This is the twelfth edition of the Federal Reserve Exit Watch. The first edition was posted in August 2009. The Great Recession, many contend, ended in July 2009 and, at that time, the major task of the Federal Reserve System appeared to be the task of reducing, as judiciously as possible, the massive amount of reserves that the central bank had put into the banking system to combat the threat that the Great Recession might turn into a second Great Depression.
On July 8, 2009 on the Fed’s balance sheet, total factors supplying reserve funds to the banking system totaled over $2.0 trillion, up from around $0.9 trillion one year earlier. It was September of 2008 when the liquidity crisis hit the financial system in the United States which resulted in the rapid injection of funds into the banking system to protect the system from a series of systemic failures. In July 2009, excess reserves in the banking system average around $750 billion.
The concern at that time was that all of these excess reserves in the banking system would eventually end up in the money stock and this would result in inflationary pressures threatening significant increases in consumer and asset prices.
One year later on July 7, 2010, total factors supplying funds to the banking system amounted to about $2.4 trillion. Excess reserves in the banking system totaled more the $1.0 trillion. Obviously, the Federal Reserve System did not remove reserves from the banking system during the past twelve months.
The reason given for not removing reserves from the banking system is that the economy has remained excessively weak: and the Federal Reserve will not start removing reserves from the banking system until the economy seems to be picking up momentum.
My belief has been that the health of the smaller banks in the banking system, those 8,000 or so banks that are smaller than the 25 largest banks, is still not good and the Fed will not begin to remove reserves from the banking system until these non-big banks get in much better shape. With about one in eight banks in the United States on the problem bank list of the FDIC, the banking system is a long ways from being healthy.
And, the Fed has promised that it will continue to keep its target interest rate close to zero “for an extended period” of time. That is, banks should not be afraid of rising short term interest rates any time soon. Many market analysts don’t expect short term interest rates to begin rising until after the start of 2011.
One crucial thing to understand about the operations of the Federal Reserve over the past 12 months is that the injection of funds into the banking system through the fall of 2008 and into the summer of 2009 consisted primarily of “innovative” efforts by the central bank to provide liquidity to specific parts of the money and capital markets. The reserves injected into the financial system were not anything like the classical operations of a central bank which mainly came from the sale or purchase of U. S. Treasury securities in the open market and discount window borrowings from the district Federal Reserve banks.
A major part of the exit strategy of the Fed related to the reduction in these “special” sources of funds and moving back into more traditional forms of central bank operations. Therefore, in the initial stages of the Fed’s exit strategy, efforts were directed at seeing the “special” sources of reserves decline as their needs receded and replacing the reduction in reserves with the purchase of securities from the open market.
The twist in this effort was that the Fed focused, not on the purchase of traditional source of open market securities, U. S. Treasury issues, but on acquiring a lot of mortgage-backed securities, up to $1.250 trillion worth, in order to provide support for the mortgage and housing markets, and on acquiring Federal Agency issues. On July 8, 2009, mortgage-backed securities on the books of the Federal Reserve System totaled about $462 billion. On July 9, 2010, this total reached $1.1 trillion. Federal Agency issues rose from around $98 billion on the earlier date to $165 billion on the latter date. U. S. Treasury securities rose as well, but only by about $104 billion.
Thus, in this 12-month period, total factors supplying reserve balances rose by $341 billion, and the amount of securities the Federal Reserve bought outright rose by $826 billion. The portfolio purchases replaced a lot of the “special” sources of funds supplied to the banking system by the Fed over the past ten months. This was an important part of the Fed’s exit strategy.
So, in the past 12-month period, the Fed actually increased the amount of excess reserves in the banking system. However, in the last 13-week period, excess reserves have actually fallen slightly. One could strongly argue that the decline in excess reserves has come more from operating factors rather than from any overt efforts to reduce bank reserves.
One cause for the reduction in excess reserves was the increase in U. S. Treasury deposits at the Federal Reserve in the Supplementary Financing Account. This is an account set up by the Treasury Department to specifically help the Fed drain reserves from the banking system. (See my post of April 19, 2010, “The Fed’s New Exit Strategy”, http://seekingalpha.com/article/199444-the-fed-s-new-exit-strategy.) During the past 13-week period this account rose by $50 billion, helping to bring down bank reserves. Other operating factors that drained reserves from the banking system was a $12 billion increase in currency in circulation. Also, reducing reserves was a decline in central bank liquidity swaps that fell by about $8 billion during this time period.
