Treasury Secretary choices


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(email exchange)

>   
>   On Fri, Nov 7, 2008 at 11:12 PM, wrote:
>   
>   Geithner’s very smart,
>   

Then why couldn’t he even hit his Fed funds target? When I asked operations people at the NY Fed why they can’t just make a one basis point market around the target they said that would mean continuous ‘intervention’ all day which would be a lot of ‘work.’ They said they only wanted to intervene once in the late morning so were trying to ‘guess’ the right amount to intervene then. This is a ridiculous way to run policy!

It took them three tries on paying interest on reserves to get the ‘right’ level which was the obvious- set it at the Fed funds target.

They are the ones passing along the swap line requests and must know or should know the likely consequences of this madness and that the FOMC doesn’t fathom what’s going on, as part what could be the biggest blunder in ‘monetary policy history.’ How does the Fed even get to loan 30 billion to Mexico secured only by pesos without Congressional discussion of any kind? The total advanced is now up to some $580 billion, with the biggest chunk to the ECB, completely under any radar screen.

>   
>   But at a time when backbone might be nice along with brains, he’s not
>   exactly worry-free. Or perhaps I should say that backbone would have
>   been nice along with his brains at the New York Fed: I think he saw all
>   too clearly the disaster in the making which hugely leveraged Wall
>   Street balance sheets represented, but was way too go along to get
>   along to put his foot down.
>   

Worse. He was part of the decisions to not give ‘depositors’ their funds back in the Lehman failure, and part of the ‘lie’ that the Fed loaned Bear $31 billion when in fact it bought the securities.

>   
>   His testimony during the Bear hearings are a model of velvet-gloved
>   disingenuousness, although in that it differs little from the testimony of
>   his fellow savior of the banking system, Dr. Bernanke.
>   

Exactly. I’ll give them the benefit of the doubt as the overwhelming evidence is they didn’t comprehend the subject matter.

>   
>   As you know, I’m all for Corzine, of the three rumored frontrunners.
>   

The least worst. Remember his ‘whispers’ caught by mics during an address with the black clergy in NJ?

Also, I met with him a couple of years back to discuss how to question then Chairman Greenspan. He agreed with what I was saying but chose not to do it for reasons unknown. I subsequently wrote ‘Interview with the Chairman’ as a guide to any congressman questioning the Fed chairman.

An Interview with the Chairman

At best he’s seriously ‘intellectually dishonest.’

Also note the TARP belonged in the Fed, not Treasury. The Fed ‘spending’ is monetary as it routinely buys securities/financial assets (like the $31 billion from Bear), while treasury federal spending is ‘fiscal’ like paying the soldiers and the postal workers, etc. If they put the TARP where it belonged it would not be part of the ‘budget’ and the spending not accounted for as part of the ‘deficit.’ I’m not so cynical to think the reason they gave it to Treasury was to allow it to show up as increased deficit spending and hopefully put a cap on ‘social programs’ to a misguided Congress. Instead I’d just call it more evidence of ignorance of monetary operations and public accounting.

Just one more thing- the Obama talk yesterday shows a continuing ‘upside down’ approach to the economic ‘problem.’ Seems to me both GM and the Banks, for example, need a population that can afford to buy cars and make payments (aka aggregate demand), which all the ‘investment loans’ and ‘financial injections’ don’t address at all.

Government always has a choice of providing additional public goods and/or supporting private consumption oriented output. For me the move to support private sector output such as cars and financial services would best be done with a ‘payroll tax holiday’ where the treasury makes all the fiscal payments which would immediately (and progressively) give working people an immediate, ongoing, and substantial increase in income to facilitate the payment of mortgages and the buying of cars. (If they don’t want to buy cars for non financial reasons so be it- let the industry shut down.) If instead government wants more public goods, it can facilitate the various public projects it’s been discussing to increase the output of public goods, and not necessarily for the further purpose of increasing the real output of private sector goods (always meaning to include services for both sectors, of course). When using up real excess capacity we can also have both, but at the macro level there is a real choice between public and private goods and services.

