst. Thanks to his emergency action the bubble has been re-inflated and the world is safe again, at least until next election year. We should all take some time over this holiday to thank his swift actions because after all inflation doesn’t create itself.

To Read More of the Bernanke Greatest Person of 2009: Time Magazine

Fear of the abyss that gripped financial markets a year ago has dissipated and many investors see improving economic data from around the world as reason to believe the economic rebound that is now under way will only blossom further.

Yet some investors caution that high U.S. unemployment and a lack of credit to drive investment and spending are major impediments to a full recovery.

Chances that growth will remain anemic are strong. As a result, the Fed is likely to keep interest rates — now close to zero — pat through much of next year, spurred by the fear of deflation, these investors say.

“We are at risk of getting into a deflationary environment for the first time since the 1930s, a serious risk. I’m very concerned about that risk,” said Aaron Gurwitz, in charge of investment strategy at Barclays Wealth, which has $221 billion in assets under management.

“Central bankers are very concerned about that risk, and for that reason we expect rates could be kept low for a very long time,” Gurwitz told the Summit. “We expect some central bank action in the fourth quarter of next year, but just a token move.”

JAPAN MISTAKES

Fed Chairman Ben Bernanke is faced with the difficult task of deciding when to scale back the enormous monetary stimulus the Fed has injected to revive the crippled U.S. economy. A move too soon could squash the economy and cause further pain, such as occurred in Japan a decade ago.

Gurwitz said the Bank of Japan tightened too quickly in 2000, choking off growth and pushing the economy back into deflation, which is when prices decline and further hobble growth. The Fed will err on keeping liquidity available, he said.

Pressure on wages and the inability of companies to increase prices are signs of deflation that suggest growth rates and inflation will remain low, said Bob Doll, who oversees about $390 billion in assets as global chief investment officer of equities at BlackRock Inc (BLK.N).

“How many industries do you know that are raising prices? How many industries do you know where there’s a constant sale going on? These are all reminders that deflation is with us, and deflation means low nominal growth,” Doll said.

The human spirit is to overcome diversity and move forward, but the number of hurdles the United States and other countries face makes chances of stumbling much higher than normal, said Max Darnell, chief investment officer at First Quadrant LP, where he oversees just under $18 billion.

The U.S. economy may be headed for a “double-dip” recession if broad access to credit remains impaired, he said.

“It’s very hard to formulate well thought-out expectations for growth,” Darnell said. “This is one of the reasons why you find so many people that are very objectively oriented, being more pessimistic.”

Darnell cited the lack of credit as a major impediment to a return to solid growth.

Bill Gross, who runs influential bond management firm Pacific Investment Management Co, told the Summit Pimco expects the United States and other parts of the developed world to experience subpar growth.

While Gross said Pimco does not expect a return to zero or negative growth, and it expects positive, albeit limited job creation for the next three to six months, there is evidence of continued deflationary pressures.

Gross cited the property scare in Dubai last month and a downgrade in the credit worthiness of Greece as examples that, if not handled properly, could be downward tipping points.

Jonathan Xiong, a senior portfolio manager at Mellon Capital Management where he helps manage $18 billion in assets, said the United States must avoid replicating Japan’s woes.

Since a property bubble burst in Japan 20 years ago the country has struggled to overcome deflationary bouts despite rounds of government stimulus spending.

“One very bad scenario is that we could end like Japan,” Xiong said, adding that too many investors foresee the return of higher inflation, which is mistaken.

“The skew and the size of returns between a deflation and an inflation environment is enormous. The downside in a deflation environment could be horrendous,” he said.

“You should let a little bit of inflation pick up before you take the liquidity away from the market because the deflationary story as we see it in Japan could be very detrimental,” Xiong said.

(Additional reporting by Manuela Badawy; Editing by Andrew Hay and Leslie Adler)

Paul, the 74-year-old House libertarian from Texas with the high-pitched voice, has fought for decades to kill off the Federal Reserve.

Bernanke, the mild-mannered ex-Princeton professor and chairman of the bank, is waging a high-stakes battle for the Fed’s reputation. And he’s doing everything possible to knock out Paul.

The fight is still in the early rounds. But with the full House expected to vote this week to give government auditors more power to scrutinize the Fed, Paul has the upper hand.

