More and more attention is being directed toward the problems that governments are having with their financial situation. We have spent so much time this year discussing the problems in the financial industry, in housing, in credit cards, in consumer credit, in business bankruptcies, in debt-swaps, and in commercial real estate, that the plight of governments, other than the federal government, has taken a back seat.
Is 2010 to be dominated by the financial problems of government: federal, state, and local?
The cloud is certainly on the horizon.
Budget and debt problems on the national level have risen to prominence in the last few weeks. Just to list a few, you can start with Ireland, Greece, Spain, Mexico, and Dubai.
Yeah, and what about California and New York?
More and more we are hearing about the sagging prospects for the states and for cities and other local administrative units. See, for example, “States Scramble to Close New Budget Gaps” in the Wall Street Journal, http://online.wsj.com/article/SB126110075141996495.html#mod=todays_us_page_one.
In almost all states, there is some kind of balanced budget requirement. This is also true of many local government bodies. This means that attempts must be made to bring budgets under control.
The problem is on the revenue side; funds are just not coming in at the rate even severely revised budget projections anticipated. And, all of these shortfalls cannot be filled by federal stimulus monies. Certainly some jobs, especially in education, were maintained by federal funds, but this source cannot be continually relied upon.
And, the situation is a cumulative one. Unemployment and non-existent economic growth have caused the revenues of these entities to slow down. This is resulting in more budget cuts, primarily in programs and layoffs which just exacerbate the problem in unemployment and slow economic growth. This in turn slows down the revenue flow even further. And, so on, and so on.
Just as businesses and households are doing, state and local governments are re-thinking what it is they do, what they can do, and how they are going to go about doing it. The de-leveraging and down-sizing are coming after 50 years or so of relatively constant expansion of budgets and programs.
The inflationary-bias that has existed in the United States for the last 50 years resulted in a very prosperous public sector to go along with the very prosperous private sector. As I have stated repeatedly in my posts over the last two years, inflation is wonderful for the creation of debt and for financial innovation, in the public sector, as well as in the private sector.
Ah, thank goodness for gambling, for it seems to be one of the “gap-filling moves” that states are relying on to replace revenue shortfalls. The problem with this is that “planned gambling expansions” are zero-sum games if people, on the whole, don’t increase their gambling activities. And, do we really want people to increase their gambling activities, especially at this time?
But, this leads us back to the federal sector. It seems as if future inflation is the only answer to the consequences of past inflation.
The latest official estimate for the federal deficit for 2010 is $1.5 trillion, up from 1.4 trillion the year before. Even scarier is that the Gross Federal Debt is projected to increase by $2.2 trillion this year, an increase of 18.6% from last year. Even shakier is that the public is supposed to absorb more of the increase in the federal debt than ever before: a rise of $2.0 trillion or 26.9% ahead of last year.
And, these budget figures don’t include the Pentagon “bill” that was passed yesterday with much pork and “earmarks”, buying things that the Pentagon didn’t even want! And, it doesn’t include the new Pelosi “jobs bill” which just passed the house last week. And, it doesn’t include real numbers for the health care legislation. Oh, yes, and where is the $100 billion going to come to help finance the climate concerns of the emerging or developing nations? This was just proposed two days ago. Also, where is the cost of the increased troop commitment to Afghanistan? And, there are four or five other things that could be included in this list.
Where are the funds going to come from to finance all of these expenditures?
In addition, we have a Federal Reserve System that is on the verge of “exiting” from the excessive liquidity that it has injected into the financial system over the past 15 months. The Fed has a portfolio of securities that amounts to $1.835 trillion. The composition of this portfolio is U. S. Treasury securities, $777 billion, Federal Agency securities, $158 billion, and Mortgage-Backed securities, $901 billion.
How is the government going to finance all of the new debt it must place on the market at the same time the Federal Reserve is trying to reduce the size of its balance sheet by selling off these securities?
Furthermore, the Congress is not going to be happy with the Fed selling securities to “exit” its current bloated balance sheet which will cause interest rates to rise at the same time that massive amounts of new federal debt is going to be hitting the financial markets.
Well, the Bernanke Fed is not independent of the government anyway.
So, inflation is the answer! Bring it on!
The interesting thing about the international concern over the financial health of the nations is that the value of the United States dollar has risen. International finance seems to be saying that maybe things in the United States are not that bad when you consider the state of other nations in the world.
As I wrote above, maybe in 2010 a lot more of the concern in credit markets will be with the status of government budgets and government debts. The question then becomes, how long can governments continue to bail out other governments? Maybe as long as some governments can still print money.
Friday, December 18, 2009
Thursday, December 17, 2009
Will Bernanke Never Learn?
The report from the Federal Reserve yesterday was positive. The headline in the Wall Street Journal was typical: “Fed More Upbeat, but Keeps Lid on Rates.” In other Federal Reserve news we hear that the Fed is going to phase out the special facilities set up during the financial crisis.
So, what else is new? (http://seekingalpha.com/article/178117-federal-reserve-exit-watch-part-5)
Our fearless leader, Time’s Person of the Year, POTY, Chairman Benjamin Shalom Bernanke, was an avid supporter of Alan Greenspan and low, low interest rates earlier this decade, rates that spurred on the credit bubble in housing and elsewhere. In 2007, Chairman Bernanke was late in identifying the fact that the economy was slowing and that there was a looming financial crisis on the horizon. Then, Time’s POTY seemingly panicked after the bailout of AIG in September 2008 and this resulted in the rushed passage of TARP. (http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic)
Once it was finally accepted that there was a financial crisis, POTY saw to it that just about everything that could be thrown against the wall, was...thrown against the wall. In this he has been deemed a savior. The balance sheet of the Fed ballooned from about $900 billion to roughly $2.1 trillion.
Now, POTY is seeing that the target rate of interest for the conduct of monetary policy can hardly be differentiated from zero and this target has been maintained since December 16, 2008.
WOW! The Fed’s zero target rate of interest was one year old YESTERDAY!
Excess reserves in the banking system have gone from about $2 billion to over $1.1 trillion!
And, what is the result?
Big banks are eating this up! There are two articles in the morning papers that attest to this. See the column by John Gapper in the Financial Times, “How America let banks off the lease”: http://www.ft.com/cms/s/0/0ad195f8-ea7a-11de-a9f5-00144feab49a.html. Gapper writes, “As the FT reported on Wednesday, banks and hedge funds have made huge profits in distressed debt trading in the past year, aided by the Federal Reserve keeping short-term interest rates low. Meanwhile, the banks that turned out to be too big to be allowed to fail are bigger than ever.”
Next, the op-ed piece in the Wall Street Journal by Gerald P. O’Driscoll, Jr., “Obama vs. the Banks”: http://online.wsj.com/article/SB20001424052748704398304574597910616856696.html#mod=todays_us_opinion. O’Driscoll states “that banks can raise short-term money at very low interest rates and buy safe, 10-year Treasury bonds at around 3.5%. The Bernanke Fed has promised to maintain its policy for ‘for an extended period.’ That translates into an extended opportunity for banks to engage in this interest-rate arbitrage.” He then asks, “Why would a banker take on traditional loans, which even in good times come with some risk of loss?” Seems like I have been arguing this point for at least six months now in assorted blog posts.
But, of even more importance is the attitude of the bankers toward financial innovation.
There is no better environment for financial innovation than the one that we are now experiencing. I would argue very strongly that financial innovation is taking place right now even though we may not see all the different forms the innovation is taking. And, the current round of financial innovation is coming at the expense of regular borrowing and lending. And, the financial innovation is benefitting the large, financially savvy financial institutions and not the small- and medium-sized organizations that don’t have the resources, or, the inclination, or, the freedom, since they still have plenty of questionable assets to deal with. Hail, Wall Street! See you later Main Street!
For the past fifty years or so, the government of the United States has basically followed an expansionary economic policy that has provided a safety-net to the financial system, and established an inflationary bias within the economy. There is no better environment for financial innovation than this!
The banks, the financial system, the non-financial system, and governments have innovated like mad during this time period.
The current federal government is just continuing to underwrite this practice at the present time.
POTY and the current administration are just exacerbating the situation they are so heavily criticizing.
And, as Gapper states, "the banks that turned out to be too big to be allowed to fail are bigger now than ever."
POTY and the current administration may win, politically, in the short run because the big bankers seem to have a deaf ear: See http://seekingalpha.com/article/178269-defining-the-banking-situation-as-a-political-issue.
In the longer run, the victory may go to another side. Paul Volcker seems to be taking the other side of the argument. See the article by Simon Johnson in The New Republic: “Is History on Paul Volcker’s Side?” http://www.tnr.com/blog/the-plank/history-paul-volckers-side.
The bottom line, however, is that Benjamin Shalom Bernanke doesn’t seem to get it…once again! Time after time, the Fed Chairman has seemed to miss the mark. Because of this record, one, I think, can seriously ask the question: “Why should we expect Bernanke to be correct this time?”
In nominating the Chairman for another term, President Obama seems to believe that Bernanke will be correct this time. More than anything else the president has done, even sending more troops into Afghanistan, his bet on the re-appointment of Chairman Bernanke may determine how his presidency is perceived by future historians. A lot is riding on Chairman Bernanke.
So, what else is new? (http://seekingalpha.com/article/178117-federal-reserve-exit-watch-part-5)
Our fearless leader, Time’s Person of the Year, POTY, Chairman Benjamin Shalom Bernanke, was an avid supporter of Alan Greenspan and low, low interest rates earlier this decade, rates that spurred on the credit bubble in housing and elsewhere. In 2007, Chairman Bernanke was late in identifying the fact that the economy was slowing and that there was a looming financial crisis on the horizon. Then, Time’s POTY seemingly panicked after the bailout of AIG in September 2008 and this resulted in the rushed passage of TARP. (http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic)
Once it was finally accepted that there was a financial crisis, POTY saw to it that just about everything that could be thrown against the wall, was...thrown against the wall. In this he has been deemed a savior. The balance sheet of the Fed ballooned from about $900 billion to roughly $2.1 trillion.
Now, POTY is seeing that the target rate of interest for the conduct of monetary policy can hardly be differentiated from zero and this target has been maintained since December 16, 2008.
WOW! The Fed’s zero target rate of interest was one year old YESTERDAY!
Excess reserves in the banking system have gone from about $2 billion to over $1.1 trillion!
And, what is the result?
Big banks are eating this up! There are two articles in the morning papers that attest to this. See the column by John Gapper in the Financial Times, “How America let banks off the lease”: http://www.ft.com/cms/s/0/0ad195f8-ea7a-11de-a9f5-00144feab49a.html. Gapper writes, “As the FT reported on Wednesday, banks and hedge funds have made huge profits in distressed debt trading in the past year, aided by the Federal Reserve keeping short-term interest rates low. Meanwhile, the banks that turned out to be too big to be allowed to fail are bigger than ever.”
Next, the op-ed piece in the Wall Street Journal by Gerald P. O’Driscoll, Jr., “Obama vs. the Banks”: http://online.wsj.com/article/SB20001424052748704398304574597910616856696.html#mod=todays_us_opinion. O’Driscoll states “that banks can raise short-term money at very low interest rates and buy safe, 10-year Treasury bonds at around 3.5%. The Bernanke Fed has promised to maintain its policy for ‘for an extended period.’ That translates into an extended opportunity for banks to engage in this interest-rate arbitrage.” He then asks, “Why would a banker take on traditional loans, which even in good times come with some risk of loss?” Seems like I have been arguing this point for at least six months now in assorted blog posts.
But, of even more importance is the attitude of the bankers toward financial innovation.
There is no better environment for financial innovation than the one that we are now experiencing. I would argue very strongly that financial innovation is taking place right now even though we may not see all the different forms the innovation is taking. And, the current round of financial innovation is coming at the expense of regular borrowing and lending. And, the financial innovation is benefitting the large, financially savvy financial institutions and not the small- and medium-sized organizations that don’t have the resources, or, the inclination, or, the freedom, since they still have plenty of questionable assets to deal with. Hail, Wall Street! See you later Main Street!
For the past fifty years or so, the government of the United States has basically followed an expansionary economic policy that has provided a safety-net to the financial system, and established an inflationary bias within the economy. There is no better environment for financial innovation than this!
The banks, the financial system, the non-financial system, and governments have innovated like mad during this time period.
The current federal government is just continuing to underwrite this practice at the present time.
POTY and the current administration are just exacerbating the situation they are so heavily criticizing.
And, as Gapper states, "the banks that turned out to be too big to be allowed to fail are bigger now than ever."
POTY and the current administration may win, politically, in the short run because the big bankers seem to have a deaf ear: See http://seekingalpha.com/article/178269-defining-the-banking-situation-as-a-political-issue.
In the longer run, the victory may go to another side. Paul Volcker seems to be taking the other side of the argument. See the article by Simon Johnson in The New Republic: “Is History on Paul Volcker’s Side?” http://www.tnr.com/blog/the-plank/history-paul-volckers-side.
The bottom line, however, is that Benjamin Shalom Bernanke doesn’t seem to get it…once again! Time after time, the Fed Chairman has seemed to miss the mark. Because of this record, one, I think, can seriously ask the question: “Why should we expect Bernanke to be correct this time?”
In nominating the Chairman for another term, President Obama seems to believe that Bernanke will be correct this time. More than anything else the president has done, even sending more troops into Afghanistan, his bet on the re-appointment of Chairman Bernanke may determine how his presidency is perceived by future historians. A lot is riding on Chairman Bernanke.
Tuesday, December 15, 2009
Banking, Banks, and the President: Defining the Issues
The side that wins the political battles is usually the one that presents the issues in such a way that the “public” responds to this presentation and goes with them rather than with the “other side.”
There is an election coming up next year and the campaigning has already begun. The battle: whether or not the Democrats are going to be able to maintain a large enough majority in Congress to control the action in Washington, D. C. Already, the Democrats are looking back over their shoulders to 1994 mid-term election and their loss of control of Congress at that time. And, they are scared.
The way to operate in politics is to “frame” important issues in such a way that they will resonate with a majority of the electorate. It takes time for specific issues to “take hold” with the public so the framing effort must be started well in advance of the election. The process of “framing” is moving ahead, full steam.
The economy is obviously going to be an issue. How it is framed will determine the result. It appears that the banking industry is going to play a big role in how the discussion on the
economy evolves. The battle lines: Main Street versus Wall Street. The issues: an unemployment rate of 10% and an underemployment rate at 17-18% versus lots of taxpayer money to bail out the banks and the subsequent profitability of the big banks. A further issue: people losing their homes through foreclosure versus the payment of large bonuses by the big banks to their executives.
Sure the meeting between the President and the heads of the major banks in the United States was a great photo op. But, what did the photo op turn into? Let me just say that a headline like “Bankers Put Obama on Hold” accompanied by a picture of the President at his desk holding a phone does not create a very favorable image of the bankers (see the article by Andrew Ross Sorkin in the New York Times: http://www.nytimes.com/2009/12/15/business/15sorkin.html?_r=1).
Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, is still a hero to many people, myself included, and is perhaps the most respected person in finance in the world today. He stated very bluntly in West Sussex, England this week that the bankers just didn’t get it. Great headlines!
In debates like this it doesn’t always matter who is right and who is wrong. We have seen over and over again that in economics, identifying the cause and effect of an economic situation is so difficult and the lags between the cause and the effect are so long, that explaining a situation to the public in terms that they understand is almost impossible.
Here I am specifically writing about the run-up to the financial collapse of 2008. To me the causes of this collapse go back to the almost 50 years of inflationary finance perpetrated by the United States government, Republican and Democratic alike, on the American people. This includes the huge deficits run up by the federal government since 9/11 and the inexcusable monetary ease that kept real interest rates negative for two to three years in the 2002-2005 period. The financial bubbles that resulted in housing and the stock market this decade produced the conditions that led to the subsequent events.
An economy with an inflationary bias is ideal for the evolution of financial innovation. It is ideal for leveraging up the balance sheet. It is ideal for assuming more and more risk.
It is difficult, however, to explain this cause and effect to the public.
Financial innovation looks like greed run amok. Assuming more and more risk looks like greed run amok. And, excessive amounts of leverage looks like greed run amok.
But, what about the government policy makers that created the incentives that made financial innovation valuable? What about those that contributed to the inflation that made high degrees of leverage worthwhile and edgy risk taking more attractive?
The connection is very difficult to put into sound bites and win the hearts and minds of voters.
In terms of financial regulation? My belief is that banks, especially the big banks have moved beyond the recent financial collapse. Congress and the regulators are always fighting the last war. The goal of Congress and the regulators is to not let the events of 2008 and 2009 happen again.
Guess what? The events of 2008 and 2009 will not happen again. The banks have moved beyond that. The reformed regulations will probably hurt the smaller banks much more than the larger banks. The smaller banks are still the ones dealing with the past, the questionable commercial real estate loans, the residential mortgages that are in arrears or are not paying at all, the consumer credit, the credit of state and local governments and so on and so on.
But, the big banks. They are already into 2010 and 2011 and beyond! More on this in another post.
This is why the banking industry must be careful at this time. In a real sense, Volcker is right; the bankers just don’t get it!
