Saturday, May 3, 2008

A proper stand: Canada will not bail out Investment Banks

The governor of the Bank of Canada says he will take a tough stand with financial institutions that wind up near bankruptcy because of poor decisions.

Maybe it is time that the United States adopted this policy. Mark Carney says the central bank won't bail out Canadian financial institutions like the U.S. government did when the Bear Stearns brokerage, one of the giants of Wall Street, ran afoul of the subprime mortgage mess.

The absurdity of the U.S. Federal Reserve bailing out Bear Stearns simply to avoid a short term financial panic in the credit market is becoming more apparent as further details are being revealed about the situation. The action will only drive more bail-out calls. It teaches a lesson to Wall Street that firms can privatize the gains, and socialize the losses. There is no reason to adopt any type of reasonable risk control if the government will be available to bail out the investment banks every time the bad decisions come home to roost. This will only drive the investment banks to maximize revenue by taking more risk.

The most current variant of the Fed’s flawed policy is opening the discount window to the investment banks in the past few weeks; in the past this lending facility was reserved for commercial banks. The Wall Street banks have been hitting up window for over $38 billion per day far more than all the commercial banks in the U.S. combined. To think that some congressmen squawked and demanded an investigation when Countrywide Financial was provided with $50 billion over several months; these legislators are strangely silent on Wall Street hitting up the Fed for nearly the same amount each day.

Even more shocking is what the Wall Street is doing with the borrowed money. The intent of the Fed action is to inject liquidity into the system in order to ease the credit markets. The Investment Banks have been happily utilizing the low cost Federal loans as capital to fund large scale gambling. The major Wall Street institutions have used the Fed cash to implement international interest-rate “carry trades” with the intent of squeezing profit out of the market. This naturally will lead to hefty bonuses for the Wall Street staff; assuming the positions don’t implode over the coming months. No concern is given to loosening the stranglehold of tightening U.S. loan conditions or unwinding the derivatives that sparked the credit crisis.

If Wall Street is not using the discount window cash for its intended purpose of easing the credit markets then the spigot should firmly be shut off. The Bank of Canada has the right mind-set when it comes to dealing with investment banks – these risk-driven firms should be responsible for their own calamities.