One Helluva Open Window

I’m a financial economist. I’ve worked for the Fed although not in that capacity.  My grandfather worked for the FED doing the War Bonds thing for both World Wars and my exhusband worked for the Fed straight out of college. I’d like to think I have some familiarity with at least two of the districts.  I also was schooled during the monetarist ascendancy so I was endowed with a certain amount of awe and respect for monetary policy.  I don’t think–as a general rule–the FED’s current open market operations should be up for purview by politicians.  I think it’s just fine and dandy that stuff comes out later because I certainly don’t want monetary policy neutralized or politicized. I would, however, like Ron Paul’s 3rd century world view of economics to be neutralized.  However, I think all the adults in Washington, D.C. have moved.  That would include the ones in the Board of Governor’s Building.

So, why am I saying all this?  Well, I’m about to announce how absolutely appalled I was to find that the FED not only opened it’s discount window to our shadow banking industry and some commercial banks abroad, but it opened the windows, doors, and vaults to just about any bank or pseudo-bank on the planet that had the misfortune to be taken in by our financiers of greed and destruction.  I know the Fed dabbles around the world.  We’ve had to prop up Mexico and Citibank’s adventures from time-to-time which seemed way out of its jurisdiction even with the broadest interpretation of their charter.  I know they “watch” our exchange rates while talking up the competitive exchange rate regime at times.   Some how, this feels WAY different.   I feel in need of a shower even reading about this.

U.S. Federal Reserve Chairman Ben S. Bernanke’s two-year fight to shield crisis-squeezed banks from the stigma of revealing their public loans protected a lender to local governments in Belgium, a Japanese fishing-cooperative financier and a company part-owned by the Central Bank of Libya.

Dexia SA (DEXB), based in Brussels and Paris, borrowed as much as $33.5 billion through its New York branch from the Fed’s “discount window” lending program, according to Fed documents released yesterday in response to a Freedom of Information Act request. Dublin-based Depfa Bank Plc, taken over in 2007 by a German real-estate lender later seized by the German government, drew $24.5 billion.

The biggest borrowers from the 97-year-old discount window as the program reached its crisis-era peak were foreign banks, accounting for at least 70 percent of the $110.7 billion borrowed during the week in October 2008 when use of the program surged to a record. The disclosures may stoke a reexamination of the risks posed to U.S. taxpayers by the central bank’s role in global financial markets.

“The caricature of the Fed is that it was shoveling money to big New York banks and a bunch of foreigners, and that is not conducive to its long-run reputation,” said Vincent Reinhart, the Fed’s director of monetary affairs from 2001 to 2007.

The FED’s always had an ‘usual and exigent circumstances’ clause that’s given a lot of leeway in times of financial crisis.  Some how, I don’t even think Woodrow Wilson figured it would be used to lend money to a fishing-cooperative financier in Japan.  You can also read Yves Smith at Naked Capitalism on exactly what went on at the Discount Window and with whom. She focuses on the ‘haircuts’.  That would be the lousy deals made by the Fed to bail out a lot of lousy dealers.  The numbers on how many of these borrowers were junk status awes.

The information was released yesterday and Bloomberg has provided a first cut on a small but juicy portion of it, the Primary Dealer Credit Facility. From a risk standpoint, the loans mace under this program violated the central bank guideline known as the Bagehot rule: “Lend freely, against good collateral, at penalty rates”. That is the prescription if the borrower is facing a bank run, meaning a liquidity crisis. The fact that 72% of the Fed’s loans on September 29 from the Primary Dealer Credit Facility were junk or equivalent (defaulted and unrated securities or equity) is further proof that many financial firms were facing a solvency, not a liquidity, crisis.

She also shows–in her words quelle suprise–which American Banks were the little failed piggies too.  I’m going to throw one of the ‘haircuts’ or discounts a the front of this quote just to curl your toes a bit.  I think we can effectively say that Wall Street trashed the value of nearly every firm in the country pretty effectively.

A 95% haircut on AAA rated ABS CDOs means the paper was effectively worthless.

This first cut by Bloomberg also shows that Morgan Stanley was the biggest user of the facility, receiving $61.3 billion of funds for securities “worth” $66.5 billion, 71.6% of which was junk or unrated. As eye-popping as those numbers are, the funds received are less than half the fall in Morgan Stanley’s liquidity pool in the two weeks after the Lehman failure, per Economics of Contempt. Merrill Lynch was second, getting $36.3 billion in funding for $39.1 billion of collateral, 83.4% of which was junk or unrated.

These are not the routine activities of central banks and central bankers. We basically bankrolled a bunch of businesses and financial outfits in a bunch of countries because they wanted in on the Wall Street greed and Wall Street failed them big time.  I’m left wondering why all this money was thrown to the foreign gamblers while Americans were being foreclosed on, frankly.  Let me also let you know that this is probably just the tip of the iceberg since there’s undoubtedly more documents that need to be discovered and analyzed.  My hope is that when the congressional hearings on this get started, we have some real brain power behind the questions that need to be asked on this because questions do need to be asked about this.  I’d like a few FED Governors around for the ride to see how many of them were on board with all of this or even knew of it.  What we need right now are a few Ferdinand Pecoras.

I also wonder who masterminded all this? Paulson?  Geithner? Bernanke? Were they that wedded to ensuring Wall Street didn’t look like a casino and American business didn’t look like a sham that they had to give away the house, the children, the pets, and the fatted calf?   They basically threw every one’s kitchen sink overseas.  Worse than that, they’ve really  not solved the basic systemic problem and the banks are already niggling over the details of the few thinks done by Dodd-Frank.  Feel used yet?