CB announcements
Posted by WARREN MOSLER on November 30th, 2011
Just looks like the Fed lowered the rate on its swap lines to keep libor down, which had been moving up to its prior swap line rate.
No big deal, apart from the fact the Fed shouldn’t be allowed to lend on an unsecured basis like this without explicit approval of congress.
Lending unsecured on an unlimited basis has the potential to be highly inflationary.
With the currency a public monopoly, the price level is necessarily a function of prices paid at the point of govt spending and or collateral demanded when govt lends.
Allowing unlimited unsecured lending has the potential to vaporize the currency. And while in this case that kind of abuse isn’t likely, the potential is there.
November 30th, 2011 at 12:12 pm
Heard Erin Burnett talking about it on CNN last night. Had to come from this site as its the only place I’ve heard it discussed in the proper context, etc ( dangerous spending without congressional approval). Keep up the good work. Eventually the financial press will come around if not in 100 years.
Reply
November 30th, 2011 at 12:32 pm
Heard Steve Liesman say that there is no risk to the Fed as the ECB must pay back the same quantity of dollars that it was lent. But how does it do this? Or more importantly, can it absolutely guarantee doing this? The answer is no. If the euro vaporizes, the ability of the ECB to pay back the same quantity of dollars gets problematic.
Reply
WARREN MOSLER Reply:
November 30th, 2011 at 1:14 pm
Like lending to someone vs his watch and he gets to wear it and lives in the next galaxy
Reply
Art Reply:
November 30th, 2011 at 3:19 pm
@WARREN MOSLER,
42?
Reply
beowulf Reply:
November 30th, 2011 at 4:09 pm
@Art,
Don’t forget your towel!
WARREN MOSLER Reply:
December 1st, 2011 at 8:58 am
Lost the context sorry
Art Reply:
December 1st, 2011 at 12:31 pm
@Warren,
Your analogy reminded me of this: http://en.wikipedia.org/wiki/The_Hitchhiker's_Guide_to_the_Galaxy
Art Reply:
December 1st, 2011 at 12:32 pm
The link got screwed up. Copy and paste if this try doesn’t work:
http://en.wikipedia.org/wiki/The_Hitchhiker's_Guide_to_the_Galaxy
kkken530 Reply:
December 2nd, 2011 at 2:02 am
@Art, Shouldn’t that be 4.2
Matt Franko Reply:
November 30th, 2011 at 4:39 pm
@Mike Norman, Mike if you read the actual settlement details you can see how it is the counterparties (ie the institutions) that are required to put the balances back in their respective NCBs account at the FRBNY:
“On the maturity date, market counterparties are required to pay back US dollar funds to the accounts of NCBs at the FRBNY by 16:00 Frankfurt time”
http://tinyurl.com/7tnkrlh
Doesn’t look like the “ECB” is even involved operationally. If you go by the actual wording of the agreement, if that matters. I suppose it is printed on ECB letterhead.
It’s not like the Fed’s agreement and operation is with the ECB and then the ECB deals with their resident institutions. The Fed is dealing with the Euro institutions directly looks like.
Resp,
Reply
Unforgiven Reply:
December 1st, 2011 at 1:29 am
@Matt Franko,
Good commentary. Thanks Matt.
Reply
November 30th, 2011 at 12:47 pm
Looks like the Fed has found a way to create inflation :)
Seriously, now I’m confused (again!). Can you help me understand the difference between the dollar swap line lending rate being inflationary when reduced, but the Fed funds rate not being so? (We were talking about interest rate channels, and how potentially the Fed could create inflation but only by increasing the Fed funds rate, which is backwards from what is typically thought.)
Also, thanks for the “there’s going to be a face-ripping rally in Europe” call, that’s working out nicely.
Reply
WARREN MOSLER Reply:
November 30th, 2011 at 1:16 pm
Fed lending to banks is different because the FDIC regulates bank spending and lending and congress is the boss of all three
Reply
ESM Reply:
November 30th, 2011 at 5:58 pm
@WARREN MOSLER,
I don’t think that’s a good answer. I would say instead that banks have capital which is in a first loss position. So not only is there a buffer against losses the Fed might take, but the shareholders and other bondholders of the banks have skin in the game, which further mitigates the risk of losses.
The Fed taking losses is the only way that the Fed can create net financial assets.
Reply
DollarMonopoly.com Reply:
November 30th, 2011 at 6:38 pm
@WARREN MOSLER,
Warren’s “Proposals for the Banking System” provided a good explanation that was helpful to me:
Section 2: US banks should not be allowed to contract in LIBOR. LIBOR is an interest rate set in a foreign country (the UK) with a large, subjective component that is out of the hands of the US government. Part of the current crisis was the Federal Reserve’s inability to bring down the
LIBOR settings to its target interest rate, as it tried to assist millions of US homeowners and
other borrowers who had contacted with US banks to pay interest based on LIBOR settings.
