The Fed That Ate the World

[John Coffey]

From Eric Posner: http://volokh.com/archives/archive_2008 ... 1223409593" onclick="window.open(this.href);return false;

The Fed That Ate the World.

Latest news is that the Fed will take over the commercial paper market. Big corporations raise funds by selling debt securities as well as borrowing from banks. But no one wants to buy these securities—“commercial paper”—because no one knows whether the corporations can pay them back. So big corporations like GE suddenly find themselves unable to obtain the funds that they need to meet payroll, make investments, and so forth. In steps the Fed. The Fed will buy up the commercial paper for the time being. If all goes well, the Fed will hold it to maturity or sell it if anyone ever decides to buy it, and the government will not lose any money. If all doesn’t go well, the Fed can wallpaper its offices with trillions of dollars of notes.

As David Zaring notes, the commercial paper market, worth $1.6 trillion, is even bigger than the $700 billion borrowing authority contemplated by the bailout bill. Yet no one seems to think that the Fed needs new statutory authority to risk trillions, rather than merely hundreds of billions, of dollars. Why not?

Section 13(3) of the Federal Reserve Act authorizes the Fed to lend money to businesses in “unusual and exigent circumstances.” This section was the same one that the Fed used for the AIG deal. There may be some uncertainty whether it is proper for the Fed to make unsecured loans to businesses (and apparently to avoid the appearance of doing so the Fed is lending to a new entity that will buy the commercial paper rather than buying the paper itself), though the statute appears to permit it. But section 13(3) would also permit the Fed to buy up mortgage-backed securities from firms. So the question is, if section 13(3) is the all-powerful authority for everything, why did the Fed bother with the bailout bill? As far as I can tell, the bailout bill was necessary because the Fed and Treasury put their heads together and decided that Treasury should buy the MBS’s, and for that, a statute was needed. But was it worth such hullabaloo to give Treasury authority that the Fed already had?

We are in the realm of psychology, maybe political psychology, not law, and not even economics. The Fed, and maybe Treasury, already have all the authority they need to take over the banking system—or I should say the functions that the banks and investment banks once served. It was important for the Fed and Treasury to get to the markets some signal that Congress backed them, but it really didn’t matter what exactly Congress authorized, as long as its authorization bore some relationship to whatever it was that the Fed and Treasury would eventually decide to do. After all, only Congress has the authority to raise money to pay back U.S. government debts, so it would be nice to know that Congress is more or less on board. On this view, the great debate about the bailout bill – what it did, and did not do, and what it should have done, or not done – entirely missed the point. Treasury and the Fed will decide how to address this financial crisis. A broad congressional endorsement is nice, but Congress had nothing of substance to contribute to policy. Other than the handouts to special interests, I will bet my portfolio of mortgage-backed securities that nothing in that statute will have any impact on how the financial crisis is addressed.

[Bob Beamesderfer]

OK, first off, why doesn't he simply use the common term for "commercial paper" -- corporate bonds. Second, a large conglomerate like GE does not rely solely on bonds to meet payroll. Bonds are one kind of revenue, not all of it. Is Posner supposed to be an economist? If so, he seems to lack a basic understanding of how corporations operate.

[Steve Ekstrand]

Eric Posner is a law professor at the Univ of Chicago. He parades around as an economist with no formal training.... Hmmm.... a lawyer teaching economics, what idiot would do that???

Eric is the son of famed federal judge Richard Posner. I view him as a arrogant asshole who gained portfolio by trading on his father's good name.


