Give the Fed a bit of credit …
For holding things together. Barely. Bad as things are, they could be worse. Really.
By my count, the Fed is now providing about $1.25 trillion in liquidity support to the global financial system.
The Fed’s latest balance sheet data shows: $80b of repos; $150b of term auction credit, $410b in other loans, $30b in portfolio investment with “Maiden Lane” (the Bear Stearns vehicle), $320b in “other assets,” and $260b in securities lent to dealers.
Do the math. It is a huge number. Or look at my CFR colleague Paul Swartz’s updated chart. I wouldn’t believe these numbers could possibly be true if I hadn’t been watching the data for a while. Frankly the TARP is now starting to look small relative to the Fed’s balance sheet.
The $1.25 trillion total likely includes the swap lines that have allowed other central banks to provide dollar liquidity to their financial institutions.** (This sentence has been edited after my initial post: see the note below, it is important)
I have long thought that sovereign funds, which provided equity capital to support banks’ existing management in the early stages of this crisis, have gotten too much credit for helping to stabilize the financial system and the Fed and other central banks have gotten too little, in part because there isn’t as obvious a set of beneficiaries.
The latest data release should settle the question; absent enormous liquidity support from the Fed, a much broader set of financial institutions — including some that received equity investments from sovereign wealth funds — would have failed.
What are sovereign investors from the emerging world doing? We don’t know much about what sovereign wealth funds are doing — and in any case, the set of sovereign funds and big state firms from the emerging world is sufficiently diverse that it makes little sense to try to paint a single picture. But we do know a little bit about what the world’s central banks are doing from the New York Fed’s custodial data.
That data suggests an overwhelming flight away from any kind of risk. Or at least any kind of risk other than the currency risk that they have to take. Central banks are petrified of losing money. This is one reason why I have long thought that sovereign investors could be destablizing; they aren’t necessarily leveraged — but they are very loss-adverse.
From August 27 to October 1, the world’s central banks added $72.6b to their custodial holdings of Treasuries, and $0.9b to their custodial holdings of Agencies. Annualized, that works out to a $872b annual growth for Treasuries — a sum well in excess of the US current account deficit.
Between July 30 and October 1, they added $118.5b to their Treasury holdings (a $710b annual pace) while reducing their Agency holdings by $12.5b.
The enormous growth in central bank custodial holdings of Treasuries has helped to support the dollar — and that is stabilizing. The United States credit crisis has not turned into a currency crisis. But the flight out of risk has destablized other key markets, and that hasn’t been stabilizing. I suspect that central banks and sovereign funds are pulling out of money market funds, for example. The growth in the Fed’s custodial holdings in September almost certainly exceeded the growth in central banks’ reserves (we will have data on this next week) — a fact that suggests that central banks have sold other, slightly more risky assets and used the proceeds to buy Treasuries.
The basic story that emerges from the Fed’s balance sheet over the past few months is simple: the emerging world’s central banks have fled from any asset with a hint of credit risk, and while the Fed (and other G-10 central banks) have been lending ever large sums to the financial system. In the process they have taken on a lot more credit risk — and offset the broad flight away from risk by private investors and emerging market central banks alike.
Absent the Fed’s liquidity support, things would be worse. Much worse.
** I initially wrote that the $1.25 trillion in liquidity support to private financial institutions that shows up on the Fed’s balance sheet data likely did not capture the swap lines with foreign central banks, and thus understates the Fed’s true activity. The comments have led me to revise this view — as it seems that “other federal reserve assets” captures the fed’s foreign assets, including the collateral posted against swap lines that have been used, and thus $1.25 trillion likely represents the global total for dollar credit extended by all central banks to all financial institutions globally. JKH was the first to suggest this, and Murph’s comments lent support to JKH’s point. I hope to get full clarity on this on Friday; if anyone knows, please email me at bsetser at cfr dot org or just contribute to the comments. It is important.
UPDATE: I have confirmed that the foreign exchange posted as collateral in dollar swap line appears in “other federal reserve assets.”
UPDATE 2: I initially wrote “the credit crisis has turned into a currency crisis” (after describing how central bank dollar purchases had been stabilizing); I meant to write “the credit crisis has NOT turned into a currency crisis.” The post has been updated.
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Brad,
Are you sure the $ 320 billion in other assets doesn’t include swap line utilization? I would have thought it does, but I don’t know. Notably the same number a year ago was only about $ 40 billion.
Reserve balances are now up to $ 170 billion. This is about 17 times “normal” level. My guess is that this reflects both domestic conditions as well as the complication of overseas swapped dollars returning in the form of reserve balances, via US clearing banks for foreign correspondents. The Fed is trying to manage its influence on both the domestic fed funds rate and offshore Libor rates, but the ultimate impact of both interventions should show up in domestic reserves, I think. Of course, the Fed can sterilize reserve balances, regardless of their source, but part of the explanation for the outsize balances may be the unusual global scale of the distribution/hoarding problem and the difficulty that poses for targeting an appropriate daily level for excess reserves. (Sterilization is now occurring via the Treasury account on the liability side, as needed, at least until the Fed starts paying interest on reserves).
Anyway, if this is generally correct, it’s not clear to me how the swap lines can be off-balance sheet.
It is interesting also that the now hyper-excessive reserve balances are concentrated at the Boston as well as the New York Fed (bottom table). The US treasury account is exclusively with the New York Fed, which isn’t surprising.
JKH — let me see if I can clarity on this point; you may well be right — I hadn’t quite figured out where to look for the swap lines. I normally would expect the fx received in exchange for $ to show up in something labeled other foreign assets.
bsetser: What are sovereign investors from the emerging world doing?
In the case of China, they made a very loud investment into the Shanghai stock exchange to keep prices there from collapsing.