While it’s far to early to lose hope, all I saw with the first press conference yesterday was what looked like an undistinguished senator with no specific ideas as to what to do making a ‘sing songy’ presentation with very odd ‘mispeaks’ such as he talked to the living ex presidents, and something like he had a good transition team because it was given a lot of thought, etc. And marching up reps of corporate America to do nothing but stand in line behind him was to me an insulting piece of showmanship. The message was this is going to take time- he needs to talk to a lot of advisors, try to grasp the issues, and then decide on what to do. And with both deficit hawks and doves in his ‘inner circle’ and seemingly no personal conviction either way there’s no telling what will happen or when it will happen. What’s also clear ‘change’ so far is change back to the fossils of past Dem admins and the introduction of Chicago Dem politics to the federal level. And his two expressed policy statements- about China and currency manipulation October 24 and yesterday’s statement that Iran will not be permitted nuclear weapons- are both continuations of the Bush regime.

Yes, even the worst case is still better than what we had, or might have had, so this is not to say he wasn’t the best choice.

I’d better stop here!

All the best!
Warren


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Banking model


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Once again, we are seeing that using the liability side of banking for market discipline doesn’t work.

That’s why deposit insurance exists in every sustainable banking system in the world.

It’s also why a floating foreign exchange rate is ‘superior’ to a fixed foreign exchange rate. With fixed foreign exchange rates, there is no such thing as credible deposit insurance.

The remaining weak link in US banking system liquidity is the interbank market.

The reason we have an interbank market is the remaining institutional structure that utilizes the liability side of banking for market discipline.

This includes the $100,000 cap on FDIC insured bank deposits and the Fed demanding collateral from banks when it lends.

Remove these two remaining obstacles for Fed member banks, and bank liquidity normalizes with no ‘cost’ or additional risk to government.

Unfortunately, no one in government seems to comprehend basic monetary operations and reserve accounting.

Including most if not all of the FOMC and the Treasury Secretary.


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Why it matters how the 700 billion is accounted for


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It would be counter productive to add the $700 billion to the budget deficit calculation if the proposal goes through and is executed, since Congress is likely to take measures to somehow constrain spending or increase revenues to try to ‘pay for it’. This would be highly contractionary at precisely the wrong time.

Note that if the Fed buys mortgage securities it doesn’t add to the deficit, while the Treasury buying the same securities does? And in both cases treasury securities are sold to ‘offset operating factors’; either way, Fed or Treasury, the government exchanges treasury securities for mortgage securities.

When any agent of the government buys financial assets, that particularly spending per se doesn’t add to aggregate demand, or in any way or directly alter output and employment.

Yet here we are listening to the Fed Chairman, the Treasury Secretary, and members of Congress talking about $700 billion of ‘taxpayer money’ and a potential increase in the deficit of $700 billion.
And no one argues with statements like ‘it is even more than we spent in Iraq’ and ‘that much money could better spent elsewhere’. Unfortunately for the US economy, this supposed addition to the deficit is likely to negatively impact future spending, perhaps at the time when it’s needed most to support demand.

I recall something like this happened in 1937, when revenues collected for social security weren’t ‘counted’ as part of the Federal budget, and the millions collected to go into the new trust fund
were in fact simply a massive tax hike. Unemployment went from something like 12% to maybe 19% (and stayed about that high until WWII deficit spending brought unemployment down to near zero). After that happened much was written regarding public vs private accounting and the cash flow from social security and other programs was subsequently counted as part of the federal budget calculation, as it is today, and for the same reason.


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Reinhart got it right


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I hadn’t noticed this back then, but Vince got it right: The Fed purchased the $30 billion of securities from JPM/Bear Stearns, with JPM agreeing that if there were any net losses it would be responsible for the first $1 billion.

It’s very odd that the Fed would call this a non-recourse loan, as they cut a better deal than that.

Unlike a non-recourse loan, if the securities turn out to be profitable, the Fed gets those funds.

So why would the Fed use language that implies the transaction was worse for the Fed than it actually was?

Perhaps there was a legal or some other restriction that prevented the Fed from purchasing the securities?

Seem there is a lot more to the story than has been revealed?

Press Release
Summary of Terms and Conditions Regarding the JPMorgan Chase Facility


March 24, 2008

The Federal Reserve Bank of New York (“New York Fed”) has agreed to lend $29 billion in connection with the acquisition of The Bear Stearns Companies Inc. by JPMorgan Chase & Co.

The loan will be against a portfolio of $30 billion in assets of Bear Stearns, based on the value of the portfolio as marked to market by Bear Stearns on March 14, 2008.

JPMorgan Chase has agreed to provide $1 billion in funding in the form of a note that will be subordinated to the Federal Reserve note. The JPMorgan Chase note will be the first to absorb losses, if any, on the liquidation of the portfolio of assets.

