Monthly Archives: December 2009

Auerback Critiques Bernanke

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Well stated!!

Bernanke doesn’t understand the basic economics of central banking

By Marshall Auerback

Dec 19 — I would like to incorporate a critique of quantitative easing based on Bernanke’s comments in Ed’s post “Quantitative easing and inflation expectations.”

You’ve got to focus on improving the conditions for potential borrowers, not on the banks’ balance sheets. Banks are never reserve constrained. Even the BIS, the central banks’ central bank, understands this. In a recent report, the BIS said the following:

In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans. The aggregate availability of bank reserves does not constrain the expansion directly.

It is obvious why this is the case. Loans create deposits which can then be drawn upon by the borrower. No reserves are needed at that stage. Then, as the BIS paper says:

in order to avoid extreme volatility in the interest rate, central banks supply reserves as demanded by the system.

The loan desk of commercial banks have no interaction with the reserve operations of the monetary system as part of their daily tasks. They just take applications from credit worthy customers who seek loans and assess them accordingly and then approve or reject the loans. In approving a loan they instantly create a deposit (a zero net financial asset transaction).

The only thing that constrains the bank loan desks from expanding credit is a lack of credit-worthy applicants, which can originate from the supply side if banks adopt pessimistic assessments or the demand side if credit-worthy customers are loathe to seek loans. Banks are never reserve constrained, so this comment below from Bernanke is either ignorant or deliberately misrepresents the actual operations of the banking system (as opposed to the nonsensical Economics 101 version).

Ultimately, if the economy normalized, and the Fed took no action, the banks would take those reserves, try to lend them out, and they would begin to circulate, and the money supply would start to grow. And then, ultimately, that would create an inflationary risk. So, therefore, as the economy begins to recover, and as we move away from this very weak economic environment, the Federal Reserve is going to have to pull those reserves out of the system.

The mainstream belief is that quantitative easing will stimulate the economy sufficiently to put a brake on the downward spiral of lost production and the increasing unemployment. Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts. It is commonly claimed that it involves “printing money” to ease a “cash-starved” system, and based on the erroneous belief that the banks need reserves before they can lend and that quantitative easing provides those reserves. That is a major misrepresentation of the way the banking system actually operates.

Bank lending is not “reserve constrained.” Banks lend to any credit worthy customer they can find and then worry about their reserve positions afterward. Even the BIS recognizes this. In reality, if the banks are short of reserves then they borrow from each other in the interbank market or, ultimately, they will borrow from the central bank through the so-called discount window. They are reluctant to use the latter facility because it carries a penalty (higher interest cost). But the reason that the commercial banks are currently not lending much is because they are not convinced there are credit worthy customers on their doorstep.

The current incoherence of our economic policy making could diminish if we had a Fed chairman who understood how the banking system genuinely operated, as well as one who would understanding the linkages between banking lending and fiscal policy, which he persistently downplays (or even worse when he starts calling for long term reforms to balance the Federal government’s budget). It is a national tragedy that this man is being given the chance at another term in office.


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Stiglitz Warns US Economy May Contract Next Year

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Unfortunately, he and all the other deficit doves still can’t refute, and thereby tacitly support, the notions that include ‘we have to borrow money from China to pay for it.

So, while probably right on the prognosis, he remains part of the problem rather than part of the answer as The 7 Deadly Innocent Frauds continue to take their toll.

Stiglitz Warns US Economy May Contract Next Year

Nobel Prize-winning economist Joseph Stiglitz warned there’s a “significant” chance the U.S. economy will contract in the second half of next year, and urged the government to prepare a second stimulus package to spur job creation.


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Bernanke statements to TIME editor

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This is a recent statement by Chairman Bernanke regarding the ‘exit strategy:’

Federal Reserve Chairman Ben Bernanke sat down on Dec. 8, 2009 with TIME managing editor Richard Stengel, Time Inc. editor-in-chief John Huey, TIME assistant managing editor Michael Duffy, and TIME senior correspondent Michael Grunwald for a conversation on everything from the state of the economy to the contents of his wallet. Here is an extended, edited transcript of the interview:

Ultimately, if the economy normalized, and the Fed took no action, the banks would take those reserves, try to lend them out, and they would begin to circulate, and the money supply would start to grow. And then, ultimately, that would create an inflationary risk. So, therefore, as the economy begins to recover, and as we move away from this very weak economic environment, the Federal Reserve is going to have to pull those reserves out of the system.

