Is The Federal Reserve Going To Close The Investment Banking Window?

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Widespread expectations that the borrowing window opened to investment banks in the midst of the Bear Stearns collapse last March will be made permanent may be misplaced, according to a longtime Fed watcher and banking expert we spoke with today. It may also explain why Lehman was so eager to shore up its balance sheet.
"All the talk coming out of the Federal Reserve about moral hazard and the unique situation we faced in March is meant to signal that the window will be closed," he said over a bowl of gazpacho in a Soho restaurant.
The Federal Reserve is concerned that the widespread impression among Wall Street executives and investors that the Fed now stands behind investment banks may encourage excess risk taking, he said. Many are skeptical that further regulation could effectively stem risks, and fear that further entrenching the Federal Reserve in the financial system could endanger its independence.
Remarks made today by New York Federal Reserve Bank President Timothy Geithner seem to support this idea. "I know that many hope and believe that we could design our system so that supervisors would have the ability to act preemptively to diffuse pockets of risk and leverage," he said. "I do not believe that is a desirable or realistic ambition for policy. It would fail, and the attempt would entail a level of regulation and uncertainty about the rules of the game that would offset any possible benefit."
Lehman's decision to raise $6.0 billion in new capital was driven in part by fear that the Federal Reserve's borrowing window will permanently be closed to investment banks, he said. He believes the Fed has been quietly telling investment banks to expect the emergency borrowing facilities not to be renewed after they expire in September.

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