March 13, 2008
The new $200 billion program announced by the FED on March 11 is peculiar. It is not a pure injection of new funds into the banking system. It is a loan of T-bills to top-bidding banks.
Here is the FED's official description. The first two paragraphs are clear. They are a warning call.
Since the coordinated actions taken in December 2007, the G-10 central banks have continued to work together closely and to consult regularly on liquidity pressures in funding markets. Pressures in some of these markets have recently increased again. We all continue to work together and will take appropriate steps to address those liquidity pressures.To that end, today the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing specific measures.
This is an international credit crisis. Make no mistake about this. No single central bank can deal with it successfully.
The second paragraph is written in central bank Esperanto, the better to confuse the public.
Federal Reserve ActionsThe Federal Reserve announced today an expansion of its securities lending program. Under this new Term Securities Lending Facility (TSLF), the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. The TSLF is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally. As is the case with the current securities lending program, securities will be made available through an auction process. Auctions will be held on a weekly basis, beginning on March 27, 2008. The Federal Reserve will consult with primary dealers on technical design features of the TSLF.
The TSLF involves the loan of Treasury debt to the 20 primary dealers, who in turn will auction them off to hard-pressed banks. These assets are liquid. The banks unload supposedly AAA debt certificates to the FED.
The following is deceptive: "The TSLF is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally." There is no need for liquidity for Treasury debt. Why is there a need for AAA-rated debt? Because AAA ratings are nonsense, and everyone knows this. The ratings agencies are no longer trusted by the capital markets. This is very bad news, yet disguised here.
So, is this inflationary? No. The FED transfers ownership of its assets, Treasuries, and receives AAA (hahahaha) collateral. There is no net creation of funds. The monetary base stays the same.
In addition, the Federal Open Market Committee has authorized increases in its existing temporary reciprocal currency arrangements (swap lines) with the European Central Bank (ECB) and the Swiss National Bank (SNB). These arrangements will now provide dollars in amounts of up to $30 billion and $6 billion to the ECB and the SNB, respectively, representing increases of $10 billion and $2 billion. The FOMC extended the term of these swap lines through September 30, 2008.
This is chump change. The capital losses vastly exceed this.
The actions announced today supplement the measures announced by the Federal Reserve on Friday to boost the size of the Term Auction Facility to $100 billion and to undertake a series of term repurchase transactions that will cumulate to $100 billion.
So, we have a 28-day swap of assets, for which banks must pay interest. Supposedly, this will increase liquidity. How? There is no new money. The banks can borrow against the Treasury debt for 28 days. They can't borrow against the AAA-rated assets. If they could, the $200 billion swap would not make sense.
This is an admission by the FED of a bank credit lock-down. AAA-rated paper is no longer sufficiently liquid for the banks to use in their operations.
The banks get paid by the Treasury -- under 2% on T-bills. They presumably are getting paid more by AAA-rated paper.
So, what is the deal? I think it's the new accounting rule: Rule 157. The financial industry must now mark assets at market price, not book value. T-bills trade at close to face value. AAA-rated paper may not be.
If commercial banking is allowed by the government and the FED to escape this new rule, there will be a huge stink. The bank could buy AAA-rated paper at a discount and then post it at face value on its books -- a nice way to increase the balance sheet. Congress might even ask "why?" The answers would accelerate the crisis.
What if banks are exempted? There is still a problem. What if banks want to borrow against assets? At what price? Not face value. But T-bills are marked at close to face value. So, by taking possession of T-bills in exchange for AAA paper, banks can get liquid. They can borrow, no questions asked.
To call this into question publicly is to call the ratings into question. If this happens, Fitch, Moody's, and S&P will have to downgrade paper on a massive scale, which they have refused to do.
The banks must pay the FED interest for the swap. This will cut into their profit-and-loss statements. There has to be something very valuable that they are paying for. I think they are paying to protect their FASB-approved balance sheets.
What is the FED's motivation? Not to restore solvency. That is impossible for the FED. William Poole, president of the St. Louis FED, is correct. "As I have emphasized before, the Federal Reserve can deal with liquidity pressures but cannot deal with solvency issues." Not even to restore liquidity. Then what? To keep big banks' balance sheets from indicating insolvency. I think the FED is looking at a banking crisis. This is a fast and cheap way to conceal reality until, as Dickens' Mr. Macawber put it, something turns up.
Remember: the FED is not under FASB rules. The FED is under FED rules. It does not matter what collateral it holds. It's all AAA.
My prediction: this program will last long beyond 28 days. It's going to be more than $200 billion.
That's my assessment. If you have a better one, let me know. Forward the link to a friend. Post it. I want to know if I have misintepreted this.
So, the FED is still not inflating. It may still even be deflating (see M1 chart to Feb. 28, 2008).
Read the letter I received this morning. It follows the chart.
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I've just finished reading your article. You are definitely correct that the Banks are fearful about reporting huge new losses on paper that they hold. I also believe that the Fed action is to bolster overnight lending amongst banks.
I work at a foreign commercial real estate bank, and we're currently considering purchasing AAA-rated CMBS paper to hold to maturity. When you hold to maturity, you do not need to mark-to-market, and thus the loan will always be booked at face value.
Anyway, the AAA-rated piece's margin has jumped up to 310 over LIBOR! Yet, the coupon on this tranche is LIBOR + 55 basis points (we're buying the loan at a $5MM discount). The investment bank trying to dump this paper onto the market is doing so at firesale prices, and thus must be fearful of having to mark-to-market the paper. If said Bank could exchange this paper for AAA-rated Treasuries, whose face value is currently holding, it would save itself an enormous amount in write-downs.
A U.S. commercial bank, where I know someone in Treasury, has seen its cost of funds jump through the roof (it has a funding gap (too many loans, not enough deposits) and must borrower overnight from other lenders). I currently heard LIBOR + 150bps, and this bank is a conservative and reputable lender. American banks are simply not trustful of one another anymore and what's represented on their balance sheet, and if they can show more treasuries and less CMBS/MBS paper, maybe the overnight lending amongst banks will become cheaper, thereby alleviating the credit crunch.
What we are facing here is a massive distrust in the American financial system, which will not correct itself overnight; it's tough to see the mighty fall, especially as an American living overseas.
If you are going to quote me, please conceal my name.
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