One thing about SWF’s, I think this reveals how small they are in the grand scheme of things since there is no way that any single SWF could intervene as heavily as the Central Banks.
Together they could coordinate action to shore up the credit markets, but one of the big questions that we have to ask ourselves is do we want the SWF to be able to coordinate action in case of a financial emergency.
another question on SWF’s —
how many of them and to what level are directly exposed to this current crisis other than by simply holding dollars?
i realize it’s almost impossible to know (the dark flows), but how about the one that are more transparent, like for example, norway?
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Brad,
If the swap utilization turns out to be in “other assets”, it may be the case that the Fed entry is a dollar loan to the foreign exchange fund, which transacts the swap and holds the related foreign currency assets on its books (Just another guess).
Brad, How does the Supplementary Financing Program fit into this?
http://www.treasury.gov/press/releases/hp1144.htm
The Treasury has been raising cash for the Fed like crazy, see:
http://www.treasurydirect.gov/instit/annceresult/press/preanre/2008/2008_cmb.htm
Another $45 billion for the Fed today alone.
This is a little confusing – the Treasury selling hundreds of billion in cash management bills – and giving the cash to the Fed. Isn’t that taking money away from other investments, or sending money in a circle? I admit I’m a little confused.
Best Wishes!
At this rate, pretty soon the Fed is going to catch FHLB as a source of liquidity for the banking system.
Well, if Paulson wants to buy $700 billion of toxic waste, he may need to look no further than the Fed.
Seriously, though, Bernanke is taking a risk with the Fed as an institution. If when all is said and done, he ends up with a few hundred billion of losses, the Fed’s reputation and possibly independence may suffer.
Brad,
Could the increased swap line be part of the “Other Assets” of $318 Billion ? The increase of $218 Billion in this category since September 17th’s report coincides with the September 18 announcement of a $180 Billion expansion of the swap lines.
The footnote indicates that “Other Assets” includes assets denominated in foreign currencies.
(?)
Murph — the footnote, plus JKH’s comment, leads me to think that this line item does reflect the swap lines. I want to confirm this, but at this stage i suspect that the $520b (not fully drawn) is captured in the fed data. I would argue that the fed — which is generally quite transparent — could be more transparent here.
CR — tis a rare pleasure to see you over here, now that you are a mega-blogger! congrats, by the way — your site/ blog is superb.
To answer your question — the fed has effectively expanded its balance sheet via the supplementary financing program. Not so long ago the fed had $800-900b in assets. all those and some have effectively bent lent out. So it needed more funds to act as the lender of last resort, and the treasury supplementary financing program provided the funds.
you can think of it as sterilizing the fed’s lending, or as funding the fed as a lender of last resort now that it has lent out its assets. it works out to the same thing.
the key macro point is that a lot of financial intermediation in the US has come to halt. confidence in money market funds plummeted post Lehman. Money that previously was lent to the banks/ other borrowers is now being parked in treasuries. and buy issuing tbills to meet this demand, depositing funds at the fed and allowing the fed to lend to the banks/ brokers who previously borrowed in the money markets, the treasury and the fed are effectively acting to avoid a complete breakdown.
as i noted in my post, they are taking the risk of providing short-term financing to the banks — something private investors don’t want to do.
bsetser: What are sovereign investors from the emerging world doing?
The Russians have decided to invest at home. Given the situation, that’s more than obvious.
But overall, especially with overseas investments, SWFs are clearly destabilizing. That might be a result of the bad investments in American banks recently. Outside of their home turf they feel like the underinformed suckers and therefore are scared to death by everything.
If any of these funds had some common sense, they’d be investing in undervalued mining companies around the world right now. Investing in a bank may be risky business, but mining is pretty straightforward, especially if your country is an importer of that particular commodity. (A possible example: Mechel is at a P/E of 5 right now)
If you’re more chicken than the chicken in a deflationary environment, that’s clearly destabilising.
Calculated Risk, here is another take on the “Supplementary Financing Program” from “Black Swan” at Mish’s blog:
2008-10-1
4:34:27
MethodMan, I don’t think you understand. The Fed no longer has a balance sheet. It’s keeping two sets of books. It has reserve limits on the original balance sheet of between $800 and $900 billion. In its “U.S. Treasury, supplementary financing account”, it has no reserve limits. How else could the Fed run close to going over its $800 billion limit in the original account, and still come up with another $620 billion for European IBs and $138 billion for JPM?
btw, the recent $620 billion currency swap was a currency intervention (aka “manipulation” when the China/GCC’s do it) to drive EUR down and prop up the dollar. Brad notes, correctly, that this is a currency crisis.
Also note you can’t give the Fed credit for providing that kind of liquidity since an FX swap is off balance sheet and has less reserve requirements. The Fed has no reserve requirements, it can put on a trillion dollar FX swap if it wanted to.
SWFs are dealing with cold hard cash so they are going to be more risk averse than an entity that can create money out of thin air.
Brad,
To reiterate what I wrote last week, I think that the Fed custody holdings are being swollen by the activities of foreign central banks under the reciprocal swap programme (which now stands at $620bn), and so cannot be taken as indicating either an increase in dollar reserves or a retreat to safer treasury assets by central banks. See my blog posting:
http://reservedplace.blogspot.com/2008/09/beware-rising-custody-holdings.html
jboss, you sound like sarah palin…drill baby drill!
your plea is interesting though, for if you look at the policy brief from the Peterson Institute here (table 1):
http://www.petersoninstitute.org/publications/interstitial.cfm?ResearchID=902
you will see that the source of funds for most of the SWFs come from ‘natural resources’ (by the way, if you look at table 3 you will see that the fund at the top of the scorecard is exactly the same one that ms. palin referenced last night).
so in essence, what you are suggesting is a very tight circle of capital flows concentrating in one particular industry, yes?
no matter what, anon is right, your shouts are only whispers in the wind right now and everyone is boarded up in their basements.
the only entity(ies) that is dishing out cash at the moment is not doing so for the sake of productivity, not in the classical sense anyhow.
