US Government...Worlds Biggest Investment Bank?

What happened this past weekend surely was historic and a real game changer. No, I'm not talking about the JPMorgan pouncing on opportunity, at the potential expense of the Federal Reserve via the Bear Stearns deal (As of November 2007, Bear had around $46 billion of MBS/ABS, Fed agreed to take the "most illiquid", i.e the worst $30 Billion of it). Far more monumental is the fleecing that the US investment banks have parlayed on the Federal Reserve.

The US government has effectively become a joint venture partner with the investment banks, one which though provides all, yes all of the upside to the investment banks, while giving the taxpayers nothing except for potential liability for future losses (yes I know technically the Fed is not the government, but they are responsible for printing Federal Reserve Notes (dollars) and those are fully backed by the US Government). The Fed has completely opened up their entire, theoretically limitless, balance sheet for the use of the investment banks, to use as collateral however they see fit in order to attempt to improve their profits (no not reduce losses, improve profits, just in the last week alone, we learned that last quarter, not year, right in the heart of the credit crisis, writedowns and all, Morgan Stanley checked in at $1.55 Billion in profits, Goldman made $1.5 Billion, and even supposedly shaky Lehman made $489 million). Listen to the words of the Lehman CFO herself as to what the Fed will now accept as collateral for the effectively limitless loans they will now provide to the investment banks;

"Its actually a very broad range of collateral...All BBB- assets or better, across all asset classes in fixed income"

"This is a fantastic decision, unprecedented"

Of course it is,...for the banks. A government guarantee, literally achieved overnight! The potential ramifications are enormous.

If this works in terms of stabilizing the financial system and if we do not head into a serious economic downturn, then perhaps the Fed's gambit will work. Down the line then, the Fed simply withdraws the line or at tells the investment banks that they have to play by the same rules and regulations as the commercial banks, i.e. enjoy both the benefits and the responsibilities of a post-Glass-Steagall world. The solution perhaps ends up in between.

On the other hand, consider if the economic forces leading to a significant downturn are just too strong. Rather then letting market forces take their course in terms of investment banks, cleaning out the excesses and the weak, i.e. Drexel, E.F Hutton, and Salomon Brothers, the Fed might find themselves in a rather untenable situation, actually weakening the investment banking sector by artificially supporting excesses and the weak, and paying a potentially vast sum in order to make things worse. I thought that it was pretty well accepted that even the AAA ratings on many securities were at the least very questionable in some cases. The Fed is accepting collateral all the way down to BBB-! Further, they are doing this right into the teeth of an economic downturn. Quite a high stakes gambit by the US government!