They can’t afford to look as if they are making the President look silly. They can’t afford to make themselves look like they are “fat cats.” Whoops, that is what the President called them Sunday night and it is all over the country. The bankers can’t afford to look as if they are staunchly against regulation reform. The bankers can’t look like they don’t care about mortgage foreclosures, or small-business loans, or getting people back to work.
The issues are being “framed” right now. The bankers cannot put themselves in a position to be characterized as “Scrooge” while the Obama administration comes on as “Tiny Tim.”
There is an election coming up next year and the campaigning has already begun. The battle: whether or not the Democrats are going to be able to maintain a large enough majority in Congress to control the action in Washington, D. C. Already, the Democrats are looking back over their shoulders to 1994 mid-term election and their loss of control of Congress at that time. And, they are scared.
The way to operate in politics is to “frame” important issues in such a way that they will resonate with a majority of the electorate. It takes time for specific issues to “take hold” with the public so the framing effort must be started well in advance of the election. The process of “framing” is moving ahead, full steam.
The economy is obviously going to be an issue. How it is framed will determine the result. It appears that the banking industry is going to play a big role in how the discussion on the
economy evolves. The battle lines: Main Street versus Wall Street. The issues: an unemployment rate of 10% and an underemployment rate at 17-18% versus lots of taxpayer money to bail out the banks and the subsequent profitability of the big banks. A further issue: people losing their homes through foreclosure versus the payment of large bonuses by the big banks to their executives.
Sure the meeting between the President and the heads of the major banks in the United States was a great photo op. But, what did the photo op turn into? Let me just say that a headline like “Bankers Put Obama on Hold” accompanied by a picture of the President at his desk holding a phone does not create a very favorable image of the bankers (see the article by Andrew Ross Sorkin in the New York Times: http://www.nytimes.com/2009/12/15/business/15sorkin.html?_r=1).
Paul Volcker, former Chairman of the Board of Governors of the Federal Reserve System, is still a hero to many people, myself included, and is perhaps the most respected person in finance in the world today. He stated very bluntly in West Sussex, England this week that the bankers just didn’t get it. Great headlines!
In debates like this it doesn’t always matter who is right and who is wrong. We have seen over and over again that in economics, identifying the cause and effect of an economic situation is so difficult and the lags between the cause and the effect are so long, that explaining a situation to the public in terms that they understand is almost impossible.
Here I am specifically writing about the run-up to the financial collapse of 2008. To me the causes of this collapse go back to the almost 50 years of inflationary finance perpetrated by the United States government, Republican and Democratic alike, on the American people. This includes the huge deficits run up by the federal government since 9/11 and the inexcusable monetary ease that kept real interest rates negative for two to three years in the 2002-2005 period. The financial bubbles that resulted in housing and the stock market this decade produced the conditions that led to the subsequent events.
An economy with an inflationary bias is ideal for the evolution of financial innovation. It is ideal for leveraging up the balance sheet. It is ideal for assuming more and more risk.
It is difficult, however, to explain this cause and effect to the public.
Financial innovation looks like greed run amok. Assuming more and more risk looks like greed run amok. And, excessive amounts of leverage looks like greed run amok.
But, what about the government policy makers that created the incentives that made financial innovation valuable? What about those that contributed to the inflation that made high degrees of leverage worthwhile and edgy risk taking more attractive?
The connection is very difficult to put into sound bites and win the hearts and minds of voters.
In terms of financial regulation? My belief is that banks, especially the big banks have moved beyond the recent financial collapse. Congress and the regulators are always fighting the last war. The goal of Congress and the regulators is to not let the events of 2008 and 2009 happen again.
Guess what? The events of 2008 and 2009 will not happen again. The banks have moved beyond that. The reformed regulations will probably hurt the smaller banks much more than the larger banks. The smaller banks are still the ones dealing with the past, the questionable commercial real estate loans, the residential mortgages that are in arrears or are not paying at all, the consumer credit, the credit of state and local governments and so on and so on.
But, the big banks. They are already into 2010 and 2011 and beyond! More on this in another post.
This is why the banking industry must be careful at this time. In a real sense, Volcker is right; the bankers just don’t get it!
They can’t afford to look as if they are making the President look silly. They can’t afford to make themselves look like they are “fat cats.” Whoops, that is what the President called them Sunday night and it is all over the country. The bankers can’t afford to look as if they are staunchly against regulation reform. The bankers can’t look like they don’t care about mortgage foreclosures, or small-business loans, or getting people back to work.
The issues are being “framed” right now. The bankers cannot put themselves in a position to be characterized as “Scrooge” while the Obama administration comes on as “Tiny Tim.”
Monday, December 14, 2009
Federal Reserve Exit Watch: Part 5
Something new this week: the Fed started to see how the financial markets would accept its strategy for reducing the size of its security portfolio. At the close of business on Wednesday December 9, 2009 the Federal Reserve showed $180 million on its balance sheet under the line item “Reverse repurchase agreements”.
The Federal Reserve had warned us that it was going to start “testing” the use of reverse repos as the mechanism for reducing the size of its securities portfolio. It had also informed us that a “test period” would begin last week.
It has begun, albeit in a very small amount.
Reserve balances with Federal Reserve Banks changed by only an insignificant amount last week.
Reserve balances did rise over the past 4 weeks and the past 13 weeks. In the last 4-week period reserve balances rose by a little more than $60 billion, $52 billion coming from factors supplying reserves and a negative $10 billion from factors absorbing reserves.
The $52 billion increase in factors supplying reserves was centered on an $85 billion increase in securities held outright ($79 billion in Mortgage-backed securities and $6 billion Federal Agency securities) and a $36 billion reduction in two accounts associated with the insertion of funds into the banking system early in the financial crisis last year. The Term Auction Credit Facility (TAF) dropped by almost $24 billion in the last four weeks and Central Bank Liquidity Swaps fell by about $13 billion.
The rest of the items connected with the innovative market facilities that the Fed created during the time of financial distress changed very little.
So the “Special Facilities” continue to wind down and the Fed continues to substitute marketable securities in its portfolio for the funds that were injected into the banking system to stem the crisis.
In terms of factors absorbing reserves at this time, the general account of the U. S. Treasury Department, its operating account at the Fed (it pays its bills out of this account), dropped by about $8 billion and this added reserves to the banking system and was the primary factor in the additional $10 billion increase in Reserve Balances mentioned above. The Treasury writes checks, they get deposited in banks, and bank reserves increase.
Over the longer term, the last 13 weeks, the government accounts have played a big part in the injection of reserves into the banking system. There is an account titled “U. S. Treasury, Supplemental Financing Account” which has been around since October 2008 (and reached a maximum of about $560 billion in November 2008 (Connected with TARP?). This account declined by $185 billion over the last 13 weeks.
The U. S. Treasury general account rose by $51 billion during this time, apparently the funds from the supplemental account were transferred to the general account so that they could write checks on it. Consequently, the net of the two, $134 billion got into the banking system and ended up as a part of Reserve Balances with Federal Reserve Banks.
During this 13-week period, the Fed also supplied $100 billion in reserves to the banking system through open-market purchases. To do this the Federal Reserve added $281 billion to the securities that it bought outright. The purchases were across the board: $229 billion in Mortgage-backed securities; $33 billion Federal Agency securities; and $19 billion in Treasury securities.)
The run-off in the special accounts over the past 13 weeks is obvious. The Term Auction Credit Facility (TAF) declined by $126 billion and Central Bank Liquidity Swaps fell by $45 billion, a total of $171 billion.
Primary bank loans from the discount window also fell by $10 billion so, over the past 13-week, period the Fed supplied reserves by buying $281 billion in securities and this was offset by a decline in “crisis” accounts of $171 and $10 in bank borrowing so that $100 billion additional funds reached Bank Reserves.
Conclusions:
The Federal Reserve had warned us that it was going to start “testing” the use of reverse repos as the mechanism for reducing the size of its securities portfolio. It had also informed us that a “test period” would begin last week.
It has begun, albeit in a very small amount.
Reserve balances with Federal Reserve Banks changed by only an insignificant amount last week.
Reserve balances did rise over the past 4 weeks and the past 13 weeks. In the last 4-week period reserve balances rose by a little more than $60 billion, $52 billion coming from factors supplying reserves and a negative $10 billion from factors absorbing reserves.
The $52 billion increase in factors supplying reserves was centered on an $85 billion increase in securities held outright ($79 billion in Mortgage-backed securities and $6 billion Federal Agency securities) and a $36 billion reduction in two accounts associated with the insertion of funds into the banking system early in the financial crisis last year. The Term Auction Credit Facility (TAF) dropped by almost $24 billion in the last four weeks and Central Bank Liquidity Swaps fell by about $13 billion.
The rest of the items connected with the innovative market facilities that the Fed created during the time of financial distress changed very little.
So the “Special Facilities” continue to wind down and the Fed continues to substitute marketable securities in its portfolio for the funds that were injected into the banking system to stem the crisis.
In terms of factors absorbing reserves at this time, the general account of the U. S. Treasury Department, its operating account at the Fed (it pays its bills out of this account), dropped by about $8 billion and this added reserves to the banking system and was the primary factor in the additional $10 billion increase in Reserve Balances mentioned above. The Treasury writes checks, they get deposited in banks, and bank reserves increase.
Over the longer term, the last 13 weeks, the government accounts have played a big part in the injection of reserves into the banking system. There is an account titled “U. S. Treasury, Supplemental Financing Account” which has been around since October 2008 (and reached a maximum of about $560 billion in November 2008 (Connected with TARP?). This account declined by $185 billion over the last 13 weeks.
The U. S. Treasury general account rose by $51 billion during this time, apparently the funds from the supplemental account were transferred to the general account so that they could write checks on it. Consequently, the net of the two, $134 billion got into the banking system and ended up as a part of Reserve Balances with Federal Reserve Banks.
During this 13-week period, the Fed also supplied $100 billion in reserves to the banking system through open-market purchases. To do this the Federal Reserve added $281 billion to the securities that it bought outright. The purchases were across the board: $229 billion in Mortgage-backed securities; $33 billion Federal Agency securities; and $19 billion in Treasury securities.)
The run-off in the special accounts over the past 13 weeks is obvious. The Term Auction Credit Facility (TAF) declined by $126 billion and Central Bank Liquidity Swaps fell by $45 billion, a total of $171 billion.
Primary bank loans from the discount window also fell by $10 billion so, over the past 13-week, period the Fed supplied reserves by buying $281 billion in securities and this was offset by a decline in “crisis” accounts of $171 and $10 in bank borrowing so that $100 billion additional funds reached Bank Reserves.
Conclusions:
- The Federal Reserve continues to let accounts connected with the financial crisis run off. This appears to be going along quite smoothly.
- The Federal Reserve continues to substitute funds from open-market purchases to replace the funds that are running-off. This appears to be going along quite smoothly.
- The Fed is now testing the mechanism, Reverse Repurchase Agreements, by which it means to reduce its portfolio of securities and drain excess reserves from the banking system. The first test went along quite smoothly.
- The U. S. Treasury supplemental financing account is now just $15 billion and will probably not be a big factor in changing bank reserves in the future.
- The Federal Reserve is going to be facing a lot of “operating factors” over the next month that may cloud up any other actions that the Fed may be taking. These “operating factors” relate to government deposits and the increased use of currency in circulation during the holiday season. These disruptions should end by the middle of January 2010.
Note: Excess Reserves in the banking system still are running above $1.1 trillion. There is little evidence yet that banks want to do anything with these reserves other than hold onto them: this, in spite of the efforts of the Obama administration to get banks lending, especially to small business.
Thursday, December 10, 2009
Bank Holding Companies and Other Financial Institutions
Bank Holding Companies
The Flow of Funds accounts from the Federal Reserve System just came out today. This gives us a chance to look at parts of the financial system that we do not get to look at on a more frequent basis.
In terms of the banking sector, one area of interest at this time is the activity going on in bank holding companies. In terms of assets, bank holding companies, at the end of the third quarter, 2009, are holding $2.8 trillion in assets, up from $1.9 trillion one year ago and up from $1.8 trillion at the end of 2007. So assets in bank holding companies rose by almost 50% in the past year.
The large increase in assets came in the area of investments in nonbank subsidiaries. The rise from the end of the third quarter of 2008 was $537 billion, or 135%. The increase since the end of 2007 was $592 billion, or an increase of 172%
These holding companies also increased their investment in bank subsidiaries as well, but only by $164 billion or by 14% since the end of the third quarter 2008. The increase since the end of 2007 was $188 billion.
Financing this increase in assets was an increase in bonds issued by these holding companies and in residual equity. The net increase in corporate bonds issued was $508 billion for the year ending in the third quarter of 2009. The net increase since the end of 2007 was $553 billion.
There was roughly an $400 billion increase in the residual equity of these organizations during this time period. The increase in residual equity since the end of 2007 was approximately $500 billion.
These increases in bank holding company assets took place at the same time that total assets in U. S. chartered commercial banking sector rose only by about $139 billion from the third quarter of 2008 to the third quarter of 2009. It should be noted that during this same time period total bank loans in the banking industry declined by almost $383 billion, with reductions taking place in every category of loan.
Note that since the end of the third quarter 2008, vault cash and reserves at the Federal Reserve rose by $384 billion. The increase since the end of 2007 was $540 billion.
It is obvious that banks and bank holding companies are not doing the ordinary business of banking.
The commercial banks, themselves, are becoming “pools of liquidity”, but they are not lending.
It seems that bank holding companies, however, are further diversifying into nonbank subsidiaries because of the tremendous opportunities for profit that are now available to them in these areas. Also, it seems as if this is all happening for the largest banks and the largest bank holding companies.
So, here is the picture: commercial banks are essentially static right now; nothing is happening in the industry as a whole.
Bank holding companies are moving ahead full steam: and what they are doing is very, very profitable!
Saving Institutions
The thrift industry continues to shrink!
In the last four quarters, the total financial assets in savings and loan associations, mutual savings banks, and federal savings banks fell by $145 billion, or by about 10%, to just $1.4 trillion. Since the end of 2007, financial assets have fallen by $442 billion, or by about 25%.
One really has to wonder about the existence of this part of the finance industry and the need for such an expensive regulatory structure to support it.
Its main reason for existence, the issuing of mortgages, continues to erode as mortgages on the books of these savings institutions fell by $155 over the past year, an 18% decline. Since the end of 2007, mortgages at these institutions fell by $367 billion, a decline of one-third. Statistics indicate that, on average, institutions in this industry are just about breaking even, profit-wise.
Although it is not getting a lot of headlines in the press, the savings industry is not doing too well. Maybe it is now too insignificant to warrant much attention!
Credit-Unions
Credit unions continue to grow. They ended the third quarter at $873.4 billion in total financial assets, increasing by $73 billion over the last four quarters.
One wonders when the total assets at credit unions are going to exceed that at savings institutions.
Although the totals are not large, credit unions continue to increase their loan portfolios across the board.
The total amount of credit extended by credit unions was $592 billion at the end of the third quarter 2009, roughly two-thirds of the $875 billion in loans on the books of savings institutions. Credit unions have only about 63% of the assets that savings institutions do.
Mortgages on the books at credit unions are about 44% of the amount of mortgages that sit on the books of savings institutions, up from 35% at the end of the third quarter in 2008. But, consumer loans are 308% of the total of consumer loans at savings institutions. This is just a little higher than it was one year ago.
Credit unions seem to be doing very well and continue to be on the rise!
The Flow of Funds accounts from the Federal Reserve System just came out today. This gives us a chance to look at parts of the financial system that we do not get to look at on a more frequent basis.
In terms of the banking sector, one area of interest at this time is the activity going on in bank holding companies. In terms of assets, bank holding companies, at the end of the third quarter, 2009, are holding $2.8 trillion in assets, up from $1.9 trillion one year ago and up from $1.8 trillion at the end of 2007. So assets in bank holding companies rose by almost 50% in the past year.
The large increase in assets came in the area of investments in nonbank subsidiaries. The rise from the end of the third quarter of 2008 was $537 billion, or 135%. The increase since the end of 2007 was $592 billion, or an increase of 172%
These holding companies also increased their investment in bank subsidiaries as well, but only by $164 billion or by 14% since the end of the third quarter 2008. The increase since the end of 2007 was $188 billion.
Financing this increase in assets was an increase in bonds issued by these holding companies and in residual equity. The net increase in corporate bonds issued was $508 billion for the year ending in the third quarter of 2009. The net increase since the end of 2007 was $553 billion.
There was roughly an $400 billion increase in the residual equity of these organizations during this time period. The increase in residual equity since the end of 2007 was approximately $500 billion.
These increases in bank holding company assets took place at the same time that total assets in U. S. chartered commercial banking sector rose only by about $139 billion from the third quarter of 2008 to the third quarter of 2009. It should be noted that during this same time period total bank loans in the banking industry declined by almost $383 billion, with reductions taking place in every category of loan.
Note that since the end of the third quarter 2008, vault cash and reserves at the Federal Reserve rose by $384 billion. The increase since the end of 2007 was $540 billion.
It is obvious that banks and bank holding companies are not doing the ordinary business of banking.
The commercial banks, themselves, are becoming “pools of liquidity”, but they are not lending.
