The Fed is acting to prevent a spillover from the Lehman collapse, taking a series of emergency liquidity actions explained in Fed braces markets for likely Lehman collapse.

WASHINGTON (Reuters) – The U.S. Federal Reserve on Sunday launched a series of emergency measures to calm financial markets and ease any trading disruptions that could arise from a collapse of investment bank Lehman Brothers.

One of the biggest changes the Fed made was to accept equities as collateral for cash loans at one of its special credit facilities, the first time that the Fed has done so in its nearly 95-year history.

The most striking new Fed action was its decision to accept equities as collateral for cash loans under its Primary Dealer Credit Facility for investment banks. Until now, collateral was limited to investment-grade debt securities.

“The Fed’s action allows dealers to pledge an asset class that is a significant part of the Street’s securities positions,” said Tony Crescenzi, chief bond market strategist, Miller, Tabak & Co in New York, giving them significantly more access to loans if they need them.

The Fed also said it was increasing the total amount that it offers under a separate program that lends out liquid Treasury securities to $200 billion from $175 billion. It will also begin holding auctions under this program more frequently.

In a third step, it said it will temporarily allow commercial banks to extend liquid funds to their brokerage affiliates for assets that would normally be accepted in tri-party repurchase agreements.

It said this would be permitted only until January 30, 2009, apparently reflecting the Fed’s hope that stressed repo markets would be operating more normally by then.

Bernanke Violates Federal Reserve Act Section 23A

Allowing banks to extend funds to their brokerage affiliates is in violation of Federal Reserve Act Section 23A.

Section 23A of the Federal Reserve Act ( Act ), originally enacted as part of the Banking Act of 1933, is designed to prevent the misuse of a bank’s resources through non-arm’s-length transactions with its affiliates and to limit the ability of a bank to transfer its federal subsidy to its affiliates.

Bernanke’s willingness to break the law is in strict accordance with Fed Uncertainty Principle Corollary Number Four.

The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it’s easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

Supposedly the Fed “will temporarily allow commercial banks to extend liquid funds to their brokerage affiliates for assets that would normally be accepted in tri-party repurchase agreements.”

For starters I doubt it will be temporary. But the main point is the Fed is taking steps that it knows to be blatantly illegal.

Banks Set Up $70 Billion Liquidity Fund

Bloomberg is reporting Banks, Firms Set Up $70 Billion Fund for Liquidity.

A group of banks including Bank of America Corp., Citigroup Inc. and JPMorgan Chase & Co. are putting up $70 billion for a borrowing fund aimed at providing liquidity.

The Federal Reserve also said it will accept other types of securities — including equities — as collateral for making direct loans to investment banks, according to a joint statement today. The firms plan to use the facility beginning this week.

Each participating financial firm will provide $7 billion to establish the fund and have the ability to borrow up to a third of the total.

Fed Puts Up $23 Billion

If 1/3 can be borrowed, rest assured 1/3 will be borrowed. That money will come from the Fed.

No government funds for Lehman?

I am sticking with a strict interpretation of Paulson’s Claim Of “No Government Sponsorship”.

The steps taken above, including the first ever action to swap equities, illegal actions in regards to Federal Reserve Act Section 23B, and the $23 billion liquidity provided by the Fed shows the claim “no government funds for Lehman” is patently false.

Broker Dealer Business Model Fundamentally Flawed

Roubini On Ripple Effects for Wall Street

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Roubini: “All of the independent broker dealers are going to disappear. In March it was Bear Stearns. Tonight it was Lehman and Merrill Lynch. Morgan Stanley and Goldman Sachs should go find a buyer tomorrow. The business model of broker dealers is fundamentally flawed. They cannot survive.

Bazooka Paulson

“If you have a bazooka in your pocket, and people know you have a bazooka, you may never have to take it out.” (See Henry Paulson, Why Scare My Mother?)

It seems to me Paulson took out his bazooka, fired it, and shot Fannie Mae in the arse. After Fannie Mae blew sky high, Paulson was adamant not to fire another shot.

Indeed, Paulson didn’t fire another shot but Bernanke did, with a number of questionable actions including one illegal one.

Mike “Mish” Shedlock
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