Giant Bank Profits Send a Clear Signal: Close the Fed Discount Window, Already

Last Updated May 4, 2010 6:10 PM EDT

It's nice that Congress was able to get its jollies last week permanently tarnishing Goldman Sachs' reputation. But if it really wants to punish the formerly white-shoe investment bank, it should stop playing the schoolmarm in public and instead demand to know why the Federal Reserve just delivered Goldman (GS) -- along with Bank of America (BAC), Citibank (C), Morgan Stanley (MS) and others -- plus-sized quarterly profits.

As Eric Fry points out in The Daily Reckoning:

On the surface, these monster profits would seem like good news. But this silver cloud contains a very dark lining: without the Fed's low-cost financing, fixed-income profits will be much harder to come by.'
As we know, Goldman Sachs conveniently reported near-record first quarter earnings of $3.29 billion exactly one week before certain Senators began using comically tame expletives to describe its two-faced approach to the Abacus 2007-AC1. (That instrument, the sexiest collateralized debt obligation ever created, has been compared to the Springtime for Hitler of the shadow economy.)

A day before, Citibank reported its best profits since 2007; JPMorgan Chase's rose 57%; Morgan Stanley bulldozed estimates. All attributed the turnarounds to "the improving economic climate.'' But the bottom line is that the bond trading has delivered the results, thanks in particular to the Fed's open-ended invitation to its discount window.

More from Fry:

When it converted into a bank holding company back in 2008, Goldman became eligible to borrow cheap money from the Fed's discount window. Morgan Stanley did the same thing. As a result, Goldman, Morgan Stanley et al. may borrow billions of dollars from the Federal Reserve and use the proceeds to purchase higher-yielding government securities of longer duration.

In other words, Goldman may borrow from the government at 0.75%, then loan the money back to the government at 3% or 4%. All in a day's "trading." Not surprisingly, all the major financial firms have been reporting blockbuster profits.'

No one knows who ponied up to the discount window and when, although we may get to see that information soon if the Fed obeys a court order to give the information to Bloomberg and other media outlets -- but that's another story. One thing we do know: shopping at the discount window used to be a sign of weakness, an embarrassment for your large, self-respecting bank. But during the crisis, that stigma pretty much evaporated, and Big Wall Street decided it may as well take advantage of the open bar while it stayed open.

So why doesn't the Fed shut the window, already? It did finally get around to putting up some curtains -- in February, it boosted the discount rate 50 points to 0.75% and a few weeks later tightened the term on discount loans from 28-days to overnight, which is what it was pre-crisis.

Still, it's hard to argue this isn't too little too late when confronted with the morbidly obese profits Goldman and Morgan and Citi and B of A banked the easy way. It's time to let these heartily-recovered institutions fly on their own.

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