(March 21, 2008) – On Monday I wrote about the Achilles heel of the Fed’s new loan facilities. Every dollar they lend to troubled banks through the new facilities sucks one dollar of existing reserves out of healthy banks through offsetting open market operations. Total reserves do not go up at all. Reserves in the hands of healthy institutions actually decline.
Declining reserves at healthy institutions is a problem because it will force them to either call in existing loans or tighten non-price lending standards. Either way it runs the risk of shrinking the availability of the business loans that comprise the working capital for the private companies that make up all job growth. Translation, local and regional banks and their business customers shrink.
Of particular issue–the Fed’s new facility they announced last Sunday to mainline reserves directly to the big New York investment banks. Yesterday we got the first numbers on the size of the borrowings. Click here to read the full article.
Big Wall Street investment companies are taking advantage of the Federal Reserve’s unprecedented offer to secure emergency loans, the central bank reported Thursday. Those large firms averaged $13.4 billion in daily borrowing over the past week from the new lending facility. The report does not identify the borrowers.
The Fed, in a bold move Sunday, agreed for the first time to let big investment houses get emergency loans directly from the central bank. This mechanism, similar to one available for commercial banks for years, got under way Monday and will continue for at least six months. It was the broadest use of the Fed’s lending authority since the 1930s.
On Wednesday alone, lending reached $28.8 billion, according to the Fed report.
Thursday’s report offered insight on how much credit was extended to Bear Stearns via JP Morgan through the transaction the Fed approved last Friday. Average daily borrowing came to $5.5 billion for the week ending Wednesday.
Separately, the Fed said it will make $75 billion of Treasury securities available to big investment firms next week. Investment houses can bid on a slice of the securities at a Fed auction next Thursday; a second is set for April 3. The Fed will allow investment firms to borrow up to $200 billion in safe Treasury securities by using some of their more risky investments as collateral.
On its face, the program sounds like a good idea. But by simultaneously reducing reserves–bleeding the healthy banks to support the sick ones–the Fed will transform a capital market problem into shrinking employment. This is sad, because all they have to do to fix it is to suspend the operations to offset the reserve impact, which would keep the reserves of the healthy banks intact. As it is, we should view the new lending facility as a contractionary policy.
JR
