During Crisis, Collateral Was Afterthought for Fed

FOXBusiness

The release Thursday by the Federal Reserve of a massive trove of documents related to emergency lending at the peak of the recent financial crisis was a stark reminder of how close the global financial system came to sliding into the abyss.

Fed watchers said Friday that the documents revealed no great secrets, but instead re-emphasized the depth of the vast banking calamity wrought by bad investments in toxic mortgage-related securities.

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Former bank regulator Mark Williams, who teaches finance at Boston University and is the author of a book on the collapse of Lehman Brothers, said the information casts a poor light on the Fed.

The revelation that numerous foreign banks, notably a Middle Eastern bank with ties to Libya, eagerly and repeatedly tapped the Fed’s discount window is “additional evidence that the Fed stepped outside of its core mandate,” said Williams.

Williams argued that the Fed’s core mission is to ensure a “stable U.S. economy and full employment in the U.S.” Lending billions of dollars to European, Middle Eastern and Asian banks reaches far outside that mission, he said.

Dexia, Erste Group and Depfa, were among the foreign banks that turned to the Fed in a big way in late 2008 as credit markets dried up and banks had no other alternative but to seek U.S. government bailout dollars.

Other big foreign borrowers were Norinchukin Bank of Japan, Bank of Scotland, and Germany’s Landesbank Baden-Wurttemberg and France’s Societe Generale.

The Fed released the documents Thursday after a lengthy court battle initiated by media outlets including FOX Business, which sought the data under the Freedom of Information Act.

“It appears to me that during the heat of the financial crisis all you had to do is knock on the   Fed’s door and they’d give you access to the discount window,” said Williams.

That posed a large risk to the Fed -- and ultimately U.S. taxpayers -- he noted, because the central bank seemed willing to accept “almost anything as collateral, and that’s counter to strong banking principles.”

Williams said the documents reveal that the Fed was accepting a wide range of securities as collateral from banks borrowing from the discount window -- “everything from AAA Treasury bonds to mortgage-backed securities,” he said.

“The disclosures pointed to the fact that the collateral quality was not consistently high,” he added.

According to the documents, banks ranging in size from JPMorgan Chase & Co. (NYSE:JPM) to Stearns Bank of St. Cloud, Minn., tapped the Fed’s discount window after government officials eased borrowing restrictions in an effort to pump liquidity into the world’s faltering financial markets.

The Fed and many of the banks themselves fought for two years against releasing the documents detailing who borrowed when and how much, arguing that confirming that a bank needed to borrow from the discount window amounts to a “stigma” that could damage the bank.

Satya Thallam, an economist at George Mason University, said that argument was weakened Thursday because the documents showed that a huge array of banks tapped the discount window, a fact that precluded any lone bank from being singled out as damaged goods.

In effect, he said, virtually all banks were damaged goods at the time.

“Going to the Fed window, if everyone is doing it, shouldn’t create a stigma,” said Thallam. “The entire financial system was unhealthy, not just a single bank.”

Before Thursday, the Fed had never release information related to its discount window, commonly referred to as the lender of last resort. Thallam said he supports a two-year lag for releasing that information.

“Two years from now, any bank that went to the discount window, it’s going to be a fundamentally different bank,” he said. “It’s not feasible to think that two years from now releasing the information will directly cause a panic among a bank’s counterparties and creditors,” he said.

What’s more, he said, given the Fed’s increasingly prominent role in setting U.S. fiscal policy, especially during the recent economic crisis, taxpayers “have a much more credible claim on knowing where our money is going and to whom and for what purpose.”

Finally, once released the information on which banks are borrowing from the discount window could be useful in determining if some banks are taking on too much risk, the problem widely believed to have caused the crisis in the first place, said Thallam.

Greg McBride, senior financial analyst at Bankrate.com, said the financial system was facing “a crisis of confidence” at the time.

“No one wanted to lend because they were afraid the other guy wasn’t gonna be around to pay it back,” he said.

The documents stress that point in that so many banks found it necessary to hit up the discount window.

“People can complain about it all they want but it’s much better than the alternative,” said McBride. “We’re sitting here today with job growth and a rebounding stock market. We wouldn’t be sitting in this same neighborhood had the Fed and U.S. Treasury not intervened to the extent they did they in 2008.”

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