Lined up for Fed handout
News item: Big banks have been lining up at the Federal Reserve's discount window to borrow money.
Normally, this would be toxic news for the banks that have borrowed a few billion between them. The discount window is usually a place where desperate banks go when they have nowhere else to turn. It is the place where you don't want to be seen.
Not so this week. A couple of days ago, Deutsche Bank was identified in print as a discount-window borrower. Then Citigroup put out a statement yesterday confirming it too had borrowed $500 million in a similar fashion. Within minutes, Bank of America Corp., Wachovia Corp., and JPMorgan Chase & Co. did the same.
This was nothing dire. The banks were marching to the beat of the Federal Reserve, which had lowered the discount rate last week as a way of easing the market's growing credit crisis. Those institutions borrowed money via the discount window to make it available to customers who might otherwise get stuck if they relied on markets to refinance short-term debt.
The banks don't appear to need the money, and they have cheaper places to go for cash. To their credit, big commercial banks got in step with the Fed to be part of the solution to a serious financial problem. Their leadership was intended to encourage other banks to do the same as necessary.
The great irony of that lies in the root of the problem itself, the subprime debt fiasco and the fear that spread into other kinds of credit markets. Mortgage companies and capital markets took over a function once performed by banks and ran off the rails in a big way. Now looks who's being leaned on to help clean up the mess.
When banks wrote and held mortgage loans, which wasn't that long ago, regulators made sure stupid decisions didn't become too stupid or too common. When banks did get in trouble, the same regulators evaluated collateral and decided whether lenders still had enough capital.
More recently, mortgage companies wrote loans of all kinds of quality that were packaged into securities on Wall Street and resold to investors. The buyers of those securities effectively became the system's regulators of quality and, at some point, they stopped paying attention.
It's hard to say who those buyers are. But hedge funds own lots of credit securities, including some that have suddenly became so unpopular they were almost impossible to trade.
In those cases, the job of appraising collateral and checking capital falls to big brokers that lend to leveraged hedge funds. They decide what assets are worth, and demand more cash if necessary. When times get tough, brokers protect themselves and everyone else is on their own. One ugly example: Sowood Capital Management, the Boston hedge fund that went bust last month.
That's not to say everything was great in the days when banks were in charge of credit. Bankers reliably did dumb things at the top of economic cycles going back decades, and the savings and loan fiasco of the 1980s speaks for itself.
Today, big banks like those borrowing from the Fed's discount window are just as involved in capital markets as anyone else. The credit they used to hold, from mortgages to car loans to credit card receivables, is commonly repackaged into securities.
Everyone agrees that the market system is more efficient. It is ideal until it doesn't work, and then it becomes a mess. In that case, investors who normally think the Federal Reserve should butt out raise their voices to ask what's taking so long.
For the moment, bankers and their balance sheets are an important part of the solution.
