Fed is punching holes in the firewall to quench the credit crunch.

Fed bends rules to help two big banks

If the Federal Reserve is waiving a fundamental principle in banking regulation, the credit crunch must still be sapping the strength of America's biggest banks.

Fortune's Peter Eavis documents an unusual Fed move.

By Peter Eavis, Fortune writer August 24 2007: 5:09 PM EDT

NEW YORK (Fortune) — In a clear sign that the credit crunch is still affecting the nation's largest financial institutions, the Federal Reserve agreed this week to bend key banking regulations to help out Citigroup (Charts, Fortune 500) and Bank of America (Charts, Fortune 500), according to documents posted Friday on the Fed's web site. The Aug. 20 letters from the Fed to Citigroup and Bank of America state that the Fed, which regulates large parts of the U.S. financial system, has agreed to exempt both banks from rules that effectively limit the amount of lending that their federally-insured banks can do with their brokerage affiliates. The exemption, which is temporary, means, for example, that Citigroup's Citibank entity can substantially increase funding to Citigroup Global Markets, its brokerage subsidiary. Citigroup and Bank of America requested the exemptions, according to the letters, to provide liquidity to those holding mortgage loans, mortgage-backed securities, and other securities. This unusual move by the Fed shows that the largest Wall Street firms are continuing to have problems funding operations during the current market difficulties, according to banking industry skeptics. The Fed's move appears to support the view that even the biggest brokerages have been caught off guard by the credit crunch and don't have financing to deal with the resulting dislocation in the markets. The opposing, less negative view is that the Fed has taken this step merely to increase the speed with which the funds recently borrowed at the Fed's discount window can flow through to the bond markets, where the mortgage mess has caused a drying up of liquidity. On Wednesday, Citibank and Bank of America said that they and two other banks accessed $500 million in 30-day financing at the discount window. A Citigroup spokesperson declined to comment. Bank of America dismissed the notion that Banc of America Securities is not well positioned to fund operations without help from the federally insured bank. "This is just a technicality to allow us to use our regular channels of business with funds from the Fed's discount window," says Bob Stickler, spokesperson for Bank of America. "We have no current plans to use the discount window beyond the $500 million announced earlier this week." There is a good chance that other large banks, like J.P. Morgan (Charts, Fortune 500), have been granted similar exemptions. The Federal Reserve and J.P. Morgan didn't immediately comment. The regulations in question effectively limit a bank's funding exposure to an affiliate to 10% of the bank's capital. But the Fed has allowed Citibank and Bank of America to blow through that level. Citigroup and Bank of America are able to lend up to $25 billion apiece under this exemption, according to the Fed. If Citibank used the full amount, "that represents about 30% of Citibank's total regulatory capital, which is no small exemption," says Charlie Peabody, banks analyst at Portales Partners. The Fed says that it made the exemption in the public interest, because it allows Citibank to get liquidity to the brokerage in "the most rapid and cost-effective manner possible." So, how serious is this rule-bending? Very. One of the central tenets of banking regulation is that banks with federally insured deposits should never be over-exposed to brokerage subsidiaries; indeed, for decades financial institutions were legally required to keep the two units completely separate. This move by the Fed eats away at the principle. Sure, the temporary nature of the move makes it look slightly less serious, but the Fed didn't give a date in the letter for when this exemption will end. In addition, the sheer size of the potential lending capacity at Citigroup and Bank of America – $25 billion each – is a cause for unease. Indeed, this move to exempt Citigroup casts a whole new light on the discount window borrowing that was revealed earlier this week. At the time, the gloss put on the discount window advances was that they were orderly and almost symbolic in nature. But if that were the case, why the need to use these exemptions to rush the funds to the brokerages? Expect the discount window borrowings to become a key part of the Fed's recovery strategy for the financial system. The Fed's exemption will almost certainly force its regulatory arm to sharpen its oversight of banks' balance sheets, which means banks will almost certainly have to mark down asset values to appropriate levels a lot faster now. That's because there is no way that the Fed is going to allow easier funding to lead to a further propping up of asset prices. Don't forget: The Federal Reserve is in crisis management at the moment. However, it doesn't want to show any signs of panic. That means no rushed cuts in interest rates. It also means that it wants banks to quickly take the big charges that will inevitably come from holding toxic debt securities. And it will do all it can behind the scenes to work with the banks to help them get through this upheaval. But waiving one of the most important banking regulations can only add nervousness to the market. And that's what the Fed did Monday in these disturbing letters to the nation's two largest banks.