Desperate to bring $US interest rates down for domestic borrowers, the Federal Reserve resorted to a very high risk policy of advancing unlimited, functionally unsecured, $US lines of credit called ‘swap lines’ to several foreign central banks. These loans were advanced at the Fed’s low target rate, with the hope that the foreign central banks would lend these funds to their member banks at the low rates, and thereby bring down the LIBOR settings and the cost of borrowing $US for US households and businesses. The loans to the foreign central banks peaked at about $600 billion and did eventually work to bring down the LIBOR settings. But the risks were substantial. There is no way for the Fed to collect a loan from a foreign central bank that elects not to pay it back. If, instead of contracting based on LIBOR settings, US banks had been linking their loan rates and lines of credit to the US fed funds rate, this problem would have been avoided. The rates paid by US borrowers, including homeowners and businesses, would have come down as the Fed intended when it cut the fed funds rate.
Reply
Unforgiven Reply:
November 30th, 2011 at 10:15 pm
@DollarMonopoly.com,
Great reference, DM. Yeah, that helps!
Art Reply:
December 1st, 2011 at 12:39 pm
@DollarMonopoly.com,
“If, instead of contracting based on LIBOR settings, US banks had been linking their loan rates and lines of credit to the US fed funds rate, this problem would have been avoided.”
Is it possible that banks lean toward LIBOR because ‘normal’ central bank operations tend to ignore the issue of net financial assets?
In other words, if there’s a shortage of NFAs, and you can’t count on central banks or other govt institutions to respond appropriately, doesn’t the interbank rate become the far more relevant rate for banks?
I agree it’s a severe policy ommission, just thinking that it may be driven (and justified, at least in banking system’s POV) by errors and ommissions elsewhere (e.g., macroeconomics). Of course, they’re both lending rates, and the Fed keeps the discount window open, so this might be irrelevant. Anyone?
Anders Reply:
December 1st, 2011 at 5:02 am
@WARREN MOSLER, I don’t follow why this could be hyperinflationary for the US? The context here is a huge decline in risk asset values, capital losses for investors in banks and peripheral EZ sovereigns, plus very weak Western consumer sentiment. What is the transmission mechanism between the Fed support touted here and hyperinflation?
Reply
Shaun Hingston Reply:
December 1st, 2011 at 8:04 am
@Anders,
My understanding is that the FED is giving money via swap lines to Foreign Central banks, of which the FED does not have the authority to guarantee repayment for said cash.
Therefore, hypothetically, foreign central banks could take the U.S.D, without ever paying it back. This would lead to a net transfer of wealth(Real Goods & Services) out of the U.S. economy, but the overall U.S. money supply would have increased.
Ohh, just in case, the foreign central banks lend this to their banks, who are holding U.S denominated housing debt.
Anders Reply:
December 1st, 2011 at 8:46 am
@Shaun Hingston , if the foreign central banks aren’t *able* to repay the USD to the Fed, then this isn’t inflationary because necessarily the money supply would have decreased – or rather, the increase in the money supply from the Fed loan (via the swap line) would have been cancelled out by the losses at the banks which were being supported by this swap line.
Surely the concern can’t be that the foreign central banks may not be *willing* to repay the USD to the Fed, right? Surely the Fed has sufficient negotiating leverage with Europe to make repayment of any loans a precondition of monetary cooperation in general.
Not sure what I’m missing.
Shaun Hingston Reply:
December 1st, 2011 at 9:11 am
@Anders,
I agree, the risk seems overblown to me. Also I don’t proclaim to know the ins and outs of this issue.
if the foreign central banks aren’t *able* to repay the USD to the Fed, then this isn’t inflationary because necessarily the money supply would have decreased – or rather, the increase in the money supply from the Fed loan (via the swap line) would have been cancelled out by the losses at the banks which were being supported by this swap line.
I think your getting a little mixed up here. The FED gives money to Foreign Central Bank, which gives it to local bank, which then in one way or another ends up in the U.S. economy. If the local bank fails, which would mean insolvent, then it would not have the actual U.S.D. The U.S.D is still floating around in the U.S. economy somewhere, presumably causing prices to rise.
Normally lending will involve bring extra capacity online. So the FED gives you a loan, which you then use to purchase extra idle economic capacity.(The capacity doesn’t have to be idle, but the net effect across the economy, meaning supply will increase to demand, is that capacity of the economy will increase). The FED then takes this as collateral. This process to a large extent, assuming markets are functioning correctly, ensures that there is a balance between the amount of money moving around and the amount of economic capacity.
This relationship is not as straightforward when the item of collateral is held by a foreign central bank, and the FED holds foreign currency. In some way the foreign sovereign holds collateral over U.S assets, controlled with money from the U.S.A, which the foreign sovereign exchanged only printed euros(or whatever) for.
WARREN MOSLER Reply:
December 1st, 2011 at 9:12 am
They borrow and spend heaps enough to drive up dollar prices
GaryD Reply:
December 1st, 2011 at 11:52 pm
Re Warren’s “They borrow and spend heaps enough to drive up dollar prices.”
Doesn’t inflation only result when aggregate demand exceeds the economy’s ability to produce real goods, meaning that unemployment would be waaaaay down???
I thought the MMT prescription currently IS to insert more cash into the economy to drastically reduce the 9 percent unemployment.
WARREN MOSLER Reply:
December 2nd, 2011 at 6:29 pm
All true though I wouldn’t use the word ‘insert’
November 30th, 2011 at 1:31 pm
Does the FED’s balance sheet expand in the same way via swap lines as it does with QE? The difference in the case of swap lines is that there is a potential transmission mechanism?