The Senate is a much more difficult round for Paul, though a similar stew of liberal and conservative support is starting to simmer in the upper chamber behind the Republican’s wonky auditing measure.

Bernanke and Paul have never met one-on-one behind closed doors, Paul’s office said. The battle has taken place in public — on blogs, with grassroots activists and during congressional hearings.

Bernanke has testified against the provision, given lengthy media interviews, written op-eds and attempted to lift the cloud of secrecy that hangs over the bank.

The Fed is audited, he argues, but allowing government scrutiny of interest rate decisions will politicize the Fed. Opening the door to congressionally requested audits would compromise the market’s confidence in the bank.

Paul, a longstanding supporter of a new gold standard, made his case formally in his recently published book, End the Fed.

The 2008 presidential candidate’s crusade is no longer a quixotic quest. He is a prime beneficiary of the grassroots anger this year against government bailouts for Wall Street.

First introduced in February, Paul’s bill to audit the Fed has gained 317 co-sponsors, a shocking three-quarters of the House. The bill has not won over many Democrats in leadership, but it has picked up several committee chairmen, including Reps. Bart Gordon (Tenn.), Jim Oberstar (Minn.) and John Spratt (S.C.).

Rep. Alan Grayson (D-Fla.), a prominent Paul ally on the bill, has provided a huge boost to the effort with his firebrand strain of liberal politics.
Grayson has publicly slammed the Fed, going so far as calling its top lobbyist a “K Street whore” before apologizing. Paul himself said the full force of “lobbyists for the Fed” is stacked against him.

As the popularity of the Paul-Grayson measure rose this year, Bernanke’s fell.

Praised by many economists for taking the necessary steps to right the economy over the last year, his overall public approval has soured. A Rasmussen poll in November showed that just 21 percent of those surveyed thought Bernanke should be reappointed. Meanwhile, 79 percent of those polled said auditing the Fed is a good idea.

Republicans have jumped behind Paul, who stood out in last year’s GOP presidential primary for his outspokenness against the Iraq war.

“There needs to be Fed independence and accountability for those dollars to at least look back at those decisions,” said Rep. Kevin Brady (R-Texas).

But the political value is plain as Republicans argue the government is taking too large a role in the economy.

“The Fed becomes for Republicans a very convenient, always controversial, always misunderstood, very specific whipping boy that they can ride to potential victory in 2010 and 2012,” said a Washington-based financial lobbyist.

Bernanke has the normally powerful Rep. Barney Frank (D-Mass.) in his corner. But as chairman of the House Financial Services Committee, Frank couldn’t eke out a compromise.

Frank rarely loses battles, but an attempt — with Rep. Mel Watt (D-N.C.) — at a deal on the audit issue simply fell short at the committee level. Liberal activist Robert Borosage, who is campaigning against Bernanke’s nomination for a second term, said the compromise effort was nothing more than “the establishment alternative.”

The committee voted 43-26 in favor of Paul’s amendment as 15 Democrats on the panel bucked Frank.

The vote drew a bright line between the senior Democrats atop the committee and the freshman and sophomore members.

“I think some of the newer members are in the most vulnerable districts,” said Rep. Brad Miller (D-N.C.), a Paul-Grayson co-sponsor who instead joined Frank in voting against the Paul amendment. “They were certainly getting the calls that I was getting, and they were reading the politics differently.”

Frank and Paul are both veterans of the House, and while they are on nearly opposite ends of the political spectrum, they have a mutual respect. The two have worked closely on an Internet gaming measure.

Many Democrats and Republicans on Capitol Hill say that Frank, despite his partisan rhetoric, is a pragmatist.

“I never felt [Frank] was against me,” Paul said.

Frank said last week the language wouldn’t be changed when the House heads for the vote. Ten of the 13 House members on the Rules Committee are among Paul’s backers, including Chairwoman Louise Slaughter (D-N.Y.).

“Absent some change in the way the public is reacting, I don’t see any changes,” Frank said. “I think there is this tension within the Republican Party. A lot of their people who traditionally have a lot of influence are troubled by this, but they may be cowed by the anger at the Fed.”

In the Senate, Paul has found support from Sens. Jim DeMint, the conservative Republican from South Carolina, and Bernie Sanders, the Independent from Vermont who calls himself a proud socialist.

A left-right coalition of interest groups on the outside is joining forces against Bernanke.

The Hill