The Next Financial Bailout

By :: October 6th, 2008

My sources at the Federal Reserve and in the financial markets increasingly expect that Washington is going to have to put up hundreds of billions of dollars more to directly recapitalize troubled banks.

Such a step would be in addition to the $700 billion authorized by Congress last week and could require new congressional appropriations. It would put even greater pressure on the short-term budget deficit and add to uncertainty over the total cost of cleaning up the financial system mess. It could also require new federal legislation, setting up yet another bruising battle on Capitol Hill.

The timing of such a direct cash infusion, which would come through the Fed, is unknown. Fed officials had hoped it would not be necessary at all, or at least not until after a new President is sworn in next January. However, the market’s negative reaction to last week’s bailout could accelerate the next step. Normally, the Fed could manage such a cash infusion through its own reserves. And today it announced modest efforts to get funds to financial institutions by paying interest on bank reserves. However, the magnitude of the crisis may require far more capital than the Fed has and require additional federal borrowing.