Housing Bailout Bill Also Eased Having Fed Rescue Banks

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.

From Bloomberg:

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.”

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  1. eh

    The market hasn’t reacted to this as one might otherwise have expected — the dollar has clearly risen in the last week or so since the housing bill was seen as a sure thing. But then I guess the details, sordid or not depending, are only slowly trickling out after the fact. Funny how that keeps happening…

  2. Anonymous

    The Financial Accounting Standards Board voted to delay until January 2010 the introduction of rules that will force banks to consolidate more off-balance-sheet vehicles directly in their accounts.

    Robert Herz, FASB chairman, said that the move was made reluctantly after a staff recommendation for a delay because there might not be enough time for all companies to adjust to the up-heaval.
    “It does pain me to allow something that has been abused by certain folks, to let that go on for another year,” he said.


    What loses? Wink, Wink. The banana Republic is alive and well.

  3. wintermute

    Allowing the Fed to prop up failed banks indefinitely because they are government-owned is madness. It is half-way to embracing communism when it was thought that govt knew best and should own everything so it could micro-manage the whole economy to “benefit the people”. This DOES NOT WORK. Von Mises made this clear in his explanation of the “calcuation problem”. The state cannot evaluate all the variables to establish a fair price for a good or service. Only the market can do this calcuation. This applies to government owned banks, mortgage-lending companies, car manufactuers etc.
    Why is the US embracing principles of communism just 20 years after the greatest failure of the that ideology?
    Once the FDIC pays out depositors the failed bank should be closed – immediately. This allows the remaining good banks – who clearly have better principles of day-to-day operation – to grow market-share and do more to add to GDP and the economy. Failed banks propped up by government only make it harder for good banks to compete on a level plyaing field.

    Madness by government. I have always guessed they were incompetent , have been told they are incompetent. And now I KNOW they are incompetent. GRRRR.

  4. Doug


    To build on and further explore your concerns, I recommend being more careful about the word “government”. Yes, of course, there are government leaders and institutions involved. But, when folks use the word ‘government’, too often there is an assumption that those governmental leaders and institutions act as independent players.

    We no longer have a nation where the leaders and institutions that are labeled “government” have sufficient independence as institutions and as leaders to merit a criticism that assumes independence.

    By the time we got to the 70s, it was fair to assert that government institutions — which were independent of businesses and markets — had gone far in the direction of regulation, etc to the detriment of the economy.

    Today, though, the Fed, the Treasury, the Congress, the White House, the FDIC — and on and on — cannot be portrayed fairly or objectively as independent of businesses who advise, partner and interact with them.

    Now, please take a deep breath. I am merely describing what is objectively verifiable in the face of evidence stretching back many years.

    We are on sounder footing in light of all this evidence to say that a variety of institutions and companies are led by people who believe deeply in their wisdom, experience and know how to manage our economy (and, indeed the world’s economy). Surely that is a fair description of such folks as Bernanke, Paulson, Cheney .. and Thain, Dimon and others.

    These people are sometimes executives in the private sector; and sometimes executives in public sector institutions.

    This is not a conspiracy. Far from it. It is a set of folks with trust-based, long standing relationships who share deep seated beliefs, values and experiences. They believe strongly they know best. And they believe in one another — not without some careful sense of self-interest etc. But they are and always have been ready to act together.

    And, as per your comment, among the many things they believe they know best is how to manage the economy.

    We don’t need references to ‘communism’. That’s a red-herring that will not advance clear sighted descriptions of our actual situation.

    We do need, as you mention, references to ‘managing economies” versus actual operations of markets that are neither oligopolistic nor monopolistic.

    However, when a set of leaders combine to manage the economy, they by definition act as an oligopoly. They set up arrangements and rules according to contracts among themselves — such things as Level 3 assets, terms of bail outs, lifting difficult constraints (e.g. Yves post on Fed and penalties for unwise loans to failing institutions) — and on and on.

    Oligopoly behavior, of course, is suboptimal in general and, the larger the scope of the oligopoly — in this case an entire economy — the more likely ‘suboptimal’ is better replaced with ‘disastrous’.

