Guest Post: Do Ben and Tim = Thelma and Louise?

Served by Jesse of Le Café Américain

One cannot help but note that Team Obama is trying to derail serious proposals regarding financial reform for Wall Street at the G20 meeting, as we suggested they would.

The concerns raised by US revelations at the G20 today about new intelligence regarding Iran’s secret underground nuclear facility have overshadowed financial reform and economic problems, and Gordon Brown’s prescription yesterday that the G20 would become the new governing council for the world. It also smothered coverage of the hearings on HR 1207, the audit of the Fed today.

Why waste a crisis indeed. Especially when you get a two-fer.

Yesterday we put forward a somewhat lengthy piece on the Fed and reverse repos being considered titled Fed Eyes US Money Market Funds.

There is a key quote in there that we would like to highlight today.

The central bank is now considering dealing with money market funds because it does not think the primary dealers have the balance sheet capacity to provide more than about $100 billion… Money market mutual funds have about $2.5 trillion under management…”

Only 100 billion in available capital for a relatively risk free short term investment in the global banking system including the Primary Dealers, does seem a bit tight for a set of such ‘well capitalized’ banks, especially since they aren’t making many loans, preferring to speculate in the markets.

BNP Paribas Securities Corp., Banc of America Securities LLC, Barclays Capital Inc., Cantor Fitzgerald & Co., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Daiwa Securities America Inc., Deutsche Bank Securities Inc., Goldman, Sachs & Co., HSBC Securities (USA) Inc. , Jefferies & Company, Inc., J. P. Morgan Securities Inc., Mizuho Securities USA, Morgan Stanley & Co. Incorporated, Nomura Securities International, Inc., RBC Capital Markets Corporation, RBS Securities Inc., UBS SecuritiesLLC.

Couple that with the revelation reported some time ago at ZeroHedge and covered here, that the Fed is taking on more than 50 percent of the longer dated Treasuries, and there is only about Ten Billion left on their balance sheet for expansion, and you get the picture of a financial system not cruising into recovery but heading straight at a confrontation with reality.

We have considered the possiblity that the Fed is doing this to place exclusively AAA and Treasuries on the balance sheets of the Funds, aka the Shadow Banking System, who are holding some seriously awful garbage. This is why we highlighted the at odds relationships the funds have had with the commercial banks and the Fed in the past. This does not quite make sense unless those reverse repos are of a very long duration or rolled over automatically for a long period of time. A proper program such as was extended to the banks where the Fed buys the assets outright would be that solution. It made more sense to us that the banking system is still very tight on good capital assets and liquidity.

Here is an update from ZH that is somewhat compelling if one understands the implications. Visualizing the Upcoming Treasury Funding Crisis.

“Summary: foreign purchasers are congregating exclusively around the front end
of the Treasury curve, meaning that the primary net purchaser of dated bonds has
been the Federal Reserve
. As everyone knows by now, the Fed only has $10 billion
left out of the $300 billion total allotted for Treasury QE. That should expire
next week
. … The time of unraveling may be upon us sooner than most think.”

Do Tim and Ben = Thelma and Louise?

As the Eagles sang:

“Take it, to the limit, one more time…”

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15 comments

  1. Don

    Stupid Question from a cultural illiterate. I recognize Turbo Timmy in the driver’s seat and Helicopter Ben riding shotgun, but I can’t place the person in the backseat. Who is that screaming guy?

  2. Peripheral Visionary

    Jesse, the Federal Reserve is not in a position to tap the money market funds for significant amounts without disrupting the financial system. That’s the case for a very simple reason: the MMFs are already funding the financial system to a very large extent, and any Fed involvement of significance would inevitably crowd out the financial sector.

    Right now MMF holdings are split between roughly three sectors: municipals (primarily held by tax-free funds), government-backed debt (Treasuries and agencies, primarily held by government funds), and securities related, directly or indirectly, to the financial sector. The latter are the largest group; between financial commercial paper, repurchase agreements, certificates of deposit, and other notes issued by financial firms, MMFs already fund a huge amount of the financial industry’s outstanding debt. Added to the that would be the financing provided to the financial industry indirectly through the ABS conduits (and previously through the SIVs, may they rest in peace), and the MMFs are one of the primary sources of funding, if not the primary source of funding, for the financial industry.

    The Fed cannot dip into the MMF pool without crowding out the financial companies. The amount of non-government, non-financial instruments in the MMF pool is negligible for these purposes; I would estimate 10%, if that. So it’s either going to be Treasuries, or munis, or agencies, or financial funding that get replaced by huge Fed repos; and on that list, it’s clearly the latter that is the most vulnerable.

    The Fed doesn’t realize that, but once they sit down and take a closer look, they’ll realize that this is a non-starter.

  3. seb

    I’m not sure I agree with the prior post. There is still a huge slug of money in money funds earning 0 bps. In fact, most MMF are waiving fees just to maintain a 0 bps yield. Yet money is not leaving the industry fast enough. Why? Because people would rather earn 0% with Fidelity then keep deposits at the local bank.

    With bills near 0% and corporates extending maturities to rely less on short term and bank markets, the industry is fairly starved for new product. Anything earning more than bills will get eaten up without any crowding out.

  4. Ina Pickle

    I’m strenuously hoping that “oh – look over there!” won’t work with the G-20. Given sentiment in Europe right now, surely those leaders have to be seen to take the US to task, even if we rattle the sabre and remind the EU that we’re not opposed to casualties like they are, and it is a dangerous world.

    I’m glad that Volker steped out. If I don’t see realignment and some movement towards reform, I’m going to have to admit that your worst fears are almost certainly accurate. The time for talk has ended.

