Repurchase agreements and covert nationalization

The Fed announced that it would auction off $100B in loans this month rather than the previously announced $60B via its TAF facility. In the same press release, the FRB announced plans to offer $100B worth of 28 day loans via repurchase agreements against “any of the types of securities — Treasury, agency debt, or agency mortgage-backed securities — that are eligible as collateral in conventional open market operations”.

The second announcement puzzled me. After all, the Fed conducts uses repos routinely in the open market operations by which they try to hold the interbank lending rate to the Federal Funds target. In aggregate, the quantity of funds that the Fed makes available is constrained by the Fed Funds target. So, what do we learn from this? Fortunately, the New York Fed provides more details:

The Federal Reserve has announced that the Open Market Trading Desk will conduct a series of term repurchase (RP) transactions that are expected to cumulate to $100 billion outstanding… These transactions will be conducted as 28-day term RP agreements.. When the Desk arranges its conventional RPs, it accepts propositions from dealers in three collateral “tranches.” In the first tranche, dealers may pledge only Treasury securities. In the second tranche, dealers have the option to pledge federal agency debt in addition to Treasury securities. In the third tranche, dealers have the option to pledge mortgage-backed securities issued or fully guaranteed by federal agencies in addition to federal agency debt or Treasury securities. With the special “single-tranche” RPs announced today, dealers have the option to pledge either mortgage-backed securities issued or fully guaranteed by federal agencies, federal agency debt, or Treasury securities. The Desk has arranged single-tranche transactions from time to time in the past.

There are a couple of differences, then, between this new program and typical repo operations:

  1. The loans are of a longer-term than usual. Ordinarily, the Fed lends on terms ranging from overnight to two weeks in its “temporary open market operations”. The Fed will now offer substantial funding on a 28 day term.
  2. The Fed is effectively broadening its collateral requirements by collapsing what are usually 3 distinct levels of collateral which are lent against at different rates to a single category within which no distinctions are made.

The Fed offered the first $15B of repo loans under the program today, so we can see how things are going to work. First, how did the Fed square the circle of ramping up its repos without pushing down the Federal Funds rate? Just as it had done with TAF, the Fed offset the “temporary” injection of funds with a “permanent open market operation”. The Fed sold outright $10B of Treasury securities today at the same time as it offered $15B in exchange for mortgage-backed securities under the new program (at a low interest rate than in traditional repos against MBS collateral). The net cash injection was small, but the composition of securities on bank balance sheets changed markedly, as illiquid securities were exchanged for liquid Treasuries.

In James Hamilton’s wonderful coinage, the Fed is conducting monetary policy on the asset side of the balance sheet. This is an innovation of the Bernanke Fed. Conventionally, monetary policy is about managing the quantity of the central bank’s core liability, currency outstanding. When the Fed wants to loosen, it expands its liabilities by issuing cash in exchange for securities. When it wants to tighten, it redeems cash for securities, reducing Fed liabilities. The asset side is conventionally an afterthought, “government securities”. But the Bernanke Fed has branched out. It has sought to lend against a wide-range of assets, actively seeking to replace securities about which the market seems spooked with safe-haven Treasuries on bank balance sheets without creating new cash. By doing this, the Fed hopes to square the circle of helping banks through their “liquidity crisis” without provoking a broad inflation.

“Monetary policy on the asset side of the balance sheet” is a bit too anodyne a description of what’s going on here though. The Fed has gotten into an entirely new line of business, and on a massive scale. Prior to the introduction of TAF, direct loans from the Fed to banks, including the discount window lending and repos, amounted to less than $40B, the majority of which were repos collateralized by Treasury securities. By the end of this month, the Federal Reserve will have more than $200B of exposure in its new role as Wall Street’s genial pawnbroker. Assuming the liability side of the Fed’s balance sheet is held roughly constant, more than a fifth of the Fed’s balance sheet will be direct loans to banks, almost certainly against collateral not backed by the full faith and credit of the US government (and beyond that we just don’t know). This raises a whole host of issues.

Caroline Baum wrote a column last week poopooing concerns about the Fed taking on credit risk via TAF lending. (Hat tip Mark Thoma.) I usually enjoy Baum’s work, but this column was poorly argued. In it, she points out that the Fed has all the tools it needs to manage credit risk. The Fed offers loans only against collateral, and requires that loans be overcollateralized. If the collateral has no clear market value or if there are questions about an asset’s quality, the Fed has complete discretion to force a “haircut”, writing down the asset (for the purpose of the loan) to whatever value it sees fit. And the Fed can always just say no to any collateral it deems sketchy.

All of that is quite true, and (as Baum snarkily points out) not hard to find on FRB websites. But it fails to address the core issue. Sure the Fed has all the tools it needs to manage credit risk. But does it have the will to use those tools? In word and deed, the Fed’s primary concern since August has been to “restore normal functioning” to financial markets. The Fed has chosen to accept some inflation risk in its fight against macroeconomic meltdown. Why wouldn’t it knowingly accept some credit risk as well? No one has suggested that the Fed is being “snookered”. Skeptics think the Fed is intentionally taking on bank credit risk while still lending at very low rates. Some of us find that troubling.

