Federal Reserve Chairman Ben Bernanke drew high marks from economists for stepping in on Sunday to ease collateral requirements for the emergency loans the Fed extends directly to investment banks — including an unprecedented agreement to accept as collateral the banks’ own shares.
The action, taken as banks were scrambling to protect themselves and the global financial system against the collapse of Lehman Brothers Holdings Inc., New York, gives the firms easier access to cash at a time when they have few credit alternatives.
It also extends the Fed’s role in regulating Wall Street — an oversight expansion that got a boost when it engineered New York-based J.P. Morgan Chase & Co.’s purchase of Bear Stearns Cos. Inc.last March.
“Just as there are no atheists in foxholes, there are no libertarians in a true financial crisis,” said Jay Bryson, global economist with Wachovia Corp., Charlotte, N.C. “If the Fed had sat back, the stock market’s reaction today would have been a lot more extreme.”
Even so, U.S. stocks suffered their sharpest one-day decline in seven years, with the Dow Jones industrial average slumping 504.48 points, or 4.42%, to 10,917.51; the S&P 500 dropped 59 points, or 4.71%, to 1,192.70; and the Nasdaq composite fell 81.36, or 3.6%, to 2,179.91. The decline marked single one-day point drop since a fall of 684.81 points on Sept. 17, 2001, the first day of trading after the Sept. 11 terrorist attacks.
The Fed said it would accept equities as collateral for the first time in the Primary Dealer Credit Facility, its 6-month-old program for lending cash directly to securities firms. Until now, it had accepted only investment-grade debt.
In addition, the Fed will accept investment-grade debt securities as collateral for the Term Securities Lending Facility, which auctions loans of Treasuries. These auctions will now take place every week instead of at two-week intervals.
Among the 15 or so firms eligible for these loans are Deutsche Bank Securities Inc., Goldman Sachs Group Inc., Morgan Stanley and UBS Securities.
How significant an impact the Fed’s move will have depends on how many firms actually borrow money.
“We’re in the middle of a hurricane right now and anything can happen,” said Richard Yamarone, chief economist at Argus Research in New York, adding that the Fed’s action could “go a considerable way in easing pressures that may be mounting at banks.”
One of the bigger incentives for firms to borrow: The Fed’s action will let them keep coveted Treasury bonds rather than having to use them as collateral, said Mr. Bryson, who was an economist at the Fed in the 1990s.
The risks to the Fed are modest, economists said. If firms take out loans and then collapse, the Fed may be left holding equities and debt securities that it would then have to sell.
But the Fed would have the discretion to hold the securities and sell them at a favorable time, said Cary Leahey, an economist at Decision Economics Inc., a consulting firm in New York. “The Fed’s running the largest hedge fund in the world.”
Looking to the long run, the Fed’s action seems like another step in its inevitable move to tighten regulation of Wall Street. “There will be more regulatory oversight of investment banks — at least those that are left,” Mr. Bryson said.
Neil Roland is a reporter for Financial Week, a sister publication of Pensions & Investments
