At first I was not going to comment on the re-appointment of Ben Bernanke to the position of Chairman of the Board of Governors of the Federal Reserve System. I thought I had had my say. See my post “Exit Strategy: An Argument Against Bernanke's Reappointment” of July 27, 2009. Guess this was not to be. Since this post was re-posted on several sites yesterday and people have asked me to comment on the news, I decided to provide a current comment on the situation.
There are seemingly two reasons given for the re-appointment of Ben Bernanke to another term as the Chairman of the Board of Governors. The first is that he was calm throughout the crisis. The second is that his appointment, since he is a “known”, will calm the financial markets.
Calm is “good”! I have just been writing about it: see Banking Sector Stays Quiet on August 10 and The Deleveraging Continues: What This Means on August 24. It is good that the financial markets are calm and everyone is on vacation this last week in August: a great time to make a very important appointment.
But, is “calm” what we need. The financial markets do get over changes in leadership. For example, we change Presidents and the markets get over the change! In fact, changing leadership in a time of calm is the best time to change leadership!
And, what does it mean that Bernanke was “calm” during the financial crisis. Why do I keep remembering management team after management team taking their banks public during the Savings and Loan crisis that kept telling us: “Yes, we got the bank into this mess but we learned our lesson. Now, all you have to do is give us another $100 million in new capital and we will change our ways!” And, that was the last the investors saw of their $100 million. But, these managements were calm as their institutions crumbled.
Bernanke was one of the leaders that got us into this mess. He got us through the crisis? I have over my desk the cartoon from the Financial Times showing Bernanke in front of the Federal Reserve building with two revolvers in his hands shooting off lots and lots of currency. The title of the cartoon: “A Fistful of Dollars”. He is not known as “Helicopter Ben” for nothing.
His policy for the crisis: throw as much money into the market as possible. It is way better to have too much money out there than to not have enough. A good, coherent, concise policy!
And, he did this very calmly!
Or did he? See my post of November 16, 2008: The Bailout Plan: Did Bernanke Panic?
My final concern over this re-appointment is my disappointment with President Obama. I had hopes that he would bring a whole new quality of leadership to Washington, D. C. He has been President for over six months now and I must say that hope has not been fulfilled.
Wednesday, August 26, 2009
Monday, August 24, 2009
The Deleveraging Continues
There are three major factors that will contribute to the timing and the strength of the economic recovery. First, there is the ability and speed at which individuals and businesses are able to get their balance sheets in order by reducing the amount of debt they have on them. Second, there are supply side questions about the restructuring of the economy. This has to do with the large number of people that have left the labor force and may not return in the near term and the secular decline in the capacity utilization of industry. (See my post of June 22, 2009, “Structural Shift in the U. S. Economy is Really in Supply”: http://seekingalpha.com/article/144508-structural-shift-in-the-u-s-economy-is-really-in-supply.) Third, there is the tremendous amount of debt the federal government is issuing and the fear that this re-leveraging will create a credit inflation that may go right into prices rather than output and employment.
In this post, I am primarily focusing on the first of these factors. I will discuss the progress of the second two issues in future posts. There is more immediate information on the first and it is vitally important that this deleveraging takes place in an orderly fashion or the near term concern over the latter two will be misplaced.
Perhaps the two most highly publicized methods of deleveraging continue to speed along at a rapid pace. The American Bankruptcy Institute has reported that the total number of bankruptcies in the United States filed during the first six months of 2009 increased by 36 percent over the same period of time in 2008. The only time bankruptcies have been so large is right before the bankruptcy law change earlier in this decade. Business filings during the first six months were up 64 percent over the first six months in 2008 and individual or household filings were up 35 percent.
Bank closings reached 81 for the year with four new banks added to the list on Friday, one of them being the 10th largest bank failure in United States history. Talk now is that there will be 300 or more bank closures in the near future. The FDIC is scrambling to find ways to increase its financial resources to handle the upcoming deluge of failures and is also easing restrictions on those that can bring private equity into the mix to carry some of the financial burden in taking over these failed institutions.
Getting less publicity is the effort that individuals and businesses are making to bring their own financial situation under control. Cutting expenses is, of course, one of the immediate ways that people can work toward their own best interest. Another way of saying this is that people and businesses are increasing their savings. Every week, more and more articles are appearing informing people how this saving might be accomplished and presenting stories of how households and companies are successfully meeting this challenge.
Furthermore, there are a growing number of stories of people and businesses getting in touch with those they owe money to and working with the lenders to set up terms and conditions that will increase the probability that debt will be repaid in a timely manner. My experience in banking supports the contention that financial institutions and other lenders really would prefer to work something out with those they have lent money to, but depend on those borrowers that perceive that they are going to face some difficulties in the future to get with them and initiate discussions about how things might be worked out. Postponing discussions only puts more pressure on both parties and tends to make things harder to resolve.
Refinancing is another problem looming on the horizon. There seems to be dark clouds hovering over the commercial real estate industry and less credit worthy corporate debt issuers. A lot of debt is going to come due over the next 18 months or so. The big concern is whether or not this debt will be able to be re-financed since very little of it will be able to be re-paid. The bits and pieces of news coming out of this area is that discussions are being held and although there may be failures coming out of these situations that the problems are recognized and will be absorbed in a relatively smooth fashion as time passes.
The areas of the bond market that contain firms with higher credit ratings are performing remarkably well. Volumes of new issues are up and the financial markets have absorbed these rather smoothly. If anything, corporations have turned to the bond market for funding since the commercial banking system is actually shrinking its base of commercial and industrial loans. This is an interesting thing happening to substitute bond credit for the credit extended by the banking sector at this point, but, as they say, whatever works.
Another method for de-leveraging that seems to be picking up steam is that corporations are buying back their own debt off the open market. In some cases it is reported that these companies can buy back their existing debt at 50 cents on the dollar which is a pretty good exchange for the company going forward. Look to see this pick up this fall.
Finally, the Federal Reserve does not look like it is going to pull the rug out from the banking system and the financial markets going forward. Yes, there is a lot of concern about all the reserves the Fed has put into the banking system and whether or not it is going to be able to “exit” the banking system in an orderly fashion. However, the Fed does not want a replay of the 1937-38 experience when it caused a collapse in the banking system by trying to withdraw excess reserves from the banks by raising reserve requirements. (See my post of August 21, “Federal Reserve: Exit Watch”: http://seekingalpha.com/article/157620-federal-reserve-exit-watch.) The best guess here is that the Fed will continue to keep the banking system very liquid in order to help underwrite the de-leveraging now underway.
The important thing to remember at this time is that “quiet is good”! The de-leveraging is taking place. However, the de-leveraging will take time. We just can’t become too impatient for we must let the system do its work and restructure its balance sheets. We just don’t want any more shocks! There still is a long way to go toward a full economic recovery and the other two issues I mentioned in the first paragraph are of great concern. But, we move forward by just putting one foot in front of the other.
In this post, I am primarily focusing on the first of these factors. I will discuss the progress of the second two issues in future posts. There is more immediate information on the first and it is vitally important that this deleveraging takes place in an orderly fashion or the near term concern over the latter two will be misplaced.
