There has been lots of words and press spilled on the recent revelations about who the Federal Reserve “bailed out” during the recent financial crisis. Let me just use one such article to capture some of the attitudes being expressed about this information.
Sebastian Mallaby, a senior fellow at the Council on Foreign Relations and the author of the book “More Money than God”, writes in the Financial Times” (http://www.ft.com/cms/s/0/9f5584f2-fe1d-11df-853b-00144feab49a.html#axzz173T61Eok):
“The point is that the Fed bail-outs were hair-raisingly enormous, and that neither the regulators nor the regulated should be allowed to forget that. Wall Street institutions that now walk tall again survived only because the taxpayers saved them. Goldman Sachs turned to the Fed for funding on 84 occasions, and Morgan Stanley did so 212 times; Blackrock, Fidelity, Dreyfus, GE Capital – all of these depended on taxpayer backstops. The message from this data dump is that, two years ago, these too-big-to-fail behemoths drove the world to the brink of a 1930s-style disaster – and that, if regulators don’t break them up or otherwise restrain them, they may do worse next time.”
There doesn’t seem to be much movement afoot to “break them up” at this time, but there has been, and will continue to be, great efforts to “restrain them”. I don’t see the will or the leadership to “break them up”. I have my own views about the ability of the government to “restrain them” but I treat that question elsewhere.
I would like to raise another issue at this time which I believe to be integral to the situation mentioned above.
Discussions about the actions of the Federal Reserve during the financial crisis tend to be completely void of any discussion about the actions of the federal government or the Federal Reserve in creating the environment that resulted in the financial collapse.
Leading up to the financial crisis of 2008-2009 was approximated fifty years of governmental actions that created the largest credit inflation in the history of the United States. The gross federal debt of the United States government increased at a compound rate of approximately 9 percent per year from 1961 to the start of the crisis. Monetary policy, throughout this time period, accommodated this growth in debt. And, this period saw the greatest burst of financial innovation and credit creation in world history.
Why did this happen?
Two major reasons: first, the short-run emphasis of the government to sustain high, perhaps unsustainable, levels of employment; second, the goal of the government to put as many Americans in their own home and provide them with a financial “piggybank” to secure their future.
The first reason meant that the government had to keep stimulating the economy to keep people employed in the jobs they had. As a consequence, many American workers did not have the incentive to grow and prepare themselves for the “jobs of the future.” As a consequence, about one out of every four Americans of employment age is “under-employed”! Furthermore, the length of being unemployed has trended upwards from the 1950s and in October 2010 the average duration of unemployment is just about 34 weeks, almost three years. (See “Unemployed and Likely to Stay That Way,” http://www.nytimes.com/2010/12/03/business/economy/03unemployed.html?ref=todayspaper.)
The second reason meant that the government had to build programs and provide financial innovation and finance so that more people could own their own homes. The inflation that took place in the real estate sector resulted in home ownership becoming the real “piggybank” of the middle class, producing for them the “best” investment they could experience over this time until, of course, the bubble burst.
The federal government set up the environment and the incentives that everyone else had to live within.
Chuck Prince, the former Chairman and CEO of Citigroup, made the now famous statement that “while the music keeps playing, you must keep dancing.”
The environment created by a government that set the example of “living beyond one’s means” created an almost perfect environment for taking financial risk, mismatching maturities, leveraging up debt, and financial innovation. The “Greenspan Put” during the 1990s and early 2000s sustained this environment by providing downside protection thereby creating greater “moral hazard.” In essence, the federal government “kept the music playing” and businesses, both financial and non-financial, had to “keep dancing” in order to remain competitive.
The question was constantly asked by executives, “How can I get a few more basis points return to be competitive with others in the industry?” The answer within such an environment was more leverage, more risk, and new financial innovations. At least, until the load became too heavy to bear.
But, in the rush to “break” companies up or to regulate and “restrain” them from such activity, most people have forgotten that the whole environment and the incentives set up were created by the same people now interested in breaking up these companies or restraining them.
So, within this call for breaking up these companies and regulating them more closely we hear
the same people calling for more government spending, more tax cuts, more quantitative easy on the part of the central bank, and greater welfare benefits to those that are hurting.
This is why the whole scenario seems to be one of trying to drive your car as fast as you can while at the same time trying to drive your car as safely as possible.
You are stepping on the gas and stepping on the car brakes at the same time!