Calculated Risk,
I love your blog too!
I think of the supplemental financing auctions as raising cash that the Treasury puts on deposit at its bank, the Fed. Like a normal bank, the Fed lends the money to its other customers, the commercial banks. Since the Treasury, presumably by agreement, can be relied upon not to draw on this account, the Fed can even lend to the commercial banks for a term of many days, as in the TAF.
In effect, the Treasury is lending to the commercial banks via the Fed. However, contrary to the quote from anon at 3:09 am, this activity IS on the Fed’s balance sheet. While the Fed’s balance sheet can be expanded without limit in this way, it does raise the issue of what happens if a bank that has borrowed from the Fed defaults and leaves the Fed insolvent.
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“the key macro point is that a lot of financial intermediation in the US has come to halt”
A similar way of thinking about it is that the deleveraging of the private sector has been powerful enough that the public sector has chosen to offset some of the shock by increasing its own leverage (borrowing). It’s a partial transfer of risk from the private sector to the public sector. At the same time, the distinction between the Fed balance sheet and the government balance sheet has become even more seamless with the partial funding of the Fed by the government.
The Federal Reserve is largely responsible for the US financial fiasco with its “lax financial supervision and the irresponsible expansionary monetary policy of the Federal Reserve Board era under former chairman Alan Greenspan and Bernanke, his successor”.
http://www.atimes.com/atimes/Global_Economy/JJ04Dj03.html
The mother of all golden parachutes
By Hossein Askari and Noureddine Krichene
Conventional wisdom in Washington believes that a slightly modified version of Treasury Secretary Henry Paulson’s initially US$700 billion bank bailout plan will pass the House of Representatives on Friday following the Senate’s approval on Wednesday.
Conventional wisdom fails to see that Paulson’s “Troubled Asset Relieve Program” (TARP), now an $810 billion measure thanks to an increase in the cap on federal deposit insurance and tax breaks, will do little to alleviate the ominous financial and economic clouds hanging over the United States and the rest of the world.
The initial defeat of the plan hatched by Paulson and Federal Reserve chairman Ben Bernanke in the House of Representatives at the start of the week should have ushered in the end of the George W Bush’s administration disorderly financial policies, lax financial supervision and the irresponsible expansionary monetary policy of the Federal Reserve Board era under former chairman Alan Greenspan and Bernanke, his successor.
It was a setback to the inflationist forces that wanted to put the burden of the speculative bank losses on the American workers based on the thesis that the Paulson-Bernanke plan is better for American families and their children than any other economic stabilization plan, plans which were not presented and debated. Bankers wanted to get rid of their speculative impaired assets by exchanging trash for cash, with an attendant cost to the economy of hyperinflation, in turn exacerbating food and energy price inflation and eroding family real incomes.
rebel — I am not convinced that the use of the swap lines would produce an increase in custodial holdings. my sense is that when a central bank activates the swap it is b/c it needs the $ to lend out; it isn’t something that produces any need to park funds. I’ll try to find out more — for the moment, tho, I’ll stick with my flight to safety explanation. it is consistent with a lot of other things we seen the market (low treasury yields) and that some central banks report (india shifting reserves out of commercial banks to the BIS)
jkh — I’ll just second your points above.
Here’s the Morgan take on the Fed Balance sheet this morning, and they also think swap lines are included in “other”.
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JPMorgan on the Federal Reserve Balance Sheet Expansion
October 3rd, 2008 4:08 am | by John Jansen |
Here is the JPMorgan take on the Fed balance sheet:
Assets on the Fed balance sheet increased $285 billion last week to $1.498 trillion, the biggest one-week increase ever. In fact, many features of this week’s report were superlative, as there were staggering increases in the usage of several facilities (see charts below). Discount window borrowing increased $10.2 billion to $49.5 billion (all figures are outstanding as of yesterday); the Primary Dealer Credit Facility, including the facility for three London subsidiaries of broker-dealers, increased $40.9 billion to $146.6 billion; the ABCP facility rose $79.4 billion to $152.1 billion; the AIG loan increased $16.7 billion to $61.3 billion; and the “other” category, which is mostly swap lines with foreign central banks, increased $136.6 billion to $320.5 billion. Much of the increase in the balance sheet was financed by a $184.7 billion increase in the Treasury’s supplementary financing account, though some of the extra reserves created by the expansion of the Fed’s balance sheet apparently ended up in excess reserves of depository institutions. (Note: we will have a special report out tomorrow discussing the changing mechanics of the Fed’s balance sheet). Contrary to some reports, the revaluation of assets in Maiden Lane LLC was not presented in this week’s report; the Fed intends to report that on October 23.
http://acrossthecurve.com/?p=1780
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But it still seems to be stuck somewhere because the intended effect of creating dollar liquidity for foreign banks and thereby pushing down Libor rates has not yet come to pass. Earlier this year when the Fed made it’s big interest rate cuts, the Libor rate moved down a similar amount very quickly. So that’s a indicator of how much higher the Fear Factor is today.
Also, the ECB is finally indicating it may cut interest rates. This would eliminate the last hawk in the world and give more latitude to Bernanke and other major central banks to follow with coordinated interest rate cuts and not upset the current status quo in relative currency valuations. Course that means Chinese and Middle East dollar pegs get more expensive again and inflationary pressures go up those places. More wondering to do about how long they want to take it in the shorts.
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Libor Three-Month Rate Rises to the Highest Level Since January
By Lukanyo Mnyanda
Oct. 3 (Bloomberg) — The cost of borrowing in dollars for three months in London rose to the highest level since January, the British Bankers’ Association said.
