The Pros and Cons of the Fed's Action Last Week
Last week has a historic week for the Federal Reserve. Going back to the end of the previous week we learned that one of Wall Street's oldest and most venerable investment banks was basically bankrupt. Over the weekend we learned that JP Morgan was working to buy Bear. And then we learned that JP Morgan purchased Bear for $2/share with a $30 billion guarantee from the Federal Reserve in the event some of Bear's loans were bad (which some pretty much have to be in the current environment). Now that all of this is over, let's look at the pros and cons of what the Federal Reserve did.
First let's look at what the Federal Reserve did. On March 16 they made this announcement:
First, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York.
Second, the Federal Reserve Board unanimously approved a request by the Federal Reserve Bank of New York to decrease the primary credit rate from 3-1/2 percent to 3-1/4 percent, effective immediately. This step lowers the spread of the primary credit rate over the Federal Open Market Committee's target federal funds rate to 1/4 percentage point. The Board also approved an increase in the maximum maturity of primary credit loans to 90 days from 30 days.
With this action the Federal Reserve greatly broadened their lending program. Before this action the Federal Reserve only made loans to member banks. In addition, the Federal Reserve only accepted high-grade debt instruments (think US Treasuries) as collateral for those loans.
Now the Federal Reserve will lend to "primary dealers". That means the largest Wall Street investment banks will be able to borrow money from the Federal Reserve. This means firms like Merrill Lynch and Bear Stearns can borrow directly from the Federal Reserve.
Secondly, these loans will be "collateralized by a broad range of investment-grade debt securities." That simply means the instead of only accepting Treasury securities for loans the Federal Reserve will now accept any investments with a rating of A or better. It's important to note that a lot of the problems in the bond market have been caused by high-rated paper, so this qualification isn't worth what it once was.
Third, in addition to the above mentioned action, the Federal Reserve helped to facilitate the Bear Stearns transaction by guaranteeing up to $30 billion of Bear Stearns' portfolio. That means that after JP Morgan buys Bear and takes charge Bear's investment assets, if up to $30 billion of those assets goes bad the Federal Reserve will pay JP Morgan for the losses. In other words, the Fed is essentially guaranteeing up to $30 billion in losses related to Bear Stearns portfolio.
So -- what's good about this deal?
The central reason why the Federal Reserve acted like it did was to prevent a financial sector meltdown. While there is no way of knowing for sure there was a strong possibility that a Bear Stearns bankruptcy would have frozen the credit markets. This would have had chilling effect on the credit markets and could have frozen them solid. This could have sent the economy which is already teetering on the edge of recession (if it's not already in one) into a very deep recession. It's important to remember that leading up to this event were signs of extreme distress in the credit markets. Auction rate securities -- a primary way that municipalities obtain short-term funds -- pretty much dried up over the last 2-3 months. Structures Investment Funds -- SIVs for short -- were experiencing the same problems. In effect, the Bear Stearns situation occurred at the end of a building problem in the credit markets. If Bear had failed there is more than a small likelihood that the end result would have been a much deeper recession than we will have.
On the con side, the Federal Reserve clearly bailed out a firm who's own decisions were responsible for its downfall. Bear decided of its own free will to get involved in the hedge fund and mortgage market. That was a bad decision and they have paid the price. In a free market economy (which we're supposed to be in) stupidity of this type is supposed to fall by the wayside by being unprofitable and therefore eventually going bankrupt. Some commentators have correctly noted that the Fed's action essentially "privatizes the gains and socializes the losses" of the investment community. Finally the Fed's action creates what economists call a "moral hazard". This simply means that by bailing out stupid behavior the Federal Reserve is essentially allowing it to happen again.
In conclusion, I will first note that I called Ben Bernanke a socialist for his actions. Frankly, I couldn't resist that line. As a financial writer the irony was just too rich to ignore. However, the situation is far more complicated than merely labeling a free market advocate a socialist. Bear's collapse would have had far-reaching implications and ramifications that no one would want to be responsible for. If Bernanke had let them fall he would have been burned in effigy for not doing anything. But letting them collapse would have been a sure way to make sure the reckless lending practices of the last 2-3 years wouldn't happen again. But by bailing out the situation Bernanke is now called a "socialist" -- which is probably deeply insulting to him. In other words, this is the economic no win scenario. Whatever you do you're damned.
Loading comments…
Want to reply to a comment? Hint: Click "Reply" at the bottom of the comment; after being approved your comment will appear directly underneath the comment you replied to
News is out, JPM must pay more.
This is ridiculous. Talk about catch 22. The Feds are now obligated either way to support BSC.
