Busted: Bankers and The Global Economy

December 22, 2010

Federal Reserve Contributed to Economic Crash

Filed under: banking, central bank, economy, federal reserve — Tags: , , , , , , , — digitaleconomy @ 1:19 pm

Back in early 2005, President George Bush excitedly told the nation how great the country was doing. Behind the scenes was another matter.  The housing market was overheated. Economic danger signs were in the air. The Fed had an opportunity to reduce the risk among banks, notably smaller ones. The Federal Reserve Board is also guilty of regulatory inaction that directed contributed to the mortgage meltdown.

The leadership of the Federal Reserve rejected advice from one of the nation’s top banking regulators, a professional accounting board and the Fed’s own staff for restrictions on commercial bankers use of special debt securities to raise capital. The exponential growth and lack of tracking ability for these securities threatened the fabric of banking operations.

Chairman Alan Greenspan and the other six Fed governors voted unanimously to reaffirm a nine-year-old rule allowing liberal use of what are called trust-preferred securities. Previous to that time community banks had few ways to raise capital without issuing more common stock and diluting share price. The Fed allowed the banks to count the securities as debt that they could loan against, even while counting the proceeds as reserves. Through the fractional reserve, banks were then free to borrow and lend in amounts 10 times or more than the value of the securities being issued. This kind of leveraging became the norm. The Fed enabled Wall Street bankers to encourage community banks to take on huge debt and to plunge the borrowings into real estate loans.

Institutions relying on these instruments took more risks and failed more often than those that did not include the use of these trust-preferred securities. Investment banks on Wall Street aggressively pooled these community-bank securities into complex bonds, much like the complex mortgage bonds that nearly brought down the financial system in 2008.

The consequences have continued to build for small bankers. More and more banks are defaulting, requiring intervention by the FDIC. The bank failures have already left more than $1 billion of the complex bonds on the books of the FDIC bank rescue fund.

The Securities and Exchange Commission is now investigating how securities firms promoted the sale of these complex bonds in a poorly understood,  billion dollar offshore market for debt issued by banks, insurers and real estate trusts without checking their greed. Everyone was making money and delighted by the results. As the market became saturated, bankers refused to conduct business, becoming sitting ducks in a frozen banking system. Eventually, in October 2008, the system faced a complete collapse.

McClatchy Newspapers Article

FDIC report

Fed’s mysterious policy: How do we know if it’s working?

Advertisements

Create a free website or blog at WordPress.com.