Fallout: The Financial Crisis

Fed’s spending is risky business

Steve Henn Dec 22, 2008
Fallout: The Financial Crisis

Fed’s spending is risky business

Steve Henn Dec 22, 2008


Tess Vigeland: The auto industry just got the last few billion left of the first half of the bailout money. It’ll be up to the new Obama administration to ask Congress for the second $350 billion. But that’s not the half of it. Literally. While the country has been focused on that highly publicized $700 billion rescue package, the Federal Reserve has quietly spent more than a trillion dollars behind the scenes to rescue a long list of industries. This shadow bailout has gotten little attention and even less scrutiny. But, piece-by-piece the Fed has taken over huge chucks of America’s financial system. And as Marketplace’s Steve Henn reports, it has also taken on enormous and unprecedented risks.

Steve Henn: It all began more than a year ago when the Fed started auctioning emergency loans to the world’s biggest banks after the credit markets froze. Here’s Marketplace’s Jill Barshay reporting that day.

Jill Barshay: Any financial institution can go to it. You can pledge any kind of collateral — even like sub-prime mortgage bonds to get your Fed money — and it’s a big party.

When the party started, the program was limited to $40 billion. Today, it’s lent out close to half a trillion. And it’s just one of a dozen new lending programs the Fed’s launched.

Along with doling out all this money the Fed’s also relaxed standards for the kinds of collateral it accepts. It’s bought up toxic assets from Bear Sterns and now holds billions in exotic debt most private banks wouldn’t touch. Catherine Mann’s an economist at Brandeis.

Catherine Mann: Now the balance sheet of the Federal Reserve has mostly bad assets on it.

That’s a first for the Fed, according to Alan Blinder, the former vice chairman there.

Alan Blinder: The Fed is buying all sorts of things that no one ever imagined the Fed would buy. And it is doing it in magnitudes that only six months ago we would have thought completely unimaginable.

So why is the Fed taking these risk? Because, according to Blinder, Congress’s $700 billion bailout didn’t work.

Blinder: The Fed, unlike any other institution in government, can serve as a lender of last resort in unlimited amounts, by creating money.

During the Great Depression, the Fed sat on its hands. Alan Meltzer, an economist and Fed historian, said that transformed a financial crisis into deflation, and created the worst economic downturn in modern history.

Alan Meltzer: In 95 years of their history they have never come up with a meaningful, clear program of what they are going to do in a crisis to help the financial markets.

This time, Meltzer says the Fed has used its powers with abandon, but its approach has been all over the map. So how much have they spent? Lets add it up: a half trillion on those emergency loans to big banks; $200 billion in swaps — treasury bills for mortgage-backed securities; $30 billion to clean up Bear Stearns. Then it was billions more for AIG and money market mutual funds and short-term loans to businesses. Then last month the Fed announced three new huge programs: pledging hundreds of billions for Fannie Mae and Freddie Mac, the credit card industry and CitiGroup.

Again Historian Alan Meltzer:

Meltzer: They moved from thing to thing as problems arose in each area.

The total tab: More than $1.2 trillion, with promises of up to $4 trillion more. In return for these loans the Fed’s accepted a huge range of risky, possibly worthless, assets as collateral.

Meltzer: It is taking as collateral — and in some cases purchasing outright risky assets, which is something it has never done in its history.

And Blinder says the Fed could easily lose money on these deals.

Blinder: What happens if they run a loss — those losses go to the taxpayer basically.

And that puts the Federal Reserve in an uncomfortable position. It’s made huge bets in its bid to save the economy, but in the process, it’s put more than a trillion dollars of taxpayer money at risk.

In Washington, I’m Steve Henn for Marketplace.

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