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Federal Reserve Ties Itself to Collapsing Investment Banks

Published 09/16/08 Craig Harrington - Print Article
E-mail - editor@economyincisis.org

The Federal Reserve Bank has taken historic steps in the last week to tie itself to the unsound and defaulting assets of some of America’s largest financial institutions, according to The New York Times.

The Fed declined to finance buyers of Lehman Brothers last week, after having done just the opposite in the case of Bear Stearns months before. Though not directly financing, the Fed has loosened its own standards on lending to Wall Street firms. The Fed has agreed to accept many securities, equities and junk bonds as loan-collateral, which it would have previously refused.

The loosened standards have been in place since an emergency loan program was enacted during the Bear Stearns fallout, but the plan was not frequented by Wall Street investment banks at the time. Now however, it seems as if many firms will begin dipping into the Fed’s loan program.

The Fed also loosened its capital restrictions following Bank of America’s purchase of Merrill Lynch last week. Bank of America will be allowed to maintain a capital level below the Fed’s agreed upon minimum until markets hopefully stabilize at some point in the future.

The Fed did manage to convince Wall Street firms to create their own insurance policies – ten major firms agreed to put aside over $70 billion. But by lowering its standards and purchasing bonds that have little market value, the Fed is seriously jeopardizing perhaps billions of taxpayer dollars. Bank failures, of both the investment and commercial variety, are expected to increase precipitously and many within the Treasury expect the FDIC’s insured-reserve to run out.

Considering the sorry state of so many investment banks and Wall Street firms, the Fed is taking a dangerous risk by propping them up in the hopes that they will eventually find their way. If the firms are unable to stabilize on their own, the Fed could be left holding billions in worthless collateral while they watch as the firms collapse anyway.

This outcome, coupled with rising bank failures, could put both the Federal Reserve and the Treasury on the hook for enormous sums of money. The United States government is already horribly indebted. Any major spending by government agencies is simply an increased burden on future taxpayers. With the financial system so completely undermined by bad market conditions, poor management and corruption, the government is displaying highly irresponsible behavior by placing its trust (and our money) into their hands.

Source The New York Times:

Even though the Federal Reserve refused to provide a financial backstop to potential buyers of Lehman Brothers, concerns over what may unfold in the market on Monday led it to dramatically loosen its standards on making emergency loans to major Wall Street investment banks.

At the same time, a group of 10 major banks agreed to contribute $7 billion each to an emergency borrowing facility that any of the banks can tap if they run into a crisis similar to the one faced by Lehman Brothers. The fund may grow in size as more banks agree to contribute.

Taken together, the Fed’s expanded lending facility and the banks’ emergency borrowing facility indicate that Washington officials and Wall Street have grave concerns about future losses at banks beyond Lehman.

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