It seems that bank holding companies, however, are further diversifying into nonbank subsidiaries because of the tremendous opportunities for profit that are now available to them in these areas. Also, it seems as if this is all happening for the largest banks and the largest bank holding companies.
So, here is the picture: commercial banks are essentially static right now; nothing is happening in the industry as a whole.
Bank holding companies are moving ahead full steam: and what they are doing is very, very profitable!
Saving Institutions
The thrift industry continues to shrink!
In the last four quarters, the total financial assets in savings and loan associations, mutual savings banks, and federal savings banks fell by $145 billion, or by about 10%, to just $1.4 trillion. Since the end of 2007, financial assets have fallen by $442 billion, or by about 25%.
One really has to wonder about the existence of this part of the finance industry and the need for such an expensive regulatory structure to support it.
Its main reason for existence, the issuing of mortgages, continues to erode as mortgages on the books of these savings institutions fell by $155 over the past year, an 18% decline. Since the end of 2007, mortgages at these institutions fell by $367 billion, a decline of one-third. Statistics indicate that, on average, institutions in this industry are just about breaking even, profit-wise.
Although it is not getting a lot of headlines in the press, the savings industry is not doing too well. Maybe it is now too insignificant to warrant much attention!
Credit-Unions
Credit unions continue to grow. They ended the third quarter at $873.4 billion in total financial assets, increasing by $73 billion over the last four quarters.
One wonders when the total assets at credit unions are going to exceed that at savings institutions.
Although the totals are not large, credit unions continue to increase their loan portfolios across the board.
The total amount of credit extended by credit unions was $592 billion at the end of the third quarter 2009, roughly two-thirds of the $875 billion in loans on the books of savings institutions. Credit unions have only about 63% of the assets that savings institutions do.
Mortgages on the books at credit unions are about 44% of the amount of mortgages that sit on the books of savings institutions, up from 35% at the end of the third quarter in 2008. But, consumer loans are 308% of the total of consumer loans at savings institutions. This is just a little higher than it was one year ago.
Credit unions seem to be doing very well and continue to be on the rise!
Wednesday, December 9, 2009
It Ain't Over Until It's Over
Spain has just had its debt outlook lowered by Standard and Poor’s. In January, Spain’s debt rating was lowered from AAA to AA+. Now, Spain’s debt outlook has been reduced from “stable” to “negative”. The outlook: Spain is now expected to experience a “more pronounced and persistent deterioration” in its budget and a “more prolonged period of economic weakness,” than it expected at the start of the year. Enough said.
Spain now joins Dubai and Greece in the headlines that include the label “sovereign debt.” And, the guess is that this list is going to grow in the upcoming weeks and months.
It’s not over yet!
There are still too many entities that have not fully voiced their precarious financial situation or have not yet fully accounted for their losses.
As I have said many times before that although the bad news is that there are still a lot of write-offs and write-downs that have not been taken yet, the good news is that we are not “surprised” by them and seem to be handling the bad debt problems within the “course of business.”
Many of the people I most respect believe that there will be more nations joining Spain, Dubai, and Greece as problem areas. There will be states within the United States that will be downgraded credit-wise. More corporations and businesses will find their credit rating lowered. Bankruptcies, business and personal, will continue to rise. Foreclosures on homes and commercial properties will keep going up. There will be a lot more bank failures. Remember there are 552 banks on the problem bank list of the F. D. I. C. The credit problems of the world are not going to go away for a while.
And, this is the reason why there is next to no lending going on in the economy and in the world.
Yes, some of the bigger organizations are getting funds. But, the world is bifurcating. As mentioned Monday, many of the bigger banks seem to be thriving, profit-wise, while the smaller ones are on the edge. (See http://seekingalpha.com/article/176895-big-banks-vs-small-banks.) Also, the larger banks are increasing their lending while the small- and medium-sized banks are still contracting their lending.
It seems that at this time there is very little confidence in balance sheets and in people. One just doesn’t know who to trust anymore. And, this lack of confidence extends from the private sector to the public sector and back again.
It is this underlying lack of confidence, this lack of faith that will tend to hinder the recovery and the return to a more “normal” economy, whatever “normal” is going to mean in the future.
The real problem is that I don’t see anything on the horizon that is working to change this lack of confidence. To me, the world has changed, it changed in September 2008. Yet, to a great extent, our policymakers are trying to force the world back into the form it was before these changes took place.
Just in terms of financial regulation, Congress, and many of people that advise Congress, are fighting the previous war.
Haven’t they noticed that the bigger financial institutions have already changed? JP Morgan Chase and Goldman Sachs have moved on. So have many other healthy, large organizations in the United States as well as in the world. Congress will not be able to put them back into their former mold.
In this respect, the only thing one can hope for on the regulatory side is that the Congress will not “muck-it-up” too badly in terms of banking regulation for the rest of the industry.
Remember that there are about $12 trillion assets in the banking system in the United States. Of this amount, the largest 25 domestically chartered banks possess $6.8 trillion and the “small” domestically chartered banks hold about $3.8 trillion. The rest of the assets are in the branches of foreign banks. The largest will find ways around new rules and regulations: the smaller institutions will have to deal with them directly.
The things that the current administration and Congress are doing to try and get the economy moving again lack traction in the area of building confidence where that confidence is needed. This lack of confidence is even coming from within government, itself, as Elizabeth Warren, the head of the Congressional Oversight Panel on bank bailouts, has called the Treasury’s program to restructure mortgages that are underwater so as to prevent foreclosures “ineffective” and something that the Treasury should scrap.
Confidence in the system and trust are going to be slow in coming back. Until these things return, a full recovery will not be forthcoming. It ain’t over until it’s over!
Spain now joins Dubai and Greece in the headlines that include the label “sovereign debt.” And, the guess is that this list is going to grow in the upcoming weeks and months.
It’s not over yet!
There are still too many entities that have not fully voiced their precarious financial situation or have not yet fully accounted for their losses.
As I have said many times before that although the bad news is that there are still a lot of write-offs and write-downs that have not been taken yet, the good news is that we are not “surprised” by them and seem to be handling the bad debt problems within the “course of business.”
Many of the people I most respect believe that there will be more nations joining Spain, Dubai, and Greece as problem areas. There will be states within the United States that will be downgraded credit-wise. More corporations and businesses will find their credit rating lowered. Bankruptcies, business and personal, will continue to rise. Foreclosures on homes and commercial properties will keep going up. There will be a lot more bank failures. Remember there are 552 banks on the problem bank list of the F. D. I. C. The credit problems of the world are not going to go away for a while.
And, this is the reason why there is next to no lending going on in the economy and in the world.
Yes, some of the bigger organizations are getting funds. But, the world is bifurcating. As mentioned Monday, many of the bigger banks seem to be thriving, profit-wise, while the smaller ones are on the edge. (See http://seekingalpha.com/article/176895-big-banks-vs-small-banks.) Also, the larger banks are increasing their lending while the small- and medium-sized banks are still contracting their lending.
It seems that at this time there is very little confidence in balance sheets and in people. One just doesn’t know who to trust anymore. And, this lack of confidence extends from the private sector to the public sector and back again.
It is this underlying lack of confidence, this lack of faith that will tend to hinder the recovery and the return to a more “normal” economy, whatever “normal” is going to mean in the future.
The real problem is that I don’t see anything on the horizon that is working to change this lack of confidence. To me, the world has changed, it changed in September 2008. Yet, to a great extent, our policymakers are trying to force the world back into the form it was before these changes took place.
Just in terms of financial regulation, Congress, and many of people that advise Congress, are fighting the previous war.
Haven’t they noticed that the bigger financial institutions have already changed? JP Morgan Chase and Goldman Sachs have moved on. So have many other healthy, large organizations in the United States as well as in the world. Congress will not be able to put them back into their former mold.
In this respect, the only thing one can hope for on the regulatory side is that the Congress will not “muck-it-up” too badly in terms of banking regulation for the rest of the industry.
Remember that there are about $12 trillion assets in the banking system in the United States. Of this amount, the largest 25 domestically chartered banks possess $6.8 trillion and the “small” domestically chartered banks hold about $3.8 trillion. The rest of the assets are in the branches of foreign banks. The largest will find ways around new rules and regulations: the smaller institutions will have to deal with them directly.
The things that the current administration and Congress are doing to try and get the economy moving again lack traction in the area of building confidence where that confidence is needed. This lack of confidence is even coming from within government, itself, as Elizabeth Warren, the head of the Congressional Oversight Panel on bank bailouts, has called the Treasury’s program to restructure mortgages that are underwater so as to prevent foreclosures “ineffective” and something that the Treasury should scrap.
Confidence in the system and trust are going to be slow in coming back. Until these things return, a full recovery will not be forthcoming. It ain’t over until it’s over!
Sunday, December 6, 2009
Big Banks seem to be doing just fine: Smaller Banks, not so well
Last month it seemed as if there was a glimmer of hope for the smaller banks: lending appeared to be picking up across the board. (See my November 9 post, “A Positive Trend in Small Bank Lending”: http://seekingalpha.com/article/172219-a-positive-trend-in-small-bank-lending.)
Well, the glimmer of hope went away in November. However, lending, and profits, at the larger banks seemed to become more robust as we went deeper into the fall.
Overall, bank liquidity continued to rise as the cash assets in the commercial banking system rose by $290 billion in the latest 13-week period and by $110 billion in the last 4-week period. This increase was, of course, reflected in the aggregate bank data. The Federal Reserve showed that Reserve Balances with Federal Reserve Banks averaged $833 billion in the banking week ending August 26, $1.085 trillion in the banking week ending October 28, and $1.139 trillion in the banking week ending December 2. Excess reserves in the banking system averaged $795 billion, $987 billion, and $1.120 trillion for the two-week periods ending, August 26, October 21, December, respectively. The banking system became more liquid as the fall matured.
Whereas, lending in the smaller banks showed some rise in October, lending was down across the board in the November period and this seemed to drag down the results from the last 13-week period.
The leader in this decline was lending for Commercial Real Estate. Analysts have claimed for some time now that problems were looming in this area for the small- and medium-sized banks. The concern was over timing: when were the problems being experienced by this sector going to show up on the balance sheets of these banking organizations?
Well, they really seem to be showing up now. Commercial Real Estate loans on the balance sheets of “small” domestically chartered commercial banks declined by $33 billion in the 4-week period ending November 25. They dropped by $50 billion in the last 13-week period.
Commercial and Industrial loans also decreased at the smaller banks in the latest 4-week period by $23 billion. (These loans actually had increased in the previous nine weeks.)
Furthermore, as stated in my December 1 post, these small- and medium-sized banks are not doing well profit-wise. The F. D. I. C. reported that commercial banks of $1.0 billion in assets size or less roughly broke even profit-wise in the third quarter of 2009. Banks in the $1.0 billion to $10.0 billion in asset size lost, on average, $3.0 million per bank in the third quarter.
The problem bank list, which consists primarily of small- and medium-sized banks rose to 552 at the end of the third quarter, an increase from a total of 416 at the end of the second quarter, and this is with 50 banks dropping off the list in the third quarter because they failed. (This information is reported in http://seekingalpha.com/article/175958-banking-sector-weakness-the-secret-no-one-wants-to-talk-about.)
The blip upwards in lending at the small- and medium-sized commercial banks reported last month is typical of the information flows we are getting these days. Some months the information that is reported looks good and we get excited about it. The next month…well, the information isn’t so good. The concern with the smaller banks is that the future could really be quite bleak.
With 552 banks on the F. D. I. C. problem list, we could see the banking industry taking a lot of hits in the next 12 months or so. If one-third of these banks fail, which is the estimate going around, this would mean that 184 of these banks would be closed or, in a 12-month period, roughly 3.5 banks per week would be closed. In the third quarter of 2009 three banks a week, on average, were closed. And, this assumes that no other banks come onto the problem bank list.
What about the big banks?
The big banks, except Citigroup, seem to be doing just fine. Even Bank of America is going to pay back the money it received from the federal government and it has raised additional capital.
Evidence that big banks are doing OK is present in the F. D. I. C. data just released. Commercial banks with assets in excess of $10 billion reported profits, on average, of $42 million per bank in the third quarter.
This prosperity seems to be translating itself into the performance of these larger banks. The assets of large commercial banks rose by $202 billion in the last 4-week period, whereas total assets actually dropped in the smaller banks and in foreign-related banking offices.
Loans and leases at the bigger banks surged by $163 billion in the last four weeks. This is the first substantial increase in activity in these banks this year!
Whereas the increase in loan volume was registered in all categories of loans, of particular note was an increase in Real Estate loans of $125 billion. And, the increase was distributed across residential mortgages, $80 billion, commercial real estate loans, $29 billion, and home equity loans, $16 billion. Business loans and consumer loans lagged these totals, but increased by $12 billion and $10 billion, respectively.
The bottom line:
Big banks, in general, seem to be doing very well;
Small- and medium-sized banks, in general, are not doing so good.
This presents quite a dilemma for the Federal Reserve. The bailouts of the big banks have seemingly worked. The big banks were saved from the systemic risk that existed within the financial system (yes, Mr. Goldman Sachs, you too would have failed if we had done nothing—Tim Geithner) and are now doing quite well. The Fed’s policy of keeping short term interest rates close to zero seems to be lining the coffers of these banks in record amounts.
The small- and medium-sized banks are another issue. These organizations, on average, do not seem to be making profits yet. Their loan losses really seem to be piling up and more is going to be asked of them in terms of reserves in anticipation of further losses. External capital does not seem to be readily available to them. And, they have more than 25% of their assets in cash and securities to help them through this period and to be able to pay off their own debt as it matures.
The Federal Reserve must take the condition of these smaller banks into consideration when considering a way to “exit” from its bloated balance sheet. Too quick of an exit could just exacerbate a situation that is already taxing the resources of these institutions.
Well, the glimmer of hope went away in November. However, lending, and profits, at the larger banks seemed to become more robust as we went deeper into the fall.
Overall, bank liquidity continued to rise as the cash assets in the commercial banking system rose by $290 billion in the latest 13-week period and by $110 billion in the last 4-week period. This increase was, of course, reflected in the aggregate bank data. The Federal Reserve showed that Reserve Balances with Federal Reserve Banks averaged $833 billion in the banking week ending August 26, $1.085 trillion in the banking week ending October 28, and $1.139 trillion in the banking week ending December 2. Excess reserves in the banking system averaged $795 billion, $987 billion, and $1.120 trillion for the two-week periods ending, August 26, October 21, December, respectively. The banking system became more liquid as the fall matured.
Whereas, lending in the smaller banks showed some rise in October, lending was down across the board in the November period and this seemed to drag down the results from the last 13-week period.
The leader in this decline was lending for Commercial Real Estate. Analysts have claimed for some time now that problems were looming in this area for the small- and medium-sized banks. The concern was over timing: when were the problems being experienced by this sector going to show up on the balance sheets of these banking organizations?
Well, they really seem to be showing up now. Commercial Real Estate loans on the balance sheets of “small” domestically chartered commercial banks declined by $33 billion in the 4-week period ending November 25. They dropped by $50 billion in the last 13-week period.
Commercial and Industrial loans also decreased at the smaller banks in the latest 4-week period by $23 billion. (These loans actually had increased in the previous nine weeks.)
Furthermore, as stated in my December 1 post, these small- and medium-sized banks are not doing well profit-wise. The F. D. I. C. reported that commercial banks of $1.0 billion in assets size or less roughly broke even profit-wise in the third quarter of 2009. Banks in the $1.0 billion to $10.0 billion in asset size lost, on average, $3.0 million per bank in the third quarter.
The problem bank list, which consists primarily of small- and medium-sized banks rose to 552 at the end of the third quarter, an increase from a total of 416 at the end of the second quarter, and this is with 50 banks dropping off the list in the third quarter because they failed. (This information is reported in http://seekingalpha.com/article/175958-banking-sector-weakness-the-secret-no-one-wants-to-talk-about.)
The blip upwards in lending at the small- and medium-sized commercial banks reported last month is typical of the information flows we are getting these days. Some months the information that is reported looks good and we get excited about it. The next month…well, the information isn’t so good. The concern with the smaller banks is that the future could really be quite bleak.
With 552 banks on the F. D. I. C. problem list, we could see the banking industry taking a lot of hits in the next 12 months or so. If one-third of these banks fail, which is the estimate going around, this would mean that 184 of these banks would be closed or, in a 12-month period, roughly 3.5 banks per week would be closed. In the third quarter of 2009 three banks a week, on average, were closed. And, this assumes that no other banks come onto the problem bank list.
What about the big banks?
The big banks, except Citigroup, seem to be doing just fine. Even Bank of America is going to pay back the money it received from the federal government and it has raised additional capital.
Evidence that big banks are doing OK is present in the F. D. I. C. data just released. Commercial banks with assets in excess of $10 billion reported profits, on average, of $42 million per bank in the third quarter.
This prosperity seems to be translating itself into the performance of these larger banks. The assets of large commercial banks rose by $202 billion in the last 4-week period, whereas total assets actually dropped in the smaller banks and in foreign-related banking offices.
Loans and leases at the bigger banks surged by $163 billion in the last four weeks. This is the first substantial increase in activity in these banks this year!
