During the recent testimony by Fed Chairman Ben Bernanke, Treasury Secretary Hank Paulson and SEC Chairman Christopher Cox, it has become increasingly clear that the Federal Reserve will be forced at least in the near term to extend a financial lifeline to any and all U.S. financial entities that are too big to fail. This refers to entities whose failure cold endanger the U.S. economy and in some cases the global financial markets.
I have learned during my investment career to watch what the Fed does much more than what it says. This has been demonstrated by Chairman Bernanke's extension of the discount window to Fannie Mae and Freddie Mac in recent days despite initial indications by Secretary Paulson to the contrary. Hawkish talk remains just that, not action.
The discount window was initially intended only for regulated banks to prevent a meltdown of the financial system from bank failures. In return for this financial insurance, banks are regulated, including the charging of fees. One can debate the alternatives to such an arrangement. However, this regulatory framework will probably be with us for the foreseeable future.
Therefore, we now have a situation in which certain entities -- such as investment banks which are primary dealers, Fannie, and Freddie -- are getting a "free lunch." They get the benefits of being a bank without the burden of regulation. This "moral hazard" can result in inordinate risk-taking by these organizations.
I am reminded of the old saying, "If it looks and acts like a duck, treat it like a duck." In this case, " If it acts like a bank (with the associated risks of a meltdown to our financial system), regulate it like a bank."
Since there is no "free lunch" even on Wall Street, the government has no viable alternative at the moment. I know that this is an election year, and no one really wants to deal with this until after November. However, since Wall Street detests uncertainty even more than regulation, the executive and legislative branches must address this issue before the credit crisis will begin to resolve itself.
Doug Roberts is the Founder and Chief Investment Strategist for ChannelCapitalResearch.com, an independent research firm focusing on investment strategies using the Federal Reserve's impact on stock prices, and the author of Follow the Fed® to Investment Success: The Effortless Strategy for Beating Wall Street. He previously held executive positions at Morgan Stanley Group and Sanford C. Bernstein & Co.
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Reader Comments (Page 1 of 1)
7-16-2008 @ 4:27PM
Mark said...
Hey FEDS !!!!! You need to Regulate Paypal (The scam of all scams)
Yes they act like a bank
7-16-2008 @ 5:01PM
Lawrence Phoenix said...
What piffle..the author of this article knows full well that Fannie and Freddie are regulated by law by the United States Department of Housing and Urban Development. Any improprity and they've got HUD auditors dropping out of trees...You may argue that policy making at the GSE's are too often made by Congress and due to their sheer size they can in turn influence lawmakers but regulated they are..and the proof's in the default rate. While many investment bank's loan portfolios have default's running at 40-45% Fannie's setting at 1.3% total....