naked capitalism

Anonymous says:

The world’s largest bank is admitting that it too is broke and needs a loan.

Matthew Dubuque says:

Matthew Dubuque

The Treasury markets are fine, yields are in great shape, bull market.

If there is a dramatic selloff in Treasuries, everything changes and the Fed will not hesitate to RAISE interest rates to protect its portfolio.

In the meantime, the clear and growing risk is for a deflationary burst and Bernanke knows that.

The goal is to engineer a very hard landing instead of an absolute and complete global crash. We may not make it.

Just keep your eye on the Treasury market.

That is the key.

MASSIVE inflows into Treasuries are pointing to a dramatic surge in DEFLATIONARY expectations.

The Fed is trying to manage these DEFLATIONARY expectations.

For those concerned that the implications of this move are inflationary, I might ever so gently caution them, with a maximum amount of deference, caution and sweetness, that they might want to step off of the railroad tracks to avoid the onrushing deflationary train.

Just a thought.

Matt Dubuque

Anonymous says:

POP GOES THE WEASEL

David Habakkuk says:

As someone who has waiting for some time with trepidation to see whether Bernanke’s handling of the effects of the collapse of the housing bubble would vindicate his readings of interwar economic history, I am puzzled as to how the situation might develop, if your analogy with the aftermath of 1929 holds good.

Those who have long thought that the Fed was pursuing a strategy of serial bubble blowing have commonly found it all too easy to see how the endgame might end in deflation, but equally easy to see how it might end in inflation.

If as seems increasingly likely we are going to see a contagion of distrust in financial institutions, the deflationary outcome would indeed some more likely. And this could easily spread well beyond the shadow banking system. Indeed, in the wake of the problems which have appeared with HBOS in London, some private investors here have been taking money out of cash and putting it into gilts.

So how might things play out, if Bernanke turns out to be wrong in his conviction that central bankers can always reflate?

1. Let us assume — for the purposes of argument — that a significant further number of financial institutions turn out to be threatened with bankruptcy. Let us further assume that in a number of these cases, there are, as with AIG, credible grounds for arguing that allowing them to go bankrupt might have lethal systemic effects. (Because a system has been created with so many linkages that nobody understands, it may be very difficult to know whether this is so in a given instance — and policymakers may understandably not want to put the matter to the test, even if they are deeply anxious about the effects of bailouts. Micawberism is not always an irrational strategy.)

2. Let us further assume that, while some may be allowed to go the way of Leman, a significant number are not. And let us further assume that the bailouts are in essence funded by Bernanke’s printing press — but that these attempts to reflate fail to assuage the collapse of confidence in the shadow banking system, leading to the kind of hoarding of cash which happened after 1929.

What then happens? Do we see a situation where deflation takes root in the economy, at the same time as the balance sheet of the U.S. government looks like that of a banana republic? What would be the effect on the behaviour of foreign holders of the dollar, should that happen? Are they reassured by the absence of inflation? Or do they begin to think the unthinkable, and ask whether the traditional assumption that the credit rating of the U.S. was unquestionable is valid any longer?

What kinds of options would be open to the U.S. authorities, in a situation where deflationary trends could not be combated but the public finances were a total shambles?

A possible moral of current developments is that appointment of Bernanke may have been a major mistake.

It is a problem with making policy in financial crises that prescriptions rest on a reading of a relatively small number of cases, which are only approximately comparable — and where counterfactual claims are commonly made with much more confidence than the evidence warrants.

One does not need to be disrespectful of Bernanke’s academic work to suspect that no analysis of the economic history of the Thirties can establish beyond reasonable doubt whether the argument that the fundamental failures were in monetary policy post-1929 is either accurate about the past, or (presupposing it is accurate) relevant about the present.

But one suspects that Bernanke has to believe that the argument is both accurate and relevant — because if it not both accurate and relevant the whole worth of his professional career is called into question. This may not encourage flexibility of thinking, in contemplating the possible limitations of monetary policy in current circumstances.

dearieme says:

“the policies that actually worked at that time”: but apart from stopping the run on the banks, none of the policies of that time actually worked.

Drew says:

When do we start seeing the new $5,000 and $10,000 bills?

Chris says:

Bernanke’s academic expertise is well known, and is no doubt why Bushco chose him, and gave him the White House internship as a transition.

I think his expertise might make him like those Generals who always know how to fight the last war, and neglect to study how the world has changed. With our debt we are now in a position more comparable to the one reparations saddled Germany found itself in. Hoover’s America was the source of credit for post-war Europe. Isn’t there a difference there between Bernanke’s America and Hoover’s, like mirror images of each other?

Doing the opposite of what was done before is no guarantee of success, any more than driving with the rear view mirror is the best way for someone to arrive at their chosen destination. Does Bernanke have the expertise to work on turning the US into a creditor nation again, by way of restoring balance to public and private accounts? If not he shouldn’t be in the job.

So Bernanke’s expertise is Hoover in reverse: Rev Ooh! Or put it another way: that’s not a vacuum, its a pump. You gotta know the difference between when to suck and when to blow. It seems like Rev Ooh just knows how to blow. Credit where credit is due it is the right time of year for it. And of course, in the late 1920’s they didn’t have the kind of powerful blowers we are now able to buy from China with borrowed money. Sic transit…

Moopheus says:

“If the run on the shadow banking system continues, we may see similar results even though traditional bank will (hopefully) not see a cash exodus.”

Already working on it.

doc holiday says:

The U.S. Constitution says that Treasury can only tap into about five (5) Super Supplementary Financing Programs, so we aint even close to being anywhere near there yet, and as we continue to speed along this path, the rules are obviously open to discretionary adjustments and of course not something for Congress to challenge…. SNARK!

Spectator says:

Ah, the inflation-deflation debate, that unknowable future. All depends on how the Fed tries to reflate and how the public reacts. Those that know don’t predict, and those that predict don’t know.

Can’t hope for anything but a downward trajectory for at least a year. We’ll need a bubble, say emerging markets, green energy, infrastructure, or some combination, as well as inflation, to get us out of this.

A lost decade is still possible, but I’m encouraged by Lehman and the fallout, and think PT Barnum described the American public quite well, “There’s a sucker born every minute.” American ingenuity should find a way to get cheap credit flowing again.

Anonymous says:

There are $1.222T of outstanding T-bills held by the public. See http://www.treasurydirect.gov/govt/reports/pd/mspd/2008/opds082008.pdf

T-bills have maturities of less than one year. http://www.answers.com/topic/treasury-bill

It’s at least remotely possible that after this round of buying of bills is over, the U.S. could have problems rolling over that debt. That’s what the sharp rise in credit default spreads on U.S. debt is indicating (in part)(and may also be what’s got the gold bugs hopping – gold’s up $85 now). The foreigners who hold our debt may decide – to borrow a phrase from Ken Lewis – that they’ve had about as much fun in the “safety” of U.S. debt as they can stand.

Where could the government get the money to redeem those bills and fund its operations? Incredible as it may seem, the long end of the government market may be less risky than the short end and agencies may actually be less risky than T-bills. Why? Because there is less long dated debt outstanding, and it’s not due for a relatively long time. With respect to agencies, not everyone will default on their mortgages and the defaults that occur will not all happen at once.

On the bright side, AIG’s common stock is only down 40% today. Since the government took an 80% stake in the company in the bailout, it indicates that the market is somewhat optimistic about the chances for success. AIG closed at $3.75 yesterday (before the bailout was announced). A full 80% dilution would indicate a price of $.75. This seems like a fairly good indicator. If the price of AIG common looks like it’s going to sink below $1.00, head for the hills!

Anonymous says:

no the term “super bank” the one that merged, purchased, and is indoctrinated and controlled by the “FED” will soon be in existence. This vessel will consume all or most of the largest financial institutions thus giving the Fed more control of the free market and its management. Why not? well we are bailing out the markets right now and will be in debt for the next 50 years. The interest rates need to be lowered below prime rate and warrants issued against the housing assets to stabilize the housing debtor taxpayer class. The other financial services such as retail, industrial, commercial, and corporate fiance can allow the market to dictate interest rate negotiation between seller and buyer. The above scenario has to occur if not we will not only lose the ability to obtain a mortgage the entire infrastructure will be non performing and sold and acquired for less than the prices of the 1900’s. A ripple effect will occur thus causing a global depression and the entire value of the dollar will be worthless and ofcourse the United States will be bankrupt.

RebelEconomist says:

I think Anon at 15.48 is correct. The operation described is not what I would call “printing” money. In this case, the Treasury is borrowing more money from the market by increasing its bill sales and passing this to the Fed to lend to AIG etc as the Treasury’s agent. If the Treasury felt they had the financial expertise and the market presence, they would not need to involve the Fed at all.

Printing money occurs when the Treasury borrows from the Fed.

RebelEconomist says:

And to answer Anonymous at 16.50, no, this is not diluting the dollar. It does however, by increasing government debt to acquire assets (loans to AIG) that may become worthless, increase the danger that the government will reach a stage when they feel unable to raise enough in taxes to repay the dollars they have borrowed and lost. If that day arrives, they may well turn to the Fed for finance, as in Zimbabwe. Arguably, the operation also increases the danger of inflation by compromising the Fed’s independence of government.

Anonymous says:

“Printing money occurs when the Treasury borrows from the Fed.” — rebeleconomist

If that route had been taken, the Fed would have taken $40 billion of Treasury debt into its assets. Its liability — a $40 trillion Treasury deposit created from thin air — would have been paid over to AIG by Treasury. Treasury would end up with a $40 billion “due from AIG” asset.

In the current transaction, the Fed ends up with $40 billion due from AIG, while the Treasury’s asset is a $40 billion deposit at the Fed. AIG still ends up with $40 billion of cash.

My question: is not the $40 billion in AIG’s hand still “cash created from thin air” by monetizing bad debt? If the Treasury and Fed are viewed as a consolidated entity, are these two transactions not equivalent in effect? Isn’t the Fed simply a pass-through middleman, which can be eliminated after consolidation (particularly if the Fed has no equity)? And thus, isn’t it inflationary?

Anonymous says:

OK, thanks for the follow-up. It still seems to me that they are monetizing bad debt. But since AIG is not a bank, there is no multiplier effect, as there would be with newly created bank reserves spreading from bank to bank with successive new loans and deposits.

Brian says:

anon said:
“From a monetary and inflation perspective, the key to the transaction is the liability side of the Feds balance sheet. The transaction doesn’t create new reserves or new money supply – it creates locked in government funding for the Fed and shifts existing money supply around. That’s a lot different because the monetary base doesn’t change.”

This is the part that I am struggling with … if no new reserves are created, then why the substantial increase in “Reserve Bank credit” in the H.4.1? The “Total factors supplying reserve funds” (asset side) must increase because the “Total factors, other than reserve balances, absorbing reserve funds” also increased because of the Treasury deposit of proceeds in the “U.S. Treasury, supplementary financing account” line on the H.4.1 (the proceeds from the Treasury debt auction under the Supplemental Financing Program).

In other words, it seems that Treasury credit was increased here, not Fed credit. But the H.4.1 represents it as an increase in Fed credit.

Thanks for your input.