Which brings us to the more postmodern issue of what credit risk even means to a lender with unlimited cash and an overt unwillingness to let those it lends to default. In a way, I agree with Baum. Until the current crisis is long past, I think it unlikely that any large bank will default and stiff the Fed with toxic collateral. Why not? Because for that to happen, the Fed would have to pull the trigger itself, by demanding payment on loans rather than offering to roll them over. Since TAF started last fall, on net, the Fed has not only rolled over its loans to the banking system, but has periodically increased banks’ line of credit as well. In an echo of the housing bubble, there’s no such thing as a bad loan as long as borrowers can always refinance to cover the last one.

The distinction between debt and equity is much murkier than many people like to believe. Arguably, debt whose timely repayment cannot be enforced should be viewed as equity. (Financial statement analysts perform this sort of reclassification all the time in order to try to tease the true condition of firms out of accounting statements.) If you think, as I do, that the Fed would not force repayment as long as doing so would create hardship for important borrowers, then perhaps these “term loans” are best viewed not as debt, but as very cheap preferred equity.

Let’s go with that for a minute, and think about the implications. One much discussed story of the current crisis is the role of sovereign wealth funds in helping to capitalize struggling banks. Will they, won’t they, should we worry? Sovereign wealth funds have invested about $24B in struggling US financials. Meanwhile, the Fed is quietly providing eight times that on much easier terms.

If we view TAF and the new 28-day, broad-collateral repos as equity, what fraction of bank capitalization would they represent? I haven’t been able to find current numbers on aggregate bank capitalization in the US. In June of 2006, the accounting net worth of U.S. Commercial Banks, Thrift Institutions and Credit Unions was 1.25 trillion dollars. Putting together remarks by Fed Vice Chairman Donald Kohn and data on bank equity to total assets from the St. Louis Fed yields a more recent estimate of about 1.6 trillion. The average price to book among the top ten US banks is about 1.3. So, a reasonable estimate for the current market value of bank equity is 2 trillion dollars. The $200B in “equity” the Fed will have supplied by the end of March will leave the Federal Reserve owning roughly 9.1% of the total bank equity. Obviously, the Fed isn’t investing in the entire bank sector uniformly. Some banks will be very substantially “owned” by the central bank, whereas others will remain entirely private sector entities. As Dean Baker points out, the Fed is giving us no information by which to tell which is which.

What we are witnessing is an incremental, partial nationalization of the US banking system. Northern Rock in the UK is peanuts compared to what the New York Fed is up to.

You may object, and I’m sure many of you will, that our little thought experiment is bunk, debt is debt and equity is equity, these are 28-day loans, and that’s that. But notionally collateralized “term” loans that won’t ever be redeemed unless and until it is convenient for borrowers are an odd sort of liability. Central banks are very familiar with the ruse of disguising equity as liability. Currency itself is formally a liability of the central bank, but in every meaningful sense fiat money is closer to equity.

I do not, by the way, object to nationalizing failing banks. There are (unfortunately) banks that are “too big to fail”, whose abrupt disappearance could cause widespread disruption and harm. These should be nationalized when they fall to the brink. But they should be nationalized overtly, their equity written to zero, and their executives shamed. That sounds harsh. It is harsh. One hates to see bad things happen to nice people, and these are mostly nice people. But running institutions with trillion-dollar balance sheets is a serious business. Accountability matters. These people were not stupid. They knew, in Chuck Prince’s now infamous words, that “when the music stops… things will be complicated.“, and they kept dancing anyway.

But accountability has gone out of style. The Federal Reserve is injecting equity into failing banks while calling it debt. Citibank is paying 11% to Abu Dhabi for ADIA’s small preferred equity stake, while the US Fed gets under 3% now for the “collateralized 28-day loans” it makes to Citi. Pace Accrued Interest (whom I much admire), I still think this all amounts to a gigantic bail-out. And that it is a brilliantly bad idea from which financial capitalism may have a hard time recovering. Like a well-meaning surgeon slicing up arteries to salvage the appendix, the Federal Reserve is only trying to help.

Update: Many thanks to commenter Fullcarry, who noticed that I flipped the sign on Friday’s permanent market op. Changed “purchased outright” to “sold outright”, since that’s what the Fed actually did.

Update History:
  • 8-Mar-2008, 1:00 p.m. EST: Added update re changing “purchased outright” to “sold outright”, since that’s what the Fed actually did.
  • 8-Mar-2008, 2:30 p.m. EST: Changed “trillions dollar” to “trillion-dollar”.

45 Responses to “Repurchase agreements and covert nationalization”

  1. Carl writes:

    Trying to think a bit further down the road, since this seems to be a fait accompli, isn’t it true that this will all fail unless the Fed follows through and ultimately rolls over the loans to the end borrowers? After all, if the Fed winds up owning a fair number of the institutions that made the outrageously bad loans won’t the Fed have to restructure that debt to some sustainable form mainly by reducing the principal amounts as Dr. Bernanke recently suggested ? I think that more than the badly run institutions are going to be bailed out and the whole concept of moral hazard has been nullified. What say ye?

  2. Fullcarry writes:

    Just a small but pertinent quibble. The FED didn’t buy treasury bills on Friday, they sold.

