Fed Up With Wall Street

Fed Up With Wall Street: The American Economy Will Be

Better Off If The Federal Reserve Stops Squandering

Taxpayers' Money On Bailing Out Failed Investment Banks.

By Dean Baker

This column was published on March 18, 2008

The Guardian Unlimited

http://commentisfree.guardian.co.uk/dean_baker/2008/03/fed_up_with_wall_street.html



The collapse of the housing bubble in the US continues

to wreak havoc on the financial geniuses who fostered

its growth. All over Wall Street, the mantra "Who could

have known?" is being heard with every more frequency

and greater expressions of pain.



Things got really serious last week, when Bear Stearns

was placed on life support, and was then disposed of in

a fire sale last weekend. One of the longstanding

giants of Wall Street investment banking now has less

value than a street corner lemonade stand, if not for

the generosity of the Fed. The Fed lent money to Bear

Stearns and its purchaser, JP Morgan Chase, under terms

that no private lender would have agreed to. The risk

that the Fed will end up with a substantial loss on its

advances to Bear Stearns is quite large, with no

prospect for any real return on its investment.



This raises the obvious question: why did the Fed, an

agency of the US government, use our tax dollars to keep

Bear Stearns and its rich managers and shareholders

above water? After all, the government supposedly

doesn't have enough money to provide kids with

healthcare and child care, to guarantee families decent

housing or to meet a long list of other needs. Why do we

have the money to lend tens of billions of dollars to

prop up Bear Stearns at discounted interest rates?



There are two points about this bailout that should be

clear. First, this is a bailout - we are handing money

to Wall Street. Second, we don't have to hand tens of

billions of dollars to the country's richest people to

save the financial system.



The politicians will try to do their best to obscure the

first point. They say "we aren't giving them money -

we're lending money and we're getting interest, so the

government can make a profit."



This is what politicians tell people who they think are

stupid. No private bank would have lent money to JP

Morgan Chase or Bear Stearns at the same interest rate

and under the same terms as the Fed. (We know this for

certain; otherwise Bears Stearn would not have run to

the Fed.) When the government makes a loan at below

market interest rates, it is giving away money. People

on Wall Street know this very well, that is how they got

to be fabulously rich: they borrow money at a lower

interest rate than they lend it out.



If they can't get away with the "no bailout" nonsense,

the Wall Street welfare boys will then try the route of

claiming that we have to bail them out in order to

prevent the whole financial system from collapsing. Such

a collapse could turn the recession into a depression,

leaving millions unemployed for years.



This is also nonsense. We know how to keep banks

operating even as they go into bankruptcy. The UK just

did this with Northern Rock, a major bank that managed

to get itself into huge trouble because of its holding

of bad mortgage debt. After it was clear that the bank

was insolvent, the Bank of England stepped in and

essentially took over the bank. It replaced the

incompetent managers who had ruined the bank and brought

in a new team to straighten out the books. The plan is

to resell the bank to the private sector once the books

are in order.



In the mean time, the bank keeps operating. The

depositors can continue to make deposits and withdrawals

just as before. This prevents any chain reaction from

bringing down the financial system.



The difference between the Northern Rock route and what

happened with Bears Stearns last week is that in the

Northern Rock, the highly paid managers that ruined the

bank are sent packing. What will happen to those at Bear

Stearns is not clear - its new owners are planning a

wave of staff cuts, but many will be keeping their jobs.

Similarly, the shareholders will get little or nothing.

They own a bankrupt company, why should the government

give them money?



As the financial crisis deepens, it is important that

the public realize the distinction between what the Bank

of England did with Northern Rock and the handouts from

the Fed to Bear Stearns and JP Morgan Chase. There are

other banks in serious trouble who are also looking to

the Fed for help.



The best thing that the Fed can do is to go the Northern

Rock route. Instead of giving more money to troubled

banks, it should give less. It should end the Term

Auction Facility and its other special mechanisms for

injecting money into banks. The economy will recover

quickest if we let the banks and the bankers get the

full benefit of their own bad judgment. When they have

written down their bad debts and are taken over by new

management, the banks will again be able to play a

productive role in financing growth.



Dean Baker is Co- Director of the Center for Economic

and Policy Research, in Washington , D.C.