The London interbank offered rate, or Libor, that banks charge each other for such loans climbed 12 basis points to 4.33 percent, BBA data showed today. Overnight dollar loans fell below the Federal Reserve’s target rate for the first time since Sept. 14, 2007. It dropped 68 basis points to 1.996 percent.
Credit markets have seized up as banks balk at lending to each other for longer than a day amid concern that more of their peers will fail. Governments in Europe and the U.S. have rescued six banks in the past week. The Libor-OIS spread, a gauge of cash scarcity among banks, jumped 14 basis points today to 284 basis points.
To contact the reporter on this story: To contact the reporter on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net
Last Updated: October 3, 2008 06:57 EDT
http://www.bloomberg.com/apps/news?pid=20601087&sid=a0L3w9qd.IBk&refer=home
Calc Risk:”While the Fed’s balance sheet can be expanded without limit in this way, it does raise the issue of what happens if a bank that has borrowed from the Fed defaults and leaves the Fed insolvent.”
This is where my layman economic mind thinks we cross the fine line of whether we are extending credit or just plain printing money.
Cedric — JPM’s economist knows the fed well; I think the issue is settled.
As to what happens if the fed takes losses –
a) the Fed can cover the losses out of its profits. It has a portfolio of interest bearing assets and lots of zero cost liabilities. that means a smaller fed contribution to the overall budget and a bigger budget deficit
b) The Treasury can write the Fed a check (ok, borrow money by issuing treasuries, and hand the cash over to the fed — or just give the fed a treasury bond), making up for the Fed’s losses.
It is no different than the issues around the foreign exchange losses on China’s balance sheet.
Brad,
If you look at my blog posting, you will see a link to the BoE market notice that explains how the dollar loans work. They are always secured loans, so collateral of some kind is taken. Paragraph 19 says “US Treasury securities should be delivered free of payment across Fedwire to the Bank of England’s account at the Federal Reserve Bank of New York (FRBNY)”.
brad:
In the world this may be a flight to safety, in the US it’s a flight to cash, i.e. “access all available credit lines and stash the money away safely, just in case”.
Short term government paper can only go to zero. So those rates may well understate the problem. But the euro swap rate is pretty telling.
Now if all the people in the boat hop left and the 500 pound gorilla hops left too, then the boat starts to have a problem.
The SWFs have the pockets to pursue a Buffet-style approach, taking reasonable risk, when the price is right, and wait for some dividends to come in.
But they don’t.
If you look at FX there is an ongoing flow of funds from everywhere except Japan to the US. And even then US money market funds are in trouble.
SWFs may still have positions in commodities, who knows? But they don’t seem to move in any of those assets, that provide actual capital to the real economy. Not money funds, not equity, not corporate bonds.
I don’t really want to say, what they could do, because the possibilities are countless in the moment for global long term investors.
It’s just, that they are not one of those.
Could anyone explain in more detail “currency crisis” and how exchange rates are likely to move ?
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RE,
Do you have any wild guess as to what proportion of dollar loans would be collateralized by treasuries? I wouldn’t have thought European commercial banks would have that many lying around. But I don’t know.
jkh,
I am afraid I have no clue, but the BoE notice for example says that 4% more collateral must be pledged if the securities provided are non-dollar, which provides some incentive to pledge dollar securities. I dare say the other central banks will have similar restrictions. The amount of treasuries they get will depend on the tradeoff between the haircut and the market repo rates for the various securities permitted by the central bank concerned.
Technically, the Fed is expanding the monetary base, at least temporarily. However, it is not yet formally monetizing the debt to be created by the bailout plan, and whether the massive increase in the monetary base will become inflationary depends on a number of factors, and especially on how the Treasury acts with respect to the bailout and on further moves by both it and the Fed more generally with respect to fiscal and monetary policy.
1. The Treasury has sold 150 billion of new bonds already, but it has placed the proceeds in the Fed, which is a liability of the Fed on its balance sheet. The Fed can then use that money to buy bonds, because it has been selling a huge chunk of them, and needs to replenish its holdings of Treasury securities. Doing it this way prevents the purchases of bonds by the Fed having an inflationary effect, since the original sale by the Treasury first drained money from the banking system, and given that the Treasury is not spending that $150 billion on other things.
2. The proposed bailout would also require the Treasury to sell 700 billion in new bonds. The $630 billion of new dollar liquidity recently arranged by the Fed in consort with foreign central banks will or can be used by those foreign monetary authorities to buy those bonds, or to lend to other foreign entities who wish to buy them. Again, this is not technically inflationary, because these are loans and need to be repaid, not permanent injections of new money, and because the increase in dollars would essentially be converted to an increase in Treasury bonds, keeping the money out of the banking system, and because most of the increased supply of dollar liquidity would take place abroad rather than in the US domestic economy.
However, when the Treasury starts using the money raised to buy subprime debt from the firms in trouble, the money will start circulating here. If the plan works, of course, the Treasury will get all or most of that money back when it eventually sells the subprime assets, and it can then be withdrawn from circulation. But right now, I’d say that’s a rather uncertain proposition. So the potential upside risk for inflation further down the road is considerable, in my view, since once this extra liquidity is out there, it will not be easy to reduce it without causing another credit crunch and set of insolvencies in the financial sector. So the Fed may well extend the loans practically indefinitely.
So, in sum, this big expansion of the Fed’s balance sheet probably will, to a significant extent, end up adding to the permanent money stock. At the same time, if financial intermediaries such as banks and other lenders fear recession, and they do, then they will hoard cash or its equivalent (i.e. Treasury bills) and not use it invest in the real economy. I.e., we will be in a liquidity trap. In a word, all the signs point to stagflation. You’ll have asset price deflation and consumer price inflation.