  3. Fullcarry — Very pertinent, and not so small. Embarrassing too. Thank you very much for pointing this out. It’s fixed now, with grateful attribution.

    Carl — Good question… to the degree that a non profit-maximizing Fed “owns” bad banks, it does seem more likely that certain kinds of generosity in forebearance (directed by politics rather than economics) might occur.

    In fact, when you think about it, the Fed already may well “own” some banks enough to force cooperation, despite the fact that their “equity” has no voting rights. What if Dr. B were to suggest to Citi that it participate in some New Joy program, mentioning paranthetically that the Fed might be making a deeper review of Citi’s collateral prior to the next TAF auction?

    Presumably, the ideal endgame of “covert nationalization” would be a quiet restructuring followed by a slow withdrawal of Fed support as banks grow healthier and private investors willingly offer capital. The Fed’s new role as wise central planner of the banking and monetary system will be challenging, though, to say the least. All possible solutions involve winners and losers. We are accustomed, in capitalist societies, to accepting “loserhood” if our misfortune is imposed as a “market outcome”. As the Fed and other government bits get more involved, it will get harder and harder to find sporting losers, willing to accept their misfortune gracefully rather than having it imposed by force of politics or worse. This is a dangerous road.

    By the way, it’s quite possible for the Fed to bear large losses (on behalf of the banks) without anyone noticing. They can print money for free, but that does show up as increased liability on their balance sheet. Luckily, the Fed earns a spread from the interest bearing securities it holds against the no interest currency with which it finances purchases. So long as the losses it bears are smaller than this spread, losses can be hidden in reduced profit rather than showing up as embarrassing balance sheet holes. That amounts to tens of billions in loss-bearing capacity per year. By timing the recognition of losses, the Fed can finance very large losses over a period of years without politically awkward balance sheet issues.

  4. JimmyL writes:

    More loans to solve a loan crisis? Backed by a financially irresponsible (and possibly bankrupt) government? I don’t know whether to sigh with relief or hope to God that it’s not increased again… The winds tell me that this will not end well – and the winds are sometimes right.

    If you’re a drudge fan:

  5. I think this is a very sound article giving the background.

    Okay, so the fed is bailing out the banks. Please take it one step further. What is wrong with that? What is going to happen next? Let us say that residential real estate is worth 18 billion. And it drops 30%, then someone, the banks, loose 6 trillion. So the fed prints 6 trillion dollars, gives it to the banks, and never gets repaid. Who cares? What difference does it make? Why is that a bad scenario?

  6. sk8rX writes:

    So this will mean an end to bank write-downs and failures for the banks that are becoming nationalized, increase liquidity solving the credit crunch, while being able to control the rate of inflation it’s simply an exchange of currency for toxic equity. At the same time, if the Fed owns these toxic mortgages, then the Fed could inject equity and/or change the terms of the mortgage to avoid the higher reset rates, etc. Recession averted.

    This seems like an excellent scenario but my question is, are there any concerns with this approach by the Fed? What are the potential negative implications/scenarios?

  7. Steve:

    This is all nonsense. TAF, Repo, 28 days, 56 days, overnight, who cares? The bottom line: Helicoper Ben will buy whatever bank paper he’s told to buy. I’ve been saying this since October. The result: inflation. Don’t get immersed in the details, they don’t matter.

  8. SteelCurtain writes:

    Just a newbie question, when the FED takes a bond as collateral for the RP, who gets the interest the bond pays during that period?

  9. price discovery.................................NOT writes:

    I crap in a bucket and try to sell it. Amazingly nobody wants to buy it. I need some money fast and somebody is willing to lend me boatloads of money using the bucket of crap as collateral (it *is* worth something after all I guess). The interest rate of the loan is lower than the going rate. The lender is willing to do this over and over again. Is the lender here losing out?

    Who is losing out when the Fed does what it did today? Nobody? Tax payers?

    Ponzi Q. Globalization

  10. groucho writes:

    Steve, great job! Keep up the excellent insightful analysis!

  11. Alessandro writes:

    This is a break-trough analysis in understanding the current financial crisis. The blogsphere is in flames!

    Thank you.

  12. Lew writes:

    Fascinating stuff. Thank you. You mentioned that the Fed should overtly nationalize the failing individual banks. What exactly would that process look like? I hear of foreign countries nationalizing various sectors of the economy but never quite understand what actually happens. Does the Fed basically buy all the outstanding stock or just a voting proof majority and then appoint its own board of directors? If so, could you imagine the backlash of all the hyper-capitalists (or should I say proponents of welfare for the rich) to something like this?