Over the past thirteen weeks, these factors draining reserves from the banking system was offset by about $50 billion in Fed acquisitions of mortgage-backed securities.
The net effect of all factors affecting reserve balances: a $50 billion decline in excess reserves.
Over the past four weeks Federal Reserve actions have remained relatively minor. Excess reserves in the banking system fell by about $19 billion, but this primarily resulted from operating transactions like the increase in currency in circulation and a rise in U. S. Treasury balances in the Treasury’s general account which is usually connected with tax receipts. So the last 4-week period can be considered to be uneventful.
One other thing we need to check in this analysis is the behavior of the M1 and M2 measures of the money stock. All that can be said here is that the growth rate of these two measures continues to be modest and actual growth rates have been achieved by people and businesses re-arranging assets rather than from commercial banks making loans. The year-over-year rate of growth of the M1 measure in June was about 6% while the M2 measure rose by only 1.6%.
Note that the non-M1 component of M2 grew by only 0.6% during this time period. This was because, small denomination time deposits at financial institutions have fallen by more than 22% over this time period and Retail Money Funds have dropped by more than 25%. All of these funds seem to have gone into demand deposits, other checkable deposits, and money market deposits, part of M1. This, as I have written before, is not a sign of health in the economy because people continue to transfer funds out of interest-bearing accounts and into forms of money that can be used for spending. This is a sign of desperation not of an improving economy.
A consequence of this has been that the required reserves at commercial banks have continued to rise so that the Federal Reserve must increase the total reserves in the banking system so as to keep excess reserves constant.
One other measure reflecting this shift in assets: monies in Institutional Money Funds have also fallen by 25% year-over-year.
The conclusion to this Exit Watch report is that the Federal Reserve HAS NOT YET started taking reserves from the banking system. That is, over the past year the Fed has not, if fact, exited. And, people and businesses in the aggregate still need to reduce their portfolios of invested funds in order to have money available for spending on their daily needs.
Showing posts with label retail money funds. Show all posts
Showing posts with label retail money funds. Show all posts
Sunday, July 11, 2010
Sunday, May 16, 2010
How Can The Economy Grow Without Bank Loans?
The economy seems to be picking up steam, yet bank lending does not seem to be keeping pace. Also, money stock growth does not give off positive signals in terms of how people are allocating their short-term assets in the banking system.
The question is: can the economy continue to pick up if people are staying very conservative in terms of their asset allocation in the banking system and the banks, themselves, continue to stay out of the lending market?
Overall, the total assets in the banking system (according to the H.8 release from the Federal Reserve System) have only grown modestly in recent months, up 1.3% from March to April at all commercial banks in the United States, with large banks (the twenty-five largest banks in the United States) showing a 2.1% rise and all other banks increasing at a 1.0% rate.
Over the past year Total Assets at all commercial banks are down by -1.5%, decreasing by 0.8% in the largest banks and rising 1.0% in the larger banks.
The problem with this is that the rise in the last month is due to a reporting change in the banking system and is not the result of real growth. On March 31, banks were required to bring a substantial amount of securitized loans onto their balance sheets from being accounted for as memoranda items.
The vast majority of this movement was connected with consumer loans. Thus we see that from March to April consumer loans at all banks rose by slightly more than 31%. The largest banks saw the greatest change, rising over 35%, while the smaller banks consumer loan accounts rose by slightly more than 17%.
The thing is, consumer loans are not increasing. The increase is coming solely fromt the change in the accounting for these securitized consumer loans.
All other loan classifications rose by much smaller amounts over the past month but actually declined over longer periods of time.
For example Commercial and Industrial loans, business loans, at all commercial banks rose by only 0.6% from March to April. They are actually lower over the past three months, down 4.0% and down 18.0% year-over-year.
