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Did the Fed Bank Bailout Work After All?

NEW YORK (TheStreet) -- The Federal Reserve's move to prop up the banking system amid the rubble of the Great Recession caught flak from a wide variety of critics, including the media, politicians, economists and even Main Street Americans.

A big complaint: "Why should we bail out the bankers whose policy decisions paved the way for the economic collapse in the first place?"

Yes, banks did make high-risk investment decisions, particularly in the fragile derivatives market and by issuing "no doc" home loans to borrowers who couldn't pay the money back.

No matter to the Federal Reserve, who under the direction of former chief Ben Bernanke decided job one was to provide big banks with short-term loans.

And despite the criticism, guess what? The strategy worked -- or so says a study from Washington University in St. Louis.

Jennifer Dlugosz, a finance professor at Washington University in St. Louis' Olin Business School, along with Allen Berger of the University of South Carolina; Lamont Black of DePaul University; and Christina Bouwman of Case Western Reserve University, studied two key areas linked to the Fed's post-recession bank bailout policy and found they actually led to "increased lending to firms and households."

The study found that, again and again, banks turned to crisis systems set up by the Fed known as the "discount window" and Term Auction Facility, and, instead of sitting on cash, enabled banks to use that cash to hike lending to individuals and businesses and save the economy from further damage.

"There were many news reports during that time that banks were hoarding cash from government interventions and keeping it for themselves," Dlugosz explains. "Our results show, at least in the context of these programs, that was not the case. Banks that received funds did increase their lending."

Dlugosz broke the study down to three questions:

  • Which banks used funds from the Federal Reserve during the crisis?
  • Did these funds substitute for or complement other funding sources?
  • Did banks use these funds to increase their lending?
The study authors say the questions weren't being asked -- primarily because data related to the bank loans were kept secret from the public. 

But Freedom of Information requests from Bloomberg News and Fox News for more government data on "crisis time borrowing" led to a treasure trove of information on the Federal Reserve's bank bailout strategy.

The data show "discount window" and TAF use was "widespread." From the study:

20% of small banks and more than 60% of large banks took advantage of the programs. Some banks relied on the Fed quite heavily, with top borrowers using these programs to fund as much as 5% to 15% of assets daily, on average, over the crisis period.

The study found that any financial institution taking advantage of the Fed's largesse did increase their lending capacity for short-term and long-term loans.

The result could come as welcome news to policymakers and to the public -- if you swallow a tough outcome: To rally the economy, it really did help to have federal money go to big banks after all.

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