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Federal Reserve Bailout of Megabank Raises Serious Questions About Motive
What is Fed’s real relationship with JPMorgan Chase?
By Dr. Mark W. Hendrickson
The Federal Reserve crossed a Rubicon of sorts, lending tens of billions of dollars, not to a commercial bank, as has been its historical practice, but for the first time to an investment bank.
Commercial banks pay the Federal Deposit Insurance Corporation (FDIC) for deposit insurance, whereas investment banks do not, and yet the Fed suddenly made liquidity available to the latter. Commercial banks are legally allowed to use leverage to a maximum ratio of $13 of debt to every dollar of equity, whereas investment banks—ironically subject to less regulatory oversight than commercial banks—can leverage their equity by a factor of 34.
Invoking an obscure, never-before-used legislative provision, the Fed made billions of dollars available to JPMorgan Chase to acquire another investment bank, the essentially insolvent Bear Stearns.
The Fed-engineered JPMorgan takeover of Bear raises startling questions: What is the degree of cooperation between the Fed and JPMorgan? Was this an impromptu alliance, or had it been plotted in advance? Was JPMorgan drafted against its will to absorb Bear Stearns, or did the central bank give JPMorgan a plum that it already coveted? More importantly for the country, what will be the relationship of JPMorgan and the Fed going forward?
Clearly, if Bear was “too big to fail,” then undoubtedly the much larger JPMorgan is too big to fail. JPMorgan was already a key dealer of U.S. government debt before absorbing Bear, and now it has Bear’s erstwhile share of that operation, too. Of even greater significance, even before the takeover, JPMorgan already had multiples of the kind of illiquid financial derivatives that did in Bear Stearns—in fact, more derivatives than any other company in the world—and now it owns Bear’s junk, too. This implies that the Fed will have to make good on those derivatives—even if it eventually means giving JPMorgan real money for worthless “assets”—if that’s what it takes to keep JPMorgan alive.
Apparently, investors quickly grasped that implication. The perception that
JPMorgan 
The Fed and JPMorgan partnership will remain implicit. There will be no official merger or formal union of the two; on the other hand, it may be no exaggeration to say that the Federal Reserve has effected a partial de facto nationalization of JPMorgan. It will be interesting to see what degree of autonomy JPMorgan will retain. There is an old saying that if someone owes the bank a million dollars, the bank owns him, but if someone owes the bank a billion dollars, then he owns the bank.
In the present case, JPMorgan appears to be under the Fed’s thumb. However, because the Fed now requires JPMorgan’s survival, it will do whatever it needs to do to accomplish that. The potential moral hazard created by this dynamic is enormous.
JPMorgan may have the Fed over a barrel, too. Treasury Secretary Paulson has proposed sweeping regulatory reforms that would extend the kind of control that the Fed now has over JPMorgan to all investment banks. Theoretically, such power is necessary to prevent investment banks from ever putting this country into such a precarious situation again. In practice, though, this would be a huge step toward a national banking monopoly.
Considering the various boom-bust cycles caused by the Fed, not to mention the loss of 98 percent of the dollar’s purchasing power under the Fed’s watch, do we really want to place our faith in a bulked-up, super-powered, but clearly fallible Fed?
For the present, Paulson and Bernanke have postponed the financial apocalypse. Gold and commodities prices are tumbling. Real estate markets are making necessary adjustments. It would be premature, though, to declare the financial crisis over. As long as trillions of dollars of derivatives—ticking financial time bombs—continue to lurk on the balance sheets of our major financial institutions, we are not out of danger.
Dr. Mark W. Hendrickson is a faculty member, economist, and contributing scholar with the Center for Vision & Values at Grove City College in Grove City, Pa.
(Issue # 21, May 26, 2008)
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