Galt's Gulch

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  • Posted by straightlinelogic 10 years, 3 months ago
    The banks, especially the large banks, have not been hoarding their money at all. If a bank loans money it makes a spread to its cost of funds. On a $10,000 dollar loan say that spread is 200 basis points. It will make $200 a year. Say it takes the $10,000, which may have come directly from the Fed in exchange for a government bond. It can buy another government bond with the reserve created by the Fed for the bank in the exchange for the first bond. It can than pledge that bond as security for buying or selling virtually any kind of speculative instrument or derivative, and its leverage ratio is many cases is better than 10 to 1 (it can be 100 to 1). If it writes a credit default swap, it can write a $100,000 CDS (it essentially agrees to insure full payment on a bond for the premium) for say fifty basis points a year, or $500 a year, or 2.5 times what it can make on the loan. More importantly, the bank keeps the treasury security on its books for regulatory purposes and its capital ratios, while amazingly enough, whomever it pledged the security to can rehypothecate the security to secure a loan. For the banking system as a whole, a Treasury security can serve as the collateral, at a very low collateral to loan ratio, multiple times! The reason the Fed is stopping QE is because it was swallowing up too much of this high powered Treasury debt collateral, thus threatening to curtail this source of speculative bank profits.

    I explained all this in a piece on straightlinelogic last year, "Danger Lurks In The Shadows." At the end were links to the http://zerohedge.com explanations of the shadow banking system, and the leverage build up therein. The Fed didn't acknowledge the shadow banking system before it blew up in 2008, and they will not do so this time. It would not have come to light had not JP Morgan's London Investment Office blown up, and the Fed and JP Morgan have not been forthcoming about the details of that grisly story. See the link to the straightlinelogic article for a more complete explanation:
    http://www.straightlinelogic.com/straigh...
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    • Posted by paulnathan2000 10 years, 3 months ago
      straightlinelogic

      No sense getting into the weeds on this, the fact is that the Fe's balance sheet increased to over 4 trillion and the banks excess reserves increased to about 3 trillion. That's where the new money created went and not into M2 chasing goods. If it had inflation would be running at about 33% today. The fact it isn't proves that we do not have too much money chasing goods. The money is being hoarded, therefore impotent to a large extent..
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      • Posted by straightlinelogic 10 years, 3 months ago
        We've had way more than 33 percent inflation in the stock averages, and in the growth of derivatives. That's where the money is going. Not all inflation manifests itself as goods or services prices inflation. The money has not been hoarded. Check the derivatives growth on the balance sheets of the money center banks, and read the articles.
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        • Posted by paulnathan2000 10 years, 3 months ago
          I understand your thinking, but I reject the theory. 1) stocks have followed earnings up as they always have historically. They are not out of line historically although due for a correction.

          2) The derivatives market is the only market that didn't crash during the financial crisis. It remains solvent and increases yearly. I know what your going to say, but the proof is in the fact that with all the theory about the dangers of derivatives, that market has remained one of the most stable through hell and high water. It's leverage that is the core problem, not the derivative market as such.
          Derivatives can cause too much leverage, but the market is sound. If it were what you think it is it would have crashed long ago.

