"Sometimes Government Works"

Sydney M. Williams

Thought of the Day (2)

“Sometimes Government Works”

December 2, 2010

The release yesterday by the Federal Reserve of 21,000 “individual credit and other transactions conducted to stabilize markets” in the wake of the credit crisis two years ago is virtually a text book example of the way government works best.

As credit markets froze at the time of the Lehman bankruptcy, banks and businesses were unable to access short term monetary needs. On September 22, Treasury Secretary Henry Paulson announced a $700 billion proposal to create TARP (Troubled Asset Relief Program). The terms and purposes changed as conditions did. Not all the money has been paid back, but enough has to indicate it was a success. On October 3 Congress approved the plan. (Those twelve days between the proposal and the passage of TARP were nerve racking! During those ten trading days the DJIA traded down on seven days for a combined loss of 1866 points and up on three days for a combined gain of 803 points.) During the same time, the Federal Reserve greatly expanded its balance sheet, as the lender of last resort. The VIX reached 89.53 in early October and the TED Spread (today at 15 basis points) peaked at 465 basis points. Fear ruled the day. However, by the end of 2008, the TED spread, while still high, had narrowed considerably to 131 basis points, suggesting credit markets were recovering.

Henry Paulson, working with Fed Chairman Ben Bernanke and New York Fed President Timothy Geithner deserve a great deal of credit – along with President Bush – for maintaining their cool at a time when a meltdown appeared likely.

Documents from the Federal Reserve indicate that Goldman Sachs (despite claims from CEO Lloyd Blankfein that they were doing “God’s work” and that the firm could have survived without help from the Fed) tapped the Fed’s Primary Dealer Credit Facility (PDCF) 84 times and Morgan Stanley 212 times between March 2008 and March 2009. Citigroup used the facility almost daily, tapering off in April 2009. Bank of America, between September 18, 2008 and May 12, 2009 used the facility more than 1000 times. Other lending facilities made available include the Term Asset-Backed Securities Loan Facility (TALF); Commercial Paper Funding Facility (CPFF) – used by industrial companies in need of over-night financing, with GE borrowing $15 billion a dozen times; Term Securities Lending Facility (TSLF) – providing loans up to 28 days, and the Term Auction Facility (TAF) which allowed banks to bid for loans without the stigma associated with the Fed’s discount window.

The total amount lent out by the Fed, in early 2009, reached $3.3 trillion. A number of people have expressed outrage that American tax dollars were used to bail out foreign banks, but what was critical, at the time, was to avoid systemic risk. That they did. Because speed of response was critical, it meant the Fed (and the Treasury) had to operate without full knowledge of all the facts, so loans were made to some that later proved unnecessary. Wall Street firms, in retrospect, took advantage of the system, using some of the money for “riskless” trades and to pay outrageous bonuses. However, the fact is, though we came close to the edge of the abyss, we did not fall. Had Treasury and the Federal Reserve not have been there who knows what might have happened.

The real lesson which we should have learned, but I fear we have not, is that we should never again allow ourselves to be held hostage by banks that have grown so big and so complex that they can endanger the system. Instead, big banks have become even bigger; the history of the last two years tells them that, in distress, government (taxpayers – you and me) will be there. Unfortunately the Dodd-Frank bill appears to further insulate these institutions against capitalism’s most effective governor – the risk of bankruptcy.

Nevertheless, anyone who sat on a desk in any financial firm, anywhere in the world during the fall of 2008 knew how close to total collapse we came. The fact we did not was due to the quick and effective action taken by the Federal Reserve and the Treasury. Yesterday’s press release from the Board of Governors of the Federal Reserve System tells a remarkable story.

It was government at their best.