So, where does this discussion take us? Really nowhere.
In my view, the people calling for the federal government to constantly provide fiscal and monetary stimulus to the economy are still in control and I don’t see their demise anytime soon.
People will try to regulate and restrain the financial sector, but, as I have written many times before, they will not be able to be successful. Given the global nature of finance today and the tools brought to the finance industry by information technology, these attempts to regulate and restrain will not succeed.
And, there will be renewed calls for providing social services and payments for those being hurt by the actions mentioned in the preceding two paragraphs. What is really needed to resolve the problems of the modern economy is of a long term nature and our short-sighted politicians will never implement these solutions, at least, anytime soon.
So, we must continue to face a bumpy ride. Stepping on the gas and the brake pedal at the same time produces such a ride.
Showing posts with label Morgan Stanley. Show all posts
Showing posts with label Morgan Stanley. Show all posts
Friday, December 3, 2010
Tuesday, September 29, 2009
Credit Market Debt: Why Is So Much Going to Bank Holding Companies?
Credit market debt increased by only 3% from the end of the second quarter of 2008 to the end of the quarter of 2009, a total of roughly $1.5 trillion. Of course, the primary story concerns the shifts in borrowing that took place during this time. The data used in this analysis is from the Flow of Funds accounts from the Federal Reserve.
One should note that the only two really substantial increases in credit market debt during this time period were the Federal Government and bank holding companies. Bank holding companies?
The Federal Government is easily identified as one of the primary borrowers during this time period as the debt of the government rose 36% or a total of $1.9 trillion. This is the largest year-over-year increase, dollar-wise, in history! But, this is not a surprise for we knew this was coming.
Note, that this increase does not include other sources of government debt extension in what are called “Funding Corporations” that include the creations of the Federal Reserve System to fund AIG and so on. This source of government funding reached a maximum of $445 billion in the fourth quarter of 2008 and dropped off to only $224 billion by the end of the second quarter of 2009.
One thing that has interested me is the performance of the commercial banking industry. The commercial banking industry, as a whole, has increased its use of credit market debt by a little more than 23%, although U. S. chartered commercial banks have actually reduced its reliance on this source of funds by about 6%. Note, too, that the credit market debt of the whole financial sector declined by about 1%.
The difference has come in the dramatic increase in the use of credit market debt by bank holding companies. Bank holding companies increased their use of this source of funds by 50%, an increase of $365 billion. In the process, the bank holding companies reduced their reliance on commercial paper by $78 billion and raised a net of $443 billion in corporate bonds. Thus there was not only a substantial increase in the funds bank holding companies raised during this time period, there was also a lengthening of the liabilities of these institutions.
One should call attention to the fact that Goldman, Sachs and Morgan Stanley became bank holding companies during this time period. How much of an impact this fact had on these aggregate numbers is hard to tell, but one should be aware of this movement. These two organizations became bank holding companies on September 22, 2008 and the bank holding numbers did not really increase appreciably during the third or fourth quarters of the year. Although total financial assets in bank holding companies rose modestly from the end of the second quarter to the end of the fourth quarter, actual credit market liabilities decreased. The numbers really began to jump upwards at the end of the first quarter of 2009.
Another factor influencing bank holding company debt during this time is the guarantee on bank bonds provided by the federal government. This gave bank holding companies the ability to raise funds relatively more cheaply than they could have raised them otherwise: a good reason to raise funds.
The interesting thing is that the raising of these funds did little or nothing to spur on bank lending or commercial bank growth. Investment in bank subsidiaries by bank holding companies went up by about $112 billion but this certainly doesn’t seem to have gone into bank loans since most of the increase in U. S. chartered commercial bank assets has been in the form of a rise in cash assets and government securities.
Total financial assets at banks rose by about $950 billion from the end of the second quarter of 2008 until the end of the second quarter of 2009. However, cash assets and reserves at the Federal Reserve rose by $430 and Government, Agency and GSE-backed securities rose by $185 billion. The only lending category to show much of a rise was the mortgage category, $233 billion, and this was primarily in commercial real estate. Commercial loans actually declined by about $100 billion. Something called Miscellaneous Assets rose by about $160 billion. Not a lot of lending going on in the banking sector.
However, investment by bank holding companies in nonbank subsidiaries actually rose by about $630 billion and investment in Other Miscellaneous assets rose by about $150 billion!
Thus, bank holding companies invested almost $800 billion in funding nonbank assets.