Whereas the increase in loan volume was registered in all categories of loans, of particular note was an increase in Real Estate loans of $125 billion. And, the increase was distributed across residential mortgages, $80 billion, commercial real estate loans, $29 billion, and home equity loans, $16 billion. Business loans and consumer loans lagged these totals, but increased by $12 billion and $10 billion, respectively.
The bottom line:
Big banks, in general, seem to be doing very well;
Small- and medium-sized banks, in general, are not doing so good.
This presents quite a dilemma for the Federal Reserve. The bailouts of the big banks have seemingly worked. The big banks were saved from the systemic risk that existed within the financial system (yes, Mr. Goldman Sachs, you too would have failed if we had done nothing—Tim Geithner) and are now doing quite well. The Fed’s policy of keeping short term interest rates close to zero seems to be lining the coffers of these banks in record amounts.
The small- and medium-sized banks are another issue. These organizations, on average, do not seem to be making profits yet. Their loan losses really seem to be piling up and more is going to be asked of them in terms of reserves in anticipation of further losses. External capital does not seem to be readily available to them. And, they have more than 25% of their assets in cash and securities to help them through this period and to be able to pay off their own debt as it matures.
The Federal Reserve must take the condition of these smaller banks into consideration when considering a way to “exit” from its bloated balance sheet. Too quick of an exit could just exacerbate a situation that is already taxing the resources of these institutions.
Friday, December 4, 2009
Plenty of Work Still to Do
The United States economy lost only 11, 000 jobs in November and the unemployment rate dropped to 10.0% from 10.2%. Good news!
There is still plenty of work left to do, however.
President Obama held a summit on jobs yesterday, bringing together many leaders from business, economists, labor leaders, and others to discuss the state of the jobs market and what can be done about it. To the President, this was just an “idea seeking” exercise.
Thomas Freidman, editorial writer for the New York Times, was in attendance at this jobs forum. I just happened to catch his appearance on Chris Matthews’ “Hardball” program yesterday afternoon.
Matthews asked Friedman what impression he took away from the summit. Friedman replied that the impression he walked away from the summit with was one of the uncertainty that existed among the participants. People didn’t know what health care reform was going to be and going to cost; people didn’t know what would be the full cost of the added troops going to Afghanistan; people didn’t know what carbon emissions were gong to cost; people didn’t know what more economic stimulus was going to cost; people didn’t know how the financial system was going to be regulated; and he mentioned two or three other unknowns.
Friedman argued that so much was being done and none of it was fully defined and none of it was fully costed. As a consequence, people didn’t really know what to do. They didn’t know what direction to move in.
We read that the President, himself, presented another problem: he said that “our resources are limited.” We only have so much money.
Unfortunately, I take this statement with the same seriousness that I do the statements of Treasury Secretary Geithner and Fed Chairman Bernanke when they say that they are for a strong dollar.
Washington D. C. seems to have adopted the wisdom of the world famous philosopher Winnie-the-Pooh who, when asked, “What will you have, Honey or Milk?” replied “Both!” This attitude is just another sign of the hubris of the leadership of the United States. They believe that they can go after anything they want and there will be no consequences.
We are near the end of a 50-year period in which the government of this country, Republican as well as Democrat, has constantly advocated a bias toward inflation. This bias has distorted the economy in such a way that we have plenty of excess capacity in our businesses and a labor force that is trained for jobs that existed years ago but are not trained for where things need to go. (There were several newspaper articles this week about plant closings and employees that had no where to go because they only had “one skill.”)
The inflationary bias has encouraged individuals, families, businesses, and governments to “leverage up” and this drive to achieve additional leverage has underwritten the growth of the financial industry to its present size.
The structural changes in the economy that have resulted from this bias are substantial. A lot of the uncertainty that exists, both in the private sector as well as the government, is a consequence of these changes that have taken place in America.
Even now, another structural shift in the society is being recognized. Elizabeth Warren, Professor of Law at Harvard and Chair of the Congressional Oversight Panel, overseeing bank bailouts, has highlighted another change needing consideration. See her “America Without a Middle Class,” http://www.huffingtonpost.com/elizabeth-warren/america-without-a-middle_b_377829.html. .
“Families have survived the ups and downs of economic booms and busts for a long time, but the fall-behind during the busts has gotten worse while the surge-ahead during the booms has stalled out. In the boom of the 1960s, for example, median family income jumped by 33% (adjusted for inflation). But the boom of the 2000s resulted in an almost-imperceptible 1.6% increase for the typical family.
Today, one in five Americans is unemployed, underemployed or just plain out of work. One in nine families can't make the minimum payment on their credit cards. One in eight mortgages is in default or foreclosure. One in eight Americans is on food stamps. More than 120,000 families are filing for bankruptcy every month. The economic crisis has wiped more than $5 trillion from pensions and savings, has left family balance sheets upside down, and threatens to put ten million homeowners out on the street.”
Our leaders are uncertain because they are facing something they have not faced before. And, the problems that are being faced are numerous. But, the old thinking and the old policies just don’t work like they used to, if they ever did work the way they were supposed to. As a consequence, they are running around looking for an answer, but everything they do is incomplete and unfinished.
On one side, people are saying that we are trying to do too much. On the other side, people are saying that we are not doing enough. It is not surprising that a “jobs summit” like the one held yesterday can result in someone like Thomas Friedman saying that people really didn’t know where the train is heading.
The economy seems to be improving but everyone is still very cautious. There are just too many dark clouds that are hanging over the horizon. Readers of this column know that I am still very anxious about the health of the banking industry. Also, profits, in general, have risen, but the improvement has been because of cost cutting. Little strength has been registered in revenues, for the reasons given above by Elizabeth Warren. And, the value of the United States dollar continues to slide. The rest of the world is telling us that our “Winnie-the-Pooh” philosophy of government debt creation cannot go on forever.
Yes, there is still plenty of work to do in the economy. However, right now, our leaders don’t seem to have a very good focus on what it is that needs to be done.
There is still plenty of work left to do, however.
President Obama held a summit on jobs yesterday, bringing together many leaders from business, economists, labor leaders, and others to discuss the state of the jobs market and what can be done about it. To the President, this was just an “idea seeking” exercise.
Thomas Freidman, editorial writer for the New York Times, was in attendance at this jobs forum. I just happened to catch his appearance on Chris Matthews’ “Hardball” program yesterday afternoon.
Matthews asked Friedman what impression he took away from the summit. Friedman replied that the impression he walked away from the summit with was one of the uncertainty that existed among the participants. People didn’t know what health care reform was going to be and going to cost; people didn’t know what would be the full cost of the added troops going to Afghanistan; people didn’t know what carbon emissions were gong to cost; people didn’t know what more economic stimulus was going to cost; people didn’t know how the financial system was going to be regulated; and he mentioned two or three other unknowns.
Friedman argued that so much was being done and none of it was fully defined and none of it was fully costed. As a consequence, people didn’t really know what to do. They didn’t know what direction to move in.
We read that the President, himself, presented another problem: he said that “our resources are limited.” We only have so much money.
Unfortunately, I take this statement with the same seriousness that I do the statements of Treasury Secretary Geithner and Fed Chairman Bernanke when they say that they are for a strong dollar.
Washington D. C. seems to have adopted the wisdom of the world famous philosopher Winnie-the-Pooh who, when asked, “What will you have, Honey or Milk?” replied “Both!” This attitude is just another sign of the hubris of the leadership of the United States. They believe that they can go after anything they want and there will be no consequences.
We are near the end of a 50-year period in which the government of this country, Republican as well as Democrat, has constantly advocated a bias toward inflation. This bias has distorted the economy in such a way that we have plenty of excess capacity in our businesses and a labor force that is trained for jobs that existed years ago but are not trained for where things need to go. (There were several newspaper articles this week about plant closings and employees that had no where to go because they only had “one skill.”)
The inflationary bias has encouraged individuals, families, businesses, and governments to “leverage up” and this drive to achieve additional leverage has underwritten the growth of the financial industry to its present size.
The structural changes in the economy that have resulted from this bias are substantial. A lot of the uncertainty that exists, both in the private sector as well as the government, is a consequence of these changes that have taken place in America.
Even now, another structural shift in the society is being recognized. Elizabeth Warren, Professor of Law at Harvard and Chair of the Congressional Oversight Panel, overseeing bank bailouts, has highlighted another change needing consideration. See her “America Without a Middle Class,” http://www.huffingtonpost.com/elizabeth-warren/america-without-a-middle_b_377829.html. .
“Families have survived the ups and downs of economic booms and busts for a long time, but the fall-behind during the busts has gotten worse while the surge-ahead during the booms has stalled out. In the boom of the 1960s, for example, median family income jumped by 33% (adjusted for inflation). But the boom of the 2000s resulted in an almost-imperceptible 1.6% increase for the typical family.
Today, one in five Americans is unemployed, underemployed or just plain out of work. One in nine families can't make the minimum payment on their credit cards. One in eight mortgages is in default or foreclosure. One in eight Americans is on food stamps. More than 120,000 families are filing for bankruptcy every month. The economic crisis has wiped more than $5 trillion from pensions and savings, has left family balance sheets upside down, and threatens to put ten million homeowners out on the street.”
Our leaders are uncertain because they are facing something they have not faced before. And, the problems that are being faced are numerous. But, the old thinking and the old policies just don’t work like they used to, if they ever did work the way they were supposed to. As a consequence, they are running around looking for an answer, but everything they do is incomplete and unfinished.
On one side, people are saying that we are trying to do too much. On the other side, people are saying that we are not doing enough. It is not surprising that a “jobs summit” like the one held yesterday can result in someone like Thomas Friedman saying that people really didn’t know where the train is heading.
The economy seems to be improving but everyone is still very cautious. There are just too many dark clouds that are hanging over the horizon. Readers of this column know that I am still very anxious about the health of the banking industry. Also, profits, in general, have risen, but the improvement has been because of cost cutting. Little strength has been registered in revenues, for the reasons given above by Elizabeth Warren. And, the value of the United States dollar continues to slide. The rest of the world is telling us that our “Winnie-the-Pooh” philosophy of government debt creation cannot go on forever.
Yes, there is still plenty of work to do in the economy. However, right now, our leaders don’t seem to have a very good focus on what it is that needs to be done.
Tuesday, December 1, 2009
The Secret No One Wants to Tell
The one thing that seems to provide an explanation for a lot of the things going on today is the continued weakness of the banking sector. It explains the actions of the Federal Reserve System. It explains the actions of the Treasury Department. It explains much of the data that are being released. And, it explains much of the behavior of the banking sector, itself.
The secret: the banking sector is a lot weaker than the government is letting on and the government does not want to publically recognize the fact.
The FDIC recently released numbers on the banking industry for the third quarter. Profit-wise, the industry is very skewed. It is skewed toward the larger banks. The results have been summarized this way:
The secret: the banking sector is a lot weaker than the government is letting on and the government does not want to publically recognize the fact.
The FDIC recently released numbers on the banking industry for the third quarter. Profit-wise, the industry is very skewed. It is skewed toward the larger banks. The results have been summarized this way:
- Banks with assets less than $1 billion in assets roughly broke even in the third quarter;
- Banks with assets between $1 billion and $10 billion, on average, lost $3 million apiece;
- Banks with assets in excess of $10 billion recorded an average profit of nearly $42 million each.
The big banks, the banks that the regulators were most concerned with, are reaping a bonanza. And, why not? The Fed is keeping short term interest rates down: financial institutions can borrow for three-months in the range of 20-25 basis points in the commercial paper market and the large CD market; they can borrow for six-months in the 30-65 basis points in the CD market or the Eurodollar market. They can buy Treasury bonds that can yield 330 to 400 basis points. This is a nice spread. Plus these banks are traders and there has been plenty of volatility in the bond market in recent months. And, this does not even include the possibilities that exist in the carry trade.
As Eddy, Clarke's brother-in-law, remarked in the movie “A Christmas Vacation”: “This is the gift that just keeps on giving!”
Why?
Because the Fed is going to keep short term interest rates low for an “extended period” of time.
This effort is just another way to “bail out” the big banks!
But, what about the banks that are smaller than $10 billion in asset size?
Here the commercial banking industry has been given a gift of $1 trillion in excess reserves.
And, what is going on in this part of the banking industry? The FDIC released the third quarter information on problem banks. The total of problem banks in the country is 552, up from 416 at the end of the second quarter. Almost all of these banks are of the smaller variety. Given that 50 banks were closed in the third quarter this means that 186 new banks achieved the honor of being placed on the problem list in the third quarter.
It is estimated that at least one-third of the 552 “problem” banks, or 182, will fail in the next 12 to 18 months. If this is true then the United States will experience 2.5 to 3.5 bank closures a week for the next year to a year-and-a-half. This is slightly below the rate of 3.8 bank closures per week that was achieved in the third quarter. The hope is that this situation won’t get worse.
The path ahead for even those banks that are not on the problem list is treacherous. Real Estate Econometrics released information that the US default rate for commercial mortgages hit 3.4% in the third quarter of 2009. This is a 16-year high. The company also released projections indicating that this default rate could rise to more than 5% in 2011. Many of the banks in the middle tier possess millions of dollars of these loans on their balance sheet, relatively more so than do the big banks.
The huge debt of Dubai and Greece and others hang over this market.
In terms of residential mortgages, the picture does not improve. First American CoreLogic, a real-estate information company, recently released data that indicated that roughly one out of four borrowers is underwater in terms of their mortgages. Even 11% of the borrowers who took out mortgages in 2009 owe more than their home’s value.
The Treasury continues to push mortgage firms and others for loan relief. There is an indication that some borrowers are not really helped by the relief measures already promoted and that many who have been helped still face the possibility of re-default going forward.
And, layoffs continue in large numbers, foreclosures continue to take place at a high rate, and large numbers of bankruptcies, both personal and business, continue to occur. Another fact, out this morning, is that delinquencies on auto loans are on the rise.
And, banks are not really lending in any form. The Federal Reserve continues to pump funds into the banking system, yet commercial banks seem to be very content to accept the funds and just hold onto them in the most riskless way possible. If you don’t make a loan, it won’t turn bad on you. Furthermore, commercial banks face the situation in which the longer term liabilities they had accumulated earlier in the decade are going to be maturing. They will need money to pay off these liabilities without replacing them.
Charles Goodhart, Senior Economic Consultant at Morgan Stanley, writes in the Financial Times that central banks should declare victory in the war against financial collapse and cease their policy of quantitative easing. (See “Deflating the Bubble”, http://www.ft.com/cms/s/0/2b7b26de-ddcd-11de-b8e2-00144feabdc0.html.) He writes, “If the authorities go on blowing up financial markets too much, at some point yet another bubble will develop. The last time the financial bubble burst, the taxpayers got soaked...Certainly, we can never get the timing exactly right, but now does seem the moment to declare victory for (Quantitative Easing) and withdraw.”
That is, unless there is something we don’t know and the government is not telling us, like the extent of the weaknesses that exist within the banking sector.
Monday, November 30, 2009
How People are using their Money
It is instructive to take a closer look at how people seem to be handling their money. Obviously, people are not spending much, although the Federal Reserve sure cannot be faulted for not trying to jump start consumer and business spending. The monetary base, the sum of all bank reserves and money that can serve as bank reserves has gone from a year-over-year rate of increase of about one percent at the end of 2007, to a 101%, year-over-year, rate of increase at the end of 2008, to a 102%, year-over-year, rate of increase through the third quarter of 2009.
The unwillingness of banks to lend and/or the unwillingness of people to borrow shows up in how fast this base money turns over in the economy, that is, in the velocity of use of this base money. Whereas, velocity was increasing by about 4% through 2007, it declined by 101% in 2008, and was declining at a 104% rate through the third quarter of 2009.
The consequence of this was a build-up in excess reserves in the banking system. For a current review of this result see the column of Peter Eavis, “The U. S. Economy’s $1 Trillion Question”, in the Wall Street Journal (http://online.wsj.com/article/SB20001424052748703300504574565991276510968.html#mod=todays_us_money_and_investing).
If we look at broader measures of the money stock, we see similar results, but with some interesting shifts between money stock measures. The year-over-year rate of growth in the M1 measure of the money stock was roughly flat through the end of 2007, about 16% at the end of 2008, and approximately 19% through the third quarter of 2009. The turn-over, or, velocity, of the M1 money stock increased by about 5% in the earlier period, but fell by 16% through the year of 2008 and by 20% through the first three quarters of 2009.
The M2 measure of the money stock grew at a 6% year-over-year rate of increase in 2007, a 10% growth in 2008 and an 8% rise through the first three quarters of 2009. The velocity of the M2 money stock was roughly constant in 2007, but fell at annual rates of about 10% in both 2008 and through the first three quarters of 2009.
The difference in the performance of the M1 and M2 money stock measures tell of something very interesting in terms of how people are handling their money, but, it does not tell us much about how banks are lending because all measures of bank lending have been declining throughout the summer and fall months of 2009.
