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The Fed breaks the rules, accepts equities, and waives Section 23A - what does this mean?

Tuesday, September 16, 2008, 2:26 PM

This article addresses the questions posed by ready Phredd earlier in the comments section of the post below.

The question concerns the new Federal Reserve actions allowing equities to be submitted to the Fed in exchange for cash, which requires the "temporary" suspension of "Section 23A" of the Federal Reserve Act,  which forbids a depository institution from transferring funds ('making loans') to its affiliates. 

What types of funds are we talking about?  Depositor accounts.  

Why did the fed relax this rule?  So that the BAC acquisition of Merrill could take place.

Quote:

Also, the Federal Reserve Board waived long-standing limits designed to prevent commercial banks from bailing out affiliates, including their investment banking units. The waiver, which will last through January, was seen helping B of A make the Merrill deal.

"That's specifically so that no one will question Bank of America's ability to capitalize Merrill Lynch because it allows Bank of America to use its deposit base, which is enormous, to capitalize the broker dealer," said Chris Low, the chief economist at First Horizon National Corp.'s FTN Financial Capital Markets. "It gives them time to start accumulating other types of cap to back up Merrill."

Link to Article

What will happen now that 23A has been "temporarily" waived to let the BAC/MER deal go through?  Other banks will quickly seize on this free gift to raid depositor accounts to cover up bad debts and take new risks in an attempt to "get whole."

Quote:
Section 23A of the Federal Reserve Act...originally enacted as
part of the Banking Act of 1933, is designed to prevent the misuse of a
bank's resources through non-arm's-length transactions with its
affiliates and to limit the ability of a bank to transfer its federal
subsidy to its affiliates.

This rule exists because depositor accounts are insured, so it seemed like a bad idea to let banks use those insured accounts to make loans to riskier parts of the business.  Otherwise, banks would do this all day long, and pocket the profits while handing any losses to the FDIC and/or taxpayers to pick up.

Quote:

"On Sunday the Federal Reserve announced a number of modifications to its lending policies. Two changes are particularly disturbing.

"First, the Fed will now allow investment banks to post equities as collateral in the Primary Dealer Credit Facility.

"Now the purpose of collateral is to give the lender something to hold which is of known and reasonably stable value. Equities do not fit that definition. Ben Bernanke knows this full well but obviously doesn't care.

"The second Fed action is more alarming: banks are now allowed to use depositor's [sic] money to fund the operations of their non-bank affiliates.

"Your savings account is being used to prop up the trading operations of your bank's parent company, which not coincidentally is the source of the huge losses the industry has racked up this year.

"And what happens when that deposit money goes up in smoke? Ah, yes, FDIC steps in and protects depositors. And who protects FDIC? Good question. Look in the mirror and you'll see the answer.

"Yet we are told that taxpayers aren't bailing out anyone. This action is arguably illegal, but at this point the Fed clearly is not concerned with what is legal or not. It is now a law unto itself.



Link to Article

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4 Comments

phredd's picture
phredd
Status: Member (Offline)
Joined: Sep 9 2008
Posts: 16
Thanks!

Excellent summary, as always, Chris. Thanks for sharing your insight and providing excellent source links.

-Phredd

DavidLachman's picture
DavidLachman
Status: Silver Member (Offline)
Joined: Jul 4 2008
Posts: 153
Suspend part of an act of Congress?
Hi, I don't understand how part of an act of Congress can be suspended. Either it is the law of the land or not, right? Doesn't Congress and President have to cast some votes and sign some legislation to change the law? Thanks
srbarbour's picture
srbarbour
Status: Silver Member (Offline)
Joined: Aug 23 2008
Posts: 148
How does a law get Suspended, Easy!
[quote]Hi, I don't understand how part of an act of Congress can be suspended. Either it is the law of the land or not, right? Doesn't Congress and President have to cast some votes and sign some legislation to change the law? Thanks[/quote] The answer is excruciatingly simple. It doesn't get enforced.

To put it another way, courts cannot rule upon potential crimes unless the 'criminal' is brought before them. If the Executive branch refrains from enforcing the laws -- e.g. arresting and prosecuting the criminals -- then it is exactly as if the law does not exist.

--

Steve
down-n-out's picture
down-n-out
Status: Member (Offline)
Joined: Sep 17 2008
Posts: 1
Other FED happenings OUR money is at risk

I heard about this on http://republicbroadcasting.org. If I understand the report and the bill correctly, there's a bill being considered that when passed will insure that investors rather than depositors will get their money back in the event of a bank failure. Check it out and let me know your thoughts. Go to http://vote-smart.org, enter your zip code to find your representatives and write them if you disagree.

Bill HR6659 http://thomas.loc.gov/cgi-bin/query/z?c110:H.R.6659:

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