  13. Sam writes:

    Looks like the FED has found a way to let the air out slowly and have an orderly rush to the exits. We will see if this changes anything with the current Hedge Fund domino crash. It seems amazing that given the equity of US Banks is 2T or more, that 10m from Abudabi or 200M in Repos would be the difference between success and failure for the banks

  14. All — Sorry for the slow reponse…

    Christopher & sk8rX — You ask a crucial question… However you characterize what’s going on is it a good idea? Can the strategy avert a recession / save the economy / end the crisis, whatever? That really depends on where you think the crisis comes from, and whether you think the forces that have prevented crises from emerging earlier are still in play. If you think, in Felix Salmon’s words, that credit markets are just “hysterical”, then there’s no problem with temporarily assuming aggregate credit risk until they come to their senses. Even if you think there is an “insolvency crisis”, you can argue that letting the Fed absorb the pain is a good idea, since the Fed can always paper over its own insolvency. But if you think there are deeper problems with the US economy, that the financial market crises are a symptom of misallocations and deficiencies in the real economy, then the Fed’s actions are not only unlikely to help, but may do positive harm. If resources are misallocated and the US is underproducing and badly investing relative to the consumption it wishes to maintain going forward, bailing out failing banks maintains a prominent role for organizations with a demonstrated incapacity to allocate well, rewards people handsomely for having squandered valuable resources, and creates incentivizes ambitious financiers to devote themselves to holding the macroeconomy hostage rather than figuring out how to allocate resources well.

  15. IA — How much you have to sweat the details depends on whom you’re trying to reach, I think.

    SteelCurtain — I don’t know for sure how the Fed handles this, but usually cash flows on repo-ed securities are remitted to the borrower, even though the securities are temporarily owned by the lender. Alternatively, the repurchase price can be adjusted down to take into account cash-flows from the securities. The main point is that an interest rate is negotiated and cash flows are arranged to be consistent with that rate, with the security serving as collateral, not as a revenue source on the sly. Securities pledged as TAF or discount window collateral always belong the the borrower, so there is no issue. Cash flows go to the borrower, unless the securities are seized by the Fed to remedy a default.

  16. p.d….N / P.Q.G. — I’d say that in relative terms, obviously everyone not receiving the subsidy is losing out relative to those who are. In absolute terms, whether or not the unsubsidized lose out depends on whether the Fed’s behavior contributes to inflation in the prices of things the unsubsidized hope to buy.

    groucho — Thanks! And my apologies for spacing on comments to an earlier post. I suck sometimes that way.

    Alessandro — Thank you too!

    Lew — It’s a very good question what “overt” nationalization would look like. It would require action from congress of the sort we last had in the eighties with the S&L crisis and Continental Illinois. It’s quite the point that a lot of people who are accustomed to profiting handsomely from a system that has redistributed rather than properly allocated resources should find this unpleasant.

    Sam — There are no “m”s anywhere. It’s 200B from the Fed, and billions as well from the various sovereign wealth funds. That is still a small part of 2T in capitalization, but that’s not really all the help there’s been. I’ll post a chart that suggests quite a bit of support from the FHLB, and current proposals are likely to push the (already struggling) agencies and FHA into the fray. It was probably unwise to focus so much in the original piece on the Federal Reserve. Pseudoequity injections and questionable asset purchases are likely to come from a variety of quasipublic sources, and amount to well more than the 200B in TAF and repo injections.

  17. Steve:

    You’re getting it. It doesn’t matter if the hundreds of billions come from: the Fed, Fannie Mae, Freddie Mac or the Wizard of Oz. To me, these are just details. Didn’t the Atlanta Fed give Mozillo and Co., aka, Countrywide about $50 billion in 2007? The bottom line: the banks won’t fail so the dollar will.

  18. Len writes:

    I think you’ve got the analysis nailed pretty well, but maybe haven’t penetrated to the next level.

    I’ve been watching this as well, and it appears the Fed is attempting the Japanese “solution”. I would love to credit the writer who dug out what that was several years ago, but I didn’t save the link.

    Briefly; after a huge commercial real estate/stock market bubble left most Japanese banks insolvent, the BOJ simply kept the banks flush with reserves with similar ever rolling over repos, while pretending all the non performing loans were in fact performing and also pretending the banks were not insolvent (and debtors not bankrupt). Since the Japanese consumers are inveterate savers, they were not a loan market, most commercial entities were loaned up, many only pretending solvency as well, so though flush with reserves to make loans and ready to by such regain solvency, the Jap. banks had little domestic loan demand; everybody tapped out and debt stagnated. Thus was born the foreign yen carry trade. You can tell how well that worked out, 15 years of stagnation domestically, not to mention all that yen fed into the worldwide credit bubbles, including the real estate one being nurtured by our own Fed as well as securitized debt and commodity bubbles world wide. It could be argued that as poorly as the BOJ policies worked out, preventing clearing out misallocated resources and creating a generation of stagnation, they at least avoided a ’29 style conflagrationary collapse.

    As poorly as the Japanese “solution” “succeeded”, there are some differences with our situation that make it hard to see how it would “succeed” even that well for us.

    First we have no consumer savings cushion as in Japan to soften the blow of a stagnant economy; quite the opposite, our consumers are heavily indebted. Second, Japan never lost its huge manufacturing export business as they had our consumers more than willing to go into debt to buy Toyotas and Sonys; they may have had to suffer a severe retrenchment as the bogus businesses slowly bled a way, but they had a solid economic core to prevent utter collapse. What have we got? Thirdly, they has us, a debt crazed nation of over consumptive borrowers willing to soak up all that yen (indirectly, carry trade) to buy Mc Mansions and big screen TVs, thus allowing the Jap. banks to slowly get well on the interest rate differential. While the Fed may be able to replenish our banks reserves, who are the banks going to lend to now as the credit bubble collapses?

    It’s going to be interesting to watch.