First of all, people have demanded more and more currency, a symbol of not only a move to security, but also an indication that people are paying for more of the things that they are buying with cash. The year-over-year rate of increase in currency outside of the banks was relatively flat through all of 2007 and through August 2008. In September 2008, however, the currency component of the money stock began to increase and was rising in the range of 10% to 11% by the end of 2008 through the September of 2009.
The other interesting thing about the growth of the M1 measure of the money stock was the rise in demand deposits at commercial banks. These are primarily “transactions” balances and serve much the same purpose as currency, reflecting the need to keep funds available for cash purposes. Also, people seem to feel more secure with funds in checking accounts than in other forms of bank accounts.
Demand deposits at commercial banks were actually decreasing all through 2007 and through the summer of 2008. In September 2008, the year-over-year the growth rate dramatically turned positive (16%) and then rose to a 54% rate of increase by December of that year. Demand deposits continued to grow at a 30% to 40% annual rate through most of 2009, falling off to about a 20% rate of increase in September and October 2009.
The interesting thing about this movement is where it is coming from. Primarily the movement into currency and demand deposits is coming from thrift institutions and retail money funds. The growth in savings deposits and small time deposits at thrift institutions turned negative in 2008, although the latter actually started to decline in late 2007. Since October 2008, the year-over-year rate of change of savings deposits at thrift institutions decline in the 7% to 9% range and the rate of decline in small time deposits at thrift institutions was in the teens for most of late 2008 before reaching 20% in the fall of 2009.
The biggest turnaround came in retail money funds. In late 2007 and through July 2008, the year-over-year rate of growth of money in retail money funds was in the 25% range. However, by the end of 2008, the increase was less than 10% and in March 2009, money was actually leaving these funds! In September 2009, the year-over-year rate of decline in these funds was over 16% and dropped further to -22% in October.
The bottom line of all this activity is that people have moved a massive amount of funds from time and savings accounts to demand deposits and currency. They have also moved massive amounts of funds from thrift institutions and retail money funds into commercial banks. There appear to be two main motives for this movement. The first is for people to have access to their funds for spending and to avoid the use of credit, if possible. The second is for people to feel that their funds are safer.
The consequences of this movement of funds are that the growth rate of the M1 money stock rapidly accelerated while the rate of increase of the M2 money stock only increased modestly. In recent weeks, however, the growth rates of both measures of the money stock have been slowing. Hopefully, this is a sign that fewer and fewer people are moving their funds into assets for use in transactions.
The next thing we need to look for in this area is a movement out of these “transaction” assets and back into time and savings accounts. It may take several more months for this to happen. When this movement begins we can gain greater confidence that people are feeling better about their financial circumstances and that the economy is, in fact, recovering.
Just a little aside on regulatory issues: A suggestion for restructuring the banking industry and its regulatory agencies would be to completely eliminate thrift institutions and the regulatory agencies overseeing thrift institutions and allow those thrifts that now exist the choice of either becoming a commercial bank or becoming a credit union.
The unwillingness of banks to lend and/or the unwillingness of people to borrow shows up in how fast this base money turns over in the economy, that is, in the velocity of use of this base money. Whereas, velocity was increasing by about 4% through 2007, it declined by 101% in 2008, and was declining at a 104% rate through the third quarter of 2009.
The consequence of this was a build-up in excess reserves in the banking system. For a current review of this result see the column of Peter Eavis, “The U. S. Economy’s $1 Trillion Question”, in the Wall Street Journal (http://online.wsj.com/article/SB20001424052748703300504574565991276510968.html#mod=todays_us_money_and_investing).
If we look at broader measures of the money stock, we see similar results, but with some interesting shifts between money stock measures. The year-over-year rate of growth in the M1 measure of the money stock was roughly flat through the end of 2007, about 16% at the end of 2008, and approximately 19% through the third quarter of 2009. The turn-over, or, velocity, of the M1 money stock increased by about 5% in the earlier period, but fell by 16% through the year of 2008 and by 20% through the first three quarters of 2009.
The M2 measure of the money stock grew at a 6% year-over-year rate of increase in 2007, a 10% growth in 2008 and an 8% rise through the first three quarters of 2009. The velocity of the M2 money stock was roughly constant in 2007, but fell at annual rates of about 10% in both 2008 and through the first three quarters of 2009.
The difference in the performance of the M1 and M2 money stock measures tell of something very interesting in terms of how people are handling their money, but, it does not tell us much about how banks are lending because all measures of bank lending have been declining throughout the summer and fall months of 2009.
First of all, people have demanded more and more currency, a symbol of not only a move to security, but also an indication that people are paying for more of the things that they are buying with cash. The year-over-year rate of increase in currency outside of the banks was relatively flat through all of 2007 and through August 2008. In September 2008, however, the currency component of the money stock began to increase and was rising in the range of 10% to 11% by the end of 2008 through the September of 2009.
The other interesting thing about the growth of the M1 measure of the money stock was the rise in demand deposits at commercial banks. These are primarily “transactions” balances and serve much the same purpose as currency, reflecting the need to keep funds available for cash purposes. Also, people seem to feel more secure with funds in checking accounts than in other forms of bank accounts.
Demand deposits at commercial banks were actually decreasing all through 2007 and through the summer of 2008. In September 2008, the year-over-year the growth rate dramatically turned positive (16%) and then rose to a 54% rate of increase by December of that year. Demand deposits continued to grow at a 30% to 40% annual rate through most of 2009, falling off to about a 20% rate of increase in September and October 2009.
The interesting thing about this movement is where it is coming from. Primarily the movement into currency and demand deposits is coming from thrift institutions and retail money funds. The growth in savings deposits and small time deposits at thrift institutions turned negative in 2008, although the latter actually started to decline in late 2007. Since October 2008, the year-over-year rate of change of savings deposits at thrift institutions decline in the 7% to 9% range and the rate of decline in small time deposits at thrift institutions was in the teens for most of late 2008 before reaching 20% in the fall of 2009.
The biggest turnaround came in retail money funds. In late 2007 and through July 2008, the year-over-year rate of growth of money in retail money funds was in the 25% range. However, by the end of 2008, the increase was less than 10% and in March 2009, money was actually leaving these funds! In September 2009, the year-over-year rate of decline in these funds was over 16% and dropped further to -22% in October.
The bottom line of all this activity is that people have moved a massive amount of funds from time and savings accounts to demand deposits and currency. They have also moved massive amounts of funds from thrift institutions and retail money funds into commercial banks. There appear to be two main motives for this movement. The first is for people to have access to their funds for spending and to avoid the use of credit, if possible. The second is for people to feel that their funds are safer.
The consequences of this movement of funds are that the growth rate of the M1 money stock rapidly accelerated while the rate of increase of the M2 money stock only increased modestly. In recent weeks, however, the growth rates of both measures of the money stock have been slowing. Hopefully, this is a sign that fewer and fewer people are moving their funds into assets for use in transactions.
The next thing we need to look for in this area is a movement out of these “transaction” assets and back into time and savings accounts. It may take several more months for this to happen. When this movement begins we can gain greater confidence that people are feeling better about their financial circumstances and that the economy is, in fact, recovering.
Just a little aside on regulatory issues: A suggestion for restructuring the banking industry and its regulatory agencies would be to completely eliminate thrift institutions and the regulatory agencies overseeing thrift institutions and allow those thrifts that now exist the choice of either becoming a commercial bank or becoming a credit union.
Friday, November 20, 2009
The uncertainty just won't go away!
This from the Financial Times on the morning of Friday, November 20, 2009: “Short-term US interest rates turned negative on Thursday as banks frantically stockpiled government securities in order to polish their balance sheets for the end of the year.” (See: http://www.ft.com/cms/s/0/52e0f72c-d575-11de-81ee-00144feabdc0.html.)
“The development highlighted the continuing distortions in the financial system more than a year after Lehman Brothers’ failure triggered a global crisis.”
“With the Federal Reserve maintaining an overnight target rate of zero to 0.25 per cent, investors are demonstrating a willingness to completely forgo interest income—or even to take a small loss—to own securities that are seen as safe.”
Just how “safe” do these banks have to appear?
The way they are acting indicate that they are not very “safe” at all.
Total reserves at depository institutions for the two weeks ending November 18 averaged $1,106 billion of which $1,068 were reserve balances with Federal Reserve Banks and $38 billion was vault cash used to satisfy required reserves.
The Fed has pumped roughly $350 billion into the banking system over the past 13-weeks primarily through the purchase of open market securities.
The effective Federal Funds rate has fallen steadily through the fall from August and averaged 11 basis points toward the end of the latest banking week.
Putting this information together indicates, to me, a banking system that is still seriously threatened and desirous of all the spare cash that it can attain. This is not a situation of quantitative easing but of bankers that are overly concerned with their solvency. The Federal Reserve is supplying reserves “on demand.” They are not, at this time, initiating the supply.
And, why might this be so?
Well, take a look at some of the headlines of the past week: United States mortgage delinquencies reach a record high; bankruptcies continue to remain near record levels; commercial real estate to remain major problem for years; commercial real estate too complex for government to bail out; unemployment at 25-year high; credit card delinquencies remain at record levels; and bank failures will continue to average about 3 a week for the next 12 to 18 months.
President Obama is even talking about the possibility of a “double-dip” recession.
The distortions in the financial system continue to be enormous. Even given these attitudes within the banking system, as the Financial Times reports, “many” of the leading US banks are “sitting on big trading profits.”
And, why not? When they can borrow for less than 35 basis points and lend out at 350 basis points who cannot make profits. When they can engage in the “carry” trade and profit from the declining dollar as well as earn large spreads, who cannot make profits.
Stock markets have been living off of momentum trading. There are so many unknowns about the future of business and industry, let alone finance that the justification for the rise in stock prices since March can continue to be questioned.
The real problem that exists in the market right now is the huge overhang of uncertainty. Not only are there unknowns about the recovery of industry and finance right now, there are also unknowns related to the huge cloud of government budget deficits that hang over the financial markets for the future and the concern over the ability of the Federal Reserve to “exit” from all the reserves it has put into the banking system.
The risk that is incorporated in this environment shows itself from time-to-time. Of course, the massive rise in the price of gold has been one place that investors have flocked to this year. Another continues to be the world-wide demand for United States Treasury securities. And, like yesterday, enough bad news causes currency traders to move rapidly back into United States dollars for “reasons of safety.”
I know many measures of market risk have declined substantially over the past six months or so. One has to go back to November 2007 to see a spread between Aaa and Baa yields as low as they are now. Likewise, with spreads on high-yield securities. The VIX index has fallen, once again, around its 52-week low. My belief is that these measures are so low because of the Fed’s interest rate policy. Interest rates, in general, are lower than they would be if the Fed was not forcing low rates on the market, and interest rate spreads are low for the same reason.
Still, there is much to be wary of. The only certainty that exists right now is that the Federal Reserve, and other central banks around the world, will keep short term interest rates low for an “extended period.” But, at some point, these rates are going to have to rise. Until they do, the interest arbitrage opportunities will remain and large financial institutions will continue to take away large profits from the financial market. Furthermore, the carry trade will continue to prosper using funds from the United States.
The question here is, when will all the investors that are “making it” through government support and government guarantees head for the doors. It is only logical that when there is an indication that the Federal Reserve is going to start letting interest rates rise that there will be a rush to get out of the market or move to the other side of the market. In such a situation, the financial firms that are big in the trading area cannot afford to be second or third getting to the door to pull their own exit.
How will this leave the banks that are written about in the Financial Times? If these banks, generally the smaller ones, have “stockpiled” government securities, how will they handle the decline in the prices of these securities once interest rates begin to rise? If they are concerned about their solvency now, what will their condition look like under this kind of scenario?
If there is a rush to get out of bonds, will the Federal Reserve back off its exit strategy?
Uncertainty continues to rule the markets. And, on top of the basic market insecurity, there seems to be a growing insecurity about our governmental leaders (Geithner and Bernanke to start with), and about the institutions of our government (see House attack on secrecy in the Federal Reserve). Uncertainty is bad enough but if people have little or no confidence in our leaders and our institutions where are they to turn?
“The development highlighted the continuing distortions in the financial system more than a year after Lehman Brothers’ failure triggered a global crisis.”
“With the Federal Reserve maintaining an overnight target rate of zero to 0.25 per cent, investors are demonstrating a willingness to completely forgo interest income—or even to take a small loss—to own securities that are seen as safe.”
Just how “safe” do these banks have to appear?
The way they are acting indicate that they are not very “safe” at all.
Total reserves at depository institutions for the two weeks ending November 18 averaged $1,106 billion of which $1,068 were reserve balances with Federal Reserve Banks and $38 billion was vault cash used to satisfy required reserves.
The Fed has pumped roughly $350 billion into the banking system over the past 13-weeks primarily through the purchase of open market securities.
The effective Federal Funds rate has fallen steadily through the fall from August and averaged 11 basis points toward the end of the latest banking week.
Putting this information together indicates, to me, a banking system that is still seriously threatened and desirous of all the spare cash that it can attain. This is not a situation of quantitative easing but of bankers that are overly concerned with their solvency. The Federal Reserve is supplying reserves “on demand.” They are not, at this time, initiating the supply.
And, why might this be so?
Well, take a look at some of the headlines of the past week: United States mortgage delinquencies reach a record high; bankruptcies continue to remain near record levels; commercial real estate to remain major problem for years; commercial real estate too complex for government to bail out; unemployment at 25-year high; credit card delinquencies remain at record levels; and bank failures will continue to average about 3 a week for the next 12 to 18 months.
President Obama is even talking about the possibility of a “double-dip” recession.
The distortions in the financial system continue to be enormous. Even given these attitudes within the banking system, as the Financial Times reports, “many” of the leading US banks are “sitting on big trading profits.”
And, why not? When they can borrow for less than 35 basis points and lend out at 350 basis points who cannot make profits. When they can engage in the “carry” trade and profit from the declining dollar as well as earn large spreads, who cannot make profits.
Stock markets have been living off of momentum trading. There are so many unknowns about the future of business and industry, let alone finance that the justification for the rise in stock prices since March can continue to be questioned.
The real problem that exists in the market right now is the huge overhang of uncertainty. Not only are there unknowns about the recovery of industry and finance right now, there are also unknowns related to the huge cloud of government budget deficits that hang over the financial markets for the future and the concern over the ability of the Federal Reserve to “exit” from all the reserves it has put into the banking system.
The risk that is incorporated in this environment shows itself from time-to-time. Of course, the massive rise in the price of gold has been one place that investors have flocked to this year. Another continues to be the world-wide demand for United States Treasury securities. And, like yesterday, enough bad news causes currency traders to move rapidly back into United States dollars for “reasons of safety.”
I know many measures of market risk have declined substantially over the past six months or so. One has to go back to November 2007 to see a spread between Aaa and Baa yields as low as they are now. Likewise, with spreads on high-yield securities. The VIX index has fallen, once again, around its 52-week low. My belief is that these measures are so low because of the Fed’s interest rate policy. Interest rates, in general, are lower than they would be if the Fed was not forcing low rates on the market, and interest rate spreads are low for the same reason.
Still, there is much to be wary of. The only certainty that exists right now is that the Federal Reserve, and other central banks around the world, will keep short term interest rates low for an “extended period.” But, at some point, these rates are going to have to rise. Until they do, the interest arbitrage opportunities will remain and large financial institutions will continue to take away large profits from the financial market. Furthermore, the carry trade will continue to prosper using funds from the United States.
The question here is, when will all the investors that are “making it” through government support and government guarantees head for the doors. It is only logical that when there is an indication that the Federal Reserve is going to start letting interest rates rise that there will be a rush to get out of the market or move to the other side of the market. In such a situation, the financial firms that are big in the trading area cannot afford to be second or third getting to the door to pull their own exit.
How will this leave the banks that are written about in the Financial Times? If these banks, generally the smaller ones, have “stockpiled” government securities, how will they handle the decline in the prices of these securities once interest rates begin to rise? If they are concerned about their solvency now, what will their condition look like under this kind of scenario?
If there is a rush to get out of bonds, will the Federal Reserve back off its exit strategy?
Uncertainty continues to rule the markets. And, on top of the basic market insecurity, there seems to be a growing insecurity about our governmental leaders (Geithner and Bernanke to start with), and about the institutions of our government (see House attack on secrecy in the Federal Reserve). Uncertainty is bad enough but if people have little or no confidence in our leaders and our institutions where are they to turn?
Tuesday, November 17, 2009
Excess Capacity and the Slow Economic Recovery
Ben Bernanke spoke in New York yesterday and, depending upon which paper you read this morning, he basically said one of two things. First, he said that the Fed was interested in a strong dollar and would continue to keep the value of the dollar in mind in deliberations concerning monetary policy.
Chuckle, chuckle.
Second, Bernanke said that the pain in the labor market was going to last for a long time and that we shouldn’t expect the unemployment rate to fall anytime soon.
That is, don’t expect interest rates to begin to rise in the near future.
Remember, the number one policy goal of the Federal Reserve (and the federal government) is full employment and don’t you forget it. Put inflation, commodity prices, and the value of the United States dollar on the back burner.
So much for an independent Fed!
But, we knew that.