How can they on one hand say, BSC failinfg would casue the markets to collapse, rig up a deal with JPM and now , if JPM can't get enough votes for the deal, they walk away.
That leaves us back where we started, a failing BSC which will kill the markets. Seems like the feds have to extend favorable terms to BSC, as they should have in the first place considering they offered it to everyone else.
I didn't know that ponzi schemes (hedge funds) can get in trouble and then get a guaranteed loan of $30 billion (with a B) to be paid for later by the "rabble" (in higher interest). What a country. I better get started with mine, cause I'll get bailed out for sure if I mess up if I can get cozy with Ben or whoever makes the the rules of the game/gamble.
This isn't a ponzi scheme (Like Amway/Alticor) in the classical sense, this is a bottom loaded society where the people at the top get all the sunshine and the people at the bottom get all the 'rain'.
RTeal human being. Citizens of this once great country are paying huge cost for being in the situation they are in. They don't have a voice in this new government. They have no money. Regulations and legislation is do 'to' them, not 'for' them. They pay more in taxes, they pay more in lives, they pay more in getting screwed by those above them and those that work for those above them.
I remember hearing about the refinancing that was going on. People refinancing with incredibly short times and incredibly close payments. The people that wrote those loans, that provided the crack to the people are at fault. They made a whole lot of money doing what they did and they have walked away with it too.
The people at the companies that approved these loans and artfully repackaged them in shiny wrapping paper and big pretty bows made a whole lot of money and they have mostly walked away with it too.
The CEO's of these corporations have made millions and in some cases hundreds of millions of dolars for the pop their companies had from the bubble. Some took their money within weeks of the beginning of the crash and for the most part aside from a few impotent examples, they have walked away with their money too.
Bear Sterns goes from 30 billion dollars to nearly nothing in a weekend. They bought those shiny packages of those empty loans and finally realized that they swallowed a glassful of hemlock rather than the golden nectar extricated from the lower classes. They panicked and guess who stepped in to save them and their millions? The same government that is funding a 'war on terror' of which the Iraq component is costing 12 million dollars a day. A war that the government refuses to investigate the extent of the ruthless and far reaching corruption. The thousand dollar hammers of the previous Bush are replaced by thousand dollar gallons of sewage that soldiers are supposed to wash their clothes with. Of companies that hire employees and then shift them to a Cayman Island front company to cheat the government that pays their grossly inflated invoices without question out of taxes or the pittance that the pay those that serve them.
What is wrong with this picture? The people that this economy is weighing on are near the breaking point. They are being offered 600 and 1200 dollars as a pacifier to keep them quiet. The government actively plots against them at every turn. Wreck social security, Wreck medicare. Destroy medicaid. Hose the environment. Strip financial laws from the books. Build impenetrable walls around the truth. Bitch and gut social programs for being a 'waste of money' but increase corporate welfare to astronomic levels.
The pain is real. The pain os focused. The pain of the bad decisions and trickery is strapped on the backs of those that were its victims. The rich, the filthy rich and the ruthless rich have all the voice and all the power. Save the CEO and torch the workers. It's so much like economic slavery...
It is clearly time to fire the Privately owned and operated Federal Reserve. The current crisis can be laid right at their feet.
The Fed (Greenspan) was told in 1993 to regulate loan underwriting. Not only did the Fed not regulate loan underwriting, their Chairman Alan Greenspan praised these new exotic loans as the best choice in loans. These loans are now defaulting en masse undermining every financial institution in the United States and many around the World.
In the meantime the Member Banks of the Fed were busy creating derivatives worth hundreds of trillions of dollars (that the Fed saw fit Not to regulate) that there is no legal or statuatory framework to manage. Should even a small percentage of these derivatives go bad it will bankrupt the United States.
More agregious examples of criminal negligence I cannot imagine. We need to fire the Federal Reserve and establish a Public Central Bank.
The founding fathers took it back from the crown. They were considered traitors and terrorists in the eyes of the crown. Our father's generation stopped Hitler. While you are willing to spend on diamonds and gold, laptops and cell phones, are you willing to support fair wages, health care and insurance - so that we must pay more for goods that are not produced in sweatshops? The corporatocracy spends billions each year trying to convince us that we cannot make a difference, except when we go shopping and buy product A or B.
I can remember when blacks had to ride in the back of the bus. Eugene McCarthy brought down a sitting president and MLK, Jr. and his wife Coretta taught us about the power of dreams. Even Monarchs have hearts that break, like yours and mine. They bleed. They can be brought around - or taken down. So said Thomas Jefferson.
Become aware of the issues, plan sustainable strategies for the future because no child has a future unless all children do. Join at least one Non-Government Organization that promotes an ecologically based-program, a social or political agenda about sharing the resources of this planet or promotes human rights or justice.
