Might the Fed profit from the financial crisis?

And, as a source notes, it will discuss the question of whether the executives of financial institutions should be compensated so lucratively, even if their firms suffer severe losses, and whether such rewards encourage excessive risk-taking.

One positive element arising from the financial crisis is that the Federal Reserve has recognized a fundamental change in the nation's lending system over the last 25 years, given the Fed's rescue of the New York investment banking firm, Bear Stearns, earlier this month. One duty of the Fed, established in 1913, was to act as "lender of last resort" to a commercial bank facing a run. If a rumor circulated that a bank was failing, depositors could be assured that the Fed would come to its rescue. Depositors would see that their fears were not justified and stop withdrawing money.

Today, less than half of the nation's credit is provided by commercial banks. Small businesses may still take loans from commercial banks. But big companies get their credit primarily from investment banks, says George Feiger, CEO of Contango Capital Advisors, managers of $1.9 billion in investments.

These banks buy and sell short-term commercial paper, medium-term financial notes, and long-term bonds.

Commercial banks, says the Berkeley, Calif., executive, are "minor players" now in the credit system. "The Fed figured that out just recently," he says. Considering the freeze in the commercial-paper market last summer, the central bank opened up its credit windows to investment banks almost "a year too late," he says.

As a result, packages of business loans, known as collateralized loan obligations, that sold on Wall Street at full face value last July had lost nearly 20 percent of their value by January – "a pure consequence of hysteria," Mr. Feiger says.

What the Fed should do when it rescues an investment bank from bankruptcy, Feiger proposes, is act like a hedge fund: Take half the increase in the firm's value as a result of its action. In the case of Bear Stearns, that would have given the Fed $500 million. Shareholders would split the remaining $500 million.

So far, the Fed has taken some $400 billion in collateral from various banks by propping up the nation's financial system with loans. Unless financial markets calm down suddenly and unexpectedly, it will pile up as much as $2 trillion in collateral before it is over, Feiger predicts. And the Fed may not lose "one penny" on these rescues, he says, since the collateral has real value.

Previous

1 | 2