It seems as if big financial institutions are continuing to behave in the same way that they did before the financial markets started to unravel toward the end of 2007. That is, they put their money into non-bank operations, areas that the regulators did not have a lot of insight into or control over. That is, the banking system is still not relying on the fundamentals of banking to make money these days! They are returning to the areas that proved to be so profitable to them before the crash. And, once again, we seem to be in the dark as to what exactly they are doing.
Even through the credit crisis of 2008 and 2009, the credit markets provided some issuers of debt a substantial amount of funds. However, it seems as if these funds are going into hands that were very similar to the ones that were obtaining funds right before the crisis took place.
One should note that the only two really substantial increases in credit market debt during this time period were the Federal Government and bank holding companies. Bank holding companies?
The Federal Government is easily identified as one of the primary borrowers during this time period as the debt of the government rose 36% or a total of $1.9 trillion. This is the largest year-over-year increase, dollar-wise, in history! But, this is not a surprise for we knew this was coming.
Note, that this increase does not include other sources of government debt extension in what are called “Funding Corporations” that include the creations of the Federal Reserve System to fund AIG and so on. This source of government funding reached a maximum of $445 billion in the fourth quarter of 2008 and dropped off to only $224 billion by the end of the second quarter of 2009.
One thing that has interested me is the performance of the commercial banking industry. The commercial banking industry, as a whole, has increased its use of credit market debt by a little more than 23%, although U. S. chartered commercial banks have actually reduced its reliance on this source of funds by about 6%. Note, too, that the credit market debt of the whole financial sector declined by about 1%.
The difference has come in the dramatic increase in the use of credit market debt by bank holding companies. Bank holding companies increased their use of this source of funds by 50%, an increase of $365 billion. In the process, the bank holding companies reduced their reliance on commercial paper by $78 billion and raised a net of $443 billion in corporate bonds. Thus there was not only a substantial increase in the funds bank holding companies raised during this time period, there was also a lengthening of the liabilities of these institutions.
One should call attention to the fact that Goldman, Sachs and Morgan Stanley became bank holding companies during this time period. How much of an impact this fact had on these aggregate numbers is hard to tell, but one should be aware of this movement. These two organizations became bank holding companies on September 22, 2008 and the bank holding numbers did not really increase appreciably during the third or fourth quarters of the year. Although total financial assets in bank holding companies rose modestly from the end of the second quarter to the end of the fourth quarter, actual credit market liabilities decreased. The numbers really began to jump upwards at the end of the first quarter of 2009.
Another factor influencing bank holding company debt during this time is the guarantee on bank bonds provided by the federal government. This gave bank holding companies the ability to raise funds relatively more cheaply than they could have raised them otherwise: a good reason to raise funds.
The interesting thing is that the raising of these funds did little or nothing to spur on bank lending or commercial bank growth. Investment in bank subsidiaries by bank holding companies went up by about $112 billion but this certainly doesn’t seem to have gone into bank loans since most of the increase in U. S. chartered commercial bank assets has been in the form of a rise in cash assets and government securities.
Total financial assets at banks rose by about $950 billion from the end of the second quarter of 2008 until the end of the second quarter of 2009. However, cash assets and reserves at the Federal Reserve rose by $430 and Government, Agency and GSE-backed securities rose by $185 billion. The only lending category to show much of a rise was the mortgage category, $233 billion, and this was primarily in commercial real estate. Commercial loans actually declined by about $100 billion. Something called Miscellaneous Assets rose by about $160 billion. Not a lot of lending going on in the banking sector.
However, investment by bank holding companies in nonbank subsidiaries actually rose by about $630 billion and investment in Other Miscellaneous assets rose by about $150 billion!
Thus, bank holding companies invested almost $800 billion in funding nonbank assets.
It seems as if big financial institutions are continuing to behave in the same way that they did before the financial markets started to unravel toward the end of 2007. That is, they put their money into non-bank operations, areas that the regulators did not have a lot of insight into or control over. That is, the banking system is still not relying on the fundamentals of banking to make money these days! They are returning to the areas that proved to be so profitable to them before the crash. And, once again, we seem to be in the dark as to what exactly they are doing.
Even through the credit crisis of 2008 and 2009, the credit markets provided some issuers of debt a substantial amount of funds. However, it seems as if these funds are going into hands that were very similar to the ones that were obtaining funds right before the crisis took place.
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