  19. lsbumblebee writes:

    I’m not sure I understand. How can the FED “nationalize” these banks when it is not a branch or agency of the U.S. government?

  20. groucho writes:

    “While the Fed may be able to replenish our banks reserves, who are the banks going to lend to now as the credit bubble collapses?

    It’s going to be interesting to watch.”

    Len, I think u nailed the Japan situation. I see something very similar about to happen in the US. In fact I think the FED and Treasury are counting on it. They saw how Japan was able to become the “mother of liquidity” because of the debt deflation effects on monetary policy.

    My guess is the FED is hoping to go one better and become “the FATHER of liquidity”, which as you can imagine will turbocharge the primary dealers and i-banks. Paulson is begging the money center banks “to go get capital”, now. Stay solvent long enough till the FED can get below t-bill rates. Maybe even get to ZIRP. Wouldn’t wall st love that game……free money with no currency risk?

    The big IF that I see is energy. US needs oil either capped or the surplus recycled through the money center banks. If that doesn’t happen, we’ve got war.

  21. jh writes:

    It’s an important observation on the structure of the Fed balance sheet, but the effect is a far cry from SWF capital injections.

    This is debt. Equity isn’t collateralized.

    TAF is an extension of the discount window in terms of the quality of acceptable collateral and its valuation. The Fed has the option of changing collateral valuation parameters as required by market conditions, on rollover dates.

    These are horrendous markets, but it’s a gross exaggeration to say that the Fed is nationalizing banks via TAF. If that happens, it’s a later step.

    The interesting point that no one has commented on is the existence of a Fed balance sheet constraint on limits to the outstanding TAF.

    The Fed is limited by the size of the liability side. It doesn’t ‘force feed’ currency note into the system beyond the demand of the banks and the public for currency. And it has no room to expand bank reserve balances in aggregate of it wants to maintain control over the level of the funds rate. That’s why it’s ‘sterilizing’ now.

    So the upper limit to TAF is essentially the size of the Fed balance sheet now, allowing for natural growth in currency demands of the banks and the public.

    Beyond that, the Fed couldn’t ‘sterilize’ by selling other assets. It would have to start issuing its own liabilities, such as the sterilization bonds issued by the PBOC used to offset their foreign exchange purchases.

  22. livingston guy writes:

    I think you have an intersting hypothesis but risk taking it too far. Here are two issues I would like to point out:

    1) The new repo line you talk about is nothing more than the TAF for the brokers who dont have access to the TAF. Essentially, a Merrill wants to have the same access to liquidity as JPMorgan but deoasn’t have it in the current framework of TAF which is only available to depositories. The new repo line just makes the same facility available to Merrill.

    2) Your point about the Fed providing effective equity to banks is not valid in the following context. If a company is stressed and may go bankrupt, its lenders provide a lot of flexibility during the pre bankruptcy period. Part of the reason to provide that flexibility — as the Fed is doing thru the TAF — is precisely in order not to become an equity holder if the rescue attempt fails.

  23. sk8rX writes:

    This seems like the perfect solution.

    The Fed offers to give away cash to the banks (raised through the sale of Treasuries) in exchange for the toxic equity/mortgages sitting on their balance sheets, eliminating the credit crisis. The Fed may even be able to use Treasury sales to inject home equity into these mortgages before returning them to the banks to stem off the tide of foreclosures.

    This offer appears to be holding the rest of the world hostage – If they don’t buy the Treasuries then the Fed will be forced to print more money (devaluing the US dollar) to pay for their buying binge of toxic equity.

    You can bet that countries that export heavily with the US will prefer to purchase the Treasuries instead of experiencing the pain of further devaluation of the US dollar (inflation, reduced demand for exports, etc).

    These Treasuries are simply IOUs that were given to the Fed by the US treasury. Now the Fed is passing them out abroad, but as a result the US government hasn’t gone any further into debt and the currency hasn’t devalued.

    Overall it appears to me that the Chinese &Japanese taxpayers will be left footing the bill for the housing crisis in the US.

  24. Sam writes:

    I meant B not M, thanks for pointing that out.

    Len, Sitka Pacific Capital, in its March 2008 letter to clients (for some reason I could not see it on the website yet) goes into a long explanation that BB is pursueing a Japan solution, including inflation (since as we all know inflation is the debtor’s friend (be it a consumer, bank or country) is deliberatly pushing down the dollar so that exports will flourish. Apparently BB spent some time in 1999 lecturing and writing about the Japan solution and what the BoJ could have done differently. Especially in terms of encouraging consumption. Their thesis is that inflation may work in which case commodities and other assets are the place to be. If it fails then we will face deflation. They believe we will have the answer in 8-12 months

  25. mark writes:

    I do not, by the way, object to nationalizing failing banks

    Of course there is the very slight but not completely insignificant miniscule detail that the Federal Reserve Bank is not, in fact, a government entity. It is a private company, it is not part of the national government although it has the word ‘Federal’ in its name.

    By that logic, we are not seeing a nationalization of failing banks, we just see them being taken over by a private entity for pennies on the Dollar.

