Gonzalez Says Fed Actions Fueled the Bank Fund's Losses

WASHINGTON -- The Federal Reserve has cost billions of dollars for the fund that insures bank deposits - by artificially extending the lives of failing institutions through discount window lending, the chairman of the House Banking Committee charged Tuesday.

"This is a massive form of forbearance, granted in secret by the Federal Reserve, at a huge cost to the insurance funds and taxpayers," said Rep. Henry B. Gonzalez, D-Tex.

He compared the Fed to money brokers who kept failing thrifts alive long after they became insolvent.

Legacy of Failures

Mr. Gonzalez based his comments on a committee study that reviewed all 2,990 institutions that borrowed from the discount window from Jan. 1, 1985 though May of this year.

Mr. Gonzalez said the study showed that 90% of the banks receiving extended credit in that period ultimately failed. And discount borrowing increases dramatically as an institution's financial condition deteriorates.

The committee chairman said his study showed that the central bank routinely lends money to banks with a Camel 5 rating, the lowest grade on a five-point scale used to evaluate a bank's management and financial health. A Camel 5-rated bank that borrowed from the discount window remained open an average of 10 to 12 months.

The Fed routinely lends to banks receiving the lowest possible rating from regulators, and permits institutions to increase borrowing as their condition deteriorates, Mr. Gonzalez said.

A Fed spokesman declined comment Tuesday.

According to one observer, the Fed is not necessarily to blame for keeping insolvent institutions open.

"As the lender of last resort, if the regulator hasn't closed the bank, what's the Fed supposed to do?" said Karen Shaw, president of the Institute for Strategy Development. Still, Ms. Shaw added, "it's clear that banks are being closed too slowly."

Mr. Gonzalez's charges came as his wrestles with ways to lower the cost of dealing with bank failures. The Texas Democrat said Tuesday that the Fed's discount-window policies may effectively circumvent least-cost resolutions, since losses at insolvent institutions continue to mount until they are closed.

Risks Fall on Insurer

Because Fed loans are collateralized with government securities, the central bank assumes no risk in lending to failing institutions, Mr. Gonzalez said. Instead, the insurance fund is left to absorb large losses once the bank is finally closed.

The study showed that First RepublicBank Dallas borrowed from the Fed for 4 1/2 months before it failed in 1988. Peak borrowing reached $3.3 billion.

The Bank of New England's peak borrowings reached $2.3 billion over a six-month period that ended with the institution's failure last Jan. 6.

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