Fed, Treasury's Bank of America bailout suggests they know more than we know

Posted Jan 16th 2009 2:27PM by Joseph Lazzaro
Filed under: Forecasts, Bank of America (BAC), Politics, Federal Reserve, Recession, Financial Crisis

The U.S. Treasury, U.S. Federal Reserve, FDIC's joint decision Friday to inject $20 billion into the Bank of America (NYSE: BAC) and guarantee $118 billion in assets provides another case study. Bank of America's shares fell 80 cents to $7.52 in Friday afternoon trading.

[ Earlier, my BloggingStocks colleague Peter Cohan provided an analysis of the bail-out's cost to taxpayers. ]

Economists and other public policy wonks love the theoretical and they love 'taking the other side' in arguments.

Hey, they can't help it: it's the stuff they were trained to do - - the stuff they love. And, after all, it's frequently a major source of their income.

And my economist and policy wonk colleagues and friends are no different.

Now, on the surface, it looks like yet-another taxpayer bailout of bad decisions by bankers, mortgage lenders, and borrowers. In other words, another "profits - - the bankers win, losses - - the U.S. taxpayer foots the bill." Further, because it occurs on the heels of the Bank of America's buy-out of Merrill Lynch, it looks like, in some sense, U.S. taxpayers are subsidizing a financial institution merger.

Are all the facts known?

But the above assumes "we are in normal markets, and that everything that can be known, is known, by all relevant players in the market, and has already been factored in to market prices," so says economist David H. Wang.

But that may not be the case. Economist Peter Dawson outlined another scenario. "If one proceeds from the assumption that Merrill would have collapsed absent a Bank of America takeover, today's government infusion makes sense," Dawson said. "A Merrill Lynch collapse on the heels of a Lehman Brothers collapse would have resulted in a stock market crash, and a global financial crisis much worse than the constrained credit conditions we're seeing today."

Fed and Treasury officials didn't make this known, Dawson theorizes, because "stating the whole truth at the time would have damaged the financial system much more than the alternate plan, the one announced today. If that's the case then there's a rational basis for not making all of the facts known immediately."

Bank Sector / Economic Analysis: Economist Dawson hastens to add that his analysis is "just a theory," but if it's correct, there's a rational and prudent basis for the U.S. government's action. On the surface, the Bank of America looks like another costly bail-out. If Dawson and Wang are correct, it's a costly and mandatory bail-out.

Bottom line: It's very difficult to accomplish anything from a commerce and GDP growth standpoint with a broken financial system, and if this 'subtle sequential' bail-out of institutions that are too big too fail avoids a calamity, stabilizes the financial system, and prevents the U.S. recession from worsening, it will prove to be the correct strategy.

Tags: bank bailout, bank rescue, bank sector, FDIC, inthenews, Merrill Lynch, U.S. Federal Reserve, U.S. Treasury

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Reader Comments (Page 1 of 1)

1-16-2009 @ 5:13PM

Tim Townsend said...

Yes, by your logic secrecy is a good thing.
The Federal Reserve has relied upon it since 1913...it is a private corporation that has never been audited or had any oversight. Our financial system has been broken since we left the gold standard. It just took awhile for it to fail.
So let's play monopoly!
You want to find the criminals in this mess? Follow the money.

1-16-2009 @ 6:13PM

Hale said...

Since the economy is now based on just a few 'pillars', we have to do what it takes to stablize these giants, since they are, in truth, "too big to fail". BUT, once the system has been "stablized": ALL the "too big to fail" companies MUST be broken up into at least fifty ( about one per state) separate companies. Which would NOT be "too big to fail".

1-17-2009 @ 7:37AM

CEB said...

I agree - we should never again let any private company get "too big to fail." However, I wonder what that really means. If any of these TBTF companies actually failed, someone would pick up the pieces, reorganize what was left and move on. Sure the stockholders are wiped out, but aren't they anyway?

1-17-2009 @ 10:12AM

Chas said...

Did the government strongly encourage BoA to purchase Merrill to prevent Merrill's collapse? And by so doing, jeopardized the financial health of BofA? That appears to be the case. It was as if the government was so scared of a pending financial collapse of worldwide proportion that it basically "threw it on the board in hopes that it would stick" - which is a sign of desperation. Makes you wonder what else is looming and being "masked". There has been so much lying and fraud to the public by major corporations - those that were respected. Who do you believe? Our faith in corporate America has been shattered, to a great degree because of greed. A nice profit is a great thing - greed is not. The taxpayers and the shareholders are paying a severe price, and the government bears significant responsibility. Regardless, this does not excuse Ken Lewis' inept decision to complete the purchase without due diligence. Bottom line, Ken Lewis' head should roll today. As a taxpayer and a shareholder, I am not happy. The government's job should never be to bailout the world.

1-17-2009 @ 6:00PM

blogs11111 said...

I keep hearing too big to fail, how about too big to bail? If these banks are too big and took on excessive risk knowing they would be too big to fail then I think they should be considered too big to bail. Let the large ones fail and let the little banks buy up the pieces. This way the risk is spread out and no bank would be considered too big to fail and thus would take less risks. If they bail out these banks against people's wishes, what's to stop the people from withdrawling their money and putting it in little banks to promote small banks?