  5. john bougearel

    Jesse,

    Thelma and Louise, What a powerful metaphor Timmy and Ben. We’d have to throw Summers into the 3 musketeers but that would have the same “crowding out” effect of the Fed dipping into the MMFs

  6. Peter T

    Don:
    > I recognize Turbo Timmy in the driver’s seat and Helicopter Ben riding shotgun, but I can’t place the person in the backseat. Who is that screaming guy?

    He’s taken for a ride. Who could that be?

  7. DoctoRx

    Note that the 30 yr TBond yield just equaled/marginally pierced its 2003 cycle LOW and a technician advised me today that point and figure charting shows that a breakdown to lower yields is underway.

    I am going with the Japan scenario of lower Treasury rates for the nonce-tho next week prob sees a bump up as institutions windowdress their stock portfolios.

  8. Hugh

    The difference between Team Obama and the Europeans is that the Europeans want to talk about reforms and Team Obama doesn’t. They do appear united however in not actually doing any reform.

    When money markets are mentioned I always like to ask if anyone knows about the $3.2 trillion that Treasury has apparently been backstopping them with, according to this June 2009 FDIC report:

    http://www.calculatedriskblog.com/2009/06/139-trillion-total-maximum-government.html

    And Treasury recently phased out a program for the MMF I believe, no idea if this is the same as the one above or different. It is one of the irksome things about all of these bailouts that we still know so little about them.

    It’s funny though in an unfunny sort of way that the central bank is looking to the shadow banking system for help.

  9. MarcoPolo

    Jesse, maybe a stupid question but I gotta know. How can the Fed conjure up 1t$ last March, most of which we are told has stayed on deposit with the Fed at interest as excess reserves, and not find the cash (balance sheet capacity) to reverse repo >100b$ from within the primary dealers? Carry trade?

  10. hidflect

    I have to ask; what is it that the Banksters have on Trembin’ Timmy? It seems all they have to do is blow into the room, plant their foot on his chicken-boned chest and say “OK – here it is Timmy… an’ listen up coz you’re not worth the breath repeatin’ myself..” My wilder, more paranoid side (that’d be the 90% you see up-front) suggests they’ve got (dis)tasteful B&W negs of Timmy in compromising positions… “hehehe.. and THIS one – I love the way he’s looking into the camera while he’s behind the donkey…”

  11. Rob Parenteau

    Peripheral visionary is correct. If the Fed is going to sell (or continually reverse repo, which is nearly the equivalent) assets it holds to MMMF in order to “soak up excess liquidity”, then the MMMF will have to sell their existing holdings of commercial paper, Treasuries, municipal debt, and foreign and corporate debt to make room for the assets the Fed is reverse repo’ing, or they will have to try to attract funds from other financial channels.

    All else unchanged, the prices of those securities will fall and their yields will rise. To the extent that backs up into mortgage yields, any housing recovery will be challenged.

    The only other way is for the MMMF to use their $542b in time and saving deposits, which will end up reducing the money stock outstanding and shrink bank balance sheets further. As banks lose these liabilities to the Fed, ostensibly they will have to sell an equal amount of assets.

    On the Fed running out of money to buy Treasuries, this is only true of their QE objective stated in March. They can always use open market operations to buy Treasuries, and with a fed funds rate near zero anyway, there is nothing to stop them from doing so.

  12. Jesse

    “The Fed cannot dip into the MMF pool without crowding out the financial companies. The amount of non-government, non-financial instruments in the MMF pool is negligible for these purposes; I would estimate 10%, if that. So it’s either going to be Treasuries, or munis, or agencies, or financial funding that get replaced by huge Fed repos; and on that list, it’s clearly the latter that is the most vulnerable.

    The Fed doesn’t realize that, but once they sit down and take a closer look, they’ll realize that this is a non-starter.” Peripheral Vision

    Peripheral Vision and Rob state the obvious. The Fed cannot repo into the markets to drain liquidity without affecting something. That is the very definition of a draining operation, isn’t it?

    The Fed is studying what the MMFs hold, and this is significant because it is HIGHLY usual for the Fed to conduct repo operations with them.

    That point speaks to the second point, which is that the commeercial banking system remains tight, very tight. That is why the Fed is studing non-traditional sources speaks to their thoughts that when the time comes for draining liquidity, they are concerned that the banking system will even then not yet be sufficiently capitalized to support the drains.

    The third point is that both PV and Rob make the all too common mistake that people make when they say that the price of a commodity or stock or currency cannot be manipulated and point to the total capitalization of the market and say, WOW who could do that!! So much money.

    Price are set at the margin particularly in ‘tight’ markets.
    This goes for interest rates as well as anything else.

    What you all missed in this is that the Fed knows the Shadow Banking system all too well, and is looking at it so that when the time comes to tighten (emphasis on time) they can put some restraints on it, opening it up to repos.

    To say now what the FEd can and cannot do based on at best a vague understanding of what they do know and what they wish to accomplish is a mug’s game.

    The key point in this, again, is that the banking system is tight, much tighter than we are led to believe, and that the Fed does not assume this tightness will ease even when the economy is recovering enough to start worrying about the appearance of a monetary inflation, enough so to raise rate.

    I may assume a lot of things, but I try not to assume the Fed staff is uninformed and stupid. This does put a certain cast on possibile motivations for those times when Fed Chairman feign stupidity, as Sir Alan Greenspan was so often wont to do.

  13. Jon

    My wife would very much like a copy of your weekend reading from a couple of weeks ago. Could it kindly be restored aux archives? Or jenny at highearth dot com. Thank you.

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