In fact, the causation is that loans create deposits in the banking system. Reserves are not involved. So even if the banks advanced $2T in loans tomorrow, excess reserves of $2T would still be there. Sadly, it seems to be a case of senior Fed officials who no doubt more than understand this obvious point not feeling comfortable enough to discuss it with the Chairman in casual conversation and bring him up to speed on banking and reserve accounting.

He also made the following statements, indicating he had no idea that, functionally, ‘putting capital into banks’ is nothing more than regulatory forbearance, and that the banking system- the some 8,000 regulated and supervised public/private partnerships already in place to do the bidding of the Fed- could have just as easily been used to make the loans and buy the securities in question. Instead, the Fed has burdened itself with the logistics of accounting for the multi thousands of individual mortgage backed securities it currently has in its Maiden Lane and other portfolios that are also currently removing over $50 billion in income from the ‘non govt.’ sectors:

This immediately became relevant, because in mid-October, the crisis heated up again to the point that we thought that we were again within days or hours of a collapse of many of the largest financial firms in the world. It was a dramatic weekend. It was Oct. 10 or 11, Columbus Day weekend, when the Finance Ministers and the central bankers of seven of the largest industrial economies had a meeting here in Washington, which, of course, I attended. Usually, those meetings are very scripted and very dry. In this case, there was palpable concern among the participants that the collapse of their financial system might be just days away, and there was a great deal of discussion about how we, collectively, as the policy makers leading those countries could stop the collapse.

In the days that followed, countries all over the world, particularly the advanced industrial countries, took strong measures to prevent the collapse of the financial systems. That included putting capital into banks; it included preventing the failure of large financial firms; it included guaranteeing the debts of financial firms so they could borrow and keep themselves afloat; it included making short-term loans to firms so that they would have the short-term credit they needed to pay off lenders who were withdrawing their funding. And, again, this was the U.S. doing this, but also many of the most important industrial countries around the world simultaneously, including the U.K., Germany, France, Switzerland and others.


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US Government will go “bankrupt” if health care bill doesn’t pass

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The stupidity of the rhetoric (from both sides) just keeps getting worse:

President Obama: Federal Government ‘Will Go Bankrupt’ if Health Care Costs Are Not Reined In

President Obama told ABC News’ Charles Gibson in an interview that if Congress does not pass health care legislation that will bring down costs, the federal government “will go bankrupt.”

The president laid out a dire scenario of what will happen if his health care reform effort fails.

Gibson Obama“If we don’t pass it, here’s the guarantee….your premiums will go up, your employers are going to load up more costs on you,” he said. “Potentially they’re going to drop your coverage, because they just can’t afford an increase of 25 percent, 30 percent in terms of the costs of providing health care to employees each and every year. “

The president said that the costs of Medicare and Medicaid are on an “unsustainable” trajectory and if there is no action taken to bring them down, “the federal government will go bankrupt.”


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Man of the year

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I’m perhaps a bit harsher and more direct in my criticisms than Time Magazine when they named Chairman Bernanke their
Man of the Year:

His latest speech shows he’s got ‘quantitative easing’ and monetary operations completely wrong as he believes the banks lend out reserves.

His alphabet soup of programs for the interbank lending freeze up completely missed the
point that all the fed has to do is lend in the fed funds market which would have immediately solved the problem that never should have happened, and lingered for over 6 months and contributed to the last leg of the collapse.
He’s on the wrong side of fiscal policy, urging the Congress to balance the budget, at least longer term.

He’s on the wrong side of the trade issue, trying to engineer exports at the expense of domestic consumption,
which is indeed happening, and causing our real terms of trade and standard of living to deteriorate.

He hasn’t even begun to consider the evidence that is showing lower rates to be deflationary rather than inflationary.

He still adheres to inflations expectations theory.

His unlimited dollar swapline program was an extraordinarily high risk policy that fortunately worked out,
but never should have been done without discussion with Congress. In fact, last I read he still thinks it was low risk,
not understanding that fx deposits at the foreign CB are not actual collateral.

If I had to select someone from outside the Fed for the next chairman Vince Reinhart is the only one I can think of that at least thoroughly understands monetary ops and reserve accounting, though we do have our differences on theory and policy .


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Banks Given 10 Years To Meet Tougher Capital Rules – Tokyo

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Capital ratios control permissible leverage which initially appear to control bank returns on equity, but longer term spreads adjust and the roe gravitates to a bank’s cost of capital.

And since higher leverage increases risk to investors, the cost of capital eventually adjusts to the capital ratios, so over time- in the long run when we’re all dead to quote Keynes- it all comes down to about the same thing.

With markets discounting the near term a lot more than the long term it makes sense lower capital ratios will help bank equities.

