Monday, September 15, 2008

Bernanke and Paulson Gamble Depositor’s Money

The dominant news narrative today was that the Federal government had not stepped in to bail out Lehman. That's techically true, but misleading, Ian Walsh, Paul Krugman and others have tried to point out.

The most troubling thing to me was the Fed's decision to further relax Rule 23a, which limits how much much of a commercial bank's insured deposits can be diverted to finance the activities of affiliated enterprises, like, say, an investment bank subsidiary.

Ian Walsh at Firedoglake explains: "But Bernanke and Paulson are really going all in on this, they're letting banks play with depositor money . . . "

"This is a dangerous game, because instead of firewalling that money away from investment subsidiaries, it allows banks to gamble that with depositor money they may be able to turn it around. This was exactly the sort of thing that Glass-Steagall was designed to make impossible - banks to not be in the brokerage business, insurance companies not in banking, and so on. Glass-Steagall was partially repealed in 1980 (part of what made possible the Savings and Loan fiasco), further parts in 99 under Clinton, and now the Fed has violated the fundamental principle that banks shouldn't be gambling with depositor money. Because, be real clear, if you don't really know how much in the hole you are, or how much further you could get, lending money to the unit that's in the hole is gambling.

"It's also putting the FDIC (the organization which insures deposits) even more on the hook, and the FDIC does not have infinite money except in the sense that the Treasury can lend it infinite money. At this point the FDIC has about 50 billion. Banks have about 4.7 trillion in insured deposits. Yes, that's a bit of a gap."

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