    These leaders (both private and public) are negotiating amongst themselves every single day to buy time while they arrange things to (1) get through the mess while also (2) maximizing their continued control and benefit from the arrangements that keep them in charge.

    That’s not really that hard to understand or imagine. It is also consistent with facts and behavior on display every single day.

    The leaders who so deeply share a set beliefs and behaviors by which they know in their hearts and minds that they are the best positioned to solve things are the same leaders and the same set of beliefs and behaviors that have been ‘in charge’ for close to (at least) 20 years.

    They are the leaders who have indeed managed the economy over this whole time frame — and I recommend strongly that all readers reflect on (1) how well has the economy – the real economy — done over this period; and, (2) how well have these leaders done.

  5. Anonymous

    There are two things that can happen to a failing bank:
    (1) pay money directly to the bank to keep it from failing
    (2) let it fail and be taken over by the FDIC, and support the FDIC in taking on the obligation.

    (2) is clearly the right way. The bank’s management and non-FDIC-insured creditors have to be wiped out, then the FDIC insurance honored. This is the only way to protect the people but not the banks, and it’s the right thing to do.

    Therefore, if the “housing rescue” bill does this, they did something right!!

  6. wintermute

    Doug, appreciate the feedback and explanation of “government”. Yes, communism is not the correct word – it was deliberately selected to shock – because that is what it takes to get the public to realise what is happening (such as growth of oligopoly). Only from the public can pressure for change really occur. I certainly do not believe in conspiracy theories – these detract from rational analysis.
    Note that Africa is still dirt poor despite 50 years of opportunity since colonialism. This is primarily because of kleptocratic government. It is a slippery slope from oligopoly to kleptocracy. I hope that transition never occurs in the West – it would be worse than Great Depression II.

  7. joebhed

    On the first order, why would anybody be surprised to learn that the American bankers have “leveraged” their knowledge of the money system into the next opportunity to come along, in this case the so-called ‘housing bailout bill’ ?

    What else were people expecting?

    I see this as the entire gist of the article.

    So, it is the bankers doing it, and it is to help the bankers, again, all at both cost and risk to the taxpayers.

    All of which, of course, is aimed at shoring up the failing commercial and investment banks, as we continue to roll-out the next phase of failures in our bosomous financial services industry.

    Easing a provision here, giving access to the public purse there, and you have the question, why not just give the bankers a blank check signed off by the taxpayers.

    The high irony in the comments is the Mises warning about the government bailing out banks that are government owned or government entities.

    We are further warned against the public’s largesse in thinking “that govt knew best and should own everything so it could micro-manage the whole economy to “benefit the people”.

    ummmmm, here a clue.
    The FED is not the government. It is an amalgalm of private banking interests with the privelege of creating the nation’s money and managing the whole economy to benefit the people’.

    Due to the failures of our political system to provide oversight to that FED, it is that FED that has failed miserably in building a sound and sustainable economy so as to benefit the people.

    It is the failure of the market system in financial matters and services that has led to the current beginnings of a massive economic paralysis.
    It is now affecting that same whole economy, and to the detriment of the people.

    So, the failure of the government is real, in that it has allowed this so-called free market in the money and financial system to become so embrittled and so little understood, by legislators, by investors, by insurers, by accountants and by regulators.

    I know the Mises solution will be a shrug of the market shoulders, offering historic proof that the marketplace will take care of these trivial matters of joblessness, homelessness, healthlessness and a sad reduction in human spirit and dignity, with yet another round of traditional repairs from such minor free-market failures.

    And, a generation from now, they will be trotting out statistics on exactly what DID happen to each of the nonsensical economic parameters as PROOF that markets do work. Perfectly.

    Excuse me if I puke.

    What this fiasco is proof of to me is no less than the need for much greater direct government leadership and participation in rebuilding our future.
    I suggest we begin with the abolishment of the private banking FED powers through transition to a new branch of the Treasury, all as contained in this well-thought out proposal for monetary reform.


    Let the bankers lend out their own money and that of their depositors at 100 percent reserves, and put the people in charge of a more democratic economic future.

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