Fed Loans $188 Billion A Day: Who Needs Bailout?

The Fed has been loaning banks and money managers an average of $188 billion a day over the last week. That is four times what the sum averaged a week earlier.

Absent a bailout from Treasury, Fed Chairman Ben Bernanke has held the line against the fallout from the credit crisis and it appears that the banking system is the better for it. At the very least, the complex tapestry of the US financial markets has not been torn into pieces.

According to Reuters, "This looks like the balance sheet of a central bank that is keeping the financial system on life support," said Michael Feroli, U.S. economist with JPMorgan.

With the Fed as the de facto lender of last resort, does the financial system need a bill for $700 billion to buy bad bank assets? Perhaps not.

The purchase of toxic assets works because it takes a problem away from banks and allows them to use capital for credit instead of keeping reasonable reserves against write-downs. Restructuring balance sheets by jettisoning bad paper works, but it may not be the sole solution to the puzzle.

Liquidity can be produced a number of ways. Pumping money into the banking system may be a reasonable alternative to buying out a compromised asset base. Some financial firms will fail because the amount of money needed to keep them solvent is not available. Washington Mutual’s balance sheet was so badly damaged that no other institution, including the government, was willing to take on those liabilities though making loans. But a stronger institution, JP Morgan (JPM), was happy to buy them at a big discount.

If Treasury cannot have its way because the Congress slaughters its proposal, moving to the Fed for aid is the next best thing. The problem with the hundreds of billions of dollars that the central bank is loaning out is that it is due back, in some cases in less than a month. But, the government has modified many rules during the crisis to put in a fix which was not otherwise available.. The money the Fed needs will ultimately come from the taxpayer, but that is the case with any plan meant to save the system. Over time, as the loans from the Fed are paid back, the average citizen should not have an excessive burden.

Extending the maturity of money loaned out by the Fed may be an imperfect way to solve the credit crisis, but there is still no evidence that the Treasury’s plan to buy toxic paper has a 100% chance of working.

The market does not need the Treasury. It already has the Fed.