Not only are we getting bailouts, we are now getting Chinese puzzle box bailouts, with new tricks nestled inside other vehicles. Maybe we should quit pretending and just give the American Bankers Association and the National Association of Realtors blank checks from the Treasury Department. We might as well be straightforward about what is happening.
The effect of the new legislation is to end penalties for Fed loans extending beyond a certain time limit to failed banks. The original purpose was to keep the central bank from keeping institutions that ought to be shuttered open. Think there’s any risk that might happen? But the practical effect is that this appears to be a backdoor way to shore up the FDIC.
The Federal Reserve will be able to lend more easily to failed banks under government control because of a provision in legislation that bailed out Fannie Mae and Freddie Mac.
In the rescue signed into law by President George W. Bush yesterday, the Fed will no longer have to pay penalties on loans it makes to institutions taken over by the Federal Deposit Insurance Corp.
The measure may mean more use of the central bank’s balance sheet to prop up the U.S. financial system,…
“We are pushing forward the line on what the government will backstop, and what the Federal Reserve will backstop,” said Vincent Reinhart, former director of the Fed’s Monetary Affairs Division who is now at the American Enterprise Institute in Washington…
The Federal Reserve Act’s Rule 10B penalizes the Fed for loans to undercapitalized institutions exceeding specific time periods. The original provision was aimed at preventing the central bank from keeping failing banks open.
The exemption in the new law, which was requested by the FDIC without objection by the Fed’s Board of Governors, was aimed at making clear that once banks are taken over by the FDIC, capital rules no longer apply because they are effectively owned, operated and in liquidation by the government….
For some, the exemption opens up the Fed to more political pressure to lend to government agencies, instead of forcing Congress, the FDIC, or the Treasury to explain to taxpayers why they need more money.
“Once the Fed starts lending to a bridge bank, or indirectly to the FDIC, where is the incentive to ever stop?” said Walker Todd, a former Cleveland Fed attorney and visiting research fellow at the American Institute for Economic Research in Great Barrington, Vermont.
The FDIC had $52.8 billion in its deposit-insurance fund as of March 31. The FDIC could raise more money by tapping a $40 billion credit line it has with the U.S. Treasury, increasing assessments on its members, or turning to Congress.
“Like any open depository institution, there will be short-term borrowing needs by the bridge bank,” which may need to “tap the discount window,” Gray said, referring to the name for the Fed’s direct loans to commercial banks. “Longer-term borrowing needs would typically be met by a loan from the FDIC.”…
A request by the FDIC could always be rejected by the central bank. Still, the removal of the penalties may open up the Fed to more political pressure, possibly encroaching on its independence, analysts said.
“Why should they be doing it?” said Robert Eisenbeis, former Atlanta Fed research director and now chief monetary economist at hedge fund Cumberland Advisors LLC. “The whole idea” of the rules in the Federal Reserve Act is “to make it costly and difficult to support an insolvent institution.”