The Federal Reserve came out with a press release today at 4pm. The long version is linked here. The short version is: If you are a large U.S. financial institution you will not be able to pay back the government capital until the system is working. This is great news. The Federal Reserve Board gave themselves a lot of subjective wiggle room to prevent banks from paying them back. “Whether a BHC (bank holding company) can redeem its Treasury capital and remain in a position to continue to fulfill its role as an intermediary that facilitates lending to creditworthy households and businesses” It seems fair to assume that the banks, besides Citi and Bank of America, could pay back that capital with some combination of public capital raising and balance sheet contraction. This means that there is demand to shrink the capital base of the banking system and the Federal Reserve has it hands on the nozzle controlling that force. Wha la! A new monetary policy tool, a capital escape value. Although that was not the point (the point being they didn’t want the banks shrinking there balance sheets and thus induce a deflationary depression just to get out from of the burning wrath of congress) it doesn’t change the reality that is what happened. And as I’m a big proponent of dealing with reality instead of what you would like to had happen. I’m inclined to argue that it (the faucet of capital) needs to tended with care. The Fed should think more about system level capital (in addition to the bank level capital). This is what should have been done (and quite possibly was done) with the stress test program. Also the Fed should avoid shocking the system by having it all paid back at once. They may also want to consider unwinding their own interactions with the financial system before letting the traditional banking sector back away from the table.
