Friday, September 19, 2008

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Financial: You're Letting Them Do What???

by Reb Akiva at Mystical Paths

(Yahoo - AP) The United States Federal Reserve has waived its restrictions on how much bank holding companies can lend to their investment banking affiliates. The depositor-insured funds had previously been walled off from being used by the companies' riskier broker-dealer units in order to protect the capital of a bank and its depositors.

When a US bank is in trouble, it's almost always because it's investment division or it's loan division has screwed up. They've taken greater risks - sometimes intentionally and sometimes accidentally - than fits their business model. Then they don't have the capital to cover the debts, and they're toast. BUT, the deposit reserve is just fine and once the debt imbalance is cleared off (by the FDIC insurance fund) they're a worthy asset to pick up and another bank takes them over. Because the deposits are the bank value. As long as they are there, there is value.

What happens when a bank 'lends' its deposit reserve to the troubled investment division? Well, it can't, it's illegal and monitored. The deposit base is stable. Even if the bank corporation crashes, the deposit base is ready to be transferred to a rescuing bank. Your accounts are generally safe under this model.

...But it's not illegal or monitored as of MONDAY. Next time a bank goes down, there may be nothing left but an empty shell. A deposit reserve that isn't there can't be transferred, normal account operation can't resume.

Before, the banks were at risk. Now, the customers are.

(Being fair, the idea is to give the banks access to the money they need to 'fix' the problems before they, using their own - or rather your - wallet, knowing the Fed literally can't cover it all. But as we're already written, AIG "could not quantify" it's risk and impact. So the banks are being allowed to try to fix a problem without knowing if it's fixable.)

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