The central bank inflates the monetary base, but investors hoard cash and/or buy only gilt-edged government securities, while reducing investment in capital goods. But the inflated currency and low interest rate charged by the central bank causes a fall in its relative exchange value. As the dollar falls against other currencies, the price of imported goods rise, leading to a wage-price spiral. Employers react by cutting employment and output, which reinforces the fall in demand for capital goods and falling asset values.
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The haircut economics certainly favour treasuries. But my suspicion is they tend not to hold a lot of treasuries to begin with, partly because it may not be a preferred source of prudential asset liquidity in their dollar books when they have other choices (too expensive as a running margin cost). Just a guess, though.
jkh,
Another thought is that, as well as treasuries, some of the central banks may accept agencies as loan collateral, which can also be placed in custody with the Fed, but probably trade cheaper in repo. There may even be some acceptable supranational – eg World Bank – bonds that can be held at the Fed too.
[...] Give Fed Credit: Brad Setser, writing on the Council of Foreign Relations, talks about what the Fed has done right. “By my count, the Fed is now providing about $1.25 trillion in liquidity support to the global financial system
jboss: If any of these funds had some common sense, they’d be investing in undervalued mining companies around the world right now
One problem is that the governments that own a lot of these SWF’s are countries with large amounts of resource extraction, and their main goal is to invest in places that will keep paying cash when the oil runs out.
DJC: The Federal Reserve is largely responsible for the US financial fiasco with its “lax financial supervision”
I’d argue the opposite. The Fed did a very good job at financial risk supervision and the companies that the Fed supervised (the megabanks) are in pretty good shape. It’s the institutions that weren’t supervised by the Fed (the standalone commercial banks and standalone investment banks) that are having problems.
There were a lot of unintended consequences of Gramm-Leach. One was that it put the mega-banks under Fed supervision. The result of this was that they were actually supervised, because Treasury and the SEC, the Fed was much more immune to the Bush philosophy of massive deregulation, and so they were still regulating.
The article in the NYT about how the SEC broke down makes sense to me. If you do risk management for a mega-bank, you are constantly aware of the presence of the Fed. However the SEC has never stopped by to look at risk exposures.
bsetser: b) The Treasury can write the Fed a check (ok, borrow money by issuing treasuries, and hand the cash over to the fed — or just give the fed a treasury bond), making up for the Fed’s losses.
Except that Treasury needs the permission of Congress to do this. I have this feeling that a good fraction of the “Wall Street bailout” will eventually go to bail out the Fed (which answers the question of what happens if a lender to the Fed defaults).
bsetser: It is no different than the issues around the foreign exchange losses on China’s balance sheet.
One big difference is that the US Congress is much less of a rubber stamp than the Chinese National People’s Congress.
first — I have formally confirmed that JKH and Murph were right; the collateral posted against the swaps appears as “other federal reserve assets.”
second, Rebel — I am still not convinced (and I looked at your post carefully). My sense is that the BOE, others are lending against something other than Treasury collateral (remember the banks now want treasuries and anything else that is kind of liquid); they could be lending against Agencies — but if that is the case, the rise in agency holdings from european central banks has offset a fall in agency holdings from others. If you have evidence that most of the collateral that the ECB/ BoE and others are accepting for $ liquidity is treasuries, do share it — but for now my base case is that they are lending against less good collateral (like the fed) and that the rise in custodial holdings reflects a flight to safety by EM central banks.
incidentally, i think the FRBNY only holds treasuries and agencies in its custodial accounts (and gold); it doesn’t offer this service (to my knowledge) for dollar denomianted “supranational” bonds (i.e. world bank bonds)
third, I agree with those who have noted here that SWFs are increasingly being used to stabilize their home markets.
jboss: Outside of their home turf they feel like the underinformed suckers and therefore are scared to death by everything.
That’s because they’ve been treated like underinformed suckers. One rule is that if a foreign government authorizes a sale of an asset, you probably want to think twice about buying it since if it was any good, they wouldn’t be selling it to you.
One thing that a SWF has to ask when someone wants an investment is why they are desperate enough to want cash from an SWF.
If you go back a year and a half, the attitude seemed to be “no American in his right mind would buy these assets, so let’s try to see them to the Chinese/Koreans/Saudis who have more cash then sense.”
Brad,
Extract from http://www.frbservices.org/serviceofferings/fedwire/fedwire_security_service.html
“The Fedwire Securities Service provides safekeeping, transfer, and delivery-versus-payment settlement services to U.S. depository institutions and U.S. branches and agencies of foreign banks. The Fedwire Securities system maintains in electronic form all marketable U.S. Treasury securities, as well as many federal government agency, government sponsored enterprise (GSE) and certain international organizations’ securities.”
I assume that “certain international organisations” includes the World Bank.
bsetser Says:
rebel — I am not convinced that the use of the swap lines would produce an increase in custodial holdings. my sense is that when a central bank activates the swap it is b/c it needs the $ to lend out; it isn’t something that produces any need to park funds. I’ll try to find out more — for the moment, tho, I’ll stick with my flight to safety explanation. it is consistent with a lot of other things we seen the market (low treasury yields) and that some central banks report (india shifting reserves out of commercial banks to the BIS)
Brad – I think these swaps between Central Banks have a very simple explanation. Short-term funding all over the world needed these dollars from Central Banks to keep the short-term market opertaing. Private banks were unwilling to lend to other private banks.
I see that Citigroup and Wells Fargo are arguing over who gets to buy Wachovia. That shows that some banks whose price has been driven down by the market may still have positive net assets.
This crisis will disappear only when transparency is restored. The current reporting system for banks evidently does not provide enough public information for other banks to be confident that loans will be repaid.
