Cheap Fed Cash for Banks, Lending as a Last Resort, OWS and the Tea Party

The Drudge Report set one of the main topics for TV and radio shows today with its headline noting the $7.77 trillion that the Federal Reserve secretly lent to the banks during the financial crisis that was metastasizing in 2008 and early 2009. As we’ve long discussed on this blog and elsewhere at Reason, the Fed was the main bailout source for the banks by creating unlimited lines of credit for banks to tap and keep themselves afloat. It calls into question what the point of TARP was with all of this Fed lending going on (hint: Paulson only could think in terms of stocks and the confidence that drives the marketplace), but the reality is that without Bernanke and the Fed stepping in the way they did, the financial system would not look the same as it does today. Some will argue it would be worse. I’d argue it would be better.

At the very least, there would be fewer crony capitalists about. I’ll continue to fight against the idea that Washington can regulate the soundness of the financial system through something like Dodd-Frank, but the $13 billion that Bloomberg reports the banking system was able to generate from the loans that were supposedly needed to keep the banking system from collapsing is not profit generated from a free market. And that should not be defended.

The OWS crowd is right on target in complaining about illicit gains leveraged the backs of taxpayers. It makes sense that commentators would argue, why should the banks get this special treatment? Where is the access to virtually free money for homeowners to pay their bills and avoid foreclosure? The problem is that the banks shouldn’t have been given a lifeline and neither should homeowners. We don’t want to become a bailout society. The desire for a “main street bailout” looks like a pitch for “fairness” but unfortunately it is more out of a sense of envy than anything else—almost like Scott Peterson being envious that O.J. got off with the help of some shrinking gloves.

How about no one gets a bailout? An era of responsibility?

The justification for the Fed stepping in with its trillions in liquidity stems from a misperception on what the role of a central bank is supposed to be as “lender of last resort.” The LLR idea was developed by Henry Thornton and Walter Bagehot in 19th Century England, and the thought at the time was for an institution with monetary authority to be able to lend freely at a high interest rate to creditworthy borrowers who had good collateral but were unable to find access to needed liquidity for an abnormal reason. The very idea of an LLR assumes market failure, though when it has been needed in the past the supposed market failure can be traced back to a government failure. But the key point is to creditworthy borrowers, with a penalty rate, and demanding of good collateral.

The lender of last resort is not supposed to rain cash down on anyone claiming to be a bank, for virtually free, and without getting much of anything in return. In fact, the Fed has gone a step beyond and just straight bought the crappy collateral from the banks in separate actions that they should have been avoiding even lending against.

The whole LLR role in the financial system has become completely screwed up. And the result is over $7 trillion flowing to broken banks that should have been liquidated now (with their deposits scattered among a handful of smaller banks as individuals seek alternative places to keep their money). The result is financial institutions banking a ridiculous carry trade. And then as a result the banking system starts to look healthier, executives get bonus pay, and the masses get enraged.

From this perspective it is not the bonuses—it is the Fed. It is the government that is so desperate to avoid change that they perpetuate the system and the guys who have screwed up and as a result undeserving compensation gets dished out.

You can see how capping executive pay is not going to solve this problem. Neither will a Volcker Rule. If Occupy Wall Street wants to screw over the banks they hate so much they should push to cut off the lifeline to Washington. If the Tea Party wants to push for real change it should reject conservative talking points that just defend the financial system without recognizing the crony capitalism that has made Wall Street what it is today.

See the whole Bloomberg story here.