Fed’s New Plan Bails Out the Careless, Greedy, and Stupid Banks

Acting in concert with the Bank of Canada, the Bank of England, and the European Central Bank, the Fed has announced a new policy governing loans from its discount window: it is going to take securities of dubious and/or unknown value as security for loans.

Under the Term Auction Facility (TAF) program, the Federal Reserve will auction term funds to depository institutions against the wide variety of collateral that can be used to secure loans at the discount window. All depository institutions that are judged to be in generally sound financial condition by their local Reserve Bank and that are eligible to borrow under the primary credit discount window program will be eligible to participate in TAF auctions. All advances must be fully collateralized. By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress.

This will inject liquidity, stave off deflation (fan inflation? maybe not), and fatten bank balance sheets. Capital for everyone! Especially those who have demonstrated that they can't be trusted with it. (The others won't need it.)

But don't take my word for it.

Interfluidity :: TAF is a really, really big deal:

I agree with several commentators (Felix Salmon, Calculated Risk) that the Bair/Paulson Plan, whatever it is, is not a bailout. But this, this is a bailout,. Nearly all government bailouts take the form of subsidized loans, extending credit at low rates to counterparties or against collateral for which the market would have demanded a high premium. That is precisely what the TAF will do. The Fed's press release claims, of course, that loans will only be available to “sound” banks, and that they will be “fully collateralized”. But no one who can get the same deal from private markets will use this facility. The need for the program arises because private markets are skeptical about the soundness of counterparties and the quality of the assets they have to offer as collateral. The Fed hints at this when it mentions the “wide variety of collateral” that can be used to secure loans. You can bet that whatever it is private lenders are eschewing will be pledged as collateral to the Fed under TAF. The Fed is going to bear private risk that the market refuses to. That is a bailout.

So we're rewarding the people who made dumb choices, and allowing their shareholders who took above-market gains to escape unharmed. Talk about moral hazard.

See also Calculated Risk, Fed and Other Central Banks Inject More Funds into Market.

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One Response to Fed’s New Plan Bails Out the Careless, Greedy, and Stupid Banks

  1. Ben Hyde says:

    Meltdown v.s. moral hazard, delightful choices eh? The weakest economic players are held hostage.

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