Its not taking over. Its not socialism. We have a gross market failure. You can't unring this bell. You can do nothing like Herbert Hoover and spend the next 20 years wallowing in a great depression that will won't make it 20 years because we will fall into World War IV before the depression ends. The US gov't is just trying to do what is necessary to get markets moving. When companies can't trust doing business with companies and banks can't trust doing business with companies, banks, or you and I, then you can do nothing and we eat dirt or you can try to create a backstop to get transaction counts going again. People say let them fail, let the markets shake the dead fruit out of the trees. If you do that with no intervention and no backstopping, then everything will fail. We can't immediate move from being over leveraged to a zero credit world. It is impossible without intervention, to think otherwise defines you as either ignorant or an idiot. Posner would be the idiot. Also don't for a minute think that living in a debt free zero leverage world is what you want. You'll be eating dirt under that scenario as well. The only way out of economic abysses is through growth. If you can't charge the paddles and get a rhythm, then you have to pronounce the patient dead.

[Steve Ekstrand]

BTW-In law school, we primarily used the term commercial paper and not the more stodgy wording of corporate bonds. So, it might just be a frame of reference thing as Posner is a law professor not an economist. I followed the link and read some of his recent blogs. They aren't as bad as I feared, but he's not his father, a man I disparately hoped would get nominated to the supreme court while I was in law school as I watched a series of idiots get appointed.

[Kurt Rahn]

Also don't for a minute think that living in a debt free zero leverage world is what you want.

I'd be living in a cardboard box, taking the bus everywhere and my course walks would double for my timed runs. What class does a bicycle run in?

[KJ Christopher]

BTW-In law school, we primarily used the term commercial paper and not the more stodgy wording of corporate bonds. So, it might just be a frame of reference thing as Posner is a law professor not an economist. I followed the link and read some of his recent blogs. They aren't as bad as I feared, but he's not his father, a man I disparately hoped would get nominated to the supreme court while I was in law school as I watched a series of idiots get appointed.

In my limited experience dealing with global corporate treasury types, they all have used the term commercial paper too.

[Bob Beamesderfer]

BTW-In law school, we primarily used the term commercial paper and not the more stodgy wording of corporate bonds. So, it might just be a frame of reference thing as Posner is a law professor not an economist. I followed the link and read some of his recent blogs. They aren't as bad as I feared, but he's not his father, a man I disparately hoped would get nominated to the supreme court while I was in law school as I watched a series of idiots get appointed.

In my limited experience dealing with global corporate treasury types, they all have used the term commercial paper too.

I suppose it includes debt instruments other than bonds.

[John Coffey]

I don't understand where you guys got sidetracked on economics in the above quote? Posner was talking about the statutory aspects of the bailout and how Paulson made a political move by getting Congress to approve something he already had authority to do.

[Bob Beamesderfer]

I don't understand where you guys got sidetracked on economics in the above quote? Posner was talking about the statutory aspects of the bailout and how Paulson made a political move by getting Congress to approve something he already had authority to do.

Our minds wandered?

I'm not certain Paulson had all the authority he needed. The purse isn't his to plunder alone.

[John Coffey]

BTW... the man in charge of administering the bailout is... wait for it... a Goldman Sachs guy!

http://blogs.wsj.com/deals/2008/10/06/m ... on-wallet/" onclick="window.open(this.href);return false;

Let's review.

1. Goldman Sachs guy runs Treasury.
2. Goldman Sachs guy convinces Fed not to bail out Lehman.
3. Goldman Sachs guy convinces Fed to bail out Goldman Sachs.
4. Goldman Sachs guy convinces Congress to bail out every other financial institution.
5. Goldman Sachs guy appoints Goldman Sachs guy to run bailout of every other financial institution.

I'm going to change my voter registration to Democrat. Oh wait, there's the whole Dodd and Frank brother thing with Fannie and Freddie. I'm changing my voter registration to Communist and hanging with Ayers.

[Bob Beamesderfer]

So, Goldman Sachs stock is now a buy?

[Sebastian Rios]

Are these short term bonds or "commercial paper" unsecured? Is there any precedent for this kind of action from the federal government?
As a layman, it seems like the government is getting into risky territory.

[Bob Beamesderfer]

Are these short term bonds or "commercial paper" unsecured? Is there any precedent for this kind of action from the federal government?
As a layman, it seems like the government is getting into risky territory.

Secured by the mortgaged properties.