There Should Be a Quid Pro Quo between the Fed and Financial Institutions
The Fed's creation of various facilities in recent months - the Term Auction Facility (TAF) for depository institutions, the Term Securities Lending Facility (TSLF) for primary government securities dealers and the Primary Dealers Credit Facility (PDCF) - would be expected to alleviate some institutional liquidity issues that otherwise could metastasize into institutional solvency issues. Commercial and investment banks now can borrow against seemingly credit-worthy collateral with a much smaller "haircut" than otherwise. The Fed has created these new liquidity facilities in order to forestall a systemic failure of the financial system, not to enhance financial institution shareholder value.
A byproduct of the new Fed liquidity facilities, however, undoubtedly has been to enhance financial institutions' shareholder value - perhaps save for one. By the Fed taking onto its balance sheet less creditworthy collateral as result of these new facilities, U.S. taxpayers have increased contingent liabilities. (The Fed turns over to the Treasury each year the bulk of its profits. If the Fed were to sustain losses on its collateral, the amount of profits it turned over to the Treasury would be reduced.) Why should the current shareholders of financial institutions benefit at the expense of U.S. taxpayers in general?
In a case where man bites dog, it appears as though the Fed and the Treasury may be looking out for the interests of the U.S. taxpayer. Publicly, both Fed and Treasury officials have urged financial institutions to raise additional capital post haste. I am not privy to private conversations, but I would hope Fed and Treasury officials are directly communicating to the CEOs of large financial institutions with "skinny" capital positions that they will raise more capital. By raising more capital, the contingent liabilities of U.S. taxpayers will be reduced and the existing shareholders of these large financial institutions will bear some of the social costs of these new Fed facilities through a dilution of their ownership in the financial institutions.
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Author: Paul Kasriel
Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
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Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.
Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
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