Monday, August 27, 2007

Two “voices” weigh in on recession possibility

First, former Clinton Treasury Secretary Larry Summers. And, since Summers is now part of a hedge-fund group, he ought to know, right?

But, like a number of Congressional Democrats, he wants the easy way out of letting Fannie Mae and Freddie Mac carry a larger loan portfolio.

To be, this is just one or two steps removed from a full-blown bailout. Bush is probably right that the two agencies need to be reformed first. But, of course, the Fed needs to be reformed even more.

And, the second voice, speaking of reforming? The Fed First, former Clinton Treasury Secretary bent its own rules last week for Citigroup and Bank of America:

The Aug. 20 letters from the Fed to Citigroup and Bank of America state that the Fed, which regulates large parts of the U.S. financial system, has agreed to exempt both banks from rules that effectively limit the amount of lending that their federally-insured banks can do with their brokerage affiliates. The exemption, which is temporary, means, for example, that Citigroup's Citibank entity can substantially increase funding to Citigroup Global Markets, its brokerage subsidiary. Citigroup and Bank of America requested the exemptions, according to the letters, to provide liquidity to those holding mortgage loans, mortgage-backed securities, and other securities.

And, this isn’t a minor issue:
So, how serious is this rule-bending? Very. One of the central tenets of banking regulation is that banks with federally insured deposits should never be over-exposed to brokerage subsidiaries; indeed, for decades financial institutions were legally required to keep the two units completely separate. This move by the Fed eats away at the principle.

Sure, the temporary nature of the move makes it look slightly less serious, but the Fed didn't give a date in the letter for when this exemption will end. In addition, the sheer size of the potential lending capacity at Citigroup and Bank of America — $25 billion each — is a cause for unease. ….

Don't forget: The Federal Reserve is in crisis management at the moment. However, it doesn't want to show any signs of panic. That means no rushed cuts in interest rates. It also means that it wants banks to quickly take the big charges that will inevitably come from holding toxic debt securities. And it will do all it can behind the scenes to work with the banks to help them get through this upheaval. But waiving one of the most important banking regulations can only add nervousness to the market. And that's what the Fed did Monday in these disturbing letters to the nation's two largest banks.

I’m not enough of a financial analyst to tell you where to invest, but I can safely say that if you have any money in stocks, make sure it isn’t in bank stocks.

Financial-industry blogger Mish has more.