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Monday, December 6, 2010

On the Fed's Lending to Financial Institutions

I was forwarded this link today: http://www.thinkbigworksmall.com/mypage/archive/1/55002/

I think one of the misconceptions in most discussions of the Fed's interventions during the financial crisis was that they simply handed this money out and it was never heard from again. In some cases that was what happened, but for the vast bulk of it these were short term liquidity facilities that were repaid in short order. This isn't as though the U.S. Treasury issued $3.3 trillion in bonds, wrote checks to a long list of domestic and foreign institutions, and sent them out.

The overall size of the Fed's interventions was a function of the magnitude of the crisis, which paralyzed nearly every conventional lending channel during the worst of the panic. The Fed stepped into the breach and lent out money in a nearly panicked way in which it seems that it extended aid to all comers. Having followed the credit markets very closely at the time, they were so broken that municipal issuers even couldn't take their issues to market reliably, which is actually astounding. In that environment, it is easy to understand how vast amounts of Fed lending occurred.

As far as the lending to foreign institutions, the financial crisis not only paralyzed markets here, but around the world. The Fed is one of the few institutions (the only other two being the ECB and the Bank of Japan) with the resources necessary to backstop not only our own financial markets, but those around the world. As to whether or not it should be in this role, that is a legitimate discussion, but it is also one that inevitably ends in the argument that it was necessary. I'm not sure that those that have it in for the Fed will ever fully appreciate just what we were facing back in late 2008. Not every action undertaken by the Fed or the Treasury was necessary or correctly handled to be sure, but I'm willing to give a pass on the errors given the alternative.

In general, these nominal numbers get thrown around as if there was a transfer of that magnitude to executive compensation of these banks or to the bottom lines of those institutions. Nothing of the sort happened. I remember when there were headlines that combined the value of the guarantees issued on deposits with the short term lending facilities of the Fed and the value of TARP to arrive at a $13 trillion bailout. The next logical thing for people to say was "They've taken out $13 trillion of the taxpayers' money and given it to the banks!". None of that was the case, but it made for good outrage. That being said, I'm all for questions being asked over why specific loans were approved. That's fine and we may find cases where the Fed was in error and their internal control procedures failed. I have nothing against that. However, looking at the totality of the Fed's actions, I do not find fault with them.

Now, on a somewhat related issue, that is not to say that the approach taken in the aftermath of those dark days has been sound. The lack of fundamental reform has been disheartening and there were very weak efforts to ensure that the emergency relief would be used entirely for the preservation of the firms rather than the enrich the executives of those firms at the same time. Frankly, all officers of every firm that got assistance should have gotten nearly zero pay and been forced to pay back their bonuses for prior years since they clearly did not deserve that compensation. To some extent, this is the fault of hopelessly complacent shareholders who accept every proposal from the board of directors without question. However, given that our government and others had to provide such massive assistance both through the central banks and through programs such as TARP (which has to be viewed separately), the onus falls on them and the taxpayers to demand concessions and inevitably that did not happen.

It could be argued that because the Fed got us through the worst of the crisis and avoided complete disaster, we no longer have the leverage to make the changes that were needed and the impetus for true reform has been lost. In the meantime, it appears that the anger of a public increasingly weary from recession and high joblessness is being misdirected at the institution that saved the world from utter collapse rather than the actors who caused the world to get to that point in the first place.

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