This problem is an opportunity to reform the economics of greed. Corporations must be contained like wildfires. Fire itself isn't evil, but the goal of unrestrained economic growth should not be our goal. All corporations should have a beneficial social purpose or their charters revoked. Like the East India Company, they can be defeated if not tamed.
Together, we have the power to change this. It isn't up to the Fed. The Fed itself can and probably should be abolished in favor of a more socialistic and democratic economic banking system based on a government system of credit, not a monetary system. Money itself has not real value, only the fruits of our agriculture and manufacturing. Money itself should no longer be our real God.
And remember, out, as many historians are just now beginning to admit, that war was fought because many colonies had begun minting their own currency. You could agitate against soldiers barracked in your homes, argue loudly for changes in the tariff structure, or make demands of the Crown for all sorts of transgressions--But once the Americans threatened the Bank of England and its monopoly on our money, That is when war broke out. Bankers are not a group to be trifled with!
`
welfare is okay for the haves
but not for the have-nots
it ruins their work ethic,
& makes them forever dependent on the gov.
am i making sense?
.
Pro's --- Like Prostituties selling themselves for a dollar.
BEAR and STEARNS Executive gor to keep the $ 40 million in Stock Option BONUSES they took in December.
They had to know their problem was huge in december.
Of course they did. They probably knew by December 2006, or even from the moment that they started doing it. The problem was that their greed was too large, and the regulation was too small, that they were able to continue to pay themselves even though they knew that the whole thing was on the verge of collapse!
Ain't these "Big Government is an interferring entity that can only mess up business" guys just great?
And I truly admire the way the just hate any kind of government welfare.
And of course, what they hate the most is all this Liberal hypocrisy.
Gotta love their iron clad principles.
The only 'pros' would be if you were a wealthy person at BS.
The 'cons' are the con games people like Bush run who rant on about the 'free market' and at the first sign of trouble for the wealthy, use Big Mummy Gummit to bail out their wealthy friends.
There are no pro's.
If the Sotck was in jeopardy becasue the company was reckless, it should be allowed to fail. Its as simple as that.
If the feds want to help, then they help all, they can't get mixed up brokering private deals on the side.
NMo one knows how bad BSC was but LEH was mentioned to be in worse condition. LEH is up ovwer 100% in 4 days, are you kidding me ????? Talk about irrational. This deal was in process for some time. Everyone knew what the stakes were,. All these experts allowed it to get to this point.
You can't call it a Free Market when manipulkation is rampnat. i for one hope every retail investor pulls out of the market. That should send a signal to everyone that these games won't be tolerated anymore.
Ya, sometimes the right thing to do is allow everyhting to be flushed down the toilet, only then can you rebuild with a system that does honor to Capitalism, an insitution where everyone benefits.
Two things, first, the feds action simply obligates we, the tax payers, to cover all the 'bad' paper out there. Second, the problems of BS and other troubled financial houses is only attributal to the lack of regulation and oversight. Following the 30s great depression, regulations were put in place that would have prevented this situation we have today. The de-regulation era of Reagan, Bush Sr. as well as Clinton has seen the elimination of such regulations and is solely responsible for this calamity we face today.
I read Bernanke's action as a stalling maneuver, with hopes that it will give a superficial confidence boost to the Markets. The contaminated securities are still in the financial ether making mischief ... the question is, with Nationalization of Investment Firms being an acceptable intervention in the current crisis, what else does the vile socialist Bernanke have left in his bag of tricks?
Actually, I appreciate less the irony of being able to call Bernanke's actions socialistic than I do the fact that they seem to me to be clearly beyond the FEDs responsibility, if not its authority.
Before that, I am glad that Hale has characterized the FEDs "guarantee" as nothing more or less than a potential payment, with no potential income. Other writers have described the FEDs position as a potential $30B "loan" to JP.
So, this really is kind of corporate financial socialism, in spades.
I thought the FED was a private bank consortium, limited to serving its members.
I know I could be wrong about that, and probably am. But I don't think I can be wrong that, if the FED is going to pledge the public's money against potential losses by any banker in a merger/acquisition situation, well, they definitely should ONLY be in a position to lose $30 B of the people's money to a bank that is under its jurisdiction.
Having said that, of course, I don't believe that any private banking consortium SHOULD be in a position to pledge up to $30B of the people's money in losses, with no potential of any return.
Not the FED and not any private bank.
Paul Volker suggested clearly on Charlie Rose that only a true "governmental" presence can be sufficient for a public guarantee to the likes of unregulated, high-risk ventures.
The reason we can glibly and fairly call the FEDs actions socialistic, is because these types of actions should only be taken BY the public, on the public's behalf.