    We are seeing the extreme side of deregulation, where a sector of private enterprise reneges on its responsibility to account for its actions. Entities which ‘self regulate’ simply don’t. They just want to shed accountability. In this instance the world is left to bear the incredible cost in lost jobs and equity throughout the spectrum of the banking world, which touches almost every aspect of the human experience. It is past high time to put a stop to that.

  26. eurolander writes:

    These are some insights by John Hussman which I find interesting. He also wrote some very interesting pieces about the ECB’s “injections” of liquidity.

    “The Fed did bump its “term auction facility” up to $100 billion on Friday, which was interesting because it is a material increase of about $40 billion in Fed liquidity. So the Fed did indeed expand its promise of liquidity provision. The problem is that even that $40 billion only represents repurchase agreements. This is not permanent money – just short-term liquidity that gets reversed after a month or two. Even if the Fed was making permanent purchases of defaulting securities (which it’s not), the amount would be a drop in the bucket in a $13 trillion banking system, with about $5 trillion of that as mortgages, 8% of which were already delinquent or in foreclosure last December, with far more to come, of which banks are only recovering 50% of principal value. And that’s just FDIC insured institutions. Let’s not even talk about non-bank institutions, much less credit cards and other unsecured loans.” (

  27. Len & Groucho — I really need to learn a lot more about Japan… It’s so commonly cited as an example of where we might be going, but I don’t understand what the full situation there well enough to know what I think it tells us. What’s different if you’re a massive debtor with a much less collectivist culture?

    jh — I think you’re too quick in your certainty that TAF is just short-term collateralized debt because that’s what it claims to be. It’s the Fed’s very discretion, w.r.t. collateral, rollover, etc that IMHO makes it likely that it will function more like equity.

    Your point about the Fed’s balance sheet constraint is quite interesting. By the end of March, holding the liability side constant, between 20% and 25% of the Fed’s balance sheet will be devoted to these loans. Of course liabilities are likely to expand, as the Fed is expected to reduce rates, but that probably won’t be large enough to matter. The Fed has room to roughly quadruple the scale of these programs before hitting that constraint, though — for the moment, it is far from binding. But if they really pushed it, they would indeed have to issue interest-bearing sterilization bonds a la PBoC, which would be quite a development. Interesting.

    livingston guy — Good point about wider accessibility to repo auctions than to the discount window/TAF. I hadn’t thought about that. I think your distressed debt analogy doesn’t quite hold, though. If the Fed were being flexible with pre-existing loans, I might agree it’d be natural to say it is trying to avoid an equity position. Even in this case, it’s trying to avoid the messiness of formal equity because it already has something very close, distressed debt, and formal bankruptcy would push it into actually having to operate or liquidate. Trying to avoid equity less water at all when the Fed is actively ramping up its position. People often accumulate distressed debt precisely because they see it as a cheap way of getting equity when the firm defaults.

    sk8rX — A long time ago (2003), I thought there were ways the US could “play” the already present BW II dynamic to its advantage, by shifting costs to foreign central banks that were making foolish choices. Now I think we’re way beyond that, the pent up costs of this game both domestically or abroad are such that we’ll be lucky to avoid international conflict owing to a variety of perceived grievances to which the various downturns will be attributed.

    Sam — Thanks. That’s an interesting summary, and the inflation vs deflation debate remains, as far as I’m concened, vexing.

    Isbumblebee & Mark — the question of exactly what sort of entity the Fed is seems to invite a lot of debate. I do treat the Fed as an arm of government, but there is certainly a defensible view that it is the property of member banks. I’m not sure I’d predict different behavior very in either case, at least under the present composition of government.

    eurolander — Hussman has generally been a skeptic that anything central banks do much matter, although the present environment undercuts his liquid-cash-for-liquid-treasuries-what’s-it-matter argument some. It’s sometimes liquid cash for illiquid stuff. I want to learn more about ECB. It has a TAF-like facility, and I wonder if that has turned into semipermanent capitalization for some corners of the eurofinancial world. The argument that TAF expansions are temporary has been often made but never observed so far, TAF has consistently expanded, providing “permanent” (at least five month-ish) liquidity, although the Fed has sterilized by selling more bonds.

  28. SteelCurtain writes:

    Steve Randy Waldman — Thank you for the answer about the interest on the collateral.

    New question.

    The FED is a private bank. Who owns it? Can I get some stock :-).

  29. Pliny writes:

    Government intervention is what has brought us to the brink of disaster. More government intervention is only deepening the crisis and nationalizing banks would be an unmitigated disaster unparalled in American history. It is astounding that government failures are met with calls for even more government. Let the free markets work again by getting the Fed out.

  30. Len writes:

    SRW -Perhaps I wasn’t explicit enough; but in fact I don’t believe we CAN go the Japanese route in part for precisely the cultural differences you cite; they are inveterate savers, not ostentatious consumers. I’m not sure how their being more collectivist bears exactly on the subject, but they do have a strong manufacturing (as opposed to non productive service) work ethic and do in fact tend to prioritize the common good over the individual somewhat. Perhaps that allowed them to navigate the crisis years in more orderly fashion. The strong savings ethic also provided them a cushion we simply do not have, and their collectivist obeisance to authority probably prevented some Socialist spasm we seem to be contemplating here; but this is all getting into a lot of speculation and away from the monetary economics.

