Ordered by Congress on the basis of the Frank-Dodd financial reform bill, the United Sates Federal Reserve recently dumped on its website details of around 21,000 lending transactions it undertook to deal with the crisis that engulfed the financial system and threatened a collapse comparable with the Great Depression. Through multiple programmes referred to with confusing acronyms, the Fed clearly launched a massive bailout. Besides facilities that provided credit on an overnight basis, the Fed implemented programmes such as: (i) the mortgage-backed securities (MBS) programme under which MBS could be exchanged for cash; (ii) the term auction facility that provided 28-to-84 day credit to both US firms and foreign entities with a US branch; and (iii) the term asset-backed facility in which such assets can be pledged for a loan. Though the fact that the Federal Reserve intervened in the midst of the crisis and provided cheap credit against worthless collateral was known, this evidence is telling for a number of reasons.

The first is the sheer size of the Fed’s intervention, totalling $3,300 billion in the case of these transactions or close to a quarter of US Gross Domestic Product in 2009. The Fed had clearly stretched itself to ensure that financial firms did not collapse because of lack of liquidity to lend their way out of the crisis. What is also important is that this lending was against collateral that was worthless inasmuch as there was no market for them. The Fed made the market and held what could be worthless paper in return for a huge volume of lending.

This lending was not just a source of liquidity for cash-strapped financial firms unable to meet commitments and carry on their business, but it cost them virtually nothing. Ignoring the need to provide for a margin to cover risk that would have been huge, the Federal Reserve provided credit at near zero interest rates, giving financial firms the option of making a profit in any investment anywhere in the world that offered a positive return. They in fact went and found investment avenues that gave them significant yields, which allowed them to record profits and pay out huge bonuses rather quickly.

What is noteworthy, even if partly public knowledge, is that though in principle the Federal Reserve is responsible for providing liquidity to the banking system it regulates, a large amount of emergency Fed financing went to firms in the shadow banking system. Investment banks like Bear Stearns, Morgan Stanley and even the failed Lehman borrowed from the Fed, with Bear Stearns receiving as much as $28 billion in March 2008. Even Goldman Sachs that had claimed that it had navigated the crisis without government support is reported to have turned to the Fed 84 times, with daily borrowing having peaked at $24 billion.

What is more, the Federal Reserve was not just defending US financial firms that were on the verge of failure but a host of foreign entities that had been exposed to toxic assets generated in the US and were therefore likely to fail taking their trading partners down with them. Barclays and the Royal Bank of Scotland from UK, UBS from Switzerland, Dexia from Belgium and a host of other European banks had been bailed out with Federal Reserve funding. Saving the US financial system seems to have required saving foreign firms entangled with that system.

When put together, this evidence reveals a story that perhaps bears telling, even if it is speculative. The most obvious element of the story is that though the financial crisis was known to have been big, the scale of the rescue effort made by the Fed indicates that the magnitudes involved were much larger than most had estimated. TARP or the troubled asset relief programme that was seen as huge was expected to cost the exchequer just $700 billion, as compared with the $3300 billion outlaid here. This possibly explains why the Fed had to take on this responsibility. Operating through Federal Reserve emergency lending allows the system to bypass Congressional scrutiny, which was crucial given the opposition from sections of Congress even to the much smaller TARP experienced. Thus the Wall Street-Treasury nexus that crafted the rescue seems to have consciously chosen the Federal Reserve as the main fire-fighting agent rather than other government bodies.

That the Fed’s role was consciously planned is suggested by the fact that its involvement seems to have begun well before the collapse of Lehman Brothers in September 2008. Even in 2007 the Fed had begun to pump liquidity into the system including lending to non-US borrowers. Yet, as financial analyst and University of San Diego Professor of Law Frank Partnoy notes (Financial Times, December 3, 2010): ''Fed officials claimed they did not know of the need for large-scale intervention in financial markets until autumn 2008.'' While much bargaining about the rescue effort was going on in the Treasury, a lightly monitored Federal Reserve had already been put on the job.

The need to bypass scrutiny arose not only because of the scale and reach of the rescue effort that was necessary. It was also because the bail-out required ignoring risk when taking on collateral and pricing loans. As noted earlier, much of the massive lending provided by the Fed was against collateral that seemed worthless at the time the loans were provided, that too at interest rates that did not price for the risks involved. The gambit paid off because the liquidity was used by the financial firms concerned to invest their way to profits. But that outcome was not assured and the Fed was taking risks with ''public'' money that may not have been acceptable if subjected to scrutiny. It is true that the Fed having got back its interest and capital in most cases has not suffered explicit losses. But there is an implicit loss involved inasmuch as the returns for the kind of risks taken, if they had to be taken at all, were low or even non-existent. This implicit loss is the subsidy paid out to save financial firms that had speculated their way to near-insolvency. That the Fed could be used in this fashion makes nonsense of the theory that the Federal Reserve and central banks generally can be independent and impeccable managers of money and finance.

The use of the Fed to bypass scrutiny and finance a huge bail-out of irresponsible and often manipulative financial firms is inviting criticism also because not enough has been done to restore the real economy to health and support those who have had to bear the consequences of the unemployment resulting from the recession induced by the financial crisis. On the other hand Wall Street firms and some of the banks are back in the times of good profits and fat bonuses. The Fed’s data dump has, therefore, revived the view that Main Street has had to pay the price for Wall Street’s misbehaviour, but the government has bailed out the latter while the former still remains in crisis.

Adding insult to injury is the evidence that the bail out of Wall Street extends beyond borders, involving large sums of cheap credit against doubtful collateral to even foreign firms. The Fed was an instrument to help not just US firms but global finance capital consisting of a set of networked and financially entangled firms which function as a single supranational entity, even though they may be registered and headquartered in different nations. Being the central bank of the country that is home to the world’s reserve currency in the age of finance, the Federal Reserve is playing the role of being the lender of last resort not just to banks but financial firms generally, and not just to US financial firms but even those non-US firms which are part of the financial network that US firms dominate. The Federal Reserve is no more just an economic arm of the US state but the handmaiden of global finance.

All this leads to conclusion that we live in a world that is overwhelmed by moral hazard. Given the evidence at hand it is difficult to believe that any financial firm with even a minimum of systemic significance would be allowed to fail. This would incentivise speculative behaviour and could encourage action of a kind that would make even the speculative frenzy which preceded the 2008 crisis seem a minor aberration. This is why major reregulation of financial markets, institutions and instruments of different kinds is imperative. But that does not seem to be on the agenda. The victory of finance implies that even operationalisation of the small gains that the Frank-Dodd Bill promises to deliver would be a bonus for the rest of society.

December 22, 2010.