Reply
WARREN MOSLER Reply:
December 1st, 2011 at 8:53 am
Only if swap lines are used
Depends on how any borrowed dollars are used
Reply
November 30th, 2011 at 1:42 pm
“Vaporize the currency” meaning hyperinflation? What would be the channels? Dollar goes down in foreign exchange making imports more expensive … that might be one. But there should also be an export surge in that case … stimulus via the back door. Wouldn’t idle people and resources need to become employed before the inflation materializes, just like spending by Congress?
Reply
WARREN MOSLER Reply:
December 1st, 2011 at 8:54 am
In theory 100t could be borrowed and spent on real goods and services
But not likely any will be
Reply
Art Reply:
December 1st, 2011 at 12:44 pm
@WARREN MOSLER,
“In theory 100t could be borrowed and spent on real goods and services
But not likely any will be”
Right, you’d still need strong agg demand somewhere in the world for that to happen, no? And swaps don’t add to NFAs unless they aren’t repaid?
Only other channel I can think of is abuse of privilege, somewhat similar to episodes of EM external debt and imploding domestic currencies, which seems a stretch (near impossibility?) for the CBs/countries involved.
Reply
November 30th, 2011 at 1:49 pm
Good observation. The public needs to know specifics of the collateral. If it is unsecured, it should be marked to market. It’s a good cause for somebody like Ron Paul to request it to be secured at minimum, and forbid the practice ideally.
Reply
Ed Rombach Reply:
November 30th, 2011 at 3:58 pm
@KB,
Hmmmnnn….Warren Mosler and Ron Paul nearly on the same page.
Ron Paul Statement On The Fed’s Bailout Of Europe
“Congress should not permit this type of open-ended commitment on the part of the Fed, a commitment which could easily run into the trillions of dollars. These dollar swaps are purely inflationary and will harm American consumers as much as any form of quantitative easing.”
Reply
Ed Rombach Reply:
November 30th, 2011 at 3:59 pm
@Ed Rombach,
Meant to include the link: http://www.zerohedge.com/news/ron-paul-statement-feds-bailout-europe
Reply
beowulf Reply:
November 30th, 2011 at 4:26 pm
@Ed Rombach,
World’s collide! :o)
I’d point out that Bernanke and Summers agree that the Secretary speaks for the govt on fx issues (see below), so clearly Geithner, at minimum, signed off on this. And since he’s the President man, clearly this is far more a political issue than monetary policy where the Secretary’s authority is more indirect.
“At a recent news conference, Ben S. Bernanke, the Federal Reserve chairman, was asked about the falling dollar. He parried the question, saying that the Treasury secretary was the government’s spokesman on the exchange rate — and, of course, that the United States favors a strong dollar…
I [Christy Romer] began: “The exchange rate is a price much like any other price, and is determined by market forces.”
“Wrong!” Larry [Summers] boomed. “The exchange rate is the purview of the Treasury. The United States is in favor of a strong dollar.”
http://www.nytimes.com/2011/05/22/business/economy/22view.html?pagewanted=all
Reply
wh10 Reply:
November 30th, 2011 at 4:39 pm
@Ed Rombach,
Except he is wrong about the QE part.
Reply
Unforgiven Reply:
November 30th, 2011 at 4:44 pm
@wh10,
Purely inflationary?
WARREN MOSLER Reply:
December 1st, 2011 at 9:00 am
Except that qe wasn’t inflationary or risky.
Reply
November 30th, 2011 at 2:18 pm
With the dollar being the global reserve currency, the problem is that if the Fed doesn’t provide liquidity in extremis — which we can probably assume is now — the risk is a liquidity crisis and risk of deflationary spiral. Is there time to try to get congressional approval, which is unlikely to be forthcoming under present gridlock? What’s the alternative to doing nothing and watching the global economy freeze up? Hope that TPTB in the EZ (Germany) come to their senses in time to avoid a meltdown?
Reply
JCD Reply:
November 30th, 2011 at 2:28 pm
@Tom Hickey,
Right. Despite the fact that the market is up today, this seems like bad news to me. I’m guessing the Fed was moved to act because a euro bank was in extremis.
And ultimately, this doesn’t solve any problems. PIIGS are still horribly uncompetitive and facing real refinancing risk. Austerity is still the order of the day around the globe.
It’s painful to watch policy makers blunder about like this.
Reply
WARREN MOSLER Reply:
December 1st, 2011 at 8:56 am
With imports benefits and exports costs (real) deflation there benefits us
Reply
Art Reply:
December 1st, 2011 at 12:46 pm
@WARREN MOSLER,
“With imports benefits and exports costs (real) deflation there benefits us”
Clinton Admin and Greenspan pulled off something like that in the 90s…
Reply
November 30th, 2011 at 2:38 pm
Isn’t this happening at the level of CBs’ and EU + US banks’ reserves? 29 trillion US$ of various FED’s bailouts did not prove inflationary because of that. Why should this swap do? Thx for any reply. P.
Reply
WARREN MOSLER Reply:
December 1st, 2011 at 8:57 am
It won’t unless the dollars go to consumption which they won’t in this case
Reply
November 30th, 2011 at 3:49 pm
If we give our owners enough time, they will show compassion and start implementing policies that benefit us all…. You’ve got to be somewhat naive to think that this all just boils down to incompetence. Its more than that.
