Will The Fed Put Up $500 Billion?

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The Fed has already provided a facility of $200 billion to banks to help them improve balance sheets by exchange some of their less-than-liquid and less-than-valuable paper for real honest-to-God money from the government.

Now, the agency is passing on capital to primary dealers, opening its window to a category of companies which may have larger problems than the money center banks do.

S&P recently said that the total loss from subprime paper could hit $285 billion. Not all of that will be in the US and some has already been written off. But, it does not take into account that the recession in the US may be getting very deep and that mortgage defaults could be much higher than forecast.

There are other pools of capital which will vex banks and brokerages. LBO debt is high on that list. The FT wrote that banks still hold $200 billion in impaired debt from this source.

The ripple effect of credit card loses and car loan defaults is only just being felt. Some of this began to show up in the Q4 earnings at American Express (NYSE: AXP). Many of these loans are not secured and are bundled the way that mortgages were. That means that the value of those instruments, some of them held by banks, will likely drop sharply.

US hedge funds and sovereign funds are unlikely to step in to fill the breach. The investments would be too dangerous and uncertain in nature. It is a game that even a riverboat gambler would not want to play.

That leaves the Fed. It stands in the center of a crisis which may only be beginning. Could its $200 billion commitment double? Almost certainly. And, the idea that its support will have to go much beyond that becomes more likely by the day.

Douglas A. McIntyre