Fed May have to Take Broader Role to Prevent Large Bank Failures

As the Federal Reserve expands its protection of financial firms by expanding the use of its discount lending window, at least one analyst says that the Fed will need to help out even more or some major financial services firms will fail.

Merrill Lynch, Wachovia and other financial companies are at risk of failure as the cost of raising capital soars at a time when the banks need to pay settlements over auction rate securities, David Kotok, chairman & chief investment officer from Cumberland Advisors, Vineland, N.J., told CNBC earlier this week.

“I think the financial problem is half way through the cycle … there's another shoe to drop ahead of us and it could be more severe,” Kotok said. Merrill Lynch, Wachovia, Fannie Mae, and Freddie Mac “are either going to have to get [funds] from the Federal Reserve, through some direct or indirect means, which means more leverage, more Fed balance sheet, more regularly oversight or they're going to have to get it in the capital markets.”

That means paying a premium, Kotok said. “The price in the Federal Reserve is about 2 plus percent, in the capital markets it's four times as high,” Kotok said. “If they pay the higher price, there is no profitability for them so their franchises are jeopardized. This is a serious developing issue as we cure years of overleveraging.”

According to a report from Bloomberg, The Federal Open Market Committee has ordered a formal study of the Fed’s broader role in providing funding. It’s unknown when that report will be completed.

Federal Reserve Chairman Ben Bernanke is expected to discus some of the Fed’s recent actions Friday when he addresses the Kansas City Fed’s economic symposium Friday in Jackson Hole, Wyo.