The proper Fed role should be to force the needed transparency. Without Fed intervention, it is in the interest of every bank to keep secret its own problem.
I suppose it is possible for voluntary exchange of information between individual banks to provide some increase in transparency. However, if a rapid restoration of the credit markets is required, requirements issued by the Fed is the way to go.
The Federal Reserve is doing exactly what it should be doing. Preventing a fall in the money supply.
In 1929, when many banks failed, the Federal Reserve did not yet see its job as maintaining the money supply as its job. Now it does.
The New York Times has an article today which says that small businesses are having no trouble getting the money that they need, providing that they have a good credit rating ( http://www.nytimes.com/2008/10/02/business/smallbusiness/02sbiz.html?_r=1&em&oref=slogin ).
In other words, the bailout is not needed at all. The big banks that are going broke have top managers who have been looting their own companies through excess salaries, huge bonuses, and share buybacks (to produce artificial income on managers’ stock options in order to take advantage of the low 15% capital gains tax rate).
The bailout claims to establish provisions “to prevent unjust enrichment by participants of the program.” But all of the participants of the program would be unjustly enriched. In fact their past misbehavior would be rewarded. The U.S. Treasury would buy their “troubled assets” for much more than they are worth just so those same managers who mismanaged their companies can keep their jobs and their power.
Howard Richman
http://www.tradeandtaxes.blogspot.com
rebel — I’ll check with FRBNY and get back to you. My sense is that if the Fed was holding say World Banks bonds as a custodian, it would want to report those holdings along with its other custodial holdings.
reformer — yes, the swaps were meant to help foreign central banks supply $ to the offshore market.
ReformerRay: The current reporting system for banks evidently does not provide enough public information for other banks to be confident that loans will be repaid.
It’s not a transparency problem. The problem is many of the loans *won’t* be repaid. People are paranoid because they should be paranoid.
The trouble is that if people do what is individually rational (since we don’t know which loans won’t be repaid, we pull out all our money, therefore insuring that even more loans won’t be repaid.)
ReformerRay: The proper Fed role should be to force the needed transparency. Without Fed intervention, it is in the interest of every bank to keep secret its own problem.
The trouble is that no one knows what their own exposure is. How much money do *you* stand to lose if nothing is done? You probably don’t know.
A loans to B. B loans to C. C loans to D. D loans to E. E loans to F. etc. etc. etc. down to Z.
We *know* Z is broke. Once we Z is broke, then no one in the chain knows how Z affects them. So everyone pulls out their money, and that actually makes the situation worse.
The thing to do in this situation is to make D, E, and F sure about how much money they stand to lose.
Let me ask you something. Suppose you found out that FDIC was going to go broke. What would you do? Most people would run down to their bank and take all of their money out right now, while they could.
That happens about two weeks ago. When Lehman went under, lots of hedge funds thought that they were in good shape, because they bought insurance. Then AIG mentioned that they didn’t have enough money to cover the insurance they sold.
At that point you had mass panic, as people left and right started pulling money out.
Stunney,
Yup, that’s how I think it works.
The unknown at this point is what flavor of stagflation we get. If the Chinese decide to continue to peg at all cost, import inflation would be muted from that side. If opec, et all, maintain the pricing power they have in oil, which is easy seeing how inelastic the price curve is now…maybe a 5% reduction in output is good for a large boost in price…then we are in for energy import inflation…which works itself into the price of everything.
As far as price inflation of US goods and services, they are pressured by a weak economy, but inflationary effects generally surface after a time lag, i.e. once the economy starts to to recover.
But we could get considerable capital destruction in investment, which is one way to reduce the effects of increased money stock.
In 2002-2003 we had a coordinated effort among central banks to re-flate the global economy. It sort of “worked” (look at us now) because the consumer was in relatively good shape and had enough credit capacity to borrow and start the housing boom.
Now there is no consumer shock absorber left, and business in the US basically has no reason to spend and expand.
Now we are getting the same medicine from the powers to be, but the diagnoses is quite different. That always makes me wonder if our economic witch doctors really know what they are doing. Milton Freidman did once convince everyone that the Great Depression was caused by a too restrictive monetary policy by the Fed (I my opinion it was caused by the Roaring Twenties, but I’m the only one that thinks that). But later Milt seemed to have changed his mind and said the Fed should be abolished and replaced by a computer that is programmed to just slowly increase the money supply at a fixed rate. Bernanke is however a subscriber to Milt’s first conclusion.
It’s not a bailout so much as a clean up.
Richman: In other words, the bailout is not needed at all.
The beach is a very nice place, two hours before the tsunami hits.
Right now the short term credit markets have completely broken down. The fact that few people on Main Street notice is because the Fed has pumped hundreds of billions of dollars into the financial system, but they are about to run out.
Richman: But all of the participants of the program would be unjustly enriched. In fact their past misbehavior would be rewarded.
No. Most of the offenders have been driven out of business, and their CEO’s and senior management have been kicked out. They may have gotten golden parachutes, but they were still kicked out of the plane.
But closing down bad banks and kicking out senior management is just the start of the problem. You still have to deal with the mess that they left behind.
Brad, thanks! Times have changed since we used to chat all the time. I appreciate the response, and I read your site every day.
Best Wishes,
CR
CR — I know. We both have gone off and become respectable …
bsetser: “b) The Treasury can write the Fed a check (ok, borrow money by issuing treasuries, and hand the cash over to the fed — or just give the fed a treasury bond), making up for the Fed’s losses.”
Who buys those issued treasuries ? The primary dealers ? Aren’t primary dealers either bankrupt or levered 30 to 1 ? Where do they get the money ? Repo/TAF/TSLF/AMLSF with the Fed ? Where does Fed get the money ? Treasury ?
If something external to this “triangle” doesn’t provide real funds, then this is standard “triangular debt.” Better hope foreigners step up to the plate.
first time I agree with Howard Richman !