>   
>   FYI – FSA just stated no agreement has been reached yet.
>   

*JAPAN’S FSA SAYS NO AGREEMENT TO EXTEND RULE IMPLEMENTATION
*JAPAN’S FSA SAYS INTERNATIONAL TALKS ON CAPITAL RULES ONGOING
*JAPAN BANK REGULATOR SAYS `NO TRUTH’ CAPITAL AGREEMENT REACHED

By Shingo Kawamoto
Dec. 16 (Bloomberg) — Japan’s Financial Services Agency
says no agreement has been reached on delaying new rules on
capital adequacy for banks. Motoyuki Yufu, a spokesman for the
regulator, spoke after the Nikkei newspaper reported
international banking authorities agreed to start introducing
new capital adequacy rules from 2012, giving lenders a
transition period of 10 to 20 years to implement the
regulations.

>   
>   Based on article below this transition period could potentially apply to
>   all banks and not just Japanese banks
>   

Banks Given 10 Years To Meet Tougher Capital Rules

TOKYO (Nikkei)- Global banking regulators have agreed to effectively delay the enforcement of new capital adequacy rules for large banks, opting to create a transition period of at least 10 years, The Nikkei learned Tuesday. The Basel Committee on Banking Supervision, made up of the banking authorities of major countries, has been discussing introducing stricter capital requirements since September 2008 in an effort to prevent a recurrence of the global financial crisis.

The proposed changes include raising the 8% minimum capital ratio banks are currently required to maintain and focusing on a narrower definition of core capital. The committee will stick to its plan to gradually introduce the new rules starting in 2012, but will establish a transition period of 10-20 years. This means that the rules will not be fully implemented until at least the early 2020s.

Banking authorities have apparently determined that a rush to adopt stricter requirements might deter lending by major banks and hurt the chances of a recovery in the global economy. “The Basel Committee has turned to a more cautious approach,” says a financial regulatory official in Japan. The committee will also consider allowing banking regulators in each country or region to decide when to fully adopt the new requirements. The slow phasing in of new capital rules will come as good news to Japanese banks, which had faced the prospect of being forced to bolster their capital through the issuance of common shares.

The Basel Committee plans to compile an outline of its proposals before the end of this year and roll out a concrete plan sometime next year.
(The Nikkei Dec. 16 morning edition)


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Greece Sells 2 Billion Euros of 2015 Debt to Banks

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That spread for its own banks that it guarantees shows a serious funding issue.

During a period of euro weakness funding problems could become worse and spread to other euro nations.

When foreign govts. buy euros for their portfolio of fx reserves, they have to hold them in some kind of account or security. Most probably opt for eurozone national govt paper. Same with international institutional investors.

When they stop adding to their euro portfolios and/or reduce them, they stop buying and/or sell that paper.

The new holders of euro (those who buy the euros when portfolios sell them) may or may not buy that same govt paper, and the euros may instead wind up as excess reserves at the ECB in a member bank account, or even as cash in circulation as individuals who don’t trust the banks turn to actual cash. The banks with the excess reserves may or may not buy the National govt paper or even accept it as repo collateral, to keep their risk down, and instead simply hold excess reserves at the ECB.

Markets will clear via ever widening funding spreads as national govt paper competes for euros that are otherwise held as ‘cash reserves.’ The amount of reserves held at the ECB doesn’t actually change, apart from some going to actual cash.

What changes are the ‘indifference levels’- yield spreads- between having cash on your books and holding national govt paper risk. And the ability to repo national govt paper at the ECB doesn’t help much.

Would you buy Greek paper today if you were concerned it might default just because you could repo it at the ECB, for example?

Also, while Americans go to insured banks and Tsy secs when they get scared, Europeans exit the currency as they have a lot more history of hyper inflation.

That means a non virtuous cycle can set in with a falling euro making National govt funding problematic, which makes the euro continue to fall.

This happened a little over a year ago due to a dollar funding liquidity squeeze.

The Fed bailed them out with unlimited dollar swap lines and the euro bottomed at something less than 130 to the dollar.

This time it’s not about dollars so the Fed can’t help even if it wanted to.

And the ‘remedies’ of tax hikes and/or spending cuts Greece intends to pursue will only make it all worse, especially if undertaken by the rest of the eurozone as well. Fiscal tightening will only slow the economy and cause national govt. revenues to fall further, unless the taxes are on those taxpayers who will not reduce their spending (no marginal propensity to spend) and the spending cuts don’t reduce the spending of those who were receiving those funds.