Perhaps the two most highly publicized methods of deleveraging continue to speed along at a rapid pace. The American Bankruptcy Institute has reported that the total number of bankruptcies in the United States filed during the first six months of 2009 increased by 36 percent over the same period of time in 2008. The only time bankruptcies have been so large is right before the bankruptcy law change earlier in this decade. Business filings during the first six months were up 64 percent over the first six months in 2008 and individual or household filings were up 35 percent.
Bank closings reached 81 for the year with four new banks added to the list on Friday, one of them being the 10th largest bank failure in United States history. Talk now is that there will be 300 or more bank closures in the near future. The FDIC is scrambling to find ways to increase its financial resources to handle the upcoming deluge of failures and is also easing restrictions on those that can bring private equity into the mix to carry some of the financial burden in taking over these failed institutions.
Getting less publicity is the effort that individuals and businesses are making to bring their own financial situation under control. Cutting expenses is, of course, one of the immediate ways that people can work toward their own best interest. Another way of saying this is that people and businesses are increasing their savings. Every week, more and more articles are appearing informing people how this saving might be accomplished and presenting stories of how households and companies are successfully meeting this challenge.
Furthermore, there are a growing number of stories of people and businesses getting in touch with those they owe money to and working with the lenders to set up terms and conditions that will increase the probability that debt will be repaid in a timely manner. My experience in banking supports the contention that financial institutions and other lenders really would prefer to work something out with those they have lent money to, but depend on those borrowers that perceive that they are going to face some difficulties in the future to get with them and initiate discussions about how things might be worked out. Postponing discussions only puts more pressure on both parties and tends to make things harder to resolve.
Refinancing is another problem looming on the horizon. There seems to be dark clouds hovering over the commercial real estate industry and less credit worthy corporate debt issuers. A lot of debt is going to come due over the next 18 months or so. The big concern is whether or not this debt will be able to be re-financed since very little of it will be able to be re-paid. The bits and pieces of news coming out of this area is that discussions are being held and although there may be failures coming out of these situations that the problems are recognized and will be absorbed in a relatively smooth fashion as time passes.
The areas of the bond market that contain firms with higher credit ratings are performing remarkably well. Volumes of new issues are up and the financial markets have absorbed these rather smoothly. If anything, corporations have turned to the bond market for funding since the commercial banking system is actually shrinking its base of commercial and industrial loans. This is an interesting thing happening to substitute bond credit for the credit extended by the banking sector at this point, but, as they say, whatever works.
Another method for de-leveraging that seems to be picking up steam is that corporations are buying back their own debt off the open market. In some cases it is reported that these companies can buy back their existing debt at 50 cents on the dollar which is a pretty good exchange for the company going forward. Look to see this pick up this fall.
Finally, the Federal Reserve does not look like it is going to pull the rug out from the banking system and the financial markets going forward. Yes, there is a lot of concern about all the reserves the Fed has put into the banking system and whether or not it is going to be able to “exit” the banking system in an orderly fashion. However, the Fed does not want a replay of the 1937-38 experience when it caused a collapse in the banking system by trying to withdraw excess reserves from the banks by raising reserve requirements. (See my post of August 21, “Federal Reserve: Exit Watch”: http://seekingalpha.com/article/157620-federal-reserve-exit-watch.) The best guess here is that the Fed will continue to keep the banking system very liquid in order to help underwrite the de-leveraging now underway.
The important thing to remember at this time is that “quiet is good”! The de-leveraging is taking place. However, the de-leveraging will take time. We just can’t become too impatient for we must let the system do its work and restructure its balance sheets. We just don’t want any more shocks! There still is a long way to go toward a full economic recovery and the other two issues I mentioned in the first paragraph are of great concern. But, we move forward by just putting one foot in front of the other.
Friday, August 21, 2009
The Federal Reserve Exit Watch--Number One
There is great concern about the “Exit Strategy” the Federal Reserve might follow to reduce its balance sheet back to the levels that existed before the “Big Explosion” in the Fall of 2008. I plan to keep an eye on the Fed’s balance sheet over the next 12 months or so to try and keep abreast of what the Fed is doing to return to a more normal operating procedure. I discussed the prospects for a reduction in the Fed’s balance sheet in three posts on June 25, June 29, and July 2. This is just a checkup to see how things have progressed.
Over the past 13 weeks (a calendar quarter) from May 20, 2009 to August 19, 2009, the Federal Reserve allowed the total factors supplying reserve funds to decline by $128 billion. This helped to account for the major part in the decline of Reserve Balances with Federal Reserve Banks which fell by $146 billion. These are the deposits commercial banks maintain at the central bank. Other factors absorbing reserves accounted for the small difference ($18 billion) between these two figures.
The crucial contributors to this decline were all new programs that the Federal Reserve had instituted going back to December 2007 when the first innovations were introduced to relieve the liquidity crisis that was occurring in both the United States and in financial institutions all over the world. For example the amount of funds outstanding connected with the Term Auction Facility (TAF) declined by $208 billion in the May 20 to August 19 quarter. This account reached a peak amount of $493 billion in early March 2009. Currently it stands at $221 billion. This innovation was put into place to get reserves to the banks that needed them as quickly as possible. It looks as if this facility is winding down as the financial markets seem to be operating in a more normal fashion.
Another innovative response to the crisis was the Central Bank liquidity swaps in which the Federal Reserve was able to get dollars out to the rest of the world so as to avoid the problems of resolving pressures that were being felt around the world in converting financial assets into dollars. Over the past 13 weeks, the accounts related to foreign central banks and currency holdings dropped by $166 billion, another massive movement. These accounts had gotten up to around $390 billion in February of this year and on Wednesday August 19 totaled around $70 billion: another facility that seems to be winding down.
Another line item that seems to be going out of business is the Commercial Paper Funding Facility. This account dropped by $103 billion in the last quarter. This facility supported the commercial paper market and its dealers.
So, these three line items, created under the pressure of the financial crisis beginning in December 2007, have accounted for a reduction of about $477 billion of assets on the Federal Reserve’s balance sheet in the last 13 weeks. And, the declines were still continuing in the past 4 weeks so the runoff has not stopped. The figures here show that the TAF declined about $17 billion in the last 4 weeks while the Commercial Paper Funding Facility dropped $56 billion and the Central Bank facility dropped about $29 billion during the same period.
What has changed because the Total Factors Supplying Reserves only fell by $128 billion?
Well, the Federal Reserve is conducting open market operations again, seemingly to keep longer term interest rates from rising and to provide liquidity support to the mortgage backed securities markets. Securities held outright by the Federal Reserve rose $366 billion in the 13 weeks ending August 19! The biggest increase came in the Fed’s holdings of Mortgage Backed Securities, an increase that totaled $178 billion. The Fed also added $153 billion to its holdings of U. S. Treasury securities and $35 billion to its holdings of Federal Agency securities.
Over the last four weeks the Fed increased its holdings of Mortgage Backed securities by $64 billion, its holdings of U. S. Treasury’s by $43 billion and its holdings of Federal Agency securities by $9 billion.
The bottom line is that the Federal Reserve is allowing the special facilities created during the height of the financial crisis to run off but is substituting purchases of open market securities to keep bank reserves at high levels. Reserve balances with Federal Reserve Banks stood at $805 billion on Wednesday August 19, the vast majority of the reserves being just “Excess Reserves” in the banking system.
