Monday, September 23, 2013

Today's links

1---Lehman Was Not Alone – Measuring System Risk in the 2008 Crisis, Institute Blog

On September 15, 2008, Lehman Brothers filed for bankruptcy and ushered in the worst part of the recent financial crisis. Today, we still discuss whether taxpayer money should have been used to rescue Lehman. My colleagues at NYU and I have developed measures of systemic risk, and this fifth anniversary affords us a good opportunity to look at what these measures would have indicated to Treasury Secretary Paulsen if they had been available at that time.
The answer is quite surprising.
We estimate the amount of capital that a financial institution would have to raise in order to continue to function normally if we have another financial crisis like the one in 2008. This is interpreted as a capital cushion to protect against a decline of 40% in the broad equity market over the six months after this occurs. The rationale is that if all financial firms have an adequate capital cushion there cannot be a financial crisis. If one firm needs to raise capital under such circumstances, it is likely that the market can provide it or competitors can absorb its market share. But if many firms try to raise capital in the middle of a financial crisis, there is no source except the government.
We call this measure SRISK. We compute it weekly and post it on the website systemicrisk. The estimation uses equity prices with methods that are extensions of the volatility models that formed the basis for my Nobel Prize. SRISK combines information on size, leverage, and risk to indicate how serious a default would be.
On the website, you can go back to August 29, 2008, to see the ranking of U.S. firms based on SRISK.  . Was Lehman at the top of the list in 2008? No. In fact, it was Number 11. The top of the list was Citigroup, which was estimated to need $139 billion. Following Citi, in order, were JPMorgan Chase, Bank of America, Morgan Stanley, Merrill Lynch, Freddie Mac, AIG, Fannie Mae, Goldman Sachs, and Wachovia. Interestingly, all of these institutions were either nationalized or rescued, with the arguable exception of JPMorgan Chase.
We estimate that the first ten firms, excluding JP Morgan, needed about $700 billion in capital, which is the precise amount of the TARP request. At Number 11, the estimate is that Lehman would have needed $48 billion in capital. And it was allowed to go under. Interestingly, Washington Mutual, at Number 14, also was allowed to fail. 
Bill Gross has a wonky column in the FT, saying that setting interest rates at zero doesn’t boost economic growth:
With policy rates at or approaching zero yields and QE facing political limits in almost all developed economies, it is appropriate to question not only the effectiveness of historical conceptual models but entertain the possibility that they may, counterintuitively, be hazardous to an economy’s health.
Certainly the record will show that countries with persistently low interest rates tend to have sluggish growth, and although the obvious causality there runs the other way — central banks cut rates in response to slow growth — it’s never been clearer than it is now that such policies don’t always work.
Gross’s point is that zero rates, far from encouraging people to borrow more, actually encourage deleveraging instead, at both the short and the long end of the curve.
The question is whether reducing interest rates actually boosts demand for credit, at the margin. Certainly it does in normal times, when central banks cut rates from, say, 6% to 5.25%. But borrower calculus is different when rates get cut from 1% to 0.25%. If a semi-permanent ZIRP is a sign of a country in a prolonged economic slump, then one can see how it could act to discourage potential borrowers rather than get them flocking to their banks to demand credit...
When the financial system can no longer find outlets for the credit it creates,” says Gross, “then it de-levers”. And deleveraging tends to cause economic contraction
3---The good and bad of zirp, smart investor
ZIRP is good. It stimulates business investment. ZIRP enables consumers to better finance expensive items such as cars, boats and homes. It creates more demand for goods and services which creates earnings for companies and the need to hire employees and lower unemployment.
Or maybe ZIRP is bad. ZIRP provides poorly run banks with reserves at a low cost, enabling them to avoid failure and continue with policies that are damaging and should be abandoned. It robs responsible savers from the interest they should be earning in their savings accounts and forces them to take more risk to get returns that can provide a decent lifestyle. ZIRP also creates inflation, so while earning nothing at the bank, the cost of goods and services rise. ZIRP encourages government borrowing, spending and expansion.
Government spending at all levels is far below the level of any other recent recovery. Sixteen quarters after the end of the recession, spending during past recoveries has been 7-15 percent higher than it was at the start. This time it's 7 percent lower, despite the fact that the 2008-09 recession was the deepest of the bunch. Reagan, Clinton, and Bush all benefited from rising spending during the economic recoveries on their watches. Only Obama has been forced to manage a recovery while government spending has plummeted.
And there's no end in sight. Ted Cruz will lose his battle to defund Obamacare. But the tea partiers have already won their battle to cripple the American economy and Obama's presidency with it.
In  a world in which all the matters is "scale", the ability to Martingale down on losing bets as close to infinity as possible (something which JPMorgan learned with the London Whale may not be the best strategy especially when one can't print money out of thin air), and being as close to the Fed's Heidelberg rotary printer as possible, it was expected that that "expert" of government backstops and bailouts, the Octogenarian of Omaha, Warren Buffett, would have only kind words for Ben Bernanke. But not even we predicted that Buffett would explicitly admit what we have only tongue-in-cheek joked about in the past, namely that the Fed is the world's greatest (and most profitable) hedge fund. Which is precisely what he did: "Billionaire investor Warren Buffett compared the U.S. Federal Reserve to a hedge fund because of the central bank’s ability to profit from bond purchases while accumulating a balance sheet of more than $3 trillion. "The Fed is the greatest hedge fund in history,” Buffett told students yesterday at Georgetown University in Washington. It’s generating “$80 billion or $90 billion a year probably” in revenue for the U.S. government, he said. From Buffett's presentation at Georgetown last week:
The Fed remitted $88.4 billion to the U.S. Treasury Department last year. The payments have ballooned as the central bank built its balance sheet during the past five years.