          Check your premises.
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          • Posted by straightlinelogic 10 years, 3 months ago
            Check your history. The derivatives market did indeed crash in 2008. CDOs, CDOs squared, and other sliced and diced mortgage securities went to zero, taking Bear Stearns and Lehmann Brothers with them. The credit default swaps market would have crashed had not the government bailed out one of the largest CDS underwriters, AIG, and made its counterparties (the largest of which was Goldman Sachs) whole. The size of the OTC derivatives market depends on how you look at it. Notionally, the size is huge, over $700 trillion according to the BIS. Most exposures are netted out, which assumes that all counterparties will remain solvent. If they don't, net exposures become nominal ones. In 2008, the bankruptcy of one counterparty, Lehmann Brothers, was enough to unravel the daisy chain. The possible bankruptcy of AIG had financial regulators looking into the abyss, and once it became an inoperative counterparty, paulnathan2000 is correct, no drop in the bucket could have stopped things from becoming completely unravelled. Derivatives were and are the markets in which the maximum leverage may be used, and they crashed. When speculative markets crash, it is always the most leveraged that crash the hardest. Even the equity market in 2008, where by law a mere 50 percent leverage may be employed (although there are numerous ways around that) went down over 50 percent before the market bottomed in 2009. Stocks have never followed earnings, look at a chart of PE ratios the last 100 years; they are all over the lot. History will repeat itself, because our financial markets are leveraged speculation. Total global debt has increased from about $70 trillion to about $100 trillion since 2008, far faster than underlying economic growth. That is an unsustainable trend, thus, it will not be sustained.
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          • Posted by dbhalling 10 years, 3 months ago
            There is inherently nothing wrong with the derivatives market. However, in 2008 the Fed clearly saved the derivatives markets. It bought enough of the underlying securities (CMOs etc.) so that it would not impolde. That was done under TARP and even more so on the Feds own initiative.

            The underlying problem starts with the Fed and government agencies like Fannie and Freedie. But without the Fed and TARP the derivatives market would have imploded. The Fed won't be able to save the derivatives market this time.
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  • Posted by Lucky 10 years, 3 months ago
    Interesting. But I do not follow.
    Consider- you have money in your bank, government doubles it.
    not just for you but everyone. Will your spending be unchanged?
    Perhaps for a while, but most others will sooner or later start to spend their windfall. You will find prices have gone up whether you spend or not. Then you spending may be unchanged but it will be at twice the money for the same goods.
    The current situation is not quite like that, the bank accounts of individuals have not been doubled, but certain institutions have got the proceeds of these 'loans'. What are they going to do? Is it possible for them to resist spending, investing and handing it out, especially when the Keynesian bosses say, it is your duty to spend?
    It could be that in the short term no extra spending will happen, the big banks allow the injection to exist for improving their capital ratios. My opinion is that extra spending will happen, then prices will rise.
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    • Posted by khalling 10 years, 3 months ago
      This is about uncertainty. Most markets are short term. People hoard when they lack confidence in tomorrow. Outside banks plumping their ratios, that's more perplexing. Since they are at the top of the pyramid and apparently teflon, why aren 't they loaning? If businesses and individuals were getting loans uncertainty would diminish. My fear is the complexity of regulatory burden is playing a much larger role in all of this. I suspected it playing a large role in the last crisis, but economists give it little attention.
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      • Posted by $ stargeezer 10 years, 3 months ago
        Another angle may be that banks are not loaning because there's so little profit to be made on loans right now. A bank is like any other business that has a product for sale. If they have money they have loaned us to cover a mortgage @ 5%, but they are paying close to that for CD's that may be approaching maturity, it's difficult to then reloan that money on a 3.5% mortgage and it's a real cinch the new depositor won't be enticed by the rates on new CD's
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  • Posted by paulnathan2000 10 years, 3 months ago
    Lucky 8
    You said "It could be that in the short term no extra spending will happen; that the big banks may allow the injection to exist for improving their capital ratios." This is true.
    The banks are increasing their capital throughout the world by law and by choice. They've paid back almost all the loans made to them, and consumers are choosing to also pay down debt as well as banks lending only to the most credit worthy individuals and businesess. All of this has led to the lowest velocity of money in modern times.

    Khalling, you ask "why aren 't the banks loaning?" They're scared. They rather have the money liquid than tied up. Your point about regulations being a big reason for this is right on. Thousands of regulations have been impsoed over the last few years causing uncertaint. Uncertainty has caused people and businesses to freeze. We are just beginning to see a thaw in lending, but still, over a third of home purchases are made with cash. The banking system is still highly disfunctional.

    But the bottom line and purpose of the articlal is that intellectually, many at the Fed are now rejecting both Monetarism and Keynsianism, in favor of Ludwig von Mises's theories of money and credit.

    Whether this eventually leads to an actual change in monetary policy is still unknown.

    PN

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