Wednesday, April 21, 2010

The Bailout of 2008 that Started Socialism…or Did it?

Nearly everyone has an opinion about the bailout of 2008, officially known as Troubled Asset Relief Program (TARP). Some say it was the rich being bailed out by the middle class. Others say it was Goldman Sac cronies in the government helping out Goldman Sac cronies on Wall Street. Others say it was the first huge step towards Socialism in America in over 75 years.

I'll be focusing on the last point: Was the TARP program an overstepping of government into private industry? How did the Federal Reserve get the authority to do what it did? And was this some new power that was given to the federal government during an emergency that has been abused since then?

I recently finished a book titled Too Big to Fail, and must encourage anyone who has an interest in the events leading up to the collapse of Lehman Brothers to the passing of TARP to read this book. It is very insightful and is a good foundation to gain just a basic understanding of what happened.

While reading the book, a certain sentence caught my attention, and is now leading to me writing this. "Federal Reserve Act, Section 13, point 3, a unique provision that permitted the Fed to lend to institutions other than banks under 'unusual and exigent' circumstances. (p. 394)"

The first thing I thought was, "What the heck is the Federal Reserve Act?" So, I did what most people of my generation do and I went to the library…Just kidding, I Googled "Federal Reserve Act, Section 13, point 3" and came across, to my astonishment, several articles describing it with words such as "loophole" to "powerful paragraph".

So in short, what does Federal Reserve Act, Section 13, point 3 say? It says, according to David Fettig, "'In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may …,' and then there's a lot of technical language which essentially means that the Federal Reserve can lend money to 'any individual, partnership, or corporation,' as long as certain requirements are met."

Pretty open-ended. So when was the Federal Reserve Act passed? 1932, under FDR (according to some revisionist historians post-2007, our first "Socialist" President. I guess it all depends if you sided with the 4 Horsemen or not…).

So what is some of the history behind Federal Reserve Act, Section 13? David Fettig does a good job in putting an easy to comprehend timeline to this Act and its modifications over the years:

1932: Emergency Relief and Construction Act: Added paragraph 3 to Section 13 of the Federal Reserve Act, opening the discount window to nonbanks "in unusual and exigent circumstances."

123 loans were made over four years by all 12 Federal Reserve banks, totaling about $1.5 million.


1933: Emergency Banking Act: Allowed 90-day advances to nonbanks on the security of direct obligations of the U.S. government, at interest rates fixed by the Reserve banks.


1934: Industrial Advances Act: Added Section 13(b) to the Federal Reserve Act, allowing Federal Reserve district banks to make advances of working capital to established businesses if these enterprises were unable to find such capital from usual sources. These loans were made either in partnership with a commercial bank or directly to a business, with maturities up to five years and no loan limits.

Nearly $280 million, or about 0.43 percent of gross national product, with each district apportioned a fraction, was made available for loans to businesses from Federal Reserve banks.

Through 1935, 1,993 loans totaling about $124.5 million met with Reserve bank approval. The following year, 287 loans were approved, and 126 in 1937.

Section 13(b) would reap its largest single-year total in 1942, when war production spurred over $128 million in loans.

1958: Small Business Investment Act: Repealed Section 13(b).

1970: The Nixon administration asked for discount window assistance in response to the financial problems of Penn Central Railroad. This request stalled in Congress, but the Federal Reserve worried that the company's default would spark a financial crisis, and it made clear that it would assist banks that needed help with businesses caught up in Penn Central paper.

1975: The financial difficulties faced by the city of New York raised questions about whether the Federal Reserve might serve as a source of emergency credit. Federal Reserve officials cautioned against such an idea and, in the end, the Federal Reserve served only as a fiscal agent for the government's eventual loans to the city. (The Federal Reserve also served as fiscal agent for loan guarantees made to Lockheed in 1971 and Chrysler in 1979.)

1991: The Federal Reserve discount window was invoked to dispense $25 billion as a direct loan to the Federal Deposit Insurance Corporation's Bank Insurance Fund. Then-FDIC Chairman L. William Seidman requested the loan, through Congress, but Fed Chairman Alan Greenspan testified in opposition. Undeterred, the Treasury Department made another pitch to Congress for the $25 billion based, in part, on the initial Fed subscription imposed by Congress in 1933, but Congress said no.

1991: FDIC Improvement Act: Amended Section 13 paragraph 3 to allow the Fed to lend directly to nonbank firms during times of emergency.

2001: In the days following the terrorist attacks of Sept. 11, 2001, some observers suggested that—based on the 1991 amendment—the U.S. airline industry could receive emergency loans. "[T]his sector's key economic role and the unpredictable after-effects of September 11 justify putting discount-window loans on the table while discussing the carriers' current crisis," the Financial Markets Center said in a Sept. 18, 2001, statement. The Fed did not make such loans.

2008: The Federal Reserve Bank of New York agreed to lend $29 billion in connection with the acquisition of Bear Stearns by JPMorgan Chase. The loan was granted under the authority of Section 13(3) of the Federal Reserve Act. The Federal Reserve Board authorized the New York Fed to enter into this loan and made the findings required by Section 13(3) on Sunday, March 16, 2008.

So under my calculations, if current logic is taken into consideration and anytime the government gets involved in "bailing out" a company, or uses its power – or even THREATENS to use its power – then it would be considered "socialist". That would mean the following Presidents could be labeled "Socialist":

Franklin Roosevelt (D), Richard Nixon(R), Gerald Ford (R), Jimmy Carter (D), George Bush Sr. (R), George Bush Jr. (R), Barack Obama (D) – the 2nd installment of TARP in 2009.

So tallying up those totals, it seems its Democrats: 3 Republicans: 4

So does that mean that the Republicans are more of a "Socialist" party than the Democrats? Or that they are both secretly "Socialist"? Or is it that people are pissed off – and in my opinion rightfully so – that the government has used tax money to bailout banks and investment-banks and insurance companies that took huge gambles, paid their executives enormous salaries, incentives and bonuses and the only outlet for these people is to brand the government as bad for doing the only thing possible to prop up an entire financial – and dare I say economic and political – system?

So, since TARP (2008) and TARP Jr. (2009), has the government become more involved in the private sector – or more to the point, is America heading into Socialism at a breakneck speed (and let's just keep our focus on the point at hand – banks and the financial sector, not healthcare…that will come later…).

First, Citigroup: The Treasury Department has begun selling the stake it owns in Citigroup and it could result in a profit to the government of about $7.5 billion. Sounds like the government is downsizing its ownership role in the bank (and financial sector).

Second, Bank of America paid back its TARP investments at the end of 2009. Again, sounds like the government is getting out of the financial sector.

Third, Chrysler (which got a bailout) was sold to Fiat.

General Motors will fully repay the $6.7 billion loan portion of its U.S. government aid earlier than its previously promised payback date of June 2010. The company got $52 billion in government aid, with the $6.7 billion considered a loan. The rest would be repaid when the company sells stock to the public, which could happen as soon as the end of this year.

If these bailouts were "Socialism", wouldn't the government be holding onto these assets? That's what makes Socialism socialism, not "Socialism".

So in short, people were right to be pissed about what was perceived as the government bailing out the fat cats who risked everything at the peril of everyone else. But in the anger, some lost sight of the checks and balances we have in our Democratic form of government, the power of the polls, and of a watchful media (however biased and easily wooed). It may not be fair, and it may not be right, but it is not Socialism, however close it seemed to resemble it.

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