The problem with the economic recovery and unemployment is captured by an article in the Wall Street Journal, “Auto Industry Has Room to Shrink Further,” (see http://online.wsj.com/article/SB125832250680149395.html?mg=com-wsj.) Although the article focuses upon the auto industry, the situation that is described can be extended to many other major (and minor) industries throughout the world.
“Over the past two years, the global auto industry has endured one of the worst downturns in its century-plus history. Auto makers around the world have consolidated, restructured and slimmed down—and yet they still have too much of just about everything, especially too many brands and too many plants.”
“According to CSM Worldwide, the auto industry has enough capacity to make 85.9 million cars and light trucks a year—about 30 million more than it is on track to sell this year, the equivalent of more than 120 assembly plants.”
Furthermore, an auto analyst is quoted as saying, “government intervention to save auto-related jobs has forestalled the inevitable—broad and deep restructuring that would shut down unneeded plants and close loss-making enterprises. Not as much capacity has come out that should have.”
This is just talking about the auto industry. But, it is true of industry in general. The United States and the global economy have become leaner due to the current contraction: still, much excess capacity remains.
Even though capacity utilization for all industry is up in the United States (note that capacity utilization for manufacturing in October did not change from September), giving further indication that the recession is over, the problem of too much capacity lingers. As I have mentioned many times before, every economic recovery since the 1960s has seen a pickup in capacity utilization as economic growth increased, but the peak reached in each cycle was no higher, and was generally lower, than the peak reached in the previous cycle.
That is, capacity utilization rose during the expansion phase of each economic cycle since the 1960s but the trend in the United States was for more and more plant and equipment to remain idle.
In addition, this contributed to the under-utilization of labor as is evidenced by the rising trend in those of the population that are labeled underemployed .
Also, as the federal government, and the independent Federal Reserve System, tried to pump up the economy so that fuller employment could be achieved, the pressure was always on for inflation to rise. Since January 1961, the purchasing power of the dollar has fallen by about 85%. This is not a coincidence!
Furthermore, these policy efforts just put people back to work in the jobs they had been in and reduced the incentive for companies to innovate and change moderating productivity growth.
The performance of industrial production in the United States carries with it the same story. (Industrial production is up in October, but at an anemic 0.1% rate.) The growth rate of industrial production rises and falls through the swings in the economic cycle, but each rebound does not bring with it the same expansion as was achieved in previous cycles. This is just another indication that although recovery takes place, the overall trend in the productive utilization of resources in the United States continues to wane.
This fundamental weakness resource utilization is resulting in changing attitudes throughout the world. David Brooks writes in the New York Times about the underlying optimism that seems to be present in China these days, an optimism that used to be present in the United States. Simon Shama writes in the Financial Times about how China is now “wagging its finger at the United States about it wayward monetary and fiscal policies, as yet, still unaccustomed “to being the strong party in the relationship.” Clive Crook, also in the Financial Times, writes about the looming political battle in the United States concerning the “big questions” that voters have to answer “about the entitlements they demand and the taxes they are willing to pay.”
The United States is strong and will continue to stay strong. But, its relative position is changing. And, the way its leaders go about attempting to resolve problems is missing the point.
The United States economy is recovering. But, unless policy prescriptions change, there will continue to be an under-utilization of capacity, a weakness to productivity growth, a bias towards inflation, further declines in the United States dollar, and the threat of protectionism.
It is said that people and a nation do not change their habits until there is a real crisis. Right now it looks as if we have wasted a pretty significant financial crisis in returning to our old ways and old policy prescriptions and will just have to be content with an economy that produces mediocre results. No one seems anxious to change how we attack our problems.
Chuckle, chuckle.
Second, Bernanke said that the pain in the labor market was going to last for a long time and that we shouldn’t expect the unemployment rate to fall anytime soon.
That is, don’t expect interest rates to begin to rise in the near future.
Remember, the number one policy goal of the Federal Reserve (and the federal government) is full employment and don’t you forget it. Put inflation, commodity prices, and the value of the United States dollar on the back burner.
So much for an independent Fed!
But, we knew that.
The problem with the economic recovery and unemployment is captured by an article in the Wall Street Journal, “Auto Industry Has Room to Shrink Further,” (see http://online.wsj.com/article/SB125832250680149395.html?mg=com-wsj.) Although the article focuses upon the auto industry, the situation that is described can be extended to many other major (and minor) industries throughout the world.
“Over the past two years, the global auto industry has endured one of the worst downturns in its century-plus history. Auto makers around the world have consolidated, restructured and slimmed down—and yet they still have too much of just about everything, especially too many brands and too many plants.”
“According to CSM Worldwide, the auto industry has enough capacity to make 85.9 million cars and light trucks a year—about 30 million more than it is on track to sell this year, the equivalent of more than 120 assembly plants.”
Furthermore, an auto analyst is quoted as saying, “government intervention to save auto-related jobs has forestalled the inevitable—broad and deep restructuring that would shut down unneeded plants and close loss-making enterprises. Not as much capacity has come out that should have.”
This is just talking about the auto industry. But, it is true of industry in general. The United States and the global economy have become leaner due to the current contraction: still, much excess capacity remains.
Even though capacity utilization for all industry is up in the United States (note that capacity utilization for manufacturing in October did not change from September), giving further indication that the recession is over, the problem of too much capacity lingers. As I have mentioned many times before, every economic recovery since the 1960s has seen a pickup in capacity utilization as economic growth increased, but the peak reached in each cycle was no higher, and was generally lower, than the peak reached in the previous cycle.
That is, capacity utilization rose during the expansion phase of each economic cycle since the 1960s but the trend in the United States was for more and more plant and equipment to remain idle.
In addition, this contributed to the under-utilization of labor as is evidenced by the rising trend in those of the population that are labeled underemployed .
Also, as the federal government, and the independent Federal Reserve System, tried to pump up the economy so that fuller employment could be achieved, the pressure was always on for inflation to rise. Since January 1961, the purchasing power of the dollar has fallen by about 85%. This is not a coincidence!
Furthermore, these policy efforts just put people back to work in the jobs they had been in and reduced the incentive for companies to innovate and change moderating productivity growth.
The performance of industrial production in the United States carries with it the same story. (Industrial production is up in October, but at an anemic 0.1% rate.) The growth rate of industrial production rises and falls through the swings in the economic cycle, but each rebound does not bring with it the same expansion as was achieved in previous cycles. This is just another indication that although recovery takes place, the overall trend in the productive utilization of resources in the United States continues to wane.
This fundamental weakness resource utilization is resulting in changing attitudes throughout the world. David Brooks writes in the New York Times about the underlying optimism that seems to be present in China these days, an optimism that used to be present in the United States. Simon Shama writes in the Financial Times about how China is now “wagging its finger at the United States about it wayward monetary and fiscal policies, as yet, still unaccustomed “to being the strong party in the relationship.” Clive Crook, also in the Financial Times, writes about the looming political battle in the United States concerning the “big questions” that voters have to answer “about the entitlements they demand and the taxes they are willing to pay.”
The United States is strong and will continue to stay strong. But, its relative position is changing. And, the way its leaders go about attempting to resolve problems is missing the point.
The United States economy is recovering. But, unless policy prescriptions change, there will continue to be an under-utilization of capacity, a weakness to productivity growth, a bias towards inflation, further declines in the United States dollar, and the threat of protectionism.
It is said that people and a nation do not change their habits until there is a real crisis. Right now it looks as if we have wasted a pretty significant financial crisis in returning to our old ways and old policy prescriptions and will just have to be content with an economy that produces mediocre results. No one seems anxious to change how we attack our problems.
Monday, November 16, 2009
A Critique of Quantitative Easing
Yesterday, I posted a report on the strategy of the Federal Reserve to exit its position of excessive monetary ease. (See http://seekingalpha.com/article/173556-federal-reserve-exit-watch-part-4.) In that report I mentioned that since August, the total reserves in the banking system had shown a substantial increase.
Looking a little further into the data we find that the Monetary Base, defined as all financial assets that serve as bank reserves or could become bank reserves, rose from an average of $1,649 billion in the two weeks ending August 12, 2009 to an average of $2,001 billion in the two weeks ending November 4. (These data are on a nonseasonally adjusted basis, but the seasonally adjusted data are not significantly different.)
The Monetary Base rose by $352 billion during this period of time. (This was both on a
seasonally adjusted bases as well as a nonseasonally adjusted basis.)
What I am interested in reporting on is the total amount of reserves available to the commercial banking system.
Technical Note: To get the figure for total reserves we must subtract the currency component of the money stock from the reported data on the Monetary Base. This amount, according to the Federal Reserve System, is total reserves (of the banking system from the H.3 release) plus required clearing balances and adjustments to compensate for float at Federal Reserve Banks plus an amount representing the difference between current vault cash and the amount of vault cash used to satisfy current reserve requirements. This total reserve amount is different from the total bank reserves reported in the H.3 release on Aggregate Reserves of Depository Institutions and the Monetary Base.
This calculated measure of total reserves in the banking system rose by $351 billion during the time period under review. In other words, currency in circulation outside of commercial banks increased by only $1.0 billion from the August 12 information to the November 4 data.
Excess reserves in the banking system increased in this 13-week period from $709 billion to $1,059 billion, a rise of $350 billion. Thus, all the increase in bank reserves during this time period came in excess reserves, the required reserves held behind the deposits of the banks remained flat!
The truly remarkable thing is that the Monetary Base averaged around $848 billion in the two weeks ending August 13, 2008 while the total reserves in the banking system calculated using the method discussed above amounted to $72 billion.
Thus, in the time between August 12, 2009 and November 4, 2009, the Federal Reserve added $352 billion to the reserves of the banking system, a system that only averaged $72 billion in total reserves in the two weeks ending August 13, 2008. That is, the Federal Reserve added about 5 times as many reserves to the banking system in a 13-week period in 2009 as the complete banking system had in total in August 2008!
However, during the later time period, total bank credit in the banking system dropped by about $150 billion, loans and leases falling around $142 billion.
While bank reserves were increasing rapidly, the effective Federal Funds rate remained relatively constant. It averaged 16 basis points in August 2009, 15 basis points in September and 12 basis points in October. It continued to average around 12 basis points in the first half of November.
The question that needs to be asked is whether or not this scenario was what the Federal Reserve hoped to achieve when it initially went into what it called Quantitative Easing. My understanding of Quantitative easing was that Fed actions were required to combat a Liquidity Trap, a situation in which interest rates could not be pushed lower by adding more reserves to the banking system. Because interest rates could not be pushed lower, aggregate economic demand could not rise. However, it was argued that as the central bank continued to add reserves to the banking system, loans would still be granted to customers and the money stock would increase. Having more funds available, even though the interest rate on the loans could not go lower, was the quantitative effect desired, and as these funds were added to balance sheets spending would increase and the economy would be stimulated.
I don’t sense in the figures presented above the presence of a liquidity trap. The banking system seems to be demanding reserves and, in order to keep interest rates from going up, the Federal Reserve is very abundantly supplying banks reserves. That is, rather than exhibiting a fear that short term interest rates cannot decline any further, the Fed is afraid that short term interest rates (as well as rates on longer term Treasury securities and mortgage rates) might actually rise. This is consistent with the almost obsessive effort the Fed is making to be sure that the market knows the Fed is not going to let interest rates rise and that it is going to keep interest rates at current levels for “an extended period” of time.
This, to my mind, is not Quantitative Easing. It is just a continuation of the strategy the Fed has been following since September 2008: in policy actions, do not err on the side of providing too little stimulus.
This is not a refined, sophisticated monetary policy. Throwing everything you can against the wall to make sure a sufficient amount of what you throw against the wall sticks to the wall is something one does when one is desperate and unsure about what one is doing. You can achieve your goal with this strategy but the problem is that you have a big mess to clean up afterward.
And, if I am correct in this analysis, the Federal Reserve is currently only exacerbating the size of the mess that will have to be cleaned up.
Looking a little further into the data we find that the Monetary Base, defined as all financial assets that serve as bank reserves or could become bank reserves, rose from an average of $1,649 billion in the two weeks ending August 12, 2009 to an average of $2,001 billion in the two weeks ending November 4. (These data are on a nonseasonally adjusted basis, but the seasonally adjusted data are not significantly different.)
The Monetary Base rose by $352 billion during this period of time. (This was both on a
seasonally adjusted bases as well as a nonseasonally adjusted basis.)
What I am interested in reporting on is the total amount of reserves available to the commercial banking system.
Technical Note: To get the figure for total reserves we must subtract the currency component of the money stock from the reported data on the Monetary Base. This amount, according to the Federal Reserve System, is total reserves (of the banking system from the H.3 release) plus required clearing balances and adjustments to compensate for float at Federal Reserve Banks plus an amount representing the difference between current vault cash and the amount of vault cash used to satisfy current reserve requirements. This total reserve amount is different from the total bank reserves reported in the H.3 release on Aggregate Reserves of Depository Institutions and the Monetary Base.
This calculated measure of total reserves in the banking system rose by $351 billion during the time period under review. In other words, currency in circulation outside of commercial banks increased by only $1.0 billion from the August 12 information to the November 4 data.
Excess reserves in the banking system increased in this 13-week period from $709 billion to $1,059 billion, a rise of $350 billion. Thus, all the increase in bank reserves during this time period came in excess reserves, the required reserves held behind the deposits of the banks remained flat!
The truly remarkable thing is that the Monetary Base averaged around $848 billion in the two weeks ending August 13, 2008 while the total reserves in the banking system calculated using the method discussed above amounted to $72 billion.
Thus, in the time between August 12, 2009 and November 4, 2009, the Federal Reserve added $352 billion to the reserves of the banking system, a system that only averaged $72 billion in total reserves in the two weeks ending August 13, 2008. That is, the Federal Reserve added about 5 times as many reserves to the banking system in a 13-week period in 2009 as the complete banking system had in total in August 2008!
However, during the later time period, total bank credit in the banking system dropped by about $150 billion, loans and leases falling around $142 billion.
While bank reserves were increasing rapidly, the effective Federal Funds rate remained relatively constant. It averaged 16 basis points in August 2009, 15 basis points in September and 12 basis points in October. It continued to average around 12 basis points in the first half of November.
The question that needs to be asked is whether or not this scenario was what the Federal Reserve hoped to achieve when it initially went into what it called Quantitative Easing. My understanding of Quantitative easing was that Fed actions were required to combat a Liquidity Trap, a situation in which interest rates could not be pushed lower by adding more reserves to the banking system. Because interest rates could not be pushed lower, aggregate economic demand could not rise. However, it was argued that as the central bank continued to add reserves to the banking system, loans would still be granted to customers and the money stock would increase. Having more funds available, even though the interest rate on the loans could not go lower, was the quantitative effect desired, and as these funds were added to balance sheets spending would increase and the economy would be stimulated.
I don’t sense in the figures presented above the presence of a liquidity trap. The banking system seems to be demanding reserves and, in order to keep interest rates from going up, the Federal Reserve is very abundantly supplying banks reserves. That is, rather than exhibiting a fear that short term interest rates cannot decline any further, the Fed is afraid that short term interest rates (as well as rates on longer term Treasury securities and mortgage rates) might actually rise. This is consistent with the almost obsessive effort the Fed is making to be sure that the market knows the Fed is not going to let interest rates rise and that it is going to keep interest rates at current levels for “an extended period” of time.
This, to my mind, is not Quantitative Easing. It is just a continuation of the strategy the Fed has been following since September 2008: in policy actions, do not err on the side of providing too little stimulus.
This is not a refined, sophisticated monetary policy. Throwing everything you can against the wall to make sure a sufficient amount of what you throw against the wall sticks to the wall is something one does when one is desperate and unsure about what one is doing. You can achieve your goal with this strategy but the problem is that you have a big mess to clean up afterward.
And, if I am correct in this analysis, the Federal Reserve is currently only exacerbating the size of the mess that will have to be cleaned up.
Sunday, November 15, 2009
Federal Reserve Exit Watch: Part 4
This is the fourth month that I have posted something about the performance of the Federal Reserve with respect to their exit strategy, the strategy it is following to remove the massive amount of reserves it put into the banking system in 2008 and beyond. On November 11, 2009, the Fed was supplying $2,176 billion in reserve funds to the banking system. (This is from the Federal Reserve release H.4.1, Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.)
This was down slightly from the $2,233 billion total on October 14, 2009, but up from the $2,055 billion on August 12, 2009.
Commercial banks had $1,041 billion in Reserve Balances at Federal Reserve Banks on November 11 and the banking system averaged $1,059 in Excess Reserves for the two week period ending November 4, 2009. On October 14, Reserve Balances were $1,049 billion, but on August 12 this number was only $772 billion. Excess Reserves in the banking system averaged $918 billion in the two weeks ending October 7, and averaged $766 in the month of August.
Thus over the last 13-week period and over the past 4-week period total assets remained form around $2.1 trillion and $2.2 trillion.
However, Total Reserves in the banking system rose from $829 billion in August to $981 in the two week period ending October 7, to $1,124 billion in the two week period ending November 4.
This is an increase of over 35% in the total reserves of the banking system!
Of this $295 billion increase in total reserves, a total of $293 billion went into excess reserves!
Just a side note, Required Reserves rose by only $2 billion over the same time period!
No lending going on here!
