Bernanke: Where to Draw the Line?

Bloomberg has an interesting story today about the difficulties that Federal Reserve Chairman Ben Bernanke is facing in defining which institutions it's safe to let fail.  The article claims that the central bank has turned its balance sheet into "a parking lot for Wall Street's hard-to-finance bonds" and provides some startling evidence of that fact.  The Bloomberg article uses a source from Wrightson ICAP to support the claim that 94% of the Fed's $24 billion in outstanding repurchase agreements with Wall Street on August 10, 2005 were in U.S. Treasuries and that on August 10, 2008 only 14% were in treasuries with the rest in mortgage and agency bonds.  Those nerdy enough to care can go to the Federal Reserve's Statistical Release of Factors Affecting Reserve Balances which provides data for the week ended August 13, 2008.  The Bloomberg article neglects to mention that total outstanding loans to Wall Street have now reached $315 billion  ($118 billion in repurchase agreements, $150 billion in term auction credit, $17 billion in discount window borrowings and $29 billion in the Bear Stearns collateral that the Fed is holding because it was too toxic for JP Morgan.)  The Fed is currently using one third of its balance sheet in an effort to help Wall Street dealers finance their inventories at extremely attractive rates, thus boosting their profits and in certain cases keeping them solvent.  If banks were not allowed to go into the Fed with this type of collateral, they would need to find alternative and more expensive sources of financing.

With the Fed's new role as a temporary consulting regulator of Fannie Mae and Freddie Mac, in addition to its new regulatory powers over investment banks, the Fed can now make recommendations on capital and liquidity positions of the largest financial institutions.  The Fed also picked up new supervisory power over nonbank consumer-finance subsidiaries of bank holding companies such as CitiFinancial, a unit of Citigroup.  One has to wonder how much supervisory power can Bernanke handle?  Does he run the risk of supervising so many institutions that he ultimately becomes ineffective in managing any of them?  More importantly, how many bailouts can the US economy finance before our lenders become weary?  With the recent rally in the dollar, it appears as if the full faith and credit of the US government still means something.  But where does Mr. Bernanke ultimately draw the line?  How will he know which financial institution's failure will not cause cascading ripples through the financial system that would do irreparable harm to the US economy?  Perhaps the best way to solve this problem is a simple game of eeny, meeny, miny, moe.   

With all of his supervisory and "recommending" powers, I am still awaiting Mr. Bernanke's phone call.  I'm fairly certain he's going to tell me to deposit more money in my Citibank checking account.  I'll probably tell him I think I have enough to cover the phone bill.  He'll more than likely respond with "Of course you have enough money to cover the phone bill.  I'm not worried about you.  Citibank needs more deposits!"