Saving Private Ryan: The Fed Puts All Hands On Deck For Banks

With Bear Stearns, Fannie Mae (FNM), and Freddie Mac (FNM) fundamentally gone as independent institutions, the Treasury and Fed have turned their attention to Lehman (LEH) and Washington Mutual (WM). Nothing to that effect has been said in public, but the depth of the troubles at the two firms assures that they are getting scrutiny.

As the situation at a number of banks and brokerages worsens the government still has not discovered a basic program to salvage the system.

To offer a counter-weight to the deteriorating balance sheets of companies which the government believes cannot pile up as serial failures, the Fed is considering opening its doors even wider. According to Bloomberg, "The Federal Reserve may have to increase the cash it provides to banks and brokers, already a record, to help them balance their books at the end of the year."

In essence, taxpayers will step in to block the breach in the wall.

The open issue is how much the Fed can "give." By IMF estimates there could be another $500 billion in write-offs at banks due to losses on mortgage-backed paper. The Fed might have to provide a substantial portion of that as firms prepare to issue their end-of-the-year earnings.

The US government does not have many choices. In the broadest sense, it cannot solve the root problems of falling home prices. Even with its intervention to shore up the two large mortgage agencies, borrowing rates for purchasing homes will not drop substantially as long as banks are gun shy about taking on meaningful risk.

Lending from the Fed has not saved the banking system so far. It has put a weak net under some institutions, That has hardly been enough to turn back the need for many banks to raise money though equity offerings, preferred shares, and the sale of key assets.

The Fed will almost certainly open its borrowing window because it has no other recourse,  which will continue to beg the question of whether good money is following bad.

Douglas A. McIntyre