Commercial banks are just not lending to businesses! And, this is across the board, in both the biggest 25 banks in the country and all the rest. Over the past year Commercial and Industrial Loans at large commercial banks dropped by over 19% while this same category of loans at small banks dropped by almost 9.0%
Real Estate loans have not fared any better. Up only modestly in the past month, these loans have declined for the past three months, the past six months and the last 12 month. Again, Real Estate loans at the biggest 25 banks have declined by slightly more than 2.0%, year-over-year, and they have declined by a little more than 4.0% at the smaller banks.
Shall we take these modest increases as a positive start to the increase in bank loans? Well, one month does not make a trend. We need to keep watching the banks to see if loan volume is increasing giving us some feel that not only loan demand is rising, but that the banks are actually lending again.
Cash assets at all banks declined over the past month. Whether this was a response to the Treasury’s use of their Supplemental Financing Account at the Federal Reserve (See my posts: “Federal Reserve Exit Watch Part 10”, http://seekingalpha.com/article/202476-federal-reserve-exit-watch-part-10; and “The Fed’s New Exit Strategy?”, http://seekingalpha.com/article/199444-the-fed-s-new-exit-strategy.) or the portfolio behavior of the banks themselves, there was a fairly sizeable drop in cash asset at all commercial banks.
Still over the past three months cash asset rose at both the biggest banks and the smaller ones. Again, the direction the banking system is taking with respect to excess reserves is still unclear. All one can say is that they have declined recently.
The banking system is still facing the fact that people are continuing to move their assets into the banking system and primarily into transactions accounts. This is seen by the fact that the M1 measure of the money stock has risen by almost 7.0%, year-over-year in April while the M2 money stock measure has risen by only about 2.0%. Thus, since there is almost no growth in the M2 measure of the money stock, there must be a substantial amount of shift between the non-M1 portion of M2 to the M1 measure.
In fact the total non-M1 M2 has risen by only 0.4% from April 2009 to April 2010.
As I have argued many times before, this is very conservative money management on the part of asset holders. People are putting their funds into transactions accounts so that they have them for spending. They are removing funds from non-transaction accounts which are less liquid and, with interest rates so low, not worth the effort of keeping their funds in these accounts.
This movement is also picked up in the decline in Retail Money Funds which have dropped almost 28%, year-over-year, and Institutional Money Funds which have dropped about 23%, year-over-year. These declines have continued at rapid paces for the last three months and the last month as well!
The efforts of the Federal Reserve are not being translated into bank loans or money stock growth. Monetary policy is not being translated into assets that support economic growth!
People and businesses are still in a defensive mode with respect to their asset management!
The Great Recession is over and the recovery has begun. Yet, the statistics coming from the banking system do not promote a lot of optimism. This is consistent, I believe, with consumers that are still reeling from being unemployed and losing their homes and with a banking system that is not out-of-the woods in terms of solvency issues (except for the largest 25 banks, of course.)
Strong recoveries are usually connected with strong growth in bank loans and the various measures of the money stock. Especially important is an increase in commercial and industrial loans…business loans. This is not happening.
From all we see the large banks are making a “killing” being subsidized with extraordinarily low interest costs. We learned last week that many large manufacturing and industrial business firms are sitting on huge amounts cash and other assets ready to “make a killing” when things do start to pick up. The big guys are in great shape!
If anything the financial collapse, the Great Recession, and government policy have done for big business what they could not have done for themselves. The transfer of wealth in America is going to be huge in the next five years or so thanks to Bush 43 and Obama 1. Greater wealth inequality…here we come!
The question is: can the economy continue to pick up if people are staying very conservative in terms of their asset allocation in the banking system and the banks, themselves, continue to stay out of the lending market?
Overall, the total assets in the banking system (according to the H.8 release from the Federal Reserve System) have only grown modestly in recent months, up 1.3% from March to April at all commercial banks in the United States, with large banks (the twenty-five largest banks in the United States) showing a 2.1% rise and all other banks increasing at a 1.0% rate.
Over the past year Total Assets at all commercial banks are down by -1.5%, decreasing by 0.8% in the largest banks and rising 1.0% in the larger banks.
The problem with this is that the rise in the last month is due to a reporting change in the banking system and is not the result of real growth. On March 31, banks were required to bring a substantial amount of securitized loans onto their balance sheets from being accounted for as memoranda items.
