Thursday, April 3, 2008

The Fed is a Bank

"Almost one-half of our nation's central bank balance sheet--more than $400 billion--is exposed to credit risk through new lending facilities. It has also entered into an open-ended commitment to use its discount window to back stop major securities firms. ... Thus, we have entered one of those rare episodes in which balance-sheet constraints put a brake on spending. ... In such circumstances the [Fed's] $900 billion balance sheet will not look that big. And the [Fed] will have conceded control of its balance sheet to the needs of private-sector entities. More seriously, the [Fed's] action [with respect to Bear Staerns] can only be viewed as rewarding bad behavior. ... The decision on Monday by executives at J.P. Morgan Chase to sweeten its takeover bid to $10 per share showed have valuable that [Fed] intervention was to the owners of Bear Stearns. Consider the alternative. Officials from the [Fed] could have commisserated with the mendicants from Bear and pointed them to the door. The [Fed] could then have offered its balance sheet to any financial institution willing to assume the portfolio of risky obligations from the defunct Bear to ensure that the financial system continued to function smoothly", Vincent Reinhardt (VR) at the WSJ, 26 March 2008.

I agree with VR, a former Fed official, that the Fed rewarded bad behavior. I part company with him over who it rewarded. It rewarded JP Morgan, not Bear's stockholders. Bear could have been pushed into bankruptcy. That is "the alternative", not Bear's orderly liquidation. It is that bankruptcy that terrified the Fed and the rest of Wall Street.

1 comment:

Buzz Saw said...

Failure is richly rewarded, the symptom of a decadent power structure. Negative selection at its finest. Caligula would be a better leader than what we have at this present time.