Fatih Özatay, PhD - [Archive]

Crises and insolvent banks 27/08/2009 - Viewed 1424 times

There are numerous rumors about when exactly the global crisis emerged. There are people that assume it as the end of 2006 as well as August 2007, as FED Chairman Bernanke argued in the speech he delivered six days ago. However, there is a consensus that the crisis peaked in September 2007. Let us recall what has happened:

Two state-sponsored giants operating in USA housing credit market, i.e. Fannie Mae and Freddie Mac, were placed into conservatorship with the biggest rescue operation of history on September 7. Bank of America announced $50 billion support package. On September 22, 2008, Morgan Stanley and Goldman Sachs transferred (had to transfer) themselves from investment banks into bank holdings. FBI launched an investigation on the role Fannie Mae, Freddie Mac, Lehman Brothers and AIG, biggest insurance company of the USA, played in the emergence of the crisis. At the end of the month, Washington Mutual, biggest savings-investment institution, was seized. The most important development that triggered the crisis was that Lehman Brothers coming to the edge of bankruptcy. And on September 15, Lehman Brothers declares bankruptcy.

FED was criticized extensively for not rescuing Lehman Brothers. Central banks encounter this type of criticisms too often. As you might remember, Central Bank of Turkey also faced a similar criticism before the burst of the 2001 crisis for not providing cash liquidity support for Demirbank in the end of November and in December in 2000. On December 6, Demirbank was transferred to Saving Deposit Insurance Fund. See how Bernanke explains in his last speech the reason why FED did not provide cash support for Lehman Brothers:

"The Federal Reserve has consistently maintained the view that the disorderly failure of one or more systemically important institutions in the context of a broader financial crisis could have extremely adverse consequences for both the financial system and the economy. We have therefore spared no effort, within our legal authorities and in appropriate cooperation with other agencies, to avert such a failure. The case of the investment bank Lehman Brothers proved exceptionally difficult, however. Concerted government attempts to find a buyer for the company or to develop an industry solution proved unavailing, and the company's available collateral fell well short of the amount needed to secure a Federal Reserve loan of sufficient size to meet its funding needs. As the Federal Reserve cannot make an unsecured loan, and as the government as a whole lacked appropriate resolution authority or the ability to inject capital, the firm's failure was, unfortunately, unavoidable."  

It is necessary to think on before criticizing central banks on grounds of such cases. Does the laws in effect allow them launch the necessary operations? Or is it the responsibility of the other institutions to deal with operations to prevent bankruptcies? Do those institutions fulfill their part? If governments and law-makers fail to introduce the legal amendments to allow the accomplishment of necessary operations in a timely manner, how can it be expected from bureaucrats to go beyond the legal boundaries? And finally it is necessary to decide what type of regulations and supervision are necessary to minimize the possibility for financial institutions to encounter such risks.

This commentary was published in Radikal daily on 27.08.2009