The Fed is obviously overwhelmed.
Americans have enjoyed the benefits of the Fed supplying and managing the world’s reserve and commodity-denominated currency. We got low inflation at home and the entitlement to run up unlimited trade and fiscal deficits while maintaining an AAA rating and inelastic demand for our government bonds. In exchange, we became responsible for the stability of financial operations throughout the entire world.
Now, through a psychedelic-level explosion of complexity in international financial “innovation” no one can possibly know enough about who has provided what credit to whom, and the resulting Tower of Babel of multi-level risk and counterparty relationships, to keep up with real time unfolding events. One of the biggest fears seems to be that we’re going to continue to find out just how crazy the credit market players have really behaved.
Our Federal Reserve System was never designed for this world-management role in such a Rube Goldberg financial environment, and its actions during the last 7 years clearly show how primitively it functions as the “World’s Central Banker.”
No wonder there is panic in the world financial centers.
Calculated Risk Says:
The Treasury has been raising cash for the Fed like crazy, see:
http://www.treasurydirect.gov/instit/annceresult/press/preanre/2008/2008_cmb.htm
–
The Treasury auctions running from 9/17 through Tuesday 9/30 add up to the $344.473 billion reported in the H.4.1 (”U.S. Treasury, supplemental financing program” entry) which is supposed to include activity through Wednesday 10/1. However, there was a $50 billion auction on Wednesday 10/1. Does anyone know why this auction result was not included in this latest H.4.1 report? Is there a time cutoff other than close of business?
Thanks,
Brian
Does anyone know why this auction result was not included in this latest H.4.1 report? Is there a time cutoff other than close of business?
–
Never mind. The auction on 10/1 had an issue date of 10/2.
Thanks,
Brian
@Twofish
Re: underinformed suckers
Couple of SWF banking investments had repricing clauses hardly the action of the underinformed suckers
Can you name any private US underinformed insane suckers who made contemporaneous or prior investments? I see quite a few.
Some of the SWFs have arguably lower costs of capital than US private investors and a currency hedge in US investments
SWFs may have strategic reasons for investments
“The trouble is that no one knows what their own exposure is. How much money do *you* stand to lose if nothing is done? You probably don’t know.”
“No. Most of the offenders have been driven out of business, and their CEO’s and senior management have been kicked out. They may have gotten golden parachutes, but they were still kicked out of the plane.”
How do you then know who the offenders are? Have you been on the Pestowire?
[...] Give Fed Credit: Brad Setser, writing on the Council of Foreign Relations, talks about what the Fed has done right. “By my count, the Fed is now providing about $1.25 trillion in liquidity support to the global financial system… The basic story that emerges from the Fed’s balance sheet over the past few months is simple: the emerging world’s central banks have fled from any asset with a hint of credit risk, and while the Fed (and other G-10 central banks) have been lending ever large sums to the financial system. In the process they have taken on a lot more credit risk — and offset the broad flight away from risk by private investors and emerging market central banks alike. Absent the Fed’s liquidity support, things would be worse. Much worse.” [...]
Will someone please teach me how to add?
Twofish had an excellent answer to my call for the Fed to enforce transparency. But I could not continue the discussion because I flunk math. Help!
I added the numbers before typing – math OK. I add the numbers after typing – math bad. Is that the secret?
Twofish says the Fed cannot enforce transparency because each individual firm does not know its own level of exposure to toxic loans.
I am a naive observer. My reply is the common sense view that each firm varies in the degree to which it is ignorant of its own exposure to bad loans and in the degree to which loans payable constitute total assets.
The fact that some firms are willing to buy parts of other firms or in some cases whole firms indicate that ignorace of bad loan exposure is not universal.
The only way out of this mess is to have each firm provide information about the good stuff on its books. Ignore the bad stuff. Would that mean that few firms would have good stuff to report?
Twofish postulates a chain of loans – from firm A to firm B to Firm C etc. It seems reasonable that a domino effect is possible.
But in no case, does any one bad loan becoming unpayable knock over any one domino. I claim there has to be some way that the least vulnerable firms can separte themselves from the rest of the pack. I also believe that it is the responsibility of the Fed to enforce this sorting.
I have no idea how to do the sorting but it must be done. To continue with the idea that no firm can be trusted to repay a loan means that the credit system cannot be reformed.
What information is available about short terms loans that are arranged off the exchange? I would expect money Market funds to arrange to make loans to firms that they trust. Is this happening?
ReformerRay Says:
Reformer Ray
Wells deal was a tax arbitrage. it says nothing of the value of banks per se other than the perpetual value of deposits. also wells has a massive valuation advantage vs. peers. This is where confidence trumps reality.
if everyone agrees that the Fed was way too loose for too long and the base needs to contract how is it that adding more liquidity is the right answer? Hussman is correct in stating this is a asset., liability and equity issue. The assets have to fall and yet the Fed is making a stand that asset prices remain elevated at the Krugman high equilibrium point (an oxymoron). The stand is to protect the banks. but why is that good for everyone else. It is commonly accepted wisdom that credit is the problem and yet the fed adminsiters more of the same. That is the definition of insanity.
The US policy to be the world’s financial champion is over. that means massive changes not trying to recap GS and kcik start the engine.
Conspiracy aside what if the US uses the elastic clause to bolster short term cofidence buy back FCB debt and use the pent up demand domestically to absorb excess liquidity. Then like FDR devalue. Preserve the treasury funding window (public interest) mop up liquidity eviscerate debt – where the problem lies in the consumer side as much as the government? The problem with hyper arguments is that there is no wage nexus. Bernanke is playing the only hand he has and it is a losing one.
