International Herald Tribune Editorial - What looks like a bailout?

International Herald Tribune Editorial - What looks like a bailout?
Copyright by The International Herald Tribune
Published: August 28, 2007

A recurring question in the recent turmoil in the financial markets has been whether the U.S. Federal Reserve would bail out the banks, non-bank lenders and investors who are complicit in the excesses that sparked the credit crisis. Events have overtaken the debate. The bailout is well under way.

Earlier this month, as the credit squeeze tightened and the Fed began to inject extra billions of dollars into the banking system, the injections were viewed as standard operating procedure.

By mid-month, when the Fed cut the lending rate it charges federally insured banks to borrow directly from the Fed, the move was viewed more as a way to calm the markets than to grease their wheels, mainly because it was of no direct use to non-bank lenders reeling from the credit crunch - like Countrywide, the nation's largest mortgage lender.

But by Aug. 20, one business day after cutting the lending rate, the Fed allowed Bank of America and Citigroup's Citibank to breach the regulatory cap on the size of loans they're permitted to make to their brokerage affiliates. Using the brokerages as conduits, the banks will be able to easily funnel substantial sums of money to their clients, like the ailing non-bank lenders.

The cap on loans to an affiliate is a tenet of prudent banking. So waiving it, even temporarily, is a significant escalation of the Fed's rescue efforts. Under normal circumstances, a bank is limited to lending any one affiliate an amount equal to 10 percent of the bank's regulatory capital. Fed documents released last Friday disclosed that the banks would be allowed to lend up to $25 billion apiece, or about 30 percent of their capital.

Compromising the cap to that extent attests to the Fed's belief that a bailout is necessary to avert greater harm to the financial system and the broader economy.

But even if the Fed succeeds in managing the crisis, its actions stir questions anew about the longer-term sustainability of the debt-fueled state of the American economy. And they are yet another reminder that even as officials are quick to try to counter threats from Wall Street, they have yet to make any real progress toward heading off the coming wave of foreclosures, which could rock the markets as early as this fall and create a social crisis on top of a financial one.

Bailouts are tolerable only if the help they provide is in the broad public interest, and if they're followed by punishing wrongdoers and imposing new rules and procedures that help to ensure that the same problems will not happen again. The Fed is playing out its role in the bailout, but the Bush administration and the U.S. Congress have yet to step up to theirs.