Fed is punching holes in the firewall to quench the credit crunch.

Fed bends rules to help two big banks

If the Federal Reserve is waiving a fundamental principle in banking regulation, the credit crunch must still be sapping the strength of America's biggest banks.

Fortune's Peter Eavis documents an unusual Fed move.

By Peter Eavis, Fortune writer August 24 2007: 5:09 PM EDT

NEW YORK (Fortune) — In a clear sign that the credit crunch is still affecting the nation's largest financial institutions, the Federal Reserve agreed this week to bend key banking regulations to help out Citigroup (Charts, Fortune 500) and Bank of America (Charts, Fortune 500), according to documents posted Friday on the Fed's web site. The Aug. 20 letters from the Fed to Citigroup and Bank of America state that the Fed, which regulates large parts of the U.S. financial system, has agreed to exempt both banks from rules that effectively limit the amount of lending that their federally-insured banks can do with their brokerage affiliates. The exemption, which is temporary, means, for example, that Citigroup's Citibank entity can substantially increase funding to Citigroup Global Markets, its brokerage subsidiary. Citigroup and Bank of America requested the exemptions, according to the letters, to provide liquidity to those holding mortgage loans, mortgage-backed securities, and other securities. This unusual move by the Fed shows that the largest Wall Street firms are continuing to have problems funding operations during the current market difficulties, according to banking industry skeptics. The Fed's move appears to support the view that even the biggest brokerages have been caught off guard by the credit crunch and don't have financing to deal with the resulting dislocation in the markets. The opposing, less negative view is that the Fed has taken this step merely to increase the speed with which the funds recently borrowed at the Fed's discount window can flow through to the bond markets, where the mortgage mess has caused a drying up of liquidity. On Wednesday, Citibank and Bank of America said that they and two other banks accessed $500 million in 30-day financing at the discount window. A Citigroup spokesperson declined to comment. Bank of America dismissed the notion that Banc of America Securities is not well positioned to fund operations without help from the federally insured bank. "This is just a technicality to allow us to use our regular channels of business with funds from the Fed's discount window," says Bob Stickler, spokesperson for Bank of America. "We have no current plans to use the discount window beyond the $500 million announced earlier this week." There is a good chance that other large banks, like J.P. Morgan (Charts, Fortune 500), have been granted similar exemptions. The Federal Reserve and J.P. Morgan didn't immediately comment. The regulations in question effectively limit a bank's funding exposure to an affiliate to 10% of the bank's capital. But the Fed has allowed Citibank and Bank of America to blow through that level. Citigroup and Bank of America are able to lend up to $25 billion apiece under this exemption, according to the Fed. If Citibank used the full amount, "that represents about 30% of Citibank's total regulatory capital, which is no small exemption," says Charlie Peabody, banks analyst at Portales Partners. The Fed says that it made the exemption in the public interest, because it allows Citibank to get liquidity to the brokerage in "the most rapid and cost-effective manner possible." So, how serious is this rule-bending? Very. One of the central tenets of banking regulation is that banks with federally insured deposits should never be over-exposed to brokerage subsidiaries; indeed, for decades financial institutions were legally required to keep the two units completely separate. This move by the Fed eats away at the principle. Sure, the temporary nature of the move makes it look slightly less serious, but the Fed didn't give a date in the letter for when this exemption will end. In addition, the sheer size of the potential lending capacity at Citigroup and Bank of America – $25 billion each – is a cause for unease. Indeed, this move to exempt Citigroup casts a whole new light on the discount window borrowing that was revealed earlier this week. At the time, the gloss put on the discount window advances was that they were orderly and almost symbolic in nature. But if that were the case, why the need to use these exemptions to rush the funds to the brokerages? Expect the discount window borrowings to become a key part of the Fed's recovery strategy for the financial system. The Fed's exemption will almost certainly force its regulatory arm to sharpen its oversight of banks' balance sheets, which means banks will almost certainly have to mark down asset values to appropriate levels a lot faster now. That's because there is no way that the Fed is going to allow easier funding to lead to a further propping up of asset prices. Don't forget: The Federal Reserve is in crisis management at the moment. However, it doesn't want to show any signs of panic. That means no rushed cuts in interest rates. It also means that it wants banks to quickly take the big charges that will inevitably come from holding toxic debt securities. And it will do all it can behind the scenes to work with the banks to help them get through this upheaval. But waiving one of the most important banking regulations can only add nervousness to the market. And that's what the Fed did Monday in these disturbing letters to the nation's two largest banks.