    None of that means, of course, that however unworkable here BB may not be attempting it.

    Sam– I would just say that if BB’s understanding of the Japanese crisis is on a par with his understanding of our own Great Depression, then we are really in trouble, since he is attempting to fix a crisis he doesn’t understand using tactics derived from another crisis he doesn’t understand. You may recall that a couple of years ago (18 mo?, memory fades) there was a rash of Fed Governor resignations and replacements by people with questionable qualifications, so we may well be in a “blind leading the blind” situation. Suspicion is, the somewhat astute people saw what they had wrought and got out of Dodge while the gettin’ was good.

    You also bring forward a widely held misconception; namely that “inflation is the debtors friend”. That IS kind of the way it worked during the Carter inflation as unions, now largely powerless due globalization, were largely able negotiate wage hikes rapidly enough to stay more or less even with inflation, creating the famous wage/price spiral which made debt an ever shrinking entity to the detriment of lenders. Nowadays we have just the /price part of that spiral, wages have been flat to negative in real terms for years. Without a means of increasing his income along with the inflating currency, the debtors debts in fact, instead of looking smaller, look ever larger as his required spending for necessities crowds out available funds for debt service, hastening insolvency. It’s much the same for business and government debtors. Inevitably as the inflationary expectations become more widespread, interest costs dramatically increase and revenues decline as more and more strapped consumers confine their spending to necessities and debt service and then enter insolvency. Government interest costs skyrocket due the inflation, while income and corporate tax revenues collapse. During the Carter inflation, the same union mechanism that increased consumer wages fed through to increased business and tax revenues; even so, there were books written about how the governments increasing interest costs were going to bankrupt it. This lack of the wage half of the spiral is probably the reason for the proposals to just send out a few hundred thou to everybody that have been popping up lately.

    What this all comes down to is Von Mises had it exactly right, much as we might wish otherwise, there is simply no means of escape from an overinflated bursting credit bubble.

    Now here’s a cheery thought to make everybody’s day, as well as a possible reason for all the terror being exhibited at the Fed and Treasury these days. Let’s say BBs solution, Japanese or otherwise, fails miserably and the credit bubble deflates utterly as in ’29, resulting in such a shrinkage of the money supply due defaulting debts that the dollar, say, triples in value, which would by necessity shrink government revenues by 2/3 solely from a currency standpoint, not even including shrinkage due collapsing economic activity. The national debt would remain a nominal $9 trillion or so. How sound is your T bill or bond going to be then?

    Nah,…couldn’t happen here…could it?

  31. e writes:


    Just curious, but I wasn’t aware that the Fed was rolling the TAF agreements at the same time as commencing new ones. From what I can see on the Monetary Policy Releases page of their website. If, by ‘rolling’, you mean new, bigger TAF auctions, I hear you. As far as I can read, there is $30 billion maturing on the 13th of March, $30 billion maturing on the 27th of March, $50 billion starting on the 13th of March and maturing on the 10th of April and another $50 billion later in March plus a further $100 billion in repos.

    Boiled down, the key for me is whether or not new TAFs replace old TAFs OR whether old TAFs are being rolled at the same time as new TAFs take place.

    Also, the projected bank write-downs will increase the debt-as-equity ownership by the Fed.

  32. e — we’ve gotta be careful to avoid double counting here. by “rolling” i mean that each month’s total TAF has been at least as large as the previous months. the Fed has not been rolling old TAFs while initiating new. total TAF funding (including just announced) has been 40B->60B->60B->100B, so on net, all original loans could have been rolled with new ones added along the way. of course, the composition of each month’s recipients change, so “rolling” is an accurate description vis-a-vis the consolidated banking system, but may or may not describe the experience of any individual counterparty.

    you sometimes see press reports suggesting that the Fed has auctioned “$160B” (pre March) via TAF. That’s double counting. They had auctioned that much, be reabsorbed $100B, for a net outlay of $60B. That net outlay is increasing to $100B over the course of this month.

  33. Chico writes:

    Great insight! I just bookmarked your site.

    In the real estate market insolvent-debt looks an awful lot like equity. For example I know of a property in the Boston area were the owner, lets call him John bought a piece this property with a commercial loan in the 80’s. He promptly failed to pay his mortgage, the bank promptly went bankrupt and its assets, including John’s mortgage were auctioned off. Another man, lets call him Gary purchased Johns mortgage that was in default. Gary was then able take control of the property without forcing John into bankruptcy. So while Johns name is still listed on the Deed as the legal owner, Gary collects all rents and pays all the taxes, insurance and maintenance fees associated with owning the piece of property.

  34. DownSouth writes:

    “…just as there are collections of animals, collections of humans…in the same way there are enormous organized accumulations of individuals which we call nations; their life only repeats on a larger scale the life of the cells which compose them.” Marcel Proust

    Christopher Lozinski, you allude to something I have often wondered about.

    The Fed publishes data on the total amount that American families owe against their homes, and I believe it pegs the figure at somewhere around $10T.

    You say that the total value of residential real estate in the US is $18T.

    That gives us a debt/equity ratio for the “average” homeowner of 56% (I’ve heard this figure used before, and remember the figure being higher, maybe 66% ???)