The New York Fed loan and the JPMorgan Chase subordinated note will be made to a Delaware limited liability company (“LLC”) established for the purpose of holding the Bear Stearns assets. Using a single entity (the LLC) will ease administration of the portfolio and will remove constraints on the money manager that might arise from retaining the assets on the books of Bear Stearns.

The loan from the New York Fed and the subordinated note from JPMorgan Chase will each be for a term of 10 years, renewable by the New York Fed.

The rate due on the loan from the New York Fed is the primary credit rate, which currently is 2.5 percent and fluctuates with the discount rate. The rate on the subordinated note from JPMorgan Chase is the primary credit rate plus 450* basis points (currently, a total of 7 percent).

BlackRock Financial Management Inc. has been retained by the New York Fed to manage and liquidate the assets.

The Federal Reserve loan is being provided under the authority granted by section 13(3) of the Federal Reserve Act. The Board authorized the New York Fed to enter into this loan and made the findings required by section 13(3) at a meeting on Sunday, March 16, 2008.

Repayment of the loans will begin on the second anniversary of the loan, unless the Reserve Bank determines to begin payments earlier. Payments from the liquidation of the assets in the LLC will be made in the following order (each category must be fully paid before proceeding to the next lower category):

  • to pay the necessary operating expenses of the LLC incurred in managing and liquidating the assets as of the repayment date;
  • to repay the entire $29 billion principal due to the New York Fed;
  • to pay all interest due to the New York Fed on its loan;
  • to repay the entire $1 billion subordinated note due to JPMorgan Chase;
  • to pay all interest due to JPMorgan Chase on its subordinated note;
  • to pay any other non-operating expenses of the LLC, if any.

Any remaining funds resulting from the liquidation of the assets will be paid to the New York Fed.

Where No Fed Has Gone Before

Why the Federal Reserve’s ‘loan’ for the Bear Stearns deal looks like an investment—and faces serious scrutiny


March 26, 2008

by Peter Coy

The Federal Reserve has stretched its mandate up, down, and sideways to prevent a financial market deluge. Now it appears to be stretching the English language a bit as well. What the Fed is calling a $29 billion “loan” to help finance JPMorgan Chase’s (JPM) purchase of Bear Stearns (BSC) looks much more like a $29 billion investment in securities owned by Bear. Although the Fed insists that it isn’t technically buying any assets, in practical terms it’s doing exactly that. All this adds up to a big and unacknowledged step up in the central bank’s financial intervention with Wall Street investment banks.

The Fed, of course, is the only part of government with the speed, power, and flexibility to arrest a bout of market panic. By rapidly intervening in mid-March to keep Bear from filing for bankruptcy, it may well have prevented a series of cascading failures that could have severely damaged the financial system and the economy. Many economists and analysts are happy that the Fed stepped into the breach. Nevertheless, now that things have quieted down a bit, the Fed is likely to face some tough questions about the precise nature of its actions as well as the legal justification for them.

The second-guessing has already begun. On Mar. 26, Senate Banking, Housing, and Urban Affairs Chairman Christopher Dodd (D-Conn.) announced an Apr. 3 hearing to explore the “unprecedented arrangement” between the Fed, JPMorgan, and Bear. Top officials from the Fed and other regulators, as well as Bear Stearns CEO Alan Schwartz and JPMorgan CEO Jamie Dimon, will likely be grilled about the details.

“That Looks Like Equity”
Meanwhile, Treasury Secretary Henry Paulson gave the Fed a gentle prod on Mar. 26 in a speech to the Chamber of Commerce. While saying he fully supported the Fed’s recent actions, Paulson stressed that “the process for obtaining funds by nonbanks must continue to be as transparent as possible.” He also urged the Fed to continue to work with other agencies to get the information necessary for “making informed lending decisions.”

So far, few people have focused on what exactly the Fed is getting in exchange for supplying $29 billion to JPMorgan Chase. That’s a bit surprising because whatever the deal is, it’s far from a standard loan. The strangest twist is that even though the money goes to JPMorgan, that firm isn’t the borrower. So the Fed can’t demand repayment from JPMorgan if the Bear assets turn out to be worth less than promised.

What’s also odd is that if there’s money left after loans are paid off, the Fed gets to keep the residual value for itself. That’s what one would expect if the Fed were buying the assets, not just treating them as collateral for a loan. Vincent R. Reinhart, a former director of the Fed’s Division of Monetary Affairs and now a resident scholar at the American Enterprise Institute, said in an interview on Mar. 26: “The New York Fed is the residual claimant. That doesn’t look to me like a loan. That looks like equity.”


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