Some aggressive spinning on the Fed data releases about its lending during the financial crisis has surfaced at Bloomberg (admittedly with some less favorable facts also included). The Friends of the Fed and other Recipients of Largesse are defending the central banks’ panicked and indiscriminate responses to the crisis. These efforts to rationalize emergency responses fail to acknowledge underlying regulatory failings that remain unaddressed.
The PR push surrounds the foreign bank that got the most support during the post-Lehman phase, namely, Dexia. From Bloomberg (hat tip Buzz Potamkin):
A European bank that got the most Federal Reserve discount window help during the financial crisis received a total of about $300 billion in loans, guarantees and cash infusions from governments and central banks. It also owned subsidiaries implicated in bid-rigging that prosecutors say defrauded U.S. taxpayers.
Details of Fed lending released last week show that Dexia SA, based in Brussels and Paris, borrowed as much as $37 billion, with an average daily loan amount of $12.3 billion in the 18 months after Lehman Brothers Holdings Inc. collapsed in September 2008….
By lending to Dexia, the Fed kept money flowing into local government projects throughout the U.S. as well as the money market funds that invested in them. Dexia guaranteed bonds issued by entities as varied as the Texas State Veterans Land Board in Austin and the Los Angeles County Metropolitan Transportation Authority….
In 2008, Dexia was hit with buyback provisions in municipal bonds, Pommee said. The bank was one of the biggest backstops of the bonds, providing letters of credit or so-called standby purchase agreements — guarantees to buy the bonds if investors wanted out. Dexia’s so-called credit enhancement made it possible for money market funds to buy the bonds.
My, my, the authorities are so solicitous of municipalities! Funny how they failed to lift a finger when another set of municipal guarnators, namely, the monlines, started hitting the wall in early 2008. The result was the collapse of the auction rate securities market. Dealers had been propping it up for years, providing investors with an exit when auctions failed. When monoline downgrades looked inevitable, that meant dealers were at risk of being stuck with ARS that were worth less due to a downgrade of the securities because the credit rating of the municipal issuer had fallen as a result of a reduction in monolines’ ratings. And as readers may recall, the failure of the auctions left some investors who needed access to their funds frozen, and also subjected issuers to eyepopping increases in the interest rates they had to pay.
So Dexia’s and the monolines’ involvement in money market instruments targeted to retail investors illustrates one unaddressed issue: overpromising (yes, the fine print of all the prospectuses goes on about the risks, but the panicked way the funds and the authorities reacted said investor perceptions were very different than the disclosures. And in the meltdown, unwarranted investor beliefs were selectively made good). Paul Volcker is right to be unhappy at the way that money market funds have been treated as substitute for bank deposits, and worse, even had a safety net thrown under them. The $1 NAV was treated as inviolable, when that was never a certainty, ex Treasury money market funds. And the money market funds continue pretty much as before, despite having been saved in multiple ways from their reckless ways, both in their marketing messages and their investment practices.
The second issue Bloomberg fails to address is: why is a European bank being rescued by US regulators? The US bailed out AIG and Citigroup, even though those had globe-spanning operations and the salvage operations also benefitted many foreign customers.
It isn’t discussed often enough that one of the roots of the inability to regulate banking properly is the so-called home-host rule. Even though banks that are licensed in foreign markets are subject to local laws in many respects (everything from securities compliance to branch hours), in most areas of bank regulation, the home country regulator is more influential than the host country, particularly as far as capital adequacy is concerned. Crudely speaking, the result is often that the host country operations are permitted to carry very little capital; they are treated as being able to ring the mother ship as needed. And if the host country sees practices it thinks are worrisome but are outside its scope, all it can do is alert the home country regulator, who may or may not act (in extremis, they can yank the local licenses, but first line responses are limited).
If in the wake of the crisis, we had decided to move to a system of more powerful national regulation of all financial entities in its borders, including having each bank licensed to do business in a particular country subject to its capital regulations, it would have reduced the tight coupling of the financial system by balkanizing them a bit (with certain customers, the banks would still have latitude as to where they booked the business, but for quite a few, the choices would be circumscribed). But that idea was never even considered. The US expended considerable effort in the 1990s and 2000s pushing “financial liberalization” so as to make the world an attractive picking ground for US banks and investment banks. Despite the considerable cost of the global meltdown, the US remains wedded to this form of economic imperialism.