Reply
Cathy Mason Reply:
December 1st, 2011 at 2:02 pm
@Shaun Hingston, A lot of it is ideology, often called neoliberalism. The insistence on austerity measures, which flies in the face of reason, is being used for Grover Norquist purposes: starve the beast, wipe out “socialistic” practices. Apparently there is a call out to give EZ authorities the right to veto the budget of any member nation if it is deemed not to toe the austerity line. This would amount to a diminishment of democracy in these countries as the work of elected officials is undone.
Reply
November 30th, 2011 at 4:40 pm
I assume that ecb will have limits in place for its usd lending to eurozone banks.
Looks like it becomes more and more difficult to find a place to hide against euro collapse.
If euro collapse may lead to hyperinflation in the US then US tsy secs are also not the place to be right?
Any idea about what kind of usd-amounts or as % of gdp we are talking per today for this exposure to ecb?
Reply
Tom Hickey Reply:
November 30th, 2011 at 4:48 pm
@Walter,
If euro collapse may lead to hyperinflation in the US then US tsy secs are also not the place to be right?
I disorderly collapse of the euro would be deflationary for the global economy. The euro is a secondary reserve currency. There would be a a sudden and severe shortage of liquidity.
The resulting capital flight could conceivably result in currency revulsion in general and a retreat into hard assets. That is different from hyperinflation.
Reply
Walter Reply:
November 30th, 2011 at 5:36 pm
@Tom Hickey,
Thanks for your quick reply Tom.
The deflationary effects of a euro collapse are clear, especially in the euro zone.
But as Warren mentions, unlimited and unsecured lending by the US to the ecb has the risk of being highly inflationary.
I assume Warren means the risk that all those loans never get repaid (as Mike also indicates above) and thus turn out to be just deficit spending. Hence my question. About how much additional deficit spending we are then possibly talking.
Could you explain a bit more about ‘the resulting capital flight’ you mention?
‘Currency revulsion’ I read as ‘nobody wants to hold the currency anymore’. Correct me if I am wrong.
If nobody wants to hold the currency anymore then we have hyperinflation.
Reply
Tom Hickey Reply:
November 30th, 2011 at 8:21 pm
@Walter,
A lot of people are startring to doubt that the EZ powers that be can handle the responsibilities attendent on managing the euro currency. Not only are rates rising, but there seems to be flight out of the euro into dollars. This is not just seeking safety, it is capital flight away from a system whose very foundations are shaking. Very Serious People are now talking openly about a likely failure of the euro experiment due to poor design, bad management, and inability to react in a timely fashion.
Hyperinflation is usually associated with an exacerbation of inflation, the idea being that there has to be inflation prior to hyperinflation. Hyperinflation results in currency revulsion, as people flee the currency for real assets. That is not the problem here.
Currency revulsion can also occur in deflationary time if a government cannot manage its monetary and fiscal responsibilities and doubts arise over the continued worth of the currency. Then people flee the currency for real assets. This seems to be happening to some degree wrt the euro, but many people are switching into what they perceive to be stronger currencies. But some feel that the global monetary system itself is getting shaky and they are switching out of currencies into hard assets like gold.
If it is widely perceived that the US is risking inflation of the USD by providing liquidity to the EZ, and that a martingale strategy may not work, where will the money flow instead of euros or dollars. Presumably, a lot will go into hard assets instead of currencies. This can result in a run that is based on currency revulsion but not hyperinflation.
pebird Reply:
December 1st, 2011 at 11:23 am
@Walter, Unless the entire EZ political class does a 180 and decide to allow government spending with an ECB debt backstop, there is little inflationary risk.
This is liquidity management only. Done through the Fed because the ECB can’t do it due to political pressures.
WARREN MOSLER Reply:
December 1st, 2011 at 9:02 am
The swap lines haven’t been used much since the 2008 binge and may not be.
All the fed did was lower the rate some
Reply
pebird Reply:
December 2nd, 2011 at 11:02 am
@WARREN MOSLER, Isn’t this an example analogous to your point that having the ECB backstop EZ debt will result in the debt being purchased by bond markets at reasonable rates with the ECB not having to purchase all debt?
The Fed offering swap line support lowered LIBOR without having to actually be accessed.
Reply
WARREN MOSLER Reply:
December 2nd, 2011 at 6:30 pm
Yes, that can happen.
November 30th, 2011 at 4:44 pm
The question is this, – At the end of the day does the confederacy of “market forces” and an “old guard” shift within the ECB, conspire, to force the ECB to change it’s “Intellectual Underwear”? Right now the equation is tilted to the ECB putting on a new pair of TIDY WHITIES, relegating the long worn “grots” of Buba Think to the hamper within 6 months. At the end of the day THEY (the ECB) is US (the FED).
Joel K.
Reply
November 30th, 2011 at 5:54 pm
What do European banks need USD for?
Reply
Anders Reply:
December 1st, 2011 at 4:59 am
@MamMoTh, a lot of international banking is dollar based. Think of shipping, trade finance, project finance etc. That’s why European banks represent something like 10% of the total deposits (incl wholesale / CDs etc) held in the US.
Reply
WARREN MOSLER Reply:
December 1st, 2011 at 9:04 am
To fond their dollar loans to their clients
Reply
Art Reply:
December 1st, 2011 at 12:55 pm
@MamMoTh,
If you can get your hands on a copy of Paul Einzig’s book The Euro-Dollar System, it’s an interesting contemporaneous (1960s-70s) look at global reintegration of money markets.
