While the Federal Reserve was publicly providing money to member banks at interest rates of up to 0.5% during the financial meltdown of 2008, a different, less public program bailed out Credit Suisse, Goldman Sachs, and Royal Bank of Scotland with short-term loans with an interest rate of only 0.01%. Those banks received the bulk of the help from this program, but Morgan Stanley, Citigroup, Bank of America, and BNP Paribas in France also received billions of dollars. If consumers like you and me wanted to borrow money for 28 days, we might have to turn to payday lenders or shady techniques, where the price of borrowing expressed in APR could be 500%, 1,000%, or even more. These banks borrowed at least $30 billion practically for free, and had the opportunity to use that cash as leverage to increase earnings during the economy’s toughest market in the recent recession.
The details of this “single-tranche open-market operation” (ST OMO) do not include exact amounts, and members of Congress did not even know the details of this program until now, despite oversight responsibilities. These transactions were kept mostly secret because releasing information about this type of bailout at the time could have had a disastrous effect on the reputations of these institutions, doing more harm than good in a time of crisis.
The Federal Reserve adopted a technique usually used for controlling the money supply and affecting interest rates, and turned it into a facility for extending loans to the banks without the loans being a part of the Troubled Asset Relief Program (TARP) or bailout. Bloomberg explains how this special type of lending worked.
Under ST OMO, cash changed hands through repos, or repurchase agreements, which the central bank has used to move money in and out of the banking system for at least 60 years. In a repo, the dealer sells securities to the Fed and agrees to buy them back for a higher price after a set period of time…
When the central bank increases the money supply — by paying cash for securities in repos — interest rates tend to fall. When it drains cash from the system by selling securities in reverse repos, rates can climb. Using repos to provide emergency cash, a step the Fed announced on March 7, 2008, was a departure from that process…
It’s possible this plan helped save these banks from collapse, but was it necessary? And given the secretive nature of the program, would have there been any damage if the details were made public at the time, as was done for other aspects of the Wall Street bailout? What did these banks do with a practically free loan?
Updated May 30, 2011 and originally published May 27, 2011. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.