The philosophy behind this? The Federal Reserve is “exiting” the special facilities it has created to get the financial system through the crisis. However, it cannot “exit” the banking system by allowing those reserves to leave the banks.
An error was made in 1937. Commercial banks were maintaining large amounts of excess reserves at that time. As at the present time, banks were attempting to get their balance sheets in order, were not lending, and were trying to work off bad loans. The Federal Reserve, seeing all of the excess reserves, RAISED reserve requirements. This resulted in another collapse of the banking system, a collapse in the money stock, and a second period of economic disaster for the U. S. economy to follow the 1929-1933 depression.
The Federal Reserve does not want to create another crisis as it did in the 1937-1938 period. My guess is that the Fed will continue to support the large quantity of excess reserves that exists within the banking system until the commercial banks to start lending again.
Thus, it appears that the concern about an “exit” strategy is not going to be about the shrinking of all the innovative lending facilities that the Fed created to combat the liquidity crisis of the recent financial collapse. It appears as if the Fed is going to substitute open market operations to replace the decline in reserves resulting from the working off of these facilities in order to maintain the high level of excess reserves that currently exist in the banking system. Therefore, the concern about “exit” strategy is going to be connected with the removal of bank reserves from the banking system when the commercial banks begin lending again.
It is going to be interesting to see how the Fed will reduce its securities portfolio by $700 to $800 billion at that time!
Over the past 13 weeks (a calendar quarter) from May 20, 2009 to August 19, 2009, the Federal Reserve allowed the total factors supplying reserve funds to decline by $128 billion. This helped to account for the major part in the decline of Reserve Balances with Federal Reserve Banks which fell by $146 billion. These are the deposits commercial banks maintain at the central bank. Other factors absorbing reserves accounted for the small difference ($18 billion) between these two figures.
The crucial contributors to this decline were all new programs that the Federal Reserve had instituted going back to December 2007 when the first innovations were introduced to relieve the liquidity crisis that was occurring in both the United States and in financial institutions all over the world. For example the amount of funds outstanding connected with the Term Auction Facility (TAF) declined by $208 billion in the May 20 to August 19 quarter. This account reached a peak amount of $493 billion in early March 2009. Currently it stands at $221 billion. This innovation was put into place to get reserves to the banks that needed them as quickly as possible. It looks as if this facility is winding down as the financial markets seem to be operating in a more normal fashion.
Another innovative response to the crisis was the Central Bank liquidity swaps in which the Federal Reserve was able to get dollars out to the rest of the world so as to avoid the problems of resolving pressures that were being felt around the world in converting financial assets into dollars. Over the past 13 weeks, the accounts related to foreign central banks and currency holdings dropped by $166 billion, another massive movement. These accounts had gotten up to around $390 billion in February of this year and on Wednesday August 19 totaled around $70 billion: another facility that seems to be winding down.
Another line item that seems to be going out of business is the Commercial Paper Funding Facility. This account dropped by $103 billion in the last quarter. This facility supported the commercial paper market and its dealers.
So, these three line items, created under the pressure of the financial crisis beginning in December 2007, have accounted for a reduction of about $477 billion of assets on the Federal Reserve’s balance sheet in the last 13 weeks. And, the declines were still continuing in the past 4 weeks so the runoff has not stopped. The figures here show that the TAF declined about $17 billion in the last 4 weeks while the Commercial Paper Funding Facility dropped $56 billion and the Central Bank facility dropped about $29 billion during the same period.
What has changed because the Total Factors Supplying Reserves only fell by $128 billion?
Well, the Federal Reserve is conducting open market operations again, seemingly to keep longer term interest rates from rising and to provide liquidity support to the mortgage backed securities markets. Securities held outright by the Federal Reserve rose $366 billion in the 13 weeks ending August 19! The biggest increase came in the Fed’s holdings of Mortgage Backed Securities, an increase that totaled $178 billion. The Fed also added $153 billion to its holdings of U. S. Treasury securities and $35 billion to its holdings of Federal Agency securities.
Over the last four weeks the Fed increased its holdings of Mortgage Backed securities by $64 billion, its holdings of U. S. Treasury’s by $43 billion and its holdings of Federal Agency securities by $9 billion.
The bottom line is that the Federal Reserve is allowing the special facilities created during the height of the financial crisis to run off but is substituting purchases of open market securities to keep bank reserves at high levels. Reserve balances with Federal Reserve Banks stood at $805 billion on Wednesday August 19, the vast majority of the reserves being just “Excess Reserves” in the banking system.
The philosophy behind this? The Federal Reserve is “exiting” the special facilities it has created to get the financial system through the crisis. However, it cannot “exit” the banking system by allowing those reserves to leave the banks.
An error was made in 1937. Commercial banks were maintaining large amounts of excess reserves at that time. As at the present time, banks were attempting to get their balance sheets in order, were not lending, and were trying to work off bad loans. The Federal Reserve, seeing all of the excess reserves, RAISED reserve requirements. This resulted in another collapse of the banking system, a collapse in the money stock, and a second period of economic disaster for the U. S. economy to follow the 1929-1933 depression.
The Federal Reserve does not want to create another crisis as it did in the 1937-1938 period. My guess is that the Fed will continue to support the large quantity of excess reserves that exists within the banking system until the commercial banks to start lending again.
Thus, it appears that the concern about an “exit” strategy is not going to be about the shrinking of all the innovative lending facilities that the Fed created to combat the liquidity crisis of the recent financial collapse. It appears as if the Fed is going to substitute open market operations to replace the decline in reserves resulting from the working off of these facilities in order to maintain the high level of excess reserves that currently exist in the banking system. Therefore, the concern about “exit” strategy is going to be connected with the removal of bank reserves from the banking system when the commercial banks begin lending again.
It is going to be interesting to see how the Fed will reduce its securities portfolio by $700 to $800 billion at that time!
Thursday, August 20, 2009
Bank Asset Values are a Lingering Problem
Is the recession over? Has the economic recovery begun? Will there be a double-dip recession?
The picture is fuzzy and one reason the picture is fuzzy is because so many banks and other financial institutions, investors, and regulators either don’t seem to have a good grasp of the value of many of the assets on the balance sheets of these banks and other financial institutions or because they are unwilling to confess what the asset values are.
Look at some of the recent articles that have been in the news this week. “Insurers’ Biggest Writedowns May be yet to Come” by Jonathan Weil, http://www.bloomberg.com/apps/news?pid=20601039&sid=a8itsmbfm9qc. “Disclose the Fair Value of Complex Securities” by Robert Kaplan, Robert Merton and Scott Richard, http://www.ft.com/cms/s/0/7eb082d6-8b8e-11de-9f50-00144feabdc0.html. “Citigroup’s Asset Guarantees to be Audited by TARP” by Bradley Keoun and Mark Pittman, http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aiWZXE5RKSCc. “We Need Daily Data to Get Credit Markets Working Again” by Richard Field, http://www.ft.com/cms/s/0/8a9f2906-8d20-11de-a540-00144feabdc0.html.
All of these articles have to do with financial institutions knowing and reporting, as well as possible and as often as possible, the current value of their assets. The managements of financial institutions claim that this will inhibit their actions and force them into decisions that are not in the best interest of their institutions or the financial markets. These managements are wrong!
