Why is the Federal Reserve Bank of Boston Fronting Billions to Big Commercial Banks Like State Street?

As this tumultuous political and economic week came to a close there was a short report in theBoston Globe that brings the Wall Street crisis home to our fair city. It seems that the Federal Reserve Bank of Boston just loaned $72.7 billion to a number of major U.S. commercial banks - fully 1/10 of the amount being debated in Congress to be used to bail out many of the same institutions.

One of the main beneficiaries of an undisclosed portion of this unprecedented largess is the giant Boston-based bank and financial services hybrid, State Street Corporation. Unprecedented because the Federal Reserve lifeline is being held out for the first time to shore up money market mutual funds, rather than to help banks pay off people with savings and other types of non-investment accounts. Meaning that the Federal Reserve is helping to make investing - which is, to be fair, a form of legalized gambling in which there are both winners and losers - a no-lose proposition.

Now one of the main jobs of the Federal Reserve system from its inception has in fact been to stop "bank panics." A traditional panic occurs when there is a run on banks by depositors looking to retrieve money saved in those institutions during a downturn in the economy. But since banks never retain more than a "fractional reserve" - a fraction of the amount of money they have out in the form of loans and other financial instruments working to make more money - in their now mostly-figurative vaults, at a certain point they no longer have the ability to pay out the demanded funds. They can also no longer make loans. And thus they collapse. If enough banks collapse, they can take the entire economy down with them.

So the Fed can help in these situations, and as banks became more and more complex as the 20th century rolled on, it developed more and more ways to help prevent monetary crises. However, since deregulation of the banking and investment industries over the last three decades allowed for the merger of the very different functions of those two types of financial service businesses it has been possible for banks to be heavily involved in various investment schemes, and for investment groups to be heavily involved in banking. As such, by way of illustration, it is possible for a large bank to have a great deal of money out in the form of investment instruments - including all those fancy investments like derivatives - that have turned out to be built on fantasies like the sub-prime mortgage market.

These types of shenanigans are all extremely complicated, and Open Media Boston cannot say with certainty that the move by the Fed isn't a necessary one. In any event, State Street has now been given the money it needs to buy debt-backed securities (we won't waste more column inches trying to explain what those are here, but they are now close to valueless) from investment houses like Putnam Investments and Fidelity Investments at something close to full price. This saves all 3 corporations from some danger for the moment.

Given that State Street, Putnam and Fidelity are major players in the Boston and global business scenes, major local employers, and also involved in conservative political crusades to do things like ... to give one salient example ... privatizing Social Security (in ways which would have benefited them and sibling financial institutions while destroying the future livelihoods of millions of working families), we think that these developments bear close scrutiny by progressives of all stripes in the Massachusetts and beyond.

We will certainly track where this is all going, but it doesn't smell right to us. We must question these types of lightning fast transactions on a monumental scale - particularly when they involve the Fed, which is this nation's central bank. As usual, we encourage our viewers to do the same. And to alert us of any developments on this front that relate to the housing crisis, the health care crisis, the job crisis, the energy crisis or the financial crisis in general.