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Thursday, December 2, 2010

Lending by the Federal Reserve

In 20-20 hindsight, much is now being made of the enormous sums lent by the federal reserve bank in 2008 and 2009 to a whole host of banks and other companies. People like senator Bernie Sanders of Vermont are upset because the fed lent funds without requiring the borrowers to undertake actions like hiring additional people or changing the terms of mortgages that they held in exchange for the loans. Sanders is also upset that some borrowers were not domestic. All this misses the point. In 2008, the commercial paper market dried up. Commercial paper is short term borrowing by various companies; much of the market consists of 30 or 60 day notes. That means that companies that had traditionally used commercial paper to finance their activities were facing an inability to borrow to cover the cost of maturing paper. Think of it this way: a company like General Electric might have billions dollars of debt coming due with nowhere to borrow that money anew. In other words, because of the broken markets for commercial paper, many companies were facing bankruptcy. The potential bankruptcies had nothing to do with the creditworthiness of the companies, only the lack of any available credit. Letting these companies go bankrupt would have cost billions of dollars in losses and millions of jobs lost. Indeed, bankruptcies like these would have fed upon each other leading to a tidal wave of losses and the complete meltdown of the economy. The fed did the right thing by stepping in to stop this from happening.

People like senator Sanders who wanted the fed to insist that the borrowing companies undertake various actions to achieve governmental social goals do not understand the gravity of the problem that the fed was facing. Nor do they understand the role of the federal reserve. It is not up to the fed to decide what programs or individuals should be favored. Indeed, the government should not even make such calls, although that is clearly not the view of the Democrats or socialists like senator Sanders. The delays that would have been necessary to set up the programs that Sanders wanted and even the extra costs associated with such programs could easily have tipped the entire economy into the depression that the fed was trying so mightily to avoid.

I will probably not be joined by many when I say this, but I think that we owe a big thank you to the fed for a job well done.

Oh, one last note: the big brouhaha over the loans to banks with foreign headquarters like Barclays and the others also misses the point. these institutions do an enormous amount of business in the US. They have large US subsidiaries. If the parent banks went under in Europe or Asia, the repercussions in the US would have been major. Once again, the fed did the right thing.

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