We are hung up right now because we don’t know the value of those assets either because the banks don’t know what the value of those assets are or the banks are not revealing what the value of those assets are.
I believe that we would face less uncertainty now and may have even avoided a good deal of the financial collapse of the last two years if these financial institutions would have been required to regularly report the fair value of their assets and responded more rapidly to changing market conditions.
Even better, it would have been a sign of outstanding management and real leadership if the banks themselves had been more open and transparent with the financial community, rather than require regulation to force them to release this information.
Alas, this didn’t happen.
This whole dilemma, to me, comes under the “No Free Lunch” argument.
Bankers mismatch the maturities of their assets and liabilities and take advantage of the positive slope to the yield curve. But, in doing so they take on more interest rate risk. Financial markets move against them and the price of the longer term assets decline. Whoops! The benefit the bank got by taking on the extra interest rate risk has backfired. Well, nothing comes for free!
Bankers add riskier loans to their loan portfolio or buy riskier securities to increase their yield. But, in so doing they take on more credit risk. The economy slows down and now these loans or securities face a larger default rate than the bankers had anticipated. Whoops! The benefit the bank got by taking on the extra credit risk has backfired. Well, nothing comes for free!
Financial institutions leverage up their balance sheets in order to squeeze out additional return on their equity position. But, in so doing they take on more financial risk. As assets prices go down the increased leverage backfires and their solvency comes into question. Whoops!
Bankers can’t get something for nothing. And, they can’t hide behind accounting rules in an effort to wait things out until times get better. As Kaplan, Merton, and Richard argue, banks typically fail to act when markets move against the risky positions they have taken and chalk the situation up to “unusual market conditions” or to “just a bump in the road”. And, if economic declines are relatively short and relatively shallow maybe they can get away with waiting the problem assets out. But, in deeper and longer periods of economic and financial dislocation they get trapped in their own failure to act. The asset values do not return to previous levels and the longer they wait to act on the existing problems the worse the situation on their balance sheet becomes.
Richard Field argues, in the article cited above, that banking and credit markets are having problems, not because the loans and securities on the books of the financial institutions are complex, but because they are opaque. This lack of clarity has helped to get us into the current crises and will continue to plague the recovery if it is not corrected. This lack of clarity allows bankers to continue to postpone action, it prevents investors from knowing the value of their investments, and it hinders regulators from in their efforts to understand the true condition of the financial institutions they are regulating.
As I have mentioned in previous posts, I have been involved in several successful bank turnarounds. One of the first things you have to do in turning around a bank is determine the value of your assets and you have to be brutally honest about what the values are. And, in going through this process, in every turnaround I was involved in, it becomes clear that the previous management failed to accept the fact that the value of their assets had declined, they continued to hope that the “unusual market conditions” would pass, and, consequently, by failing to act, the condition of the assets got worse and worse.
Good managements are not afraid of the truth and they are not afraid of releasing that information to the public!
Unfortunately, it is likely that the opaqueness with regard to the value of bank assets will continue.
The picture is fuzzy and one reason the picture is fuzzy is because so many banks and other financial institutions, investors, and regulators either don’t seem to have a good grasp of the value of many of the assets on the balance sheets of these banks and other financial institutions or because they are unwilling to confess what the asset values are.
Look at some of the recent articles that have been in the news this week. “Insurers’ Biggest Writedowns May be yet to Come” by Jonathan Weil, http://www.bloomberg.com/apps/news?pid=20601039&sid=a8itsmbfm9qc. “Disclose the Fair Value of Complex Securities” by Robert Kaplan, Robert Merton and Scott Richard, http://www.ft.com/cms/s/0/7eb082d6-8b8e-11de-9f50-00144feabdc0.html. “Citigroup’s Asset Guarantees to be Audited by TARP” by Bradley Keoun and Mark Pittman, http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aiWZXE5RKSCc. “We Need Daily Data to Get Credit Markets Working Again” by Richard Field, http://www.ft.com/cms/s/0/8a9f2906-8d20-11de-a540-00144feabdc0.html.
All of these articles have to do with financial institutions knowing and reporting, as well as possible and as often as possible, the current value of their assets. The managements of financial institutions claim that this will inhibit their actions and force them into decisions that are not in the best interest of their institutions or the financial markets. These managements are wrong!
We are hung up right now because we don’t know the value of those assets either because the banks don’t know what the value of those assets are or the banks are not revealing what the value of those assets are.
I believe that we would face less uncertainty now and may have even avoided a good deal of the financial collapse of the last two years if these financial institutions would have been required to regularly report the fair value of their assets and responded more rapidly to changing market conditions.
Even better, it would have been a sign of outstanding management and real leadership if the banks themselves had been more open and transparent with the financial community, rather than require regulation to force them to release this information.
Alas, this didn’t happen.
This whole dilemma, to me, comes under the “No Free Lunch” argument.
Bankers mismatch the maturities of their assets and liabilities and take advantage of the positive slope to the yield curve. But, in doing so they take on more interest rate risk. Financial markets move against them and the price of the longer term assets decline. Whoops! The benefit the bank got by taking on the extra interest rate risk has backfired. Well, nothing comes for free!
Bankers add riskier loans to their loan portfolio or buy riskier securities to increase their yield. But, in so doing they take on more credit risk. The economy slows down and now these loans or securities face a larger default rate than the bankers had anticipated. Whoops! The benefit the bank got by taking on the extra credit risk has backfired. Well, nothing comes for free!
Financial institutions leverage up their balance sheets in order to squeeze out additional return on their equity position. But, in so doing they take on more financial risk. As assets prices go down the increased leverage backfires and their solvency comes into question. Whoops!
Bankers can’t get something for nothing. And, they can’t hide behind accounting rules in an effort to wait things out until times get better. As Kaplan, Merton, and Richard argue, banks typically fail to act when markets move against the risky positions they have taken and chalk the situation up to “unusual market conditions” or to “just a bump in the road”. And, if economic declines are relatively short and relatively shallow maybe they can get away with waiting the problem assets out. But, in deeper and longer periods of economic and financial dislocation they get trapped in their own failure to act. The asset values do not return to previous levels and the longer they wait to act on the existing problems the worse the situation on their balance sheet becomes.
Richard Field argues, in the article cited above, that banking and credit markets are having problems, not because the loans and securities on the books of the financial institutions are complex, but because they are opaque. This lack of clarity has helped to get us into the current crises and will continue to plague the recovery if it is not corrected. This lack of clarity allows bankers to continue to postpone action, it prevents investors from knowing the value of their investments, and it hinders regulators from in their efforts to understand the true condition of the financial institutions they are regulating.
As I have mentioned in previous posts, I have been involved in several successful bank turnarounds. One of the first things you have to do in turning around a bank is determine the value of your assets and you have to be brutally honest about what the values are. And, in going through this process, in every turnaround I was involved in, it becomes clear that the previous management failed to accept the fact that the value of their assets had declined, they continued to hope that the “unusual market conditions” would pass, and, consequently, by failing to act, the condition of the assets got worse and worse.
Good managements are not afraid of the truth and they are not afraid of releasing that information to the public!