The devalue scenario is a win win for treasury, fed, banks large debtors — lose lose for savers (small constituency in US) and or J6P
i said that oil would go to a price of $40 / barrel. no one contradicted. i see that, from the peak, we are now half way there . . .
lacking the technical background information to argue with the more econowonk detail above, i am driven as always to the childish questions -
there is a big black toxic cake of negative equity on the table. it has to be swallowed. who gets to cut the cake and allocate the portions ?
the detail only smokescreens the problem.
mike shedlock -
http://globaleconomicanalysis.blogspot.com/
in his current offering, shares my view that printing money will make little difference if people remain unwilling to lend or to spend.
so has the dollar collapse been cancelled – or just rescheduled ?
“Nouriel Roubini tells us that there are 800 billion dollars deposited in US banks by foreign counterparties. Up until this week, if you were a foreign operation, would you rather be in large money-center US banks or European banks? Tough choice, but on balance you would pick the US. Then this week Ireland decided to simply insure every deposit in Irish banks, no matter the size. Predictably, money started flowing from all over Europe into Ireland. National banks and finance ministers are furious with Ireland.
….
But what if the various countries, one by one, decide to guarantee deposits in order to protect their own banks? If you are an international corporation, especially if you are outside the US, do you want your $10 million in Europe or the US if Europe guarantees your deposits with no limit? Could we see silent runs on US banks?
I think it is about an even chance that the government will have to guarantee for a period of time (say 6 months to a year) every bank deposit, regardless of size, in the US.”
think it is about an even chance that the government will have to guarantee for a period of time (say 6 months to a year) every bank deposit, regardless of size, in the US.”
I would say the odds are better than that.
S says: The Wells Fargo offer for Wachovia is not typical because of tax advantage, the two parties had good assets.
Fair enough. Probably true. Nevertheless, it points the way out of this mess. Other firms have assets and tax accountants. Federal employees in all agencies should bend all efforts to encourage such deals. I believe folks have been trying. But Paulson is not willing to wait to let this mess be rationalized on a case by case method.
I’ll admit when we had mark-to-market accounting required and short selling permitted and FDIC insurance caped at $100,000, things were moving too fast, panic was expanding. Something had to be done. Something has been done.
I am pleased that it will take weeks to set up the implementation of the bailout. I expect the situation to be much improved, by market forces, under current rules, before Paulson can act.
My local newspaper reports that Ohio State University owns 39.5 million dollars that it cannot access because it is in an account that is frozen. That account is frozen because its trustee was Wachovia bank, which has frozen all its accounts.
That is the domino effect Twofish described. Note, however, that OSU is not going out of business. It can wait to see how much of its money it will recover.
When the agents at the bottom of the pile – like OSU – can tolerate the delay in settlement, this particular event does not contribute to the panic.
Without panic, this mess will unwind as it should unwind, with many parties going out of business. Less players is good. Credit that is more expensive is not good for economic growth but it is the only way to reduce over-reliance on debt.
The past system must be destroyed and another, viable system, put in its place.
[...] Give the Fed a bit of credit … By my count, the Fed is now providing about $1.25 trillion in liquidity support to the global financial system. [...]
TwoFish wrote:
“Right now the short term credit markets have completely broken down. The fact that few people on Main Street notice is because the Fed has pumped hundreds of billions of dollars into the financial system, but they are about to run out.”
You are incorrect. To quote Milton Friedman, “There is no limit to the extent to which the [a central bank] can increase the money supply if it wishes to do so.” ( http://www.hoover.org/publications/digest/3531496.html )
Howard Richman
http://www.tradeandtaxes.blogspot.com
ReformerRay,
You’ve probably already figured this out, but the “math” issue appears to be really about “time.” If you write a longish post, then submit, you’ll be told your “math” is wrong. It’s really not the numbers you add that matter, it’s how long between the time you started to write and you submitted. I can understand the value of limiting super-long posts. Yours do not seem excessive, so here’s the trick: You write your post first, copy it (Control + C), then add the numbers and submit. If it rejects you (’cause of “math”), go back, paste in your post (Control + V), add the new numbers and submit right away. That’ll work. It’s up to you to be responsible and not go excessive on length of post.
Does anyone know if the Bailout Bill contained the acceleration of allowing the Fed to pay interest on reserves? I know it was in the version that was originally voted down in the House, but there is no press on this at all this weekend.
Paying interest on reserves at the Funds rate would do away with the need for these Treasury supplemental financing bills by allowing the Fed to expand its balance sheet infinitely, without driving rates to zero.
[...] $ nicht, ist aber schlecht f
Explanations: Report lines & T account flows
“Modern Money Mechanics” — Changes in Foreign-Related-Factors:
#41 & #38 SWAP LINES
Thanks, Michael
To get people buying should be the goal of all efforts to stabilize the economy… And if it is too expensive for anyone here, then stabilize Asia and allow them to buy our goods.
It is an open secret that Asia has been overproducing for some time…. So to get Asia to start buying merely takes making room somewhere for Asia to “dump” is surplus products…!
I suggest Hawaii (primarily) for it’s relative remoteness and lack of productive capacity (…to be negatively affected by a relatively vast influx of Asian products.) Mainland-America would have to boost tourism-travel to the Islands to take advantage of the “low” prices….!
Secondly I suggest Alaska… for the same reasons…. However, I suggest the second position as a spill-over because of it’s position on the Continental United States; and, being of the mainland might compromise the “growth” of our own factories.
Just a note… or is it just a quirk…? …That the speech introducing Alaska’s Sarah Palin in the Republican Convention was made by Hawaii’s Governor Lingle…!!!
Hmmm… I wonder…?
[...] facilities and selectively engineered rescues or forced mergers. That has been very useful, but that well is now dry. The Fed has no more good assets to trade for the bad assets the banks can offer. And the supply of [...]