(Eurodollar means a USD outside of the US banking system, euroyen is a yen outside Japan’s banking system, etc. The nomenclature has been hopelessly roiled by the introduction of the euro — especially euro-euros!)
Reply
November 30th, 2011 at 6:45 pm
“the price level is necessarily a function of … collateral demanded when govt lends.”
Warren,
So, when the Fed bought near-worthless mortgage securities at full price, that was inflationary, and not simply a relative change in the price of those mortgage securities?
Is it inflationary even when we are at way less than full employment? Or, like the deficit, is it only inflationary when it creates excess aggregate demand? How is this lending dangerous, when a higher deficit would be beneficial? Deos it have to do with the size of the lending, or is it only because of the setting of some sort of standard or precedent?
Is it as stated above that a default on such loans, whether the CDOs or today’s announced lending, is what turns an asset swap into creation of money? Or does the simple lending of money without collateral set the value of the currency to zero (or to some discounted amount representing the creditworthiness of the unsecured creditor), and that is what casues all other prices to rise accordingly?
Does the anmount of inflation depend on the size of the default, or the size of the unsecured lending, or simply on the implied price at which it is done?
If there is no default, is there any inflation? Or is the implication of your statement that there is merely a risk of inflation, comparable to the risk of default?
I’m not clear at all (as you can tell) on the mechanics of how the type of collateral influences the general price level. Can you give a detailed explanation of how that works?
Reply
John O'Connell Reply:
November 30th, 2011 at 6:53 pm
@John O’Connell,
I just read it again and noticed your use of “unlimited”. Your point can’t be that trivial, can it? Obviously, infinite quantities of anything are dangerous. If this lending is “limited”, is there still a problem? Can some of it be good for us, if we don’t overdose on it (like the deficit)? Or is it like some poisons, always harmful but not fatal in small enough doses?
Reply
WARREN MOSLER Reply:
December 1st, 2011 at 9:08 am
None is good for us, and unlimited liquidity for us banks is a benefit
Reply
John O'Connell Reply:
December 1st, 2011 at 7:12 pm
@WARREN MOSLER,
Still
“I’m not clear at all (as you can tell) on the mechanics of how the type of collateral influences the general price level. Can you give a detailed explanation of how that works?”
WARREN MOSLER Reply:
December 2nd, 2011 at 6:27 pm
In the extreme if the fed would lend unsecured and non recourse I’d be first in line to borrow all I could and spend it as fast as I could
John O'Connell Reply:
December 5th, 2011 at 11:15 am
@WARREN MOSLER,
“In the extreme if the fed would lend unsecured and non recourse I’d be first in line to borrow all I could and spend it as fast as I could” [which makes unsecured lending dangerously inflationary]
“Fed should lend unsecured to members and let the FDIC decide if they are solvent”
I’m detecting a conflict in your two statements quoted above.
If the Fed were to lend to just anyone, then I would be quite tempted to get in line right behind you, although I would be sure to borrow an amount that I would never be able to repay. But they don’t, they only lend to banks, right? FDIC insured?
If the banks are going to use the FDIC-insured money for their own proprietary trading, and lose $Trillions on it, putting the entire world at risk and causing a “Great Recession”, then I think they should be treated the same way you and I would be treated if we asked the Fed for an unsecured loan. Or if they’re going to use the money to make liars loans and lose $Trillions on them, causing a housing bubble and collapse that wipes out 70% of middle-class wealth, they should likewise be told to look elsewhere for their loan. There has to be SOME sanity check short of unlimited unsecured lending without recourse, or else the banksters will do what you suggested you would do, take the money and give it to themselves in bonuses, whatever is left after they destroy the rest of us.
WARREN MOSLER Reply:
December 1st, 2011 at 9:06 am
If the fed had done that it would have been an inflationary bias in that deflationary env. And a transfer of wealth to the seller
Reply
ESM Reply:
December 1st, 2011 at 9:41 am
@WARREN MOSLER,
“So, when the Fed bought near-worthless mortgage securities at full price…”
And to correct John’s mistatement, the Fed did not do this. Not even close.
Reply
RyanVMarkov Reply:
December 1st, 2011 at 11:26 am
ESM,
Did the Fed use such near-worthless mortgage securities as collateral for the loans it gave to the US banks? If not how was the Fed legally able to loan to Morgan Stanley such amount? – from PragCap:
“The only two big US investment banks that were allowed to survive were Goldman Sachs and Morgan Stanley. With the new information released, it turns out that Morgan Stanley borrowed massive amounts of money from the federal reserve that peaked at $107 billion as of September 2008. This is a sobering number that was 750% of the market capitalization of Morgan Stanley at the time of the loan.”
WARREN MOSLER Reply:
December 2nd, 2011 at 6:20 pm
And was ms a bank then?
ESM Reply:
December 1st, 2011 at 1:28 pm
@ESM,
@RyanVMarkov:
I believe that all collateral is marked-to-market at the beginning of the loan. You can argue that the price isn’t the same as the real bid given the poor liquidity conditions, or you can argue that there is a lot of risk that the price of the collateral can go down (or go up) after the loans are made, but it’s simply not true that nonsense prices were put on the collateral for the purpose of giving essentially unsecured loans.