Unfortunately, it is likely that the opaqueness with regard to the value of bank assets will continue.
Saturday, August 15, 2009
Bank Failures Are Up: Way Up!
On Friday, bank failures for the year reached 77. In January or March of this year people started projecting that we may make 100 by the end of the year. I think that is as sure a bet as you can get these days. Now, we are seeing forecasts of over 200 more bank failures in the next 18 months.
The headlines over the past several days have been eye-catching. On Bloomberg.com, we saw “Toxic Loans Topping 5% May Push 150 Banks to Point of No Return.” On Reuters Blogs, we saw ”Citi’s Dirty Pool of Assets,” which reported that Citigroup had identified $39.5 billion that represented deep problems on its pool of subprime mortgages, of which it has only incurred $5.3 in looses leaving another $34 billion to go. Citi also faces problems in it CDO portfolio some of which it has hedged its exposure with credit default swaps. And, Jonathan Weil, in an article titled “Next Bubble to Burst Is Banks’ Big Loan Values” on Bloomberg.com, argues that the change in mark to market accounting early this year has covered up huge losses on the books of the biggest banks that were reported in the fourth quarter of 2008 but have since disappeared.
The good news in all this is that most of the troubled assets in banks have been identified and the regulatory bodies, particularly the FDIC, are fully aware of the most troubled banks. These individual insolvency cases are being worked out on a case-by-case basis. We got headlines in the newspapers this week because of the sell-off of Colonial BancGroup Inc. which was the largest bank to fail in 2009 and one of the most costly bank failures ever. But, this bank had been identified a long time ago and it has been systematically handled. The other four that failed this week did not claim headlines. This is good because the banking sector is staying relatively quiet. (See my post of August 10 on this http://seekingalpha.com/article/154998-banking-sector-stays-quiet.) Most bank failures over the next year or so will not get major headlines. (Our most optimistic wish is that none of the bank failures coming in the next year or so will warrant headlines.)
We are in the part of the credit or debt cycle where things are relatively calm: we are way past the phase of the cycle where liquidity was the primary issue. The problem now is not that financial institutions need to and want to get rid of assets as quickly as they can. We are in the “work out” phase of the cycle. Historically, the time it takes to “work things out” depends upon the depth of the collapse in asset values. The betting now seems to be that this time around, the “work out” phase of the cycle will be a relatively long one.
If we still have to go through 125 to 150 more bank failures in the next 18 months or so, the banking system as a whole is not going to be too aggressive in putting new loans on its books. And this will not result in a strong economic rebound going forward.
In addition, the amount of debt that is still outstanding in the economic system will remain a major drag on the banking system. The uncertainty pertaining to the future repayment of loans to the banking system, in the areas of commercial real estate loans, of credit cards, and because of another wave of residential loans that will be repricing over the next 12 months or so, is still a concern. This uncertainty will further restrain banks from being too aggressive in making new loans. (See my post of August 12, “The Debt Problem Poses a Two-Sided Threat to the Fed,” at http://maseportfolio.blogspot.com/.)
And, those who have borrowed will be reluctant to spend giving the uncertainties about the state of the economy, unemployment, foreclosures, and other economic dislocations. Even Paul Krugman has recognized the role that debt plays in spending. In a recent lecture Krugman discussed why the Great Depression did not re-start after World War II when almost all economists expected it to do so. He argued in this talk that by the end of World War II the private sector of the economy, households and businesses, had worked off most of the debt that it had taken on in the 1920s, but had not been able to eliminate in the 1930s. The private sector had deleveraged by the 1950s and was now ready to spend. Krugman contends that the private sector will not begin to spend again coming out of the current recession until it has deleveraged itself from the current buildup of debt.
The financial system and the economic system are working themselves out of their recent problems. Let us hope that things stay quiet. That means, we need to avoid any more surprises. If we don’t have surprises, there is a good chance that the recovery will start and will continue. This doesn’t mean that it won’t take a long time for the banks, households, and businesses to work through their current problems. It will. And, it doesn’t mean that other problems with respect to long term interest rates and the value of the United States dollar may not worsen because of the huge and increasing load of federal debt.
This “quiet” does give us some hope that we are moving in the right direction. There will continue to be bank failures, and foreclosures, and bankruptcies, and more. But, they can be worked through if we don’t get too impatient.
The headlines over the past several days have been eye-catching. On Bloomberg.com, we saw “Toxic Loans Topping 5% May Push 150 Banks to Point of No Return.” On Reuters Blogs, we saw ”Citi’s Dirty Pool of Assets,” which reported that Citigroup had identified $39.5 billion that represented deep problems on its pool of subprime mortgages, of which it has only incurred $5.3 in looses leaving another $34 billion to go. Citi also faces problems in it CDO portfolio some of which it has hedged its exposure with credit default swaps. And, Jonathan Weil, in an article titled “Next Bubble to Burst Is Banks’ Big Loan Values” on Bloomberg.com, argues that the change in mark to market accounting early this year has covered up huge losses on the books of the biggest banks that were reported in the fourth quarter of 2008 but have since disappeared.
The good news in all this is that most of the troubled assets in banks have been identified and the regulatory bodies, particularly the FDIC, are fully aware of the most troubled banks. These individual insolvency cases are being worked out on a case-by-case basis. We got headlines in the newspapers this week because of the sell-off of Colonial BancGroup Inc. which was the largest bank to fail in 2009 and one of the most costly bank failures ever. But, this bank had been identified a long time ago and it has been systematically handled. The other four that failed this week did not claim headlines. This is good because the banking sector is staying relatively quiet. (See my post of August 10 on this http://seekingalpha.com/article/154998-banking-sector-stays-quiet.) Most bank failures over the next year or so will not get major headlines. (Our most optimistic wish is that none of the bank failures coming in the next year or so will warrant headlines.)
We are in the part of the credit or debt cycle where things are relatively calm: we are way past the phase of the cycle where liquidity was the primary issue. The problem now is not that financial institutions need to and want to get rid of assets as quickly as they can. We are in the “work out” phase of the cycle. Historically, the time it takes to “work things out” depends upon the depth of the collapse in asset values. The betting now seems to be that this time around, the “work out” phase of the cycle will be a relatively long one.
If we still have to go through 125 to 150 more bank failures in the next 18 months or so, the banking system as a whole is not going to be too aggressive in putting new loans on its books. And this will not result in a strong economic rebound going forward.
In addition, the amount of debt that is still outstanding in the economic system will remain a major drag on the banking system. The uncertainty pertaining to the future repayment of loans to the banking system, in the areas of commercial real estate loans, of credit cards, and because of another wave of residential loans that will be repricing over the next 12 months or so, is still a concern. This uncertainty will further restrain banks from being too aggressive in making new loans. (See my post of August 12, “The Debt Problem Poses a Two-Sided Threat to the Fed,” at http://maseportfolio.blogspot.com/.)
And, those who have borrowed will be reluctant to spend giving the uncertainties about the state of the economy, unemployment, foreclosures, and other economic dislocations. Even Paul Krugman has recognized the role that debt plays in spending. In a recent lecture Krugman discussed why the Great Depression did not re-start after World War II when almost all economists expected it to do so. He argued in this talk that by the end of World War II the private sector of the economy, households and businesses, had worked off most of the debt that it had taken on in the 1920s, but had not been able to eliminate in the 1930s. The private sector had deleveraged by the 1950s and was now ready to spend. Krugman contends that the private sector will not begin to spend again coming out of the current recession until it has deleveraged itself from the current buildup of debt.