The Fed “is under no pressure, none whatsoever to have to deleverage,” Buffett said. “So it can pick its time, and if you have somebody wise there -- and I think Bernanke is wise, and I certainly expect his successor to be -- it can be handled. But it is something that’s never quite been done on this scale. It will be interesting to watch.

7---Signs of an easing of credit requirements are surfacing , LA Time s

8---After a Financial Flood, Pipes Are Still Broken, NYT

9--Global warming on fasttrack, Guardian

10--Lavrov: US pressuring Russia into passing UN resolution on Syria allowing military force, RT

11---Better lock in your mortgage rate. Now!, CNBC

12---The days of easy money may be over, marketwatch
Commentary: New indicator says the time to sell is here

13---Let’s get this straight: Lehman did not cause the financial crisis, WA Post

14---Ruffer: The end game, in his view, is “absolutely obvious. It’s going to be high inflation, with interest rates well below the rate of inflation, independent investor

Ruffer believes that the defining condition of the current investment scene is monetary instability, as the world teeters back and forth between the twin threats of deflation, induced by excessive debt, and renewed inflationary pressures, arising from the unprecedented monetary stimulus policymakers are committing to try and forestall the first threat. The end game, in his view, is “absolutely obvious. It’s going to be high inflation, with interest rates well below the rate of inflation”. In other words, with their wealth eroding in real terms, virtuous savers will once again be required to pick up the bill for the excesses of the past decade, just as they did in the 1970s. “That (outcome) is as strikingly and simply obvious as the credit crunch, but the difficulty is when that is going to happen, and the fact that, between now and then, we might well be looking at teetering over the deflationary edge”.

15---The deflation/inflation conundrum, economist

Henry Maxey, a fund manager at Ruffer Investment Management, has an interesting explanation in his latest review; he puts it all down to the actions and rhetoric of the Japanese, US and Chinese central banks. It all starts with the Japanese and the Abenomics pledge to do a lot of quantitative easing. Maxey writes that
by pledging to double the monetary base, the Bank of Japan managed to engineer a massive foreign investor driven currency depreciation under the guise of domestic monetary stimulus. However, by front loading the effect of QE into weakening the currency, the first impact on the world was disinflationary because a weaker yen exports deflation to the rest of the world by making Japanese goods and services cheaper.