And the treaty prevents ECB bailouts of the national govts. so any bailout from the ECB would require a unified Fin Min action and an abrupt ideological reversal of the core monetary values of the union towards a central fiscal authority.

This is somewhat analgous to what happened to the US when the original articles of confederation gave way to the current constitution in the late 1700’s..

Greece Sells 2 Billion Euros of 2015 Debt to Banks, Bankers Say

By Anna Rascouet and Christos Ziotis

Dec. 16 (Bloomberg) — Greece sold 2 billion euros ($2.9 billion) of floating-rate notes privately to banks, eight days after Fitch Ratings downgraded the nation’s debt as the government struggles to cut the European Union’s largest budget deficit, two bankers familiar with the transaction said.

The securities, which mature in February 2015, will yield 250 basis points, or 2.5 percentage points, more than the six- month euro interbank offered rate, or Euribor, they said. That’s 30 basis points higher than a similar-maturity Greek fixed-rate bond when converted into a floating rate of interest, according to data compiled by Bloomberg.

Greek bonds have fallen in the past week, with two-year note yields rising by the most in more than a decade on Dec. 8, when Fitch cut the nation’s credit rating to BBB+, the lowest in the euro region, citing the “vulnerability” of the nation’s finances. Prime Minister George Papandreou has been unable to convince investors he can reduce a deficit the government says will rise to 12.7 percent of gross domestic product this year, after the economy shrank 1.7 percent in the third quarter.

“Selling bonds via a private placement can be a double- edged sword at this point,” said Luca Cazzulani, a fixed-income strategist in Milan at UniCredit Markets & Investment Banking. “On the one hand, it shows that Greece can always find buyers for their bonds. But the market might take it as a sign that they only have this channel left.”

Widening Spread

Greek bonds rose snapped two days of declines today, with the yield on the 10-year note dropping 11 basis points to 5.62 percent as of 10:26 a.m. in London. It rose as much as 29 basis points yesterday to 5.76 percent, the highest since April 3.

Concern some countries may struggle to pay their debt was reignited after Dubai’s state-owned Dubai World said on Dec. 1 it wanted to restructure $26 billion of debt. The premium, or spread, investors demand to hold Greek 10-year bonds instead of German bunds, Europe’s benchmark government securities, rose as high as 250 basis points yesterday, the highest closing level since April 2. It narrowed to 239 basis points today.

The participating banks in yesterday’s private placement were National Bank of Greece SA, Alpha Bank AE, EFG Eurobank Ergasias SA, Piraeus Bank SA and Banca IMI SpA, the bankers familiar with the transaction said. Italy’s Banca IMI was the only foreign-based in the group.

Worst Performers

The government paid “generous” terms, said Wilson Chin, a fixed-income strategist in Amsterdam at ING Groep NV.

“I guess you have to pay some liquidity premium, given the sale was done at the end of the year,” he said. “I would be very surprised if they continue to use this method into the first quarter of next year. That would probably be taken as a sign the market isn’t working for them.”

Greek bonds are the worst performers after Ireland among the debt of so-called peripheral euro-region countries this year, handing investors a 3.5 percent return, according to Bloomberg/EFFAS indexes.

In a private placement, issuers offer securities directly to chosen private investors as opposed to selling them through an auction or via a group of banks.

Papandreou pledged in a speech two days ago to begin reducing the nation’s debt, set to exceed 100 percent of GDP this year, from 2012. The European Commission estimates the ratio at 112.6 percent of GDP this year, second only to Italy.

‘Painful Decisions’

“In the next three months we will take those decisions which weren’t taken for decades,” Papandreou said in Athens. He said many choices will be “painful,” though he promised to protect poorer and middle-income Greeks.

Credit-default swaps on Greece rose 1 basis point to 238.5, according to CMA DataVision, after surging 25.5 basis points yesterday. Such swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should an issuer fail to adhere to its debt agreements. A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.


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CPI/Housing

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Karim writes:

CPI

  • Headline CPI +0.4% and core +0.034%
  • OER -0.1% and volatile items largely offsetting (lodging away from home -1.5% vs tobacco +1% and vehicles +0.8% (after +1.7% prior month))
  • Favorable base effects for core coming in H1 2010 should see y/y drift to 1% from current 1.7%

Housing

  • Starts up 8.9%; largely payback from weak October and driven by multi-family
  • Single family up 2.1% (-7.1% prior) and multi-family up 67.3% (after down cumulative 51% prior 2mths)
  • Permits +6% (versus prior -4.2%)
  • Net/Net housing component of GDP likely to remain flat/slightly positive for next 2-3 quarters


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