The vast majority of this movement was connected with consumer loans. Thus we see that from March to April consumer loans at all banks rose by slightly more than 31%. The largest banks saw the greatest change, rising over 35%, while the smaller banks consumer loan accounts rose by slightly more than 17%.
The thing is, consumer loans are not increasing. The increase is coming solely fromt the change in the accounting for these securitized consumer loans.
All other loan classifications rose by much smaller amounts over the past month but actually declined over longer periods of time.
For example Commercial and Industrial loans, business loans, at all commercial banks rose by only 0.6% from March to April. They are actually lower over the past three months, down 4.0% and down 18.0% year-over-year.
Commercial banks are just not lending to businesses! And, this is across the board, in both the biggest 25 banks in the country and all the rest. Over the past year Commercial and Industrial Loans at large commercial banks dropped by over 19% while this same category of loans at small banks dropped by almost 9.0%
Real Estate loans have not fared any better. Up only modestly in the past month, these loans have declined for the past three months, the past six months and the last 12 month. Again, Real Estate loans at the biggest 25 banks have declined by slightly more than 2.0%, year-over-year, and they have declined by a little more than 4.0% at the smaller banks.
Shall we take these modest increases as a positive start to the increase in bank loans? Well, one month does not make a trend. We need to keep watching the banks to see if loan volume is increasing giving us some feel that not only loan demand is rising, but that the banks are actually lending again.
Cash assets at all banks declined over the past month. Whether this was a response to the Treasury’s use of their Supplemental Financing Account at the Federal Reserve (See my posts: “Federal Reserve Exit Watch Part 10”, http://seekingalpha.com/article/202476-federal-reserve-exit-watch-part-10; and “The Fed’s New Exit Strategy?”, http://seekingalpha.com/article/199444-the-fed-s-new-exit-strategy.) or the portfolio behavior of the banks themselves, there was a fairly sizeable drop in cash asset at all commercial banks.
Still over the past three months cash asset rose at both the biggest banks and the smaller ones. Again, the direction the banking system is taking with respect to excess reserves is still unclear. All one can say is that they have declined recently.
The banking system is still facing the fact that people are continuing to move their assets into the banking system and primarily into transactions accounts. This is seen by the fact that the M1 measure of the money stock has risen by almost 7.0%, year-over-year in April while the M2 money stock measure has risen by only about 2.0%. Thus, since there is almost no growth in the M2 measure of the money stock, there must be a substantial amount of shift between the non-M1 portion of M2 to the M1 measure.
In fact the total non-M1 M2 has risen by only 0.4% from April 2009 to April 2010.
As I have argued many times before, this is very conservative money management on the part of asset holders. People are putting their funds into transactions accounts so that they have them for spending. They are removing funds from non-transaction accounts which are less liquid and, with interest rates so low, not worth the effort of keeping their funds in these accounts.
This movement is also picked up in the decline in Retail Money Funds which have dropped almost 28%, year-over-year, and Institutional Money Funds which have dropped about 23%, year-over-year. These declines have continued at rapid paces for the last three months and the last month as well!
The efforts of the Federal Reserve are not being translated into bank loans or money stock growth. Monetary policy is not being translated into assets that support economic growth!
People and businesses are still in a defensive mode with respect to their asset management!
The Great Recession is over and the recovery has begun. Yet, the statistics coming from the banking system do not promote a lot of optimism. This is consistent, I believe, with consumers that are still reeling from being unemployed and losing their homes and with a banking system that is not out-of-the woods in terms of solvency issues (except for the largest 25 banks, of course.)
Strong recoveries are usually connected with strong growth in bank loans and the various measures of the money stock. Especially important is an increase in commercial and industrial loans…business loans. This is not happening.
From all we see the large banks are making a “killing” being subsidized with extraordinarily low interest costs. We learned last week that many large manufacturing and industrial business firms are sitting on huge amounts cash and other assets ready to “make a killing” when things do start to pick up. The big guys are in great shape!
If anything the financial collapse, the Great Recession, and government policy have done for big business what they could not have done for themselves. The transfer of wealth in America is going to be huge in the next five years or so thanks to Bush 43 and Obama 1. Greater wealth inequality…here we come!
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