Gretchen Morgenson wrote this weekend in the New York Times on the Federal Reserve efforts to save the financial sector during the Great Recession, at enormous cost to the taxpayers and little benefit to Main Street.
Based on information generated by Freedom of Information Act requests and its longstanding lawsuit against the Federal Reserve board, Bloomberg reported that the Fed had provided a stunning $1.2 trillion to large global financial institutions at the peak of its crisis lending in December 2008.
The money has been repaid and the Fed has said its lending programs generated no losses. But with the United States economy weakening, European banks in trouble and some large American financial institutions once again on shaky ground, the Fed may feel compelled to open up its money spigots again. (emphasis added)
This is NOT the TARP money bailout that was publicly debated and ultimately Congressionally approved, but additional amounts of money that were lent by the Federal Reserve to large banks (including foreign banks) largely in secret and at minimal interest rates in order to make sure that these banks could meet their minimum liquidity requirements so as to avoid bankruptcy.
The Fed overnight window is nothing new - the Federal Reserve has long provided short-term liquidity to help grease the wheels of finance. But the two startling things about these lending programs are (1) the amounts ($1.2 trillion!!! And we're so worried about our debt problem pshaw!), and (2) the collateral pledged in return for these loans. Under standard operating procedures, the Fed would only accept bonds with the highest credit grades in return for their cash loans (iow, US treasuries). So under normal circumstances, the Fed is arguably just swapping almost equivalent goods. Yes, banks get cash from the Fed, but they are receiving collateral worth as much and almost as liquid.
Under the 2008 emergency lending programs however, the Fed started accepting all sorts of dreck from the banks. Stocks, junk bonds, and although not mentioned in the Bloomberg article, I remember they were even accepting asset backed securities, the basically worthless investment vehicles that started all of the big banks' problems in the first place.
Yes, it is true that the Federal Reserve has not (yet) lost money in these lending endeavors, which is what the backers of these programs would argue. However, think about this practically. You are the bank. You are given (as in Morgan Stanley's case) well over $100 billion in cold hard cash. In return, you give the Fed some paper that you own which, if you had to mark-to-market at that moment (which you didn't, thanks to new accounting rules that came into place at around the same time changing MTM rules), would be worth - for arguments sake - a quarter of that (and maybe less). If you just invest that money in a basket of S&P 500 stock, you will see returns of 27% and 14% over the next two years. And even though you can't see the future, your calculations has to run something like this: if I bet big and it pays off, I get to keep all the upside less the 1.1% interest that the Fed is asking for its money. If the bet doesn't pay off, I lose a bunch of worthless paper (the collateral being held by the Fed) and go bankrupt. Which I would be anyways, if I didn't take this money.
Hmmmm.... hard choice.
As far as I'm concerned, the Fed gave the financial sector carte blanche to play fast and loose with a whole lotta taxpayer cash. Yes, this time it "worked out", but given that the reason for this weekend's NYT article is the fact that there are hints that the spigots are about to be turned on again, just how lucky does the Fed feel?
Do you feel lucky? Well, do you, Bernanke?
Read the excellent Bloomberg article here and its associated data here.
Cross-posted at Momocrats.