The financial system and the economic system are working themselves out of their recent problems. Let us hope that things stay quiet. That means, we need to avoid any more surprises. If we don’t have surprises, there is a good chance that the recovery will start and will continue. This doesn’t mean that it won’t take a long time for the banks, households, and businesses to work through their current problems. It will. And, it doesn’t mean that other problems with respect to long term interest rates and the value of the United States dollar may not worsen because of the huge and increasing load of federal debt.
This “quiet” does give us some hope that we are moving in the right direction. There will continue to be bank failures, and foreclosures, and bankruptcies, and more. But, they can be worked through if we don’t get too impatient.
Wednesday, August 12, 2009
The Debt Problem Poses a Two-Sided Threat to the Fed
There are two numbers I can’t get out of my head. The numbers are $1.84 trillion and $1.26 trillion. These are estimates of what the deficit of the United States government is going to be for the fiscal year ending in September 30, 2009 and the fiscal year ending in September 30, 2010. (Note that revised estimates for the fiscal year were supposed to be put out in July, but the Obama administration postponed their release until sometime in August.)
It was announced today that the budget deficit in July reached an all time record of $180.7 billion and this brought the year-to-date deficit to $1.27 trillion.
Some simple calculations show that if the estimated number for fiscal year 2009 is to be hit, the budget deficits for August and September will have to average $285 billion per month.
This would mean that the deficits would be $100 billion more a month than the record deficit that was posted in July! This is not a good trend.
Some analysts are predicting that the current year deficit will actually top $2.0 trillion while the 2010 deficit will reach $1.5 trillion. With the deficit for next year at $1.5 trillion, the monthly deficits would only average $125 billion, a figure that would look pretty good given the July, August, and September figures presented above. But, is this realistic given all of the proposals and programs that are in the federal pipeline.
Gross federal debt held by the public increased by more than 28 percent, year-over-year, at the end of the second quarter of this year. That is up from 24 percent at the end of the fourth quarter of 2008 and 15 percent at the end of the third quarter of 2008. With the forecast figures for the deficit, these numbers are going to continue to be at relatively high rates in the near term.
According to the Congressional Budget Office’s alternative fiscal projections, the public debt of the United States could rise from 44 percent of GDP in 2008 to 87 percent of GDP in 2020.
Adding this much debt to the world is going to place a tremendous burden on financial markets!
The Federal Reserve announced today that it was going to continue on its path to purchase the $300 billion in Treasury securities that it had already committed to, but would extend the program through October rather than ending it in September. The Fed will also retain its plan to buy as much as $1.45 trillion of housing debt by the end of the calendar year. By August 5, 2009 the Fed had purchased $543 billion in mortgage-backed securities.
Numbers like these only cloud the picture of what an “exit” strategy might look like for the Fed. In fact, it does not look like an exit strategy at all.
But, this is just one side of the coin. The other side has to do with existing bad assets. Elizabeth Warren, the chair of the Congressional Oversight Panel that is monitoring the bank bailout effort appeared on Joe Scarborough’s “Morning Joe” program today and stated that the “toxic assets” on bank balance sheets that got us into this financial mess are still there. And, they are going to have to be dealt with at some time in the future. For the near term she warned of a looming commercial mortgage crisis, one that will require more federal money, especially for smaller banks.
Oh, and about commercial mortgages, what about the problem the Fed faces with the commercial mortgages that it already has on its balance sheet. This morning in the Wall Street Journal there was an article about how the Fed has to deal with some debt it inherited from the Bear Stearns failure. (See “Fed Grapples with Extended Stay,” http://online.wsj.com/article/SB125003659369724401.html#mod=todays_us_money_and_investing.) On the balance sheet of the Fed there is a line item dealing labeled Maiden Lane related to the Bear Stearns sale to JPMorgan Chase. Included in this line item is a $900 million debt that the Extended Stay Inc. chain of hotels owes to the Federal Reserve among others. Extended Stay is in bankruptcy now and the issue is how the Fed is treated among other debtors and the deals that have been made between Extended Stay and some of the lenders. It is messy. But, this comes with doing the deals that the Fed has been doing.
And, apparently the Maiden Lane fund holds about $4 billion in debt backed by Hilton Hotels. Messy, messy, messy.
But, the Fed has also extended money to AIG, and to money market funds, and to commercial paper dealers, and has $543 billion of assets tied up into mortgage-backed securities. The Financial Times reported this last week that the Federal Reserve Bank of New York is hiring like crazy attempting to add positions to its staff as fast as it can, positions that will deal with all the future issues arising from all the new programs that the Federal Reserve System has gotten into over the last year or so. The administrative headaches of these actions are now being felt. (Question: if the Fed exits all of these programs, does the Federal Reserve Bank of New York need to create an exit plan to have a reduction in staff when these programs go away?)
And, the National Association of Realtors released information today that home price declines accelerated in the second quarter and Realty Trac said that foreclosure filings reached a level at which 1 in every 84 U. S. households had received a filing. ForeclosureRadar warned that California was on the verge of a new wave of foreclosure sales as notices of default, the first step in the foreclosure process, rose 12% in July from one year ago. Prime borrowers that were behind on their mortgage payments rose 13.8% between March and June.
On top of this household debt remains at about 130 percent of disposable income and household net worth continues to decline.
Business defaults are above 11 percent and are heading toward 13 percent according to some experts.
As we have reached a relatively calm period in economic and financial markets, more and more people are demanding that the Fed present them with a picture of how it, the Fed, might get out of the position it is in. With all the debt that currently exists and all the debt that is going to be created, the Fed seems to be at a loss about what an exit strategy might look like. In fact, with the growth of federal debt projected to stay in the double digit range for several more years, the realistic answer to the request for the Fed to devise an exit strategy is that there seems to be nothing to exit from.
If we accept this conclusion then we must argue that the problem is not with the Federal Reserve, the problem is with the federal government. The problem is with the Treasury department and with Mr. Geithner. The problem is that there is too much debt outstanding, and the creation of more and more debt by the federal government is not helping the problem, it is only exacerbating it. And, Mr. Geithner only strains his credibility, and that of the administration, when he argues that there is already a plan to reduce the future deficits.
It was announced today that the budget deficit in July reached an all time record of $180.7 billion and this brought the year-to-date deficit to $1.27 trillion.
Some simple calculations show that if the estimated number for fiscal year 2009 is to be hit, the budget deficits for August and September will have to average $285 billion per month.
This would mean that the deficits would be $100 billion more a month than the record deficit that was posted in July! This is not a good trend.
Some analysts are predicting that the current year deficit will actually top $2.0 trillion while the 2010 deficit will reach $1.5 trillion. With the deficit for next year at $1.5 trillion, the monthly deficits would only average $125 billion, a figure that would look pretty good given the July, August, and September figures presented above. But, is this realistic given all of the proposals and programs that are in the federal pipeline.