The sovereign Central National Bank of the United States.
It's more nationalistic, maybe.
Under the Congressional guidance of the Joint Committee of the Currency and Monetary Policy.
Yes, the most powerful, open and accountable committee of the Congress.
The one we've been waiting for over two hundred years, since the Colonists threw the British money changers out.
Taxation without representation is monetary policy.
The solution of a Constitutional money system called for public money.
Only the Congress can create the money of the United States, and regulate its use in commerce.
At that point, the money system is accountable to the people.
I know its only a Constitutional thing, on the one hand.
But, today, we are being forced, more than ever before, to look at the causes of this financial chaos.
And we have all the tools we need to enact a truly accountable money system for the future.
I believe in free enterprise.
Where everyone equally has the opportunity to risk his or her money for whatever returns they demand.
I don't believe that if the people were in control of the nations money system they would allow the development of financial realms that can put the country at complete financial risk.
Such a realm is the cut-and-diced, corporate financial interstructure of transnational entities that are congenially known as the investment banks.
Whether by design or by accident, today we, the people, are faced with unprecedented potential for substantial losses amid sustained uncertainty, at best.
I know its just a coincidence that Paul Volker calls for government intervention and a government entity involved in protecting our money from the risk of a private corporate bailout.
Coincidence. But, true.
It's time for the people to restore the Constitutional money system that was gained by the fight of American revolutionaries a couple of centuries ago.
Abolish the FED.
The sovereign Central National Bank of the United States.
Our bank.
Our money.
Huzzah. Abolish the fed.
Bernanke has made an historic decision, and an astute one. Knowing that the economy has slipped the bounds of what monetarism can deal with, he has taken the fight to a new arena, the investment banks. This may prevent exacerbation of the depression by keeping investment credit markets open.
His problem is that no amount of loosening will make its way to the consumer or small business because of the over tightening of qualifications on borrowers. Loosening 2 points on credit cards is not going to be significant.
Inflation is pent up like a goose on Kaopectate. The world is waiting for some miracle from the American financial geniuses to both honor our foreign debt and stoke our markets for their goods. Commodity and raw material inflation is not so patient, driven by the falling dollar and being the new magnet for investment. Your box of corn flakes is being priced by the same people who gave you $4 gas and the housing bubble.
With one sector of the economy realizing price increases and others, consumer goods, services and housing, suffering softness, the increases in commodity prices will cause deflation in other areas.
This is truly a two headed monster. The Fed is out of its depth. It can’t fight inflation and recession at the same time. Only political action of some sort will mitigate the problem.
Unfortunately for us, the answer is socialism, or more precisely regulation and activist economic policy. I say unfortunate because of the hell bent resistance to anything that smacks of socialism in our government. It may well be that a depression must ensue for the ideological dunces to be replaced with rational thinkers that fear neither socialism or capitalism, but that can reconcile the benefits of both.
The two thing that would help the most is to repeal the Bush tax cuts and double the scheduled minimum wage increases. In case you haven’t noticed, the economy sucks because people are broke. Regulation of banking and investments would be really good too, but won’t aid in a recovery.
One of the primary contentions of Friedman was that Markets regulate themselves. As a casual observer of the ongoing financial commotion I couldn't help but notice the truth to this statement. Indeed the Markets, those who buy and sell financial instruments, were in the process of this "Self Regulation". The sellers had fraudulently passed off trillions of dollars in junk bonds as AAA paper. They had billions more on their books and in their managed funds. When the true nature of these highly denominated rolls of toilet paper became known last Summer and Fall, the Market rightly revalued them to nothing. This presented a problem to the criminal entities we all know and love as the Wall Street Brokerage Houses. The Market, in its infinite wisdom, did its job and was effectively puting these Racketeers out of business.
The Federal Reserve and the Treasury Department seeing that the Market was functioning set about injecting Socialism into the system. This was accomplished by first making money cheaper to borrow then loaning billions to the corrupt institutions. When the Market refused to roll over the Fed did what it had never done before, it took the worthless junk bonds that the Market had refused to buy as collateral for taxpayer dollars. When investors voted with their feet to flee one of the Houses of Ill Repute, the Fed agreed to buy outright billions of worthless paper with taxpayers dollars.
Thus when the Market that Free Enterprise lauds dared to rear its ugly head it was decapitated by Socialism in the name of Free Enterprise. Now as a homework assignment, lets all reread our Milton and find the chapter where he claims sweatshops are good.
This and other similarly urgent bailouts over the years demonstrate that unrestrained capitalism is by nature self-immolating, not self -correcting.
You must be logged in to comment. Log in or connect with