Matt Franko Reply:
December 1st, 2011 at 2:19 pm
@ESM, “it’s simply not true that nonsense prices were put on the collateral for the purpose of giving essentially unsecured loans.”
I think a lot of people are being led to believe otherwise, I don’t see where that is going, if it proves to ultimately be untrue.
Resp,
beowulf Reply:
December 1st, 2011 at 4:23 pm
@ESM,
“This is a sobering number that was 750% of the market capitalization of Morgan Stanley at the time of the loan.”
Hmm, I wonder what multiple of market cap would make someone at the Fed think, “Gee, maybe the shareholders should be wiped out on this one”.
ESM Reply:
December 1st, 2011 at 4:35 pm
@ESM,
@Beowulf:
Don’t follow you on that one. What does asset value have to do with market cap?
On the other hand, I wouldn’t have minded if shareholders were wiped out. I think Warren has a different take. He has written before that the punitive approach the Fed took towards Bear Stearns shareholders in March 2008 set in motion the bank run that followed six months later.
WARREN MOSLER Reply:
December 2nd, 2011 at 6:23 pm
Don’t recall saying that? Do remember saying the fed should lend to fdic insured members unsecured and unlimited
Matt Franko Reply:
December 1st, 2011 at 5:19 pm
@ESM, Et tu Beowulf? ;)
Related: Don’t you think that saying these institutions “borrowed” 7T or 20T or whatnot which was a cummulative total of many sequential 7 day operations or 30 day operations for much less is kind of… I dont know what word to use… sort of “misleading” or something like that? Rhetorical? Is there a legal term? Resp
John O'Connell Reply:
December 1st, 2011 at 7:10 pm
@ESM,
If not full price, then at least more than anyone else thought they were worth, and were willing to bid for them. Otherwise, why do it? And a high enough price that the banks were excused from most of the losses they had incurred, which would have made them insolvent.
Seems like a “nonsense price” to me.
WARREN MOSLER Reply:
December 2nd, 2011 at 6:25 pm
Fed should lend unsecured to members and let the FDIC decide if they are solvent
ESM Reply:
December 2nd, 2011 at 10:46 am
@ESM,
“…at least more than anyone else thought they were worth, and were willing to bid for them.”
There is a big difference between what people think something is worth and where they are willing to bid that something in a broken market.
Suppose you found yourself in the position of needing to raise $200K in cash in a couple of days to pay off your bookie but no assets except for a fully-paid for house. Do you think you would do better selling that house or borrowing against it?
And, by the way, the market became broken because the government wasn’t doing its job as monopoly supplier of the currency.
Matt Franko Reply:
December 2nd, 2011 at 10:56 am
@ESM, And refinancing your $200k house is not ‘borrowing’ $400k., Resp,
Matt Franko Reply:
December 3rd, 2011 at 10:48 am
@ESM, This is the Fed’s take on this issue, of course out of paradigm, but as far as their opinion of quality of collateral:
“After the start of the financial crisis in August 2007, the Federal Reserve adopted many measures to mitigate the disruptions in financial markets, including the introduction or expansion of liquidity facilities. Many studies have found that the facilities were effective in promoting financial stability during the crisis.
In addition, because the facilities were designed according to well-understood lender-of-last-resort principles—the Fed’s loans were well collateralized and generally priced at a premium to the cost of funds—they also earned considerable income.”
http://www.newyorkfed.org/research/current_issues/ci17-1.pdf
Their position is that they actually “MADE” $13B net off of the liquidity programs, that would have to preclude any losses due to “dodgy collateral” that went bad. Doesnt look like any did:
“The additional income generated by the Federal Reserve facilities came with additional credit risk, and some of the extra income should be considered compensation for this risk.
However, the Fed took numerous facility-specific steps to keep credit risk to a minimum in operating its programs, such as limiting borrowing to institutions that met eligibility criteria, providing the loans on a short-term basis, and requiring that loans be backed by adequate
collateral. As a result, the central bank has not borne any credit losses to date through its new or expanded liquidity facilities”
They grossed $20B and had a $7B “cost of funds” (oh brother!) that left them with the $13B, no credit losses… (I guess technically “so far” as they are still showing some “Maiden Lane” items on the H.4.1).
So it is to contradict the Fed to say that these liquidity operations were conducted against inadequate collateral.
And if this is a big part of your argument about the need for Fed/institutional reform… YOU BETTER BE ABLE TO BACK IT UP…. otherwise, take it to the comments section at ZeroHedge blog…. Resp,
Matt Franko Reply:
December 6th, 2011 at 3:04 pm
@ESM, The Fed shoots back:
http://blogs.wsj.com/economics/2011/12/06/fed-shoots-back-at-media-portrayal-of-crisis-lending/
WARREN MOSLER Reply:
December 6th, 2011 at 6:28 pm
part of the problem is the fed’s ability to defend itself is lacking due to their lack of understanding of banking and monetary operations.
Art Reply:
December 1st, 2011 at 1:00 pm
@WARREN MOSLER,
“If the fed had done that it would have been an inflationary bias in that deflationary env.”
Disdeflation? http://symmetrycapital.net/index.php/blog/2010/05/disdeflation/
“And a transfer of wealth to the seller”
Showing that no monetary system can be free of agency risk.
