Fed’s Use of $80 Billion Facility as Subsidy Vehicle Confirms Regulatory Deficiencies

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Bob Ivry has done a solid job of reporting on some of the documents that Bloomberg forced the Fed to release through a Freedom of Information Act request. In short form, the Fed created a special facility called the single-tranche open- market operations. It was established in March 7, 2008, the week before the Bear meltdown, and continued through the end of December. The facility size was $80 billion and the program was limited to 20 primary dealers. Three groups, Credit Suisse, Goldman, and Royal Bank of Scotland each borrowed at least $30 billion at various points.

Why is this program now controversial? First, Congress appears to have overlooked it in its Dodd Frank drafting. Barney Frank is quoted saying he never heard of it. But more troublingly, its use appears to have morphed from an “keep the markets from seizing up” by providing more liquidity in the repo market, to a back door prop to the banks. Admittedly, the numbers paled compared to the TARP, but here we have the Fed either deliberately or incompetently handing cash to the banks (we assume deliberately since anyone could see how cheap the funds on offer were). Key extracts:

They paid interest rates as low as 0.01 percent that December, when the Fed’s main lending facility charged 0.5 percent.

“This was a pure subsidy,” said Robert A. Eisenbeis, former head of research at the Federal Reserve Bank of Atlanta and now chief monetary economist at Sarasota, Florida-based Cumberland Advisors Inc. “The Fed hasn’t been forthcoming with disclosures overall. Why should this be any different?”…

In March 2008, ST OMO was “desperately needed,” because of the shaken state of short-term credit markets, said Michael Greenberger, a professor at the University of Maryland School of Law in Baltimore and former director of the division of markets and trading at the Commodities Futures Trading Commission. After the Fed created other lending mechanisms and the Treasury Department began distributing money from the Troubled Asset Relief Program in October, ST OMO became “just a way for banks to have at it,” he said.

“At such low interest rates, it’s no longer a rescue, it’s a profit-making enterprise,” Greenberger said. “By December, a lot of money was made off this program.”

Let’s draw out the implications. The Fed was concerned enough about the health of the biggest banks in the world so as to be handing out covert freebies. Yet it did not saddle up for a serious examination of how fragile these firms were. In fact, as Joe Gagnon, a former Fed official, said at a recent Roosevelt Institute conference on the Fed, the monetary side of the Fed was concerned about the banks (how could you not be when the banks weren’t willing to lend to each other), yet the regulatory side blew off their concerns. As we said in March 2008, everyone knew that Lehman, Merrill, and UBS were at serious risk. Lehman was in a constant PR offensive, trying to deny charges that turned out to greatly understate how weak the firm was. Credit default swaps were seen as the reason that Bear, a firm no one would have designated as systemic in 2006, had to be rescued. Yet all the Fed did was send two examiners to Lehman (which admittedly was more than the SEC, its nominal lead regulator, did). Instead, the Fed should, in concert with the ECB and Bank of England, should have gone and made a serious risk assessment.

The complacency of the regulatory side of the Fed, particularly in light of what amounts to covert action on the monetary side, suggests that the Fed has governance problems that likely remain unaddressed (there has been remarkably little in the way of soul-searching by the Fed; if anything, it seems proud of the job it did during the crisis, rather than seeing the fact that the crisis happened as a hanging crime).

This apparently intentional misuse of liquidity facilities is further proof of dysfunction at the Fed. All we can hope is that the crisis revelations will unearth enough dirty laundry to produce pressure for far more transparency and accountability from the central bank.

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  1. jake chase

    “The complacency of the regulatory side of the Fed, particularly in light of what amounts to covert action on the monetary side, suggests that the Fed has governance problems that likely remain unaddressed”

    Really? It seems to me it is the country which has governance problems that likely remain unaddressed. The competency of the Fed to keep kleptocratic institutions afloat cannot be questioned by anybody, and that is the only reason it exists. The only check on the Fed is the willingness of the world to accept its paper. With interest rates at zero now for two years, that appears pretty secure.

  2. ambrit

    Mz Smith, et al;
    Sorry to say, but this little pot boiler is playing out to the worst case scenario script. The reforms of the 1930’s came as the direct result of catastrophic economic and near catastrophic societal break downs. The fact that we don’t have rioting in the streets right now is due to the effectiveness of the 1930’s reforms. The present Rightist forces want to eliminate the institutional systems that have saved them from popular anger. They should be careful what they wish for.