Gross federal debt held by the public increased by more than 28 percent, year-over-year, at the end of the second quarter of this year. That is up from 24 percent at the end of the fourth quarter of 2008 and 15 percent at the end of the third quarter of 2008. With the forecast figures for the deficit, these numbers are going to continue to be at relatively high rates in the near term.
According to the Congressional Budget Office’s alternative fiscal projections, the public debt of the United States could rise from 44 percent of GDP in 2008 to 87 percent of GDP in 2020.
Adding this much debt to the world is going to place a tremendous burden on financial markets!
The Federal Reserve announced today that it was going to continue on its path to purchase the $300 billion in Treasury securities that it had already committed to, but would extend the program through October rather than ending it in September. The Fed will also retain its plan to buy as much as $1.45 trillion of housing debt by the end of the calendar year. By August 5, 2009 the Fed had purchased $543 billion in mortgage-backed securities.
Numbers like these only cloud the picture of what an “exit” strategy might look like for the Fed. In fact, it does not look like an exit strategy at all.
But, this is just one side of the coin. The other side has to do with existing bad assets. Elizabeth Warren, the chair of the Congressional Oversight Panel that is monitoring the bank bailout effort appeared on Joe Scarborough’s “Morning Joe” program today and stated that the “toxic assets” on bank balance sheets that got us into this financial mess are still there. And, they are going to have to be dealt with at some time in the future. For the near term she warned of a looming commercial mortgage crisis, one that will require more federal money, especially for smaller banks.
Oh, and about commercial mortgages, what about the problem the Fed faces with the commercial mortgages that it already has on its balance sheet. This morning in the Wall Street Journal there was an article about how the Fed has to deal with some debt it inherited from the Bear Stearns failure. (See “Fed Grapples with Extended Stay,” http://online.wsj.com/article/SB125003659369724401.html#mod=todays_us_money_and_investing.) On the balance sheet of the Fed there is a line item dealing labeled Maiden Lane related to the Bear Stearns sale to JPMorgan Chase. Included in this line item is a $900 million debt that the Extended Stay Inc. chain of hotels owes to the Federal Reserve among others. Extended Stay is in bankruptcy now and the issue is how the Fed is treated among other debtors and the deals that have been made between Extended Stay and some of the lenders. It is messy. But, this comes with doing the deals that the Fed has been doing.
And, apparently the Maiden Lane fund holds about $4 billion in debt backed by Hilton Hotels. Messy, messy, messy.
But, the Fed has also extended money to AIG, and to money market funds, and to commercial paper dealers, and has $543 billion of assets tied up into mortgage-backed securities. The Financial Times reported this last week that the Federal Reserve Bank of New York is hiring like crazy attempting to add positions to its staff as fast as it can, positions that will deal with all the future issues arising from all the new programs that the Federal Reserve System has gotten into over the last year or so. The administrative headaches of these actions are now being felt. (Question: if the Fed exits all of these programs, does the Federal Reserve Bank of New York need to create an exit plan to have a reduction in staff when these programs go away?)
And, the National Association of Realtors released information today that home price declines accelerated in the second quarter and Realty Trac said that foreclosure filings reached a level at which 1 in every 84 U. S. households had received a filing. ForeclosureRadar warned that California was on the verge of a new wave of foreclosure sales as notices of default, the first step in the foreclosure process, rose 12% in July from one year ago. Prime borrowers that were behind on their mortgage payments rose 13.8% between March and June.
On top of this household debt remains at about 130 percent of disposable income and household net worth continues to decline.
Business defaults are above 11 percent and are heading toward 13 percent according to some experts.
As we have reached a relatively calm period in economic and financial markets, more and more people are demanding that the Fed present them with a picture of how it, the Fed, might get out of the position it is in. With all the debt that currently exists and all the debt that is going to be created, the Fed seems to be at a loss about what an exit strategy might look like. In fact, with the growth of federal debt projected to stay in the double digit range for several more years, the realistic answer to the request for the Fed to devise an exit strategy is that there seems to be nothing to exit from.
If we accept this conclusion then we must argue that the problem is not with the Federal Reserve, the problem is with the federal government. The problem is with the Treasury department and with Mr. Geithner. The problem is that there is too much debt outstanding, and the creation of more and more debt by the federal government is not helping the problem, it is only exacerbating it. And, Mr. Geithner only strains his credibility, and that of the administration, when he argues that there is already a plan to reduce the future deficits.
Sunday, August 9, 2009
Banking Sector Still Remains Silent
There is good news and bad news from the banking sector. The good news is that all is quiet. The bad news is that all is quiet.
In terms of the goods news, “quiet is good” because there have been no new “discoveries” of bad loans or bad assets that will shock the financial system. We continue to hope for silence here even with the continued growth in the unemployed, in bankruptcies, in delinquencies, and in loans coming due that need to be re-priced or re-financed.
In terms of the bad news, there is still no life in bank lending. If we are going to see a pick-up in the economy and a return to growth the banking sector is going to have to start lending again, especially in the commercial sector. Commercial and industrial loans were down by 3.3%, year-over-year in June, and in the last five weeks, all in July, these loans have fallen by another $24 billion.
Real estate loans peaked in May 2009 and have declined ever since, dropping approximately $60 billion through the end of July. Even the amount of home equity loans has declined steadily since reaching a peak in May. Consumer loans continue to drop, with credit card debt falling for the fifth consecutive month.
Total bank assets are still up on a year-over-year basis by 7.5%, but the main balance sheet increases are in cash assets, primarily deposit balances at Federal Reserve Banks, and in Treasury and agency securities.
Banks are still not doing any lending to speak of and are staying very, very liquid.
On the liability side of commercial bank’s balance sheets, demand deposits are still rising at a very rapid pace, about 38% on a year-over-year basis. Other checkable deposits at commercial banks are rising at a relatively rapid pace, 19.3%, but a surprising bit of information is that other checkable deposits at thrift institutions have only increased by a modest amount, by 2.9%, year-over-year.
Checking into the thrift institution situation a little further we find that savings deposits at thrift institutions have actually declined year-over-year at a 7.9% rate and small-denomination time deposits at thrift institutions have fallen at a 14.3% rate over the same time period. These balances at commercial banks have increased at a 16.3% rate and a 15.3% rate respectively.
Two shifts seem to be taking place in depository institutions. First, there seems to be a major movement of funds from thrift institutions to commercial banks. Second, individuals are holding more and more of their funds at commercial banks in demand or other checking accounts relative to time and savings accounts. One additional note to this: retail money funds have dropped by about 11.6% on a year-over-year basis indicating another shift taking place from non-banks to commercial banks.
Another trend continues to hold and that is in terms of currency holdings outside of the banking system. Year-over-year, the currency component of the money stock continues to rise in excess of 10%. Like the banks, the public wants to remain as liquid as possible in order to be able to meet the contingencies people experience in uncertain times.
This movement of assets is reflected in the aggregate money stock figures. The Fed publishes money stock growth figures using 13-week averages. On a year-over-year basis using the thirteen weeks ending July 27, 2009, the narrow measure of the money stock, M1, has increased at a 17.0% annual rate whereas the broad measure of the money stock, M2, has increased at an 8.7% annual rate. It is obvious that the growth rate of both measures is dominated by the huge annual rate of increase in demand deposits as people have re-allocated their funds from time and savings accounts to checkable deposits in commercial banks.