This impact was exacerbated by the actions of Japanese banks, Maxey says.
the commercial banks immediately started selling bonds, aggressively causing a violent rise in yields and interest rate volatility. In reflationary terms, this was the equivalent of stepping on the clutch just as you rev the engine; a lot of noise but not much traction.
Meanwhile, with the yen no longer seen as a hard currency, plenty of worries about the euro and the Swiss capping the franc, the dollar became the major currency of choice. As we noted recently, a strong dollar is not helpful for emerging markets. Maxey writes that
A stronger dollar has the effect of sucking liquidity out of emerging markets, most of which have explicit or implicit dollar ties. Declining liquidity in emerging markets has revealed their individual structural weaknesses while also reducing their demand for, and hence the price of, commodities.
The next link in the chain is the Fed. Ben Bernanke is worried, Maxey argues, by previous instances when policy was tightened; 1937, 1994 and 2004. But he is also worried that easy policy will create asset bubbles.
By introducing the concept of tapering to the market, Bernanke hoped to introduce volatility to interest rate markets but without significant impact on the level of interest rates themselves. Like the dodgy rock band which doesn't understand the sensitivity and feedback loops of its sound system, Bernanke tapped the microphone and the amplifiers blew up. Long term real rates rose by 1%.

16---What Shadow Banking Can Tell Us About The Fed's "Exit-Path" Dead End, zero hedge
Most credit in the US is created by nonbanks; virtually all bank lending is funded by the creation of liabilities that are not subject to reserve requirements, and central banks do not ration reserves. In fact they take great pains to provide banks with the amount of reserves they desire. Central banks influence credit not by rationing the quantity of reserves but by altering the interest rate that banks must pay to obtain the quantity of reserves they desire....

What is the rough magnitude of the task if the Fed balance sheet were to remain at its current size?

  • In the two weeks ending 27 August 2008, average daily reserves held by depository institutions (banks) were $46.1 billion; required reserves were $ 44.1 billion.12 Of this, vault-cash used to satisfy required reserves was $36.4 billion and reserve balances held at FRB were $9.7 billion.
  • In the two weeks ending 21 August 2013, average daily reserves held by banks were $2.2 trillion – that’s trillion with a ‘t’; required reserves were $115 billion – that’s billion with a ‘b’. Of this, vault cash used to satisfy required reserves was $53.4 billion and reserve balances held at FRB were $2.1 trillion.
  • Thus bank excess reserves rose by $2.123 trillion during the last five years

  • Today, credit creation in general and money creation in particular are no longer tied to the stock of reserves (i.e. the stock of banks’ deposits at the Fed).

Today, bank deposits at the Fed have only one real role – to facilitate management of the payments system. They are used to settle transactions among banks.

The Federal Reserve balance sheet is much simpler than at the height of the crisis.

  • If Rip Van Winkle awoke today after a five-year nap, he would see only one key development in the Fed’s balance sheet – securities holdings higher by $2.9 trillion and deposits of depository institutions (banks) higher by $ 2.2 trillion.2

If he asked how this happened, Rip would be given a very simple answer.

  • The Fed bought securities to lower interest rates; it paid for them by creating bank reserves.

That is, the Fed credited the securities seller’s commercial bank with a deposit at one of the 12 Federal Reserve Banks, and the commercial bank then credited the seller’s account. On net, privately held securities were exchanged for Fed deposits.

If pressed further as to why banks are holding enormous reserves at the Fed, Rip would get an equally simple answer: Banks have no choice.

  • It is – for all intents and purposes – technically and legally impossible for a bank to transfer deposits at a Federal Reserve Bank to a nonbank ...
  • To make it all crystal clear, we present Exhibit A: a chart showing total loans and deposits at US commercial banks (local and foreign) just after the failure of Lehman, compared to their balance sheet as of the most recent week (as reported by the Fed's H.8 statement).
    What it shows is the following:

    This is perhaps the one chart that explains not only all that is wrong with US banks currently, but also why the US stock market is where it is.
    It shows, among other things, that while over the past five years, total loans and leases in US commercial banks have not increased by one dollar, total deposits have risen by $2.2 trillion to $9.5 trillion. Why is this important? This is what Singh had to say about deposits:
    When central banks buy securities, one of the immediate effects is to increase bank deposits, which adds to M2 (in the U.S., practically the Fed has bought from nonbanks, not banks). Whether banks maintain those added deposits as deposits, or convert them into other liabilities (or, by calling in loans, reducing or moderating the growth of their balance sheets), is an open question.
  • Sure enough, as the chart above shows, the total loan hole resulting from the increase in deposits was plugged by none other than the Fed, which over the past 5 years has injected $2.2 trillion in securities into commercial banks, leading to the observed increase in total deposits to nearly $10 trillion.
  • 17---Why suicide rate among veterans may be more than 22 a day, CNN 

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