    But American families seem to be broken down into two distinct categories—those who spend and those who save. For I have also read that a full 1/3 of American families own their homes outright, owing nothing.

    The result of this is that $6T of homes are free and clear, which throws $10 trillion dollars of debt onto only $12T in assets.

    If, as Merrill Lynch economists have commented, real estate prices fell 10% in 2007 and will fall another 25% in 2008 and 2009, then this 2/3 of American families, as a class, will be upside down on their loans, with a cumulative debt of $10 trillion backed by real estate worth less than $8 trillion. What portion of American households would then be upside down? 1/3? 1/2?

    A large portion of American families would then have to choose between becomming “house slaves” or defaulting on their loans.

    It appears to me the government has a two-pronged approach. First, it wants to encourage as many people as possible to opt for house slavedom vs. default. And for long-term relief, it is courting inflation, hoping that housing prices will also eventually be buoyed by the rising tide of inflation.

    From a cultural point of view, default doesn’t seem to carry any social stigma any more. I saw an informal poll the other day indicating 2/3 of respondents blaming not the homeowner, but banks and the goverment, for the predicament they find themselves in.

    So the government may have its hands full.

  35. iain writes:

    One critical difference between TAF, the new 28-day, broad-collateral repos and equity is that the Fed doesn’t share in the potential upside that you normally take from an equity injection.

    The downside has been nationalised/socialised by the Fed, whilst any upside remains private, in the hands of those that should take downside.

    In this sense, worst of all worlds.

  36. Jim writes:

    I doubt the U.S. consumer has any understanding of what is going with the Fed and the financial markets. However, they know exactly what is going on at the gas station and the grocery store and they will start clamoring for some relief. I can’t figure out where that will come from except more rebates from the government and more deficit spending. What do you think?

  37. Beaver writes:

    Fuck em all. Buy gold and SIlver, I’m out of this fucking god-dammend rigged market. I walk with my capital. They say “fuck Me” I say FUCK you, Bastard ASS-WIPES!!!

  38. SavvyGuy writes:

    I’ve really enjoyed reading through all the posts and comments above. I can see that there’s a lot of monetary slicing and dicing machinations going on. It makes my head spin!

    So I’m trying to somewhat reorient my thinking, as follows. For a moment, let’s all forget about money. Instead, let’s think about human needs. Money is not a human need per se. Instead, money is a means to satisfy human needs. So my thinking goes like this….why not bypass money altogether and just focus on human needs? So instead of getting a headache worrying about monetary machinations, I might just go out and invest some portion of my portfolio on some price-reduced single family homes, or maybe even farmland. Long-term, everybody needs food and shelter. And energy, metals, etc.(“commodities”).

    Screw the monetary manipulators, just invest in human needs, their value can never go to zero.

  39. Bruce writes:

    This link might help to give some here a better understanding by seeing the Big Picture.


  40. David Wozney writes:

    Steve Randy Waldman wrote: “Obviously, the Fed isn’t investing in the entire bank sector uniformly. Some banks will be very substantially ‘owned’ by the central bank, whereas others will remain entirely private-sector entities. As Dean Baker points out, the Fed is giving us no information by which to tell which is which. What we are witnessing is an incremental, partial nationalization of the U.S. banking system.”

    SteelCurtain wrote: “The FED is a private bank.”

    If the Fed is a private bank, then how is this a “partial nationalization of the U.S. banking system”?

  41. Wanderer writes:

    I agree with all what is said in this article with one exception. Since the FED is a private banking institution, what we are witnessing is not an incremental, partial nationalization of the US banking system but and incremental, partial monopolization of the US banking system. Meaning the banking cartel owners of the FED are eliminating competition. Allowing them to exist as long as they transfer power to the non-fed non-reserve non-system. The current “crises is a scam” and the FED is the one that promoted ARM to begin with as the tool to capture the so called 9.1% of total bank equity. Protecting financial institutions is not the goal but enhancing the monopoly is.

  42. malthus writes:

    Steve Randy Walman

    I have read with interest all the posts. I have one suggestion which I would like everyone to take to pieces :

    The US could adopt a proactive and regenerative immigration policy aimed at attracting some of the emerging middle classes from India and China. The USA has a similar land mass(slightly smaller according to my Atlas.) China’s development is being put at risk due to pollution. The USA still has a lot in its favour. Half a million to million skilled immigrants could soak up housing demand and give a kick to the eceonomy.It is also the one place that using US dollars for property purchases has become cheaper. I am sure my suggestion must be flawed but I can not help thinking that it is very attractive. I would have thought that this would help to speed up the absorption of the stock of available houses. Tom

  43. From Argentina and the UK writes:

    Has anyone out there thought that this whole mess was in fact a scenario that was forecast some time ago?

    IT all began with the increasing debt to China et al. Then came the bubble that burst. Then came the 9/11 engineered assasination of American Citizens by the US government justified on “national security” grounds (the country had to have an excuse to invade Iraq and take over the oil). Then came the farsical war/genocide in the name of liberty and all that crap Americans so much talk about but it is all a manipulation by the clique at the top.

    The US has chosen to ignorethe writing on the wall. It has endorsed genocide, it is endorsing debsluation as a means to not pay its debts to China et al.

    The USA will get what it deserves, you can bet on that.

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