This shift is even more obvious if one looks at the relative rates of growth over the past three months. M1 growth is 15.4% while M2 growth is 3.1%, indicating that much of the re-allocation of funds has come in the past three months.
In terms of the Fed’s assets, there continues to be a runoff of dealers using the Commercial Paper funding facility indicating some easing of liquidity in the commercial paper market. This decline was expected to occur as the commercial paper market improved and this is a hopeful sign. Central bank liquidity swaps also continued to decline indicating an additional strengthening of foreign exchange markets around the world, another hopeful sign.
Both of these declines in the Fed’s balance sheet resulted in reserves leaving the banking system. All it means, however, is that excess reserves in the banking system declined. These excess reserves still remain well above $725 billion, while required reserves total around some $65 billion.
As reported before, the banking system seems to be coming out of the big financial bust in typical fashion. This is why the claim that things are quiet in the banking system is a good thing. We can only hope that this peace and quiet will continue.
There will continue to be bank failures. We reached 72 for the year this last week, but there were no surprises in the increase, they had already been identified. One concern arising from the figures presented above is the health of the thrift industry. With funds leaving the thrift industry as reported, what pressure is this putting on thrift institutions in terms of their assets and solvency?
The big question remains: “When are the commercial banks going to start lending to businesses again?” To answer this, we need to keep a close eye on the information coming out of the banking sector. My guess is that banks will not be too quick to start lending to businesses again. There are questions about how brisk the “back-to-school” season will be and there may not be much increase in lending during this time. The next really big test after that will be the holiday season that begins in October and early November. It will be interesting to see how lending activity behaves at this time.
The Fed continues to keep funds going into the capital markets in terms of acquiring Treasury securities and mortgage-backed securities while letting some of the other facilities that were created to support liquidity in different specific areas of the financial markets run off as it was hoped that they would do. As long as the banking sector remains relatively peaceful, this seems to be the way the Fed wants to act. Then as liquidity picks up in the stressed areas of the capital market, the Fed plan is to sell these other securities back to the private sector and reduce the size of its balance sheet.
The good news in the banking sector is that things are relatively quiet. May they stay that way. In my view we will have to wait a while before we see the banks beginning to refuel businesses and the real estate sectors.
In terms of the goods news, “quiet is good” because there have been no new “discoveries” of bad loans or bad assets that will shock the financial system. We continue to hope for silence here even with the continued growth in the unemployed, in bankruptcies, in delinquencies, and in loans coming due that need to be re-priced or re-financed.
In terms of the bad news, there is still no life in bank lending. If we are going to see a pick-up in the economy and a return to growth the banking sector is going to have to start lending again, especially in the commercial sector. Commercial and industrial loans were down by 3.3%, year-over-year in June, and in the last five weeks, all in July, these loans have fallen by another $24 billion.
Real estate loans peaked in May 2009 and have declined ever since, dropping approximately $60 billion through the end of July. Even the amount of home equity loans has declined steadily since reaching a peak in May. Consumer loans continue to drop, with credit card debt falling for the fifth consecutive month.
Total bank assets are still up on a year-over-year basis by 7.5%, but the main balance sheet increases are in cash assets, primarily deposit balances at Federal Reserve Banks, and in Treasury and agency securities.
Banks are still not doing any lending to speak of and are staying very, very liquid.
On the liability side of commercial bank’s balance sheets, demand deposits are still rising at a very rapid pace, about 38% on a year-over-year basis. Other checkable deposits at commercial banks are rising at a relatively rapid pace, 19.3%, but a surprising bit of information is that other checkable deposits at thrift institutions have only increased by a modest amount, by 2.9%, year-over-year.
Checking into the thrift institution situation a little further we find that savings deposits at thrift institutions have actually declined year-over-year at a 7.9% rate and small-denomination time deposits at thrift institutions have fallen at a 14.3% rate over the same time period. These balances at commercial banks have increased at a 16.3% rate and a 15.3% rate respectively.
Two shifts seem to be taking place in depository institutions. First, there seems to be a major movement of funds from thrift institutions to commercial banks. Second, individuals are holding more and more of their funds at commercial banks in demand or other checking accounts relative to time and savings accounts. One additional note to this: retail money funds have dropped by about 11.6% on a year-over-year basis indicating another shift taking place from non-banks to commercial banks.
Another trend continues to hold and that is in terms of currency holdings outside of the banking system. Year-over-year, the currency component of the money stock continues to rise in excess of 10%. Like the banks, the public wants to remain as liquid as possible in order to be able to meet the contingencies people experience in uncertain times.
This movement of assets is reflected in the aggregate money stock figures. The Fed publishes money stock growth figures using 13-week averages. On a year-over-year basis using the thirteen weeks ending July 27, 2009, the narrow measure of the money stock, M1, has increased at a 17.0% annual rate whereas the broad measure of the money stock, M2, has increased at an 8.7% annual rate. It is obvious that the growth rate of both measures is dominated by the huge annual rate of increase in demand deposits as people have re-allocated their funds from time and savings accounts to checkable deposits in commercial banks.
This shift is even more obvious if one looks at the relative rates of growth over the past three months. M1 growth is 15.4% while M2 growth is 3.1%, indicating that much of the re-allocation of funds has come in the past three months.
In terms of the Fed’s assets, there continues to be a runoff of dealers using the Commercial Paper funding facility indicating some easing of liquidity in the commercial paper market. This decline was expected to occur as the commercial paper market improved and this is a hopeful sign. Central bank liquidity swaps also continued to decline indicating an additional strengthening of foreign exchange markets around the world, another hopeful sign.
Both of these declines in the Fed’s balance sheet resulted in reserves leaving the banking system. All it means, however, is that excess reserves in the banking system declined. These excess reserves still remain well above $725 billion, while required reserves total around some $65 billion.
As reported before, the banking system seems to be coming out of the big financial bust in typical fashion. This is why the claim that things are quiet in the banking system is a good thing. We can only hope that this peace and quiet will continue.
There will continue to be bank failures. We reached 72 for the year this last week, but there were no surprises in the increase, they had already been identified. One concern arising from the figures presented above is the health of the thrift industry. With funds leaving the thrift industry as reported, what pressure is this putting on thrift institutions in terms of their assets and solvency?
The big question remains: “When are the commercial banks going to start lending to businesses again?” To answer this, we need to keep a close eye on the information coming out of the banking sector. My guess is that banks will not be too quick to start lending to businesses again. There are questions about how brisk the “back-to-school” season will be and there may not be much increase in lending during this time. The next really big test after that will be the holiday season that begins in October and early November. It will be interesting to see how lending activity behaves at this time.
The Fed continues to keep funds going into the capital markets in terms of acquiring Treasury securities and mortgage-backed securities while letting some of the other facilities that were created to support liquidity in different specific areas of the financial markets run off as it was hoped that they would do. As long as the banking sector remains relatively peaceful, this seems to be the way the Fed wants to act. Then as liquidity picks up in the stressed areas of the capital market, the Fed plan is to sell these other securities back to the private sector and reduce the size of its balance sheet.
The good news in the banking sector is that things are relatively quiet. May they stay that way. In my view we will have to wait a while before we see the banks beginning to refuel businesses and the real estate sectors.
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