Reply
John O'Connell Reply:
December 5th, 2011 at 11:25 am
@Art,
“the central bank has not borne any credit losses to date through its new or expanded liquidity facilities”
Meaning that the MBS they still own have not yet defaulted? I was under the impression that many of these loans were underwater, and have no chance of their principal being repaid, even if the buyers are still making the interest payments.
But, nevertheless, if the Fed did not pay more than anyone else would have paid, was the market “wrong” to price them so low? Were they really worth more than the banks would have had to say they were worth under “mark to market”? If so, then why would some entrepreneur not step in and buy them up? And if it is truly a profit-making experience for the Fed, why is it still called a “bailout”? Was the government actually taking advantage of the banksters weak position, and not the other way around?
WARREN MOSLER Reply:
December 5th, 2011 at 12:31 pm
in general the securities are prices to reflect current perceptions of defaults.
individual mtgs in the pools have defaulted in general at the anticipated rates, so the investors pretty much got the yields they anticipated, though with exceptions in both directions of course.
November 30th, 2011 at 8:53 pm
so we didn’t have a completely, truly, fully fiat domestic currency until ~1968?
“Soon after private ownership of gold was banned in 1933, all of the remaining types of circulating currency, silver certificates, Federal Reserve Notes, and United States Notes, were redeemable by individuals only for silver.”
“Eventually, even silver redemption stopped in 1965-68, during a time in which all U.S. currency (both coins and paper currency) was changed to fiat currency.”
“At this point for the general public, there was little to distinguish United States Notes from Federal Reserve Notes. As a result, the public circulation of United States Notes, which was then mainly in the form of $5 bills, was replaced with $5 Federal Reserve Notes, and the stock of United States Notes was mostly converted into $100 bills, which spent most of their time in bank vaults.”
“No more United States Notes were put into circulation after January 21, 1971.[24] In September 1994 the Riegle Improvement Act released the Treasury from its long-standing obligation to keep the notes in circulation and finally, in 1996, the Treasury announced that its stock of $100 United States Notes had been destroyed.[25]
http://en.wikipedia.org/wiki/United_States_Note
********
[anyone know the context of the nearly overlapping Riegle & Platinum Seignorage acts? Were the two sets of sponsors allies or opponents?]
Riegle Community Development and Regulatory Improvement Act of 1994
Section 5119(b)(2) of Title 31, United States Code, was amended by the Riegle Community Development and Regulatory Improvement Act of 1994 (Public Law 103-325) to read as follows: “The Secretary shall not be required to reissue United States currency notes upon redemption.” This does not change the legal tender status of United States Notes nor does it require a recall of those notes already in circulation. This provision means that United States Notes are to be cancelled and destroyed but not reissued. This will eventually result in a decrease in the amount of these notes outstanding.
United States Notes are an obsolete form of currency last printed by the Bureau of Engraving and Printing in 1968. The Riegle Community Development and Regulatory Improvement Act, Public Law 103-325, codified at 31 U.S.C. 5119(b)(2), enacted in September 1994, amended 31 U.S.C. by canceling the requirement to reissue these notes when they are redeemed.
Some numismatic groups have expressed interest in selling selected notes to the public. The Bureau of Engraving and Printing consulted with Treasury’s Financial Management Service and the Bureau of the Public Debt, and the following determination was made:
Releasing the notes to the public will violate the spirit of the act, which authorized the Secretary to “not be required to reissue United States Notes upon redemption.”
The Bureau of Engraving and Printing lacks the legal statutory authority to sell these notes to the public.
The Bureau of Engraving and Printing lacks any mechanism by which it could release the notes to the public now that the requirement to reissue them when redeemed is no longer in effect.
http://www.bep.treas.gov/historicallegislation.html
Reply
December 1st, 2011 at 1:28 am
WM: “No big deal, apart from the fact the Fed shouldn’t be allowed to lend on an unsecured basis like this without explicit approval of congress. ”
And we shouldn’t be going to war without the explicit approval of Congress. That’s in the Constitution, too. Maybe Dick Cheney was right when he said that the Constitution is a “quaint document.”
Now obviously the FED has just chosen to backstop tons of Eurodebt. Will that become a liability to the US? It sure looks like it to me. What will the response be if this goes sour and the cry goes out that we “don’t have the money” to do whatever we need to do for ourselves (because we spent it in the EZ, and can’t collect it…ever?)
I hope somebody will tell me that this is wrong-headed and worry for nothing.
Reply
December 1st, 2011 at 10:41 am
I’d like to take a stab at this to see if I get it.
Euro banks owe dollars to their clients and they are having trouble getting ahold of those dollars.
The fed helps them out by lending dollars to euro banks in a “horizontal transaction”; one that doesn’t expand the USD nfa’s of the private/euro sector.
If the euro bank defaults, the euro bank loan on the fed’s balance sheet gets written off and the dollar assets are still floating around out there, resulting in an increase in nfa’s, which always has an inflationary bias.
But a bank default/bankruptcy always has a deflationary bias, so the question of whether the net effect is inflationary or deflationary depends on the size of the loan that was defaulted AND the deflationary force of the default.
Also I think we are not really talking direct inflation as in rising prices here in the US, but rather that the USD exchange rate would fall because of a flood of dollar nfa’s outside the US. Rising prices for imports at home would be a knock-on effect.
Is that right?
