Friday, 26 September 2008

Brad Setser: Extraordinary Times

Brad Setser has a fascinating insight to offer in his newest post, Extraordinary Times:

In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:

Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its “other assets” by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. And that is just what I saw on a cursory glance.

The most that the IMF ever lent out to cash strapped emerging economies in a year?

$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).

The most the IMF ever lend out over two years?

$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)

This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lent out these kinds of sums over such a short-period.




My response:

Excellent and timely, Brad. I’ve been speculating all week that the pressure being used on the Congress to pass the Paulson Plan is the threat of Fed illiquidity. As of two weeks ago, the Fed had lent out more than $600 billion of its $800 billion balance sheet Treasuries against crap MBS collateral.

The Paulson Plan would have allowed the banks to unwind the repos putting the Treasuries back in the Fed, get cash for the crap MBS, and get more Treasuries from the issues financing the $700+ billion funding of the Plan. As a bonus, the Paulson mark-to-maturity price becomes the implicit Level 3 price for capitalisation of all the firms and banks in the system, giving them some breathing room to stay in business. Everyone wins except the poor American taxpayer.

The Fed is very close to being illiquid. That is the fear factor we are seeing at work, and the reason no one will discuss why the bailout is needed - only emphasise the urgency.

13 comments:

pej said...

Hi,
Many thanks for this post. May I recommend to read this as well:

The Black Swan and the Fed

Anonymous said...

Are we setting up for a game changer? Are SWF's the new players? Is the US Treasury funding its stake as we ready best practice rules? 44 SWF and 5.3 trillion $ to compete with. This ought to be good! Globalization for fun and profit. Go US

yoyomo said...

LB,
Are we getting to the point where we have to doubt Fed data as pej suggests. I saw that graph several weeks ago and Karl Denninger did a post on it even further back and if it's not reflecting contemperaneous developments, what are we left with?

Finally, what are the practical implications of non-borrowed reserves of the banking system being negative $150B as in the graph or much more as recent data suggests? Karl interpreted it as the banking system taken as a whole being insolvent. Why haven't there been more implosions?

Gábor said...

What do you mean by FED illiquidity?
That the FED wont be able to swap in more treasuries?
They still have 400+ bn on their latest balance sheet (yesterday)
Is it needed for daily operation? Or is it a regulatory requirement?
Also how about the maturity of the many types of loans the FED ha on its balance sheet repos are only about the third of the aforementioned 600 bn. There are loans to primary dealers, TAF and something called "Other".
So when do they mature and what happens if the counterparty bank cant deliver to the FED at maturity?
regards,

Knute Rife said...

@pej
I don't think this can be characterized as a black swan. That implies a level of randomness that does not seem present in the current mess. Financial institutions issued increasing amounts of garbage in what amounted to a massive feedback loop with declining tuning and increasing oscillation. It collapsed, now there's a run. The issue still in the air is how far does the garbage dump reach? Has it leached into the groundwater and poisoned everything? If so, we're in for a true black swan event because the system, including the Fed, isn't just illiquid, it's insolvent.

@yoyomo
It means we are getting untimely data, which is always the case, but we have reached the point where the data are at least as likely to be contrary to current conditions as they are to reflect current conditions, meaning predictability goes out the window. There's your black swan rising.

As for lack of implosions, it's because no one has shut off the spigot yet. TPG Capital put US$7 billion into WaMu last Spring, as of last night that money is wind in the grass, and all the managers can say is, "Tut tut, our investors won't like that." JPMC gets WaMu for pennies on the dollar with FDIC assistance, immediately announces a US$31 million write-down, and everyone shrugs and goes back to shoveling paper into the furnace that is this economy. The implosions are contained as long as the FDIC can maintain this shell game. But only that long.

acrumb said...

Bank borrowing from Fed reaches $ 188 billion a day.
Check out:
http://www.gata.org/node/6679
Bank borrowing from Fed reaches record $188 billion a day

Irresective of what fed's liquidity situation is, the plan as envision by Henry P. is still a tar pit:
http://www.lewrockwell.com/snyder/snyder15.html
Plus ça Change You Can Believe In
Why the Bailout is Not Socialism
http://wallstreetexaminer.com/blogs/winter/?p=1918
Massive Bailout? Hardly, a Massive Tar Pit Instead
http://www.lewrockwell.com/paul/paul479.html

The Creation of the Second Great Depression

Joseph j7uy5 said...

The way I see it, the Fed taking cruddy securities as collateral, could be called Bailout 1.0. So what Congress is debating is really Bailout 2.0. We'll have both games running at the same time, just one shy of a three-ring circus.

Anonymous said...

How many people have a clue about how the Fed. works? I don't believe most in congress do and this bailout is sure to be a mess.

Where do you start educating the common man about central banks??

Anonymous said...

the fed or illicit lending money that puts us all in hock needs to go down and go away. The usa needs to go to a system of tender that doesn't put it in hock.

Disband the fed. And it might be advised to take them to court on putting the usa in such dire circumstances. Them and the bootlicking nazi brush administation.

Knute Rife said...

Hey, LB, you made Mortgage Lender Implode-O-Meter News!

Anonymous said...

And, doesn't this bailout, designed to finance the Fed, ensure an ever higher stock market? The Fed is accepting stocks as collateral now, so...??

PeterG said...

LB,
You said "As a bonus, the Paulson mark-to-maturity price becomes the implicit Level 3 price for capitalisation of all the firms and banks in the system, giving them some breathing room to stay in business. "

Others (e.g. Larry Kudlow) are saying that it is mark-to-market pricing (or close to it) that will be used, not mark-to-maturity. Who is right?

Peter

Anonymous said...

How many people have a clue about how the Fed. works? I don't believe most in congress do and this bailout is sure to be a mess.

Where do you start educating the common man about central banks??


As an American, I believe that most people especially Americans won't really care about how the Fed works until the pain of hitting the actual pocketbook takes place. There is a lot of info out there, especially in the book titled "Web of Debt" by Dr. Ellen Brown. It is sad, but by the time the common man begins to be concerned, it will probably be too late for him.