FOMC Transcripts Discuss LTCM Bailout

John Brimelow’s recent article The FOMC LTCM Transcripts: Anything New? discusses last week’s release of the FOMC transcripts. The FOMC (Federal Open Market Comittee) meets to set Fed policy. These transcripts include the discussion of the Long-Term Capital Management crisis. LTCM was a hedge fund that became insolvent after accumulating a staggering amount of leverage in global bond markets. The Fed organized a bailout of LTCM by major Wall Street banks, who were also creditors of the fund, to avoid a default.

Brimelow addresses the question, was the bailout designed to avoid a financial crisis, or to bail out the Fed’s friends in the banking industry? Another facet of Brimelow’s discussion is the extent to which the Fed mandarins believe that they can manage the financial system by setting asset prices. Greenspan is quoted to the effect that a substantial decline in the stock market would be devastating to the economy because of widespread public ownership of stocks.

According to Rothbard’s lecture on the fed, the founding of the Fed was said to be necessary because a “lender of last resort” was needed to bail out the banking system when it was on the verge of becoming insolvent. Less well understood in public discussion is the role of the Fed and the fractional reserve banking system of creating financial fragility and making the financial system vulnerable to these sorts of crises.