The composition of the Fed’s balance sheet is changing, however. Securities held outright by the Federal Reserve has risen from $1,556 on August 12, 2009 to $1,673 billion on October 14 and $1,702 on November 11.
As reported in early editions of the Exit Watch, the Fed is letting the special assets it created run off as the need for them retreats and is replacing these reserves by marketable securities. Not all of these will run off in the near term as the credit and value issues surrounding assets at AIG and other institutions may take some time to disappear. However, these special assets have declined from somewhere in the neighborhood of $550-$500 billion on August 12, to $420-$380 on October 14 to around $340-$300 billion on November 11.
The largest decrease came from the reduction in the use of the Term Auction Credit which was instituted in December 2007 as a part of the dislocations in the financial markets that surrounded the problems at Bear Stearns. On August 12, this facility totaled $233 billion. The total dropped to $155 billion on October 14 and $109 billion on November 11.
Thus, the Fed is reducing the special assets portion of its balance sheet and is substituting for these asset, ownership of securities--Treasuries, Federal Agency issues, and Mortgage Backed securities.
In pursuing this path, the Fed is taking securities out of the open market, from banks and other financial institutions, but the funds it is using to pay for these securities is just going, so to speak, into bank vaults.
Commercial banks are basically saying, “If we don’t make any loans with this money, then the loans we don’t make cannot turn into bad loans!”
Another way of saying this is that the banks have enough bad assets on their books now and they don’t need to add any more. They’ll sell securities, but they won’t do anything with the money they receive back from the sale.
This seems to be creating a very uncomfortable situation. As the Fed reduced special facility assets over the last 13-week period and increased its holdings of open-market securities, it forced $300 billion reserves on the banking system.
Note that in August 2008, Total Reserves in the banking system amounted to $45 billion.
In 13 weeks the Fed forced 6.67 times more reserves into the banking system than the banking system had accumulated in all its history in the United States! And the banks did nothing with the reserves! And, the recession ended in the third quarter!
This is not a liquidity problem!
And the Federal Reserve says that it will continue to keep its target interest rates at its current level for an extended period of time. This is “QUANTATIVE EASING”!
Interest rates are going to start rising at some time. What is the Fed going to do with all the open-market securities it has on its balance sheet? What kinds of losses will the Fed have to take to eventually reduce reserves to reasonable levels once the economy begins to pick up steam?
Well, we really don’t need to worry about the Fed because the can just print money at a cost of zero in order to cover any losses they take.
But, what about those investors, what about the Chinese, what about anyone, who purchased United States Treasury securities during this summer and fall? How are they going to cover their losses when interest rates finally begin to rise?
The Federal Reserve got us here. There is no painless way to get us out of the situation they put us in…at least as far as I can see.
Thanks, Ben!
This was down slightly from the $2,233 billion total on October 14, 2009, but up from the $2,055 billion on August 12, 2009.
Commercial banks had $1,041 billion in Reserve Balances at Federal Reserve Banks on November 11 and the banking system averaged $1,059 in Excess Reserves for the two week period ending November 4, 2009. On October 14, Reserve Balances were $1,049 billion, but on August 12 this number was only $772 billion. Excess Reserves in the banking system averaged $918 billion in the two weeks ending October 7, and averaged $766 in the month of August.
Thus over the last 13-week period and over the past 4-week period total assets remained form around $2.1 trillion and $2.2 trillion.
However, Total Reserves in the banking system rose from $829 billion in August to $981 in the two week period ending October 7, to $1,124 billion in the two week period ending November 4.
This is an increase of over 35% in the total reserves of the banking system!
Of this $295 billion increase in total reserves, a total of $293 billion went into excess reserves!
Just a side note, Required Reserves rose by only $2 billion over the same time period!
No lending going on here!
The composition of the Fed’s balance sheet is changing, however. Securities held outright by the Federal Reserve has risen from $1,556 on August 12, 2009 to $1,673 billion on October 14 and $1,702 on November 11.
As reported in early editions of the Exit Watch, the Fed is letting the special assets it created run off as the need for them retreats and is replacing these reserves by marketable securities. Not all of these will run off in the near term as the credit and value issues surrounding assets at AIG and other institutions may take some time to disappear. However, these special assets have declined from somewhere in the neighborhood of $550-$500 billion on August 12, to $420-$380 on October 14 to around $340-$300 billion on November 11.
The largest decrease came from the reduction in the use of the Term Auction Credit which was instituted in December 2007 as a part of the dislocations in the financial markets that surrounded the problems at Bear Stearns. On August 12, this facility totaled $233 billion. The total dropped to $155 billion on October 14 and $109 billion on November 11.
Thus, the Fed is reducing the special assets portion of its balance sheet and is substituting for these asset, ownership of securities--Treasuries, Federal Agency issues, and Mortgage Backed securities.
In pursuing this path, the Fed is taking securities out of the open market, from banks and other financial institutions, but the funds it is using to pay for these securities is just going, so to speak, into bank vaults.
Commercial banks are basically saying, “If we don’t make any loans with this money, then the loans we don’t make cannot turn into bad loans!”
Another way of saying this is that the banks have enough bad assets on their books now and they don’t need to add any more. They’ll sell securities, but they won’t do anything with the money they receive back from the sale.
This seems to be creating a very uncomfortable situation. As the Fed reduced special facility assets over the last 13-week period and increased its holdings of open-market securities, it forced $300 billion reserves on the banking system.
Note that in August 2008, Total Reserves in the banking system amounted to $45 billion.
In 13 weeks the Fed forced 6.67 times more reserves into the banking system than the banking system had accumulated in all its history in the United States! And the banks did nothing with the reserves! And, the recession ended in the third quarter!
This is not a liquidity problem!
And the Federal Reserve says that it will continue to keep its target interest rates at its current level for an extended period of time. This is “QUANTATIVE EASING”!
Interest rates are going to start rising at some time. What is the Fed going to do with all the open-market securities it has on its balance sheet? What kinds of losses will the Fed have to take to eventually reduce reserves to reasonable levels once the economy begins to pick up steam?
Well, we really don’t need to worry about the Fed because the can just print money at a cost of zero in order to cover any losses they take.
But, what about those investors, what about the Chinese, what about anyone, who purchased United States Treasury securities during this summer and fall? How are they going to cover their losses when interest rates finally begin to rise?
The Federal Reserve got us here. There is no painless way to get us out of the situation they put us in…at least as far as I can see.
Thanks, Ben!
Friday, November 13, 2009
A Strong Dollar?
“It is very important to the United States that we have a strong dollar.”
So said the United States Secretary of the Treasury.
Yes, Paul O’Neill said that.
Oh, yes, John Snow said that.
And, Hank Paulson.
Oh, you say, that the quote is attributed to Tim Geithner, who made the statement yesterday at a news conference of Asia-Pacific finance ministers.
As my good friends would say, “you have to walk the walk, not just talk the talk!” Or, in the case of those looking on, “watch the hips, not the lips!”
The only public person alive today that, in my mind, has any credibility on this issue is Paul Volcker. And, it is Paul Volcker that has written, “A nation’s exchange rate is the single most important price in its economy; it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate…” (This quote is found on page 232 in the book “Changing Fortunes: The World’s Money and the Threat to American Leadership” by Paul Volcker and Toyoo Gyohten, Times Books, 1992.)
The United States government has no credibility left when it comes to the value of the United States dollar.
During the administration of Bush 43, the value of the United States dollar fell by 37% against an index of major currencies from February 2002 to March 2008 while the dollar fell in value by 45% against the Euro from February 2002 to July 2008.
The United States dollar did rebound at the time of the financial crisis: up 19% against the index of major currencies and up 23% against the Euro.
However, since February of this year the United States dollar fell back by about 13% against the index of major currencies and by about 15% against the Euro.
In watching the hips, not the lips, we see, for the United States government, potential cumulative fiscal deficits of $15 to $20 trillion over the next 10 years. We have a banking system with almost $1.1 trillion in excess reserves during the two week period ending November 4, 2009. We are faced with an unknown “exit strategy” to remove these excess reserves on the part of the Federal Reserve System.
And all this with several other “shocks” on the horizon. Obama “owns” Afghanistan now and it is totally unknown what his “new strategy” for that country will mean in terms of more government spending. Then there is the health care initiative. Obama has said that the program should not add “one dime” to the deficit, yet all indications are that whatever is passed will add to the deficit, although we don’t know what that amount will be. Then there is the climate change bill along with some other proposals that are setting in the wings.
Oh, yes, people within the administration have suggested that the rest of the TARP money, whatever that amounts to, can be applied to reducing the deficit. Whoopee!
I hear the Obama administration talking the talk. I don’t see them walking the walk.
And what about Bernanke. He is staying particularly silent these days. Oh, yes, we learned from the New York Times earlier this week that he is letting Barney Frank do all his talking for him.
The strong dollar is, at present, a myth!
It will continue to remain weak and its value will continue to trend downward for the foreseeable future.
How far am I looking forward?
I will continue to believe that the dollar will remain weak until someone emerges that has some credibility. Right now, I don’t know where that person is going to come from.
So said the United States Secretary of the Treasury.
Yes, Paul O’Neill said that.
Oh, yes, John Snow said that.
And, Hank Paulson.
Oh, you say, that the quote is attributed to Tim Geithner, who made the statement yesterday at a news conference of Asia-Pacific finance ministers.
As my good friends would say, “you have to walk the walk, not just talk the talk!” Or, in the case of those looking on, “watch the hips, not the lips!”
The only public person alive today that, in my mind, has any credibility on this issue is Paul Volcker. And, it is Paul Volcker that has written, “A nation’s exchange rate is the single most important price in its economy; it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate…” (This quote is found on page 232 in the book “Changing Fortunes: The World’s Money and the Threat to American Leadership” by Paul Volcker and Toyoo Gyohten, Times Books, 1992.)
The United States government has no credibility left when it comes to the value of the United States dollar.
During the administration of Bush 43, the value of the United States dollar fell by 37% against an index of major currencies from February 2002 to March 2008 while the dollar fell in value by 45% against the Euro from February 2002 to July 2008.
The United States dollar did rebound at the time of the financial crisis: up 19% against the index of major currencies and up 23% against the Euro.
However, since February of this year the United States dollar fell back by about 13% against the index of major currencies and by about 15% against the Euro.
In watching the hips, not the lips, we see, for the United States government, potential cumulative fiscal deficits of $15 to $20 trillion over the next 10 years. We have a banking system with almost $1.1 trillion in excess reserves during the two week period ending November 4, 2009. We are faced with an unknown “exit strategy” to remove these excess reserves on the part of the Federal Reserve System.
And all this with several other “shocks” on the horizon. Obama “owns” Afghanistan now and it is totally unknown what his “new strategy” for that country will mean in terms of more government spending. Then there is the health care initiative. Obama has said that the program should not add “one dime” to the deficit, yet all indications are that whatever is passed will add to the deficit, although we don’t know what that amount will be. Then there is the climate change bill along with some other proposals that are setting in the wings.
Oh, yes, people within the administration have suggested that the rest of the TARP money, whatever that amounts to, can be applied to reducing the deficit. Whoopee!
I hear the Obama administration talking the talk. I don’t see them walking the walk.
And what about Bernanke. He is staying particularly silent these days. Oh, yes, we learned from the New York Times earlier this week that he is letting Barney Frank do all his talking for him.
The strong dollar is, at present, a myth!
It will continue to remain weak and its value will continue to trend downward for the foreseeable future.
How far am I looking forward?
I will continue to believe that the dollar will remain weak until someone emerges that has some credibility. Right now, I don’t know where that person is going to come from.
Thursday, November 12, 2009
Discipline is Needed for Real Economic Performance
There is an interesting article inside the Wall Street Journal this morning comparing the fortunes of Brazil and Argentina. (See “Argentina Falters as Old Rival Rises,” http://online.wsj.com/article/SB125798960525944513.html#mod=todays_us_page_one.) In the article a research paper published in Argentina is quoted: “Since the middle of the last century, Argentina’s economy has endured a notable decline relative to the rest of the region, falling into ‘insignificance in the international context.’”
During this time period the government of Argentina followed a very undisciplined approach to economic policy while it kept itself in power and suppressed dissent. In 2001, Argentina declared the largest sovereign debt default in history. Things have not gotten much better since.
Brazil’s government, on the other hand, after years of self-serving activity started to get its act in order about 15 years ago under the leadership of former President Fernando Henrique Cardoso. Runaway inflation was brought under control and more orthodox and conservative economic policies were put into place. The current president, Luiz Inảcio Lula da Silva, has maintained these policies. (See ”Olympic Accolade Sets Seal on Progress” in Financial Times: http://www.ft.com/cms/s/0/d16a27a6-c8d9-11de-8f9d-00144feabdc0.html.)
The central bank in Brazil is treated as independent and the stability that has been created has brought about lower interest rates and a growing mortgage market that has stimulated a construction boom. An emerging middle class has emerged and has supported the effort to obtain the Olympics and other international initiatives that will lead to a vast expansion of the Brazilian infrastructure in upcoming years.
Over and over again we see examples of the benefits of discipline in economic and financial affairs. We also see that the loss of discipline does nothing but eventually lead the undisciplined into undesirable situations in which all of the alternative options that are available to correct the condition are undesirable. In other words, there are no good choices to get one out of the difficulty in which one finds oneself.
Inflation represents a loss of discipline that always ends up hurting a large number of people. Furthermore, the consequences of inflation can leave a wreckage in which policymakers are left with no good alternative policies to follow. Often, the path of least resistance in such situations is to reflate.
Historically, governments have always excelled in spending more than they could bring in through taxes and other levies. Thus, going into debt is a normal governmental activity. Other than outright default on debt, governments got very good at inflating themselves out of excessive amounts of debt. And, the ability to inflate was helped in the twentieth century by developments in information technology: so governments got better and better at inflating their economies. (See “This Time is Different” by Reinhart and Rogoff: http://seekingalpha.com/article/171610-crisis-in-context-this-time-is-different-eight-centuries-of-financial-folly-by-carmen-m-reinhart-and-kenneth-s-rogoff.)
Philosophically, this bias toward inflation was supported by Keynesian economics as the argument was made that twentieth century governments could not allow wages and prices to fall. (See http://seekingalpha.com/article/167893-john-maynard-keynes-and-international-relations-economic-paths-to-war-and-peace-by-donald-markwell.) (Also see op-ed piece in Wall Street Journal “The Fed’s Woody Allen Policy”: http://online.wsj.com/article/SB10001424052748704402404574529510954803156.html.) So the twentieth century saw not only an improved technology to inflate but also a respected philosophy that supported a government policy that had a bias toward inflation.
The point is that inflation creates an incentive for economic units to grow and to take on greater and greater amounts of risk. This is, of course, because inflation favors debtors versus creditors. It pays individuals and businesses to take on more and more debt. And, this policy is particularly successful, at least in the early stages, when the central bank forces interest rates to stay excessively low.
Risk is minimized because inflation creates a situation of moral hazard by “bailing out” people who take on large amounts of exposure to risk. For example, one rule of thumb that floats around the banking world from time-to-time is that “In a time of inflation, anyone can become a contractor for building houses. One only learns who is bad at it is when inflation slows down or stops.” The idea can be expanded to say that in inflationary times, anyone can appear to be successful. As Citigroup’s CEO Charles O. Prince III blithely stated: “As long as the music is still playing, we are all still dancing…” Risk takes a back seat.
Second, size becomes all important! Since inflation reduces the real value of debt it becomes silly for individuals or businesses not to leverage up. What is it to create $30 of debt for $1 of equity you have? And, why not $35…or, $40? Using such leverage magnifies performance! Using such leverage magnifies bonuses! Using such leverage allows us to reach a size where we become “Too Big to Fail”!
Finally, inflation allows individuals and businesses to forget about producing good quality goods and services and diverts attention to “speculative trading” and “financial games”. Since outsize rewards and bonuses go to areas that prosper during inflationary times, more and more “talent” moves into areas connected with finance or with trading. Less and less emphasis is placed upon production and quality because rising prices contribute more to profits than does improvements in what goods and services are offered. As a consequence, the composition of the nation’s workforce becomes tilted toward finance and the financial industries.
In effect, inflation destroys discipline. And, once discipline is reduced, problems occur and until discipline is renewed the problems just cumulate and re-enforce one another. This happens in families, in businesses, and in governments.
But, as is usual in economics, the consequences associated with destructive incentives are not always easy to identify. (See “Feakonomics” or “Superfreakonomics”: http://seekingalpha.com/article/166993-the-power-of-unintended-consequences-superfreakonomics-by-steven-d-levitt-and-stephen-j-dubner.) It is so much easier to blame executive greed for the troubles we have been experiencing. This explanation covers so much territory: the growth of finance in the economy relative to “productive” jobs; the taking on of more and more leverage; the taking on of more and more risky deals; the emphasis on speculative trading rather than productive producing; and the payment of excessive salaries and bonuses.
In fact, it is often hard to identify the benefits of greater discipline unless examples of that discipline are placed alongside examples of a lack of discipline. This is why the Argentina/Brazil contrast caught my attention.