Reply
Art Reply:
December 2nd, 2011 at 4:54 pm
@briantheprogrammer,
“Euro banks owe dollars to their clients and they are having trouble getting ahold of those dollars.”
They usually owe them to each other or are trying to cover regulatory capital requirements.
Reply
briantheprogrammer Reply:
December 2nd, 2011 at 9:31 pm
@Art,
I don’t think that’s right since borrowing dollars from the fed does not increase their capital position. And if they only owed them to each other then as a group they should not need more dollars.
Reply
December 1st, 2011 at 11:29 am
Link via Jesse, written by the Fed about swap line management. FWIW
http://www.scribd.com/doc/74267527/ci16-4
Reply
December 2nd, 2011 at 11:17 am
Seems to me that if the dollars are not paid back the transaction has effectively become vertical.
Reply
December 3rd, 2011 at 11:40 pm
Bullish on the dollar, in the future, when they have to return all these dollar loans. There will be shortage of dollars in circulation and bid in dollars and ask shorting of the other currency in the swap.
So yes, print money now to save the crocks, I mean…. the banks… again. And strength the dollar in the long term. Actually because the world is heading into a depression, I mean recession, and demand destruction and deflation is due, still bullish short term on currencies (eurozone will be worse, but socio-political risk means higher premium in the price and hence lower euro) and probably, specially, in the dollar.
Reply
December 6th, 2011 at 4:33 pm
“in general the securities are prices to reflect current perceptions of defaults.
individual mtgs in the pools have defaulted in general at the anticipated rates, so the investors pretty much got the yields they anticipated, though with exceptions in both directions of course.”
If the Fed paid only what both the Fed and the banks (and the market) thought was the true value of the collateral, and they turned out to be right, then how is the bank any better off with cash than with a performing asset of equal value? Why was it a “bailout” if it was done on the same terms as an arms-length transaction would have been done?
Reply
Matt Franko Reply:
December 6th, 2011 at 5:40 pm
@John O’Connell, John,
Just to point out that the Fed did 2 things in all of this here.
1. Lender of last resort. where they did liquidity/lending against high quality/ approved collateral;
2. Quantitative easing, where they bought MBS assets with newly created balances. (they thought this would help get the system more balances “to lend out”, this was a very expensive lesson they learned at the country’s expense)
In operation 1, they are claiming victory and profits of 13B net, and taking issue with the Bloomberg claims. And I believe the assets they bought in op 2 were all (or just about all) guaranteed by the US govt.
So there is no “toxic assets” involved (perhaps some Maiden Lane items wont quite work out 100%). The “toxic asset” line is either political or made by someone who has a book to sell, as opposed to Warren’s book which is FREE.
It often looks like the truth will not allow itself to be “peddled”. Resp,
Reply
WARREN MOSLER Reply:
December 6th, 2011 at 6:34 pm
agreed.
though I do question lending to the non member banks and unsecured lending to foreign cb’s
Reply
John O'Connell Reply:
December 8th, 2011 at 7:31 pm
@Matt Franko,
I just read the Bloomberg article and the Fed response. Both are so short on particulars that it is impossible for me to tell who is distorting things.
The Fed accuses Bloomberg of “double counting”, in cases where a single borrower paid back one short-term loan and took out another, and says their total outstanding was never more than $1.5T. They don’t go so far as to say that they did not do something like loan $1.5T to bank A this month, and when it was paid off loaned it to bank B the next month. I think that counts as 3.0, not 1.5.
They also do not address the idea of taking 365 overnight loans in a row and paying the overnight rate, rather than the 1-year rate. They claim the loans were made at a “penalty” rate, but they don’t say what it was. It could have been 0.5% instead of 0.25%, and if the bank relent it at 4% they would have made only 7/8 of their potential profit if the rate were not a “penalty” rate. My heart bleeds for them. (NOT)
And they don’t address the assertion that the banks made a profit on the deal. I suppose that’s unavaoidable, if the bank is going to participate. It just galls me that these banks used those profits to pay huge bonuses before, during, and after the crisis, to the very dumba**es that screwed up.
The Fed says they were transparent, and nothing was secret, and then admits that they withheld the identities of the borrowers until it was forced out of them. That is more than disingenuous, it is just misleading.
Maybe Bloomberg and the rest are choosing their facts in order to make a more sensational-sounding story, but I find the Fed’s defense pretty flimsy.
Maybe someone can explain more about “liquidity”. Loans create deposits. Banks are not reserve-constrained. Why would a bank who may have had to write down some of their assets suddenly refuse to lend payroll money to the likes of Harley Davidson (one cited in the Fed letter), who has been a regular and quite creditworthy customer for years? If this impacts their reserves, they can always borrow some at 0.25% and the Fed will always provide it.
I understand that the toxic CDOs were illiquid, but the Fed allegedly did not buy those, or accept them as collateral. They accepted only good collateral for this “liquidity” lending program. I could see that replacing toxic, illiquid assets with cash would help liquidity, but how does replacing one liquid asset with another do anything?
Reply
WARREN MOSLER Reply:
December 15th, 2011 at 11:49 am
read my proposals and see how both sides miss the points.
http://www.moslereconomics.com/?p=8968
WARREN MOSLER Reply:
December 6th, 2011 at 6:30 pm
yes, my question as well, which was why I criticized the approach at the time.
Reply