As US regulators and government work together to increase liquidity and help stabilise the economy, mixed opinions abound on just how much public money should be used to alleviate the problems stemming from the country’s banking sector. Writer Jane Monahan.

As the financial crisis in the US, considered the worst since the Great Depression of the 1930s, causes panic in global markets and fuels recession in the US, the debate of the country’s government and regulators has shifted. The debate used to be how much banks should be regulated, and what new bank regulations are required. But now it is how much bank liquidity and capital needs to increase to unfreeze wholesale banking markets, restore confidence and start the recovery of the ­system.

However, as the country holds crucial presidential and congressional elections, it is an indication of how much bankers and regulators have lost the public relations battle. It seems that politicians, the popular press and the electorate, in contrast, are still focusing on what caused the crisis, as well as calling for greedy, reckless and incompetent bankers to be punished.

Courting controversy

The country is deeply divided about the ­crisis. Take October 6. On the one hand, Richard Fuld, the chief executive of Lehman Brothers, during questioning before a House of Representatives Oversight committee, was asked about why the 183-year-old investment bank had filed for bankruptcy under his management, and whether he considered it “fair” that he had received about $500m in pay. (Mr Fuld said the real figure was closer to $350m.)

Meanwhile, across the road, the Federal Reserve and the US Treasury worked on plans to allow the Fed to provide unsecured loans to banks. It was an unheard-of move for any central bank, to try to overcome pressing liquidity problems in the financial system that could de-stabilise the economy – the credit freeze in the term inter-bank money market, which covers all but overnight borrowing, and rapid contraction in the commercial paper market (used by US companies).

In October, the Institute of International Finance (IIF) – a group of about 400 financial firms – held a meeting entitled ‘­Systemic Crisis Requires Extraordinary Actions’. At the meeting, IIF managing director Charles Dallara told journalists: “The loss of confidence has been so big that it is difficult to know what will be the ingredients for a renewal of confidence in financial markets in Europe and the US.”

Nevertheless, Mr Dallara declared, the US government’s Troubled Asset Relief ­Programme (TARP) approved by Congress but only in a second vote on October 3, is a step in the right direction. The TARP allows up to $700bn of public money to be spent buying up US banks’ troubled assets – principally structured finance or securities, based on US subprime housing mortgages that have defaulted. It represents “a turning point in the way governments see the crisis”, said Mr Dallara, because previously the problems were mainly tackled by central banks.

Extension of power

The TARP also provides the US Treasury with powers that it can use in an ad hoc way (for example, when rescuing Bear Stearns, Freddie Mac and Fannie Mae, the US mortgage financiers and American International Group, the insurance conglomerate). It can now employ public money to re-capitalise failing financial institutions, subsidise rescue takeover deals or guarantee systemically important parts of a financial company.

That authority paves the way for the US Treasury to emulate veteran investor Warren Buffett’s recent investment in Goldman Sachs – by injecting new capital into a bank as ‘insurance’ against its capital deteriorating in return for preferred shares or ­warrants. It is a course of action that prominent economists outside government think may prove a more effective way of using public money, especially if the asset-buying ­programme has only limited results.

Pension funds and sovereign capital funds might also be offered preferred shares in bank equity in return for injecting new capital, says Mr Dallara, who advocates ­setting up a global regulatory co-­ordinating body.

The IIF has recently ­published a report on market best practices and principles of conduct with some 200 recommendations for the industry.

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter