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Busch: Danger Of Fed Overstepping Bounds With Banks

With mischief and mayhem continuing to circulate through the financial world, it's instructive to look to the "Isles" for a clue to see what lies in store for future policy for the United States.

The US is not the only country with banking problems or scandals. Ireland took steps today to stabilize their banks by injecting capital into their financial institutions after one bank had an accounting scandal hit its shares. Remember, this country intervened aggressively after the Lehman collapse to guarantee all deposits and debt of the country's major financial institutions.

The new actions by Ireland were to "ensure that the financial system in Ireland meets the everyday financial needs of individuals, businesses and the overall economy." But the steps go far beyond this euphemistic phrase.

For the three major banks, the first part of the plan is to make direct capital injections and take voting rights in exchange. This makes sense as you want to provide capital to assist with the de-leveraging financial institutions are going through to strengthen their balance sheets. The government will invest €2 billion each in Bank of Ireland PLC and Allied Irish Banks PLC, in exchange for 25% of the voting rights of each bank. In Anglo Irish bank, the terms are little different: government will make an initial investment of €1.5 billion in in exchange for preference shares that will give it 75% of the voting rights of the bank. This gives the government bureaucrats effective control of the company.

And the money comes with serious strings attached. According to the WSJ, "In exchange for the money, the banks have agreed to increase lending to small and midsize businesses by at least 10% next year, the finance ministry said. The banks also agreed to increase lending to first-time house buyers by 30% next year, subject to demand, and to wait at least six months after a homeowner first defaults on a mortgage before taking legal action or repossessing the home. The banks also promised to work with regulators to develop financial-education programs for consumers."

As US banks carry a chain of woe longer than Marley's, I can only think that the incoming US politicos are all nodding their heads in unison in agreement over what Ireland has done. Can everyone repeat after me, the government does not allocate resources efficiently. For public goods (military, drinking water, etc..), the government is necessary and critical. From there, it gets more and more questionable. In this vein, social goods are defined as public goods that could be delivered as private goods, but are usually delivered by the government for various reasons, including social policy, and finances from public funds like taxes. This is the realm we're entering for banks.

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Due to the a credit crisis brought on by lack of enforcement of laws on the books and an irresponsible monetary policy, the risk for the United States is that government oversteps its bounds and dictates what lending policies should be for the current financial institutions. While this won't kill a recovery, it will eventually produce massive misallocation of precious resources. Like Scrooge, It's not too late to change...but I'm not sure we're going to wake up in time.

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Andrew Busch

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Andrew B. Busch is Global FX Strategist atBMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor.He can be reached here .