The Fed is not worried about the stock market. A rate cut will come because they are worried about an economic slowdown leding to a recession. Also, the credit crunch is in no way over. The mortgage market is still a mess. Especially in California where non-conforming loans are viewed by investors and lenders as poisonous.

If lenders like CFC were smart they would set up their own RE brokerage business (or partner with an existing one because I think NAR has successfully lobbied against allowing banks to become RE brokers) and hold onto 90% of the homes they foreclose on and use them as rentals or lease options. There are going to be 1000’s of sellers (I’m not talking about the guys who got foreclosed on) who are currently selling their homes and think they can qualify for a loan but they can’t in this environment. So where do they go? They are going to have to rent. I have a relative in this exact situation who has $400k in the bank after selling his home. He was going to rent for 6 months until he found the house they wanted to live in for the next 20 years, but now he can’t qualify for the 900k house he was going to buy. So he and his family are renters. That scenario is going to be replayed over and over unless the limits on conforming loans are raised significantly. The credit crunch is still in full force in the mortgage industry.

Ozzie,

Why would your relative not be able to buy a home if he/she will be putting down more than 20%? Does his/her income or credit score not support 500K loan?

This is precisely why a market adjustment and tightening of credit needs to occur. It doesn’t matter if you down 400K…if you can’t afford a 500K loan based on your income, then people should not be buying those homes. People have to learn to live within the means, I don’t think conforming loan limits need to be raised to allow buyers to purchase property that they cannot afford…bottom line is that your income/savings/lifestyle choices have to be sufficient to support your mortgage.

People don’t have to rent, your relative can still buy a home with 400K down…people just have to buy a home that they can AFFORD….no one if forcing your relative to buy a 900K home.

Ozzie,

Why would your relative not be able to buy a home if he/she will be putting down more than 20%? Does his/her income or credit score not support 500K loan?

This is precisely why a market adjustment and tightening of credit needs to occur. It doesn’t matter if you down 400K…if you can’t afford a 500K loan based on your income, then people should not be buying those homes. People have to learn to live within the means, I don’t think conforming loan limits need to be raised to allow buyers to purchase property that they cannot afford…bottom line is that your income/savings/lifestyle choices have to be sufficient to support your mortgage.

People don’t have to rent, your relative can still buy a home with 400K down…people just have to buy a home that they can AFFORD….no one if forcing your relative to buy a 900K home.

who has $400k in the bank

If he can use upto $400K for down payment, even a brainless worm should be able to loan him $400K to buy a $800K home. Why is this not possible? This would be conforming too, right? And I think the 900K house sellers will gladly sell it now for 800K since they won't find too many people with 400K jingling in their pockets.

if their income doesn’t support the 400k loan payment, then they don’t get the loan