Such stories, however, cause one to worry about whether the United States will once again be able to regain its economic discipline. The fear is that as long as governmental policies contain an inflationary bias, the solution to the problems caused by this inflationary bias will continue to be re-flation. If this is so, discipline will continue to be lacking in this country, both personally and corporately. Maybe it is not so surprising that Brazil won the voting for the Olympics over the United States!
During this time period the government of Argentina followed a very undisciplined approach to economic policy while it kept itself in power and suppressed dissent. In 2001, Argentina declared the largest sovereign debt default in history. Things have not gotten much better since.
Brazil’s government, on the other hand, after years of self-serving activity started to get its act in order about 15 years ago under the leadership of former President Fernando Henrique Cardoso. Runaway inflation was brought under control and more orthodox and conservative economic policies were put into place. The current president, Luiz Inảcio Lula da Silva, has maintained these policies. (See ”Olympic Accolade Sets Seal on Progress” in Financial Times: http://www.ft.com/cms/s/0/d16a27a6-c8d9-11de-8f9d-00144feabdc0.html.)
The central bank in Brazil is treated as independent and the stability that has been created has brought about lower interest rates and a growing mortgage market that has stimulated a construction boom. An emerging middle class has emerged and has supported the effort to obtain the Olympics and other international initiatives that will lead to a vast expansion of the Brazilian infrastructure in upcoming years.
Over and over again we see examples of the benefits of discipline in economic and financial affairs. We also see that the loss of discipline does nothing but eventually lead the undisciplined into undesirable situations in which all of the alternative options that are available to correct the condition are undesirable. In other words, there are no good choices to get one out of the difficulty in which one finds oneself.
Inflation represents a loss of discipline that always ends up hurting a large number of people. Furthermore, the consequences of inflation can leave a wreckage in which policymakers are left with no good alternative policies to follow. Often, the path of least resistance in such situations is to reflate.
Historically, governments have always excelled in spending more than they could bring in through taxes and other levies. Thus, going into debt is a normal governmental activity. Other than outright default on debt, governments got very good at inflating themselves out of excessive amounts of debt. And, the ability to inflate was helped in the twentieth century by developments in information technology: so governments got better and better at inflating their economies. (See “This Time is Different” by Reinhart and Rogoff: http://seekingalpha.com/article/171610-crisis-in-context-this-time-is-different-eight-centuries-of-financial-folly-by-carmen-m-reinhart-and-kenneth-s-rogoff.)
Philosophically, this bias toward inflation was supported by Keynesian economics as the argument was made that twentieth century governments could not allow wages and prices to fall. (See http://seekingalpha.com/article/167893-john-maynard-keynes-and-international-relations-economic-paths-to-war-and-peace-by-donald-markwell.) (Also see op-ed piece in Wall Street Journal “The Fed’s Woody Allen Policy”: http://online.wsj.com/article/SB10001424052748704402404574529510954803156.html.) So the twentieth century saw not only an improved technology to inflate but also a respected philosophy that supported a government policy that had a bias toward inflation.
The point is that inflation creates an incentive for economic units to grow and to take on greater and greater amounts of risk. This is, of course, because inflation favors debtors versus creditors. It pays individuals and businesses to take on more and more debt. And, this policy is particularly successful, at least in the early stages, when the central bank forces interest rates to stay excessively low.
Risk is minimized because inflation creates a situation of moral hazard by “bailing out” people who take on large amounts of exposure to risk. For example, one rule of thumb that floats around the banking world from time-to-time is that “In a time of inflation, anyone can become a contractor for building houses. One only learns who is bad at it is when inflation slows down or stops.” The idea can be expanded to say that in inflationary times, anyone can appear to be successful. As Citigroup’s CEO Charles O. Prince III blithely stated: “As long as the music is still playing, we are all still dancing…” Risk takes a back seat.
Second, size becomes all important! Since inflation reduces the real value of debt it becomes silly for individuals or businesses not to leverage up. What is it to create $30 of debt for $1 of equity you have? And, why not $35…or, $40? Using such leverage magnifies performance! Using such leverage magnifies bonuses! Using such leverage allows us to reach a size where we become “Too Big to Fail”!
Finally, inflation allows individuals and businesses to forget about producing good quality goods and services and diverts attention to “speculative trading” and “financial games”. Since outsize rewards and bonuses go to areas that prosper during inflationary times, more and more “talent” moves into areas connected with finance or with trading. Less and less emphasis is placed upon production and quality because rising prices contribute more to profits than does improvements in what goods and services are offered. As a consequence, the composition of the nation’s workforce becomes tilted toward finance and the financial industries.
In effect, inflation destroys discipline. And, once discipline is reduced, problems occur and until discipline is renewed the problems just cumulate and re-enforce one another. This happens in families, in businesses, and in governments.
But, as is usual in economics, the consequences associated with destructive incentives are not always easy to identify. (See “Feakonomics” or “Superfreakonomics”: http://seekingalpha.com/article/166993-the-power-of-unintended-consequences-superfreakonomics-by-steven-d-levitt-and-stephen-j-dubner.) It is so much easier to blame executive greed for the troubles we have been experiencing. This explanation covers so much territory: the growth of finance in the economy relative to “productive” jobs; the taking on of more and more leverage; the taking on of more and more risky deals; the emphasis on speculative trading rather than productive producing; and the payment of excessive salaries and bonuses.
In fact, it is often hard to identify the benefits of greater discipline unless examples of that discipline are placed alongside examples of a lack of discipline. This is why the Argentina/Brazil contrast caught my attention.
Such stories, however, cause one to worry about whether the United States will once again be able to regain its economic discipline. The fear is that as long as governmental policies contain an inflationary bias, the solution to the problems caused by this inflationary bias will continue to be re-flation. If this is so, discipline will continue to be lacking in this country, both personally and corporately. Maybe it is not so surprising that Brazil won the voting for the Olympics over the United States!
Wednesday, November 11, 2009
Fannie, Freddie, and Feddie?
Will the Federal Reserve System join the ranks of other government public supported agencies like Fannie Mae and Freddie Mac?
One could argue that they are on the verge of such ignominy.
Never before has the Federal Reserve been under such attack and from all sides. The attacks have gotten so severe that the subject even made the front page of the New York Times today. (See “Under Attack, Fed Chief Studies Politics,” http://www.nytimes.com/2009/11/11/business/11fed.html?hp.) The legislative attack on the Fed continues with the new proposals on financial regulation coming from the Senate Banking Committee. (See “Senate Democrats Seek Sweeping Curbs on Fed,” http://online.wsj.com/article/SB125786789140341325.html?mod=WSJ_hps_LEFTWhatsNews.)
Certainly the leadership of the Federal Reserve seems to be deserving this scorn. Henry Kaufman states bluntly that “there is the Fed’s legacy of its inability to limit past financial excesses. By failing to be an effective guardian of our financial system, it has lost credibility.” (See, “The Real Threat to Fed Independence,” http://online.wsj.com/article/SB10001424052748703574604574501632123501814.html.)
Of course, Alan Greenspan gets his share of the blame for “keeping interest rates too low for too long in the early years of this decade”; for his failure to understand the changes in the financial markets coming from financial innovation; and for his role in the repeal of the Glass-Steagall Act.
But, Ben Benanke must also bear his share in the decline of Fed credibility. He was Greenspan’s co-conspirator, serving on the Board of Governors of the Federal Reserve System during the 2002 to 2005 period in which the Federal Funds Rate was kept below 2.00% from the time he joined the Board until November 2004. For much of the time this Fed Funds rate was around 1.00%. Bernanke was a strong defender of keeping the rates so low, both in terms of economic analysis and speeches.
After Bernanke assumed the position of Chairman he was slow responding to the possibility that the bubble was bursting in the subprime market. Then, Bernanke reacted very strongly to the financial collapse, possibly over-reacted, in the week of September 15, 2008. (See my post of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?” http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.)
Congress certainly saw Bernanke in action that week. According to a Wall Street Journal article, which I quoted in the post, “(Hank) Paulson called the leadership in Congress and asked them to have a meeting with himself and Bernanke on Friday evening. The few members of Congress that talked with the press after that meeting said that Bernanke did most of the talking and ‘scared the daylights out of everyone.’ Bernanke got his wish in that Congress ultimately passed the TARP bill, although they did not pass the bill by the next Monday as Bernanke had originally pressed for.
I’m not completely convinced that Congress, deep down, has all that much confidence in a Ben Bernanke-led Federal Reserve System going forward even though President Obama seems to.
Then, the Federal Reserve, under Bernanke’s guidance, flooded the banking system with reserves, leading up the current time where excess reserves in the banking system total more than $1.0 trillion. His concern over this time period has been the liquidity of financial markets. (See my recent post, “Dear Fed: the Problem is Solvency, not Liquidity,” http://seekingalpha.com/article/171826-dear-fed-the-problem-is-solvency-not-liquidity.)
As Kaufman points out in his Wall Street Journal article, the Federal Reserve now has another major conundrum: “How will the Fed reduce its bloated balance sheet?” This is a real problem because the Federal Reserve has subsidized the financing of massive amounts of federal debt and has also provided massive support to the markets for mortgage-backed securities and federal agency issues. As of November 4, 2009, the Fed owned outright $777 billion in U. S. Treasury issues, $774 billion in mortgage-backed securities, and $147 billion in Federal agency debt securities, roughly $1.7 trillion.
In supporting these markets, the Federal Reserve has kept the interest rates on these securities below the level they would have attained without the support of the central bank. The first question is, what will happen to these rates once the Fed stops supporting these securities. Will their rates ratchet upwards?
And, then, what will happen once the Federal Reserve finally decides it needs to let interest rates move up as the economy gains strength? If the Federal Reserve pursues its exit policy of removing reserves from the banking system it will have to take a loss on these securities. No matter though, it will just reduce the amount of funds (its profits) it returns to the Treasury Department at the end of the year.
In a sense, this will make the Fed like Fannie and Freddie in that it can absorb losses deemed necessary by the government for good social reasons. However, the Fed will not have to go to the Treasury with its hand out, as Fannie and Freddie has to, in order to cover its losses because the Fed makes so much profits by being able to create money whenever it wants to.
But, there is another problem: how much upward pressure will the liquidation of the mortgage-backed securities put on interest rates. How much will Congress resist this upward movement in interest rates? What will the housing lobby do to counter-act this move in rates because such a move will certainly not be good for a recovering housing market.
There is another concern: billions and billions of dollars of government debt have been purchased at subsidized interest rates. Helping this along was the extremely low short-term rates resulting from the Fed’s “close to zero” interest rate policy. If I can borrow for six months at, say, 50 basis points or so, and lend these funds out at around 3.00% on 7-year Treasuries, with a “guarantee” from the Fed that the 50 basis points will remain for “an extended period” of time, I have a pretty nice deal.
And, making money in this way doesn’t even include the returns that are available on the “cover” trade.
But, what will happen to those that “underwrote” the placing of the federal debt when the Fed begins to let rates start to rise? How extensive and deep will be the capital losses? Not everyone can make it through the “exit door” at the same time. Will Congress hear about this?
There are additional regulatory issues relating to institutions that are “too big to fail”. These, too, get us into the political realm. Congress is going to want to get their hands into this “solution” as well.
Has the current leadership at the Fed (Republican appointed) brought us to the brink of the government making the Fed into another Fannie Mae or Freddie Mac? Printing money is sure an attractive way to try and achieve social goals. It is interesting that the political party (the Republicans) that was supposedly the strongest supporter of free-market capitalism has brought us to the edge of greater government control of industry (like autos and housing) and financial institutions (like large banks and the Fed).
One could argue that they are on the verge of such ignominy.
Never before has the Federal Reserve been under such attack and from all sides. The attacks have gotten so severe that the subject even made the front page of the New York Times today. (See “Under Attack, Fed Chief Studies Politics,” http://www.nytimes.com/2009/11/11/business/11fed.html?hp.) The legislative attack on the Fed continues with the new proposals on financial regulation coming from the Senate Banking Committee. (See “Senate Democrats Seek Sweeping Curbs on Fed,” http://online.wsj.com/article/SB125786789140341325.html?mod=WSJ_hps_LEFTWhatsNews.)
Certainly the leadership of the Federal Reserve seems to be deserving this scorn. Henry Kaufman states bluntly that “there is the Fed’s legacy of its inability to limit past financial excesses. By failing to be an effective guardian of our financial system, it has lost credibility.” (See, “The Real Threat to Fed Independence,” http://online.wsj.com/article/SB10001424052748703574604574501632123501814.html.)
Of course, Alan Greenspan gets his share of the blame for “keeping interest rates too low for too long in the early years of this decade”; for his failure to understand the changes in the financial markets coming from financial innovation; and for his role in the repeal of the Glass-Steagall Act.
But, Ben Benanke must also bear his share in the decline of Fed credibility. He was Greenspan’s co-conspirator, serving on the Board of Governors of the Federal Reserve System during the 2002 to 2005 period in which the Federal Funds Rate was kept below 2.00% from the time he joined the Board until November 2004. For much of the time this Fed Funds rate was around 1.00%. Bernanke was a strong defender of keeping the rates so low, both in terms of economic analysis and speeches.
After Bernanke assumed the position of Chairman he was slow responding to the possibility that the bubble was bursting in the subprime market. Then, Bernanke reacted very strongly to the financial collapse, possibly over-reacted, in the week of September 15, 2008. (See my post of November 16, 2008, “The Bailout Plan: Did Bernanke Panic?” http://seekingalpha.com/article/106186-the-bailout-plan-did-bernanke-panic.)
Congress certainly saw Bernanke in action that week. According to a Wall Street Journal article, which I quoted in the post, “(Hank) Paulson called the leadership in Congress and asked them to have a meeting with himself and Bernanke on Friday evening. The few members of Congress that talked with the press after that meeting said that Bernanke did most of the talking and ‘scared the daylights out of everyone.’ Bernanke got his wish in that Congress ultimately passed the TARP bill, although they did not pass the bill by the next Monday as Bernanke had originally pressed for.
I’m not completely convinced that Congress, deep down, has all that much confidence in a Ben Bernanke-led Federal Reserve System going forward even though President Obama seems to.
Then, the Federal Reserve, under Bernanke’s guidance, flooded the banking system with reserves, leading up the current time where excess reserves in the banking system total more than $1.0 trillion. His concern over this time period has been the liquidity of financial markets. (See my recent post, “Dear Fed: the Problem is Solvency, not Liquidity,” http://seekingalpha.com/article/171826-dear-fed-the-problem-is-solvency-not-liquidity.)
As Kaufman points out in his Wall Street Journal article, the Federal Reserve now has another major conundrum: “How will the Fed reduce its bloated balance sheet?” This is a real problem because the Federal Reserve has subsidized the financing of massive amounts of federal debt and has also provided massive support to the markets for mortgage-backed securities and federal agency issues. As of November 4, 2009, the Fed owned outright $777 billion in U. S. Treasury issues, $774 billion in mortgage-backed securities, and $147 billion in Federal agency debt securities, roughly $1.7 trillion.
In supporting these markets, the Federal Reserve has kept the interest rates on these securities below the level they would have attained without the support of the central bank. The first question is, what will happen to these rates once the Fed stops supporting these securities. Will their rates ratchet upwards?
And, then, what will happen once the Federal Reserve finally decides it needs to let interest rates move up as the economy gains strength? If the Federal Reserve pursues its exit policy of removing reserves from the banking system it will have to take a loss on these securities. No matter though, it will just reduce the amount of funds (its profits) it returns to the Treasury Department at the end of the year.
In a sense, this will make the Fed like Fannie and Freddie in that it can absorb losses deemed necessary by the government for good social reasons. However, the Fed will not have to go to the Treasury with its hand out, as Fannie and Freddie has to, in order to cover its losses because the Fed makes so much profits by being able to create money whenever it wants to.
But, there is another problem: how much upward pressure will the liquidation of the mortgage-backed securities put on interest rates. How much will Congress resist this upward movement in interest rates? What will the housing lobby do to counter-act this move in rates because such a move will certainly not be good for a recovering housing market.
There is another concern: billions and billions of dollars of government debt have been purchased at subsidized interest rates. Helping this along was the extremely low short-term rates resulting from the Fed’s “close to zero” interest rate policy. If I can borrow for six months at, say, 50 basis points or so, and lend these funds out at around 3.00% on 7-year Treasuries, with a “guarantee” from the Fed that the 50 basis points will remain for “an extended period” of time, I have a pretty nice deal.
And, making money in this way doesn’t even include the returns that are available on the “cover” trade.
But, what will happen to those that “underwrote” the placing of the federal debt when the Fed begins to let rates start to rise? How extensive and deep will be the capital losses? Not everyone can make it through the “exit door” at the same time. Will Congress hear about this?
There are additional regulatory issues relating to institutions that are “too big to fail”. These, too, get us into the political realm. Congress is going to want to get their hands into this “solution” as well.
Has the current leadership at the Fed (Republican appointed) brought us to the brink of the government making the Fed into another Fannie Mae or Freddie Mac? Printing money is sure an attractive way to try and achieve social goals. It is interesting that the political party (the Republicans) that was supposedly the strongest supporter of free-market capitalism has brought us to the edge of greater government control of industry (like autos and housing) and financial institutions (like large banks and the Fed).
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