  3. john

    I know a pretty senior Hedgie who’s pretty pissed at his local US congresscritter and Senator because he’s been shoveling them money for years but the moment some wiff of scandal drifted by they turned on him.

    We now have a consolidated public/private banking sector that is trying to figure out how to eliminate the Treasury because its political goals can threaten the value of the dollar assets held by all the folks in the financial industry who have managed to tap directly into the governments money creation over the last thirty five years.

    The Wall Street Journal is the house organ for the oligarchy behind this attempted financial coup d’etat, while the NYT is the local paper where the coup is based, the paper of the bribers, and the Washington Post is the official voice the bribees.

    As long as the consolidated public/private banking sector is allowed to shovel money into the political system none of the institutional checks and balances will work. Because we have allowed the competition of ideas a free press is supposed to support to degenerate into a “marketplace”, only ideas backed by money gain any purchase in the “marketplace” and the interests of anyone without the means to bribe competitively have become “externalities” to the market.

    How to create an effective political voice outside the “marketplace” where the effects of money are open to scrutiny is the political challenge of our time and whether we succeed will determine if we succumb to the neo-liberal utopia of lower living standards or whether we re-organize and regain political and economic sovereignty within our own borders, much less our position in the world.

    1. Max424

      “…all the folks in the financial industry who have managed to tap directly into the governments money creation over the last thirty five years.”

      Yup, that’s similar to the way I see it; the fiat currency of our country is being stolen, and anybody who is anybody is in on it.

      And that’s why MMT is so dangerous, and nothing like it will ever be adopted (or even given a fair hearing), because MMT, among other things, would put an abrupt end to the theft of our money.

      Note: In my opinion, the Fed, with the help of the TBTF banks (or vice versa), has developed a fool proof system for printing endless amounts of greenbacks without creating significant domestic inflation — at least as they measure it.

      Clearly, this represents a scam so monumental in scope as to be unprecedented in financial history, and I give the Fed and the banks a lot of credit for carrying it off — undetected.*

      * Well, sort of. I think millions of Americans know what’s going on, but of most them live in the Beltway, and are the ones directly benefiting from the scam.

  4. Hugh

    It is a problem of both governance and leadership at the Fed. Bernanke like Greenspan sold the line that markets were efficient and self-correcting if left to their own devices. Regulation would only harm this process or at best be irrelevant to it.

    Then after the housing bubble burst, and then the meltdown, the unstated policy of both the Fed and Treasury became to bail out the banks, at everyone else’s expense. It was a four-pronged approach: 1) various facilities, essentially all covert subsidies were offered to the banks; 2) the banks were given official blessing to cook their books; 3) they were allowed to steepen their yield curve by charging excessive fees to their customers; and 4) they were allowed to use the money to blow new bubbles in stocks and commodities.

    All this is classic kleptocracy. Bernanke, Paulson, Geithner, Rubin, Summers, Obama, Bush, they all planned and/or signed off on it. It is just so important to realize that this didn’t just happen. They aren’t innocent. This was, and always has been, a criminal enterprise of monumental proportions.

    1. anon3

      It was not just a criminal enterprise, but was organized and orchestrated by a variety of organized criminals and criminal organizations. These public actors were the shiny faces meant to give some semblance of legitimacy to it. It was a mob money making racket all the way to the money laundering island banks. Now the various mobsters are unstoppable.

      1. hell is only half full

        I don’t understand why the RICO laws do not apply here. If they were usable to slap Michael Milken’s hand, why not here?

        Oh, but Holder spends all of his time and energy on deporting job seekers, raiding state authorized medical dispensaries and avoiding anything that might slow down President Obama’s money train for re-election.

        Well, the old expression pushed by the top thugs is dead. No one had better let me hear “Crime does not pay.”

  5. Thisson

    The obvious problem is that we have a Federal Reserve in the first place. The privilege of money creation belongs to the people. It shouldn’t be borrowed into existence so that we can have a master rentier class.

  6. just an individual

    It is Subversion of Democracy: Sedition.

    Blowback is hell, but
    I’m sure the influencials
    have a second home outside of the US
    to flee when we the individuals wake up.

    We are just individuals as there is no Government.

  7. keynes

    Any TBTF bank needs to be run as a public utility, and
    the managers on a limited salary. Any other approach
    amounts to subsidies for millionaires, as this article reveals.

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