Comments on naked capitalism: Covert Nationalization of the Banking System

March 10, 2008To: naked capitalism.comFrom: Earl L...

2008-03-11T12:43:00.000-04:00

March 10, 2008

To: naked capitalism.com

From: Earl L. Crockett
Re: Continuing conversation re: “Covert Nationalization of the Banking System”
A follow up to: “Through the Looking Glass and Down the Rabbit Hole.”
Calling a Spade a Spade.
I wish to acknowledge for myself, and hopefully without stretching the matter too far, and maybe for all of us, that we are on new, and never before seen, financial market territory. Yes “history” is important, but that “history” that is desperately being attempted to be applied to what’s happening now, I think, has to be acknowledged as being as old hat as monthly market village meetings in the Middle Ages. Why do I say this? Well let’s start out with a “$650 trillion derivative market”, and its “little cousin”, the “$45 trillion credit default swaps (CDS)”, and the fact that derivatives were only created in 1995 during the “every thing is now going up, and aren’t we the lucky ones” era of prosperity. I will be honest, and you’ve already probably figure this out, I had to go to Goggle re: Wikipedia re: “financial derivatives” last week, and left the page thinking that I had selected Portuguese rather than English as language. My only solace to this still not understood financial market, and I have no stomach to even try at the moment, has been statements like that reported by Ambrose Evans-Pritchard, International Business Editor for Telegraph.com as follows:

"We are becoming increasingly concerned that the authorities in the world do not get it," said Bernard Connolly, global strategist at Banque AIG. "The extent of de-leveraging involves a wholesale destruction of credit. The risk is that the 'shadow banking system’ completely collapses,” [read derivatives] he said”.

Well gee wiz, if the “authorities in the world do not get it," who am I to complain? Except for the fact none of us probably “get it”, and someone, someday, very soon, should ring the class room bell, and give us a quick tutorial. And I sure don’t recall my (Circa 1962) business school “Money, Credit & Banking” class Prof., Admiral Challenger, ever mentioning a “shadow banking system”. (Talk about the “Middle Ages”?)

And then this morning Paul Krugmam, under the article title of “The Slap Face Theory”, a very good article about other matters at play in the “shadow bank system” (my appellation), says “Last month another market you’ve never heard of, the $300 billion market for auction-rate securities (don’t ask), suffered the equivalent of a bank run.”
I don’t want to add to much to this, and will let the “another market you’ve never heard of”, and the “(don’t ask)” speak for itself.

This has been a rather protracted introduction to what I really want to say to all of you, as well as to myself. Everyone that I’ve read in the last week, including my own stuff to some extent, has been very gentlemanly and ladylike, in not wanting to appear to be alarmists, extremists, the sky is falling, the wolf is at the door, and hedge fund appearing salesman, fear mongers. This is an admirable way of being, indeed. Fear will not solve this problem even though it might be a useful motivator to a next, and hopefully more positive, course of action. Ambrose Evans-Pritchard, International Business Editor, for Telegragh.com, and author of multiple books, published a well thought out article titled “The Federal Reserve’s Rescue has Failed” a few days ago, and got hammered, and I mean really hammered, for what he had to say. He was also courageous, honest, and gutsy enough to end his article with this statement, “For the first time since this Greek tragedy began, I am now really frightened.” Isn’t it interesting that a clearly stated personal opinion, by a very knowledgeable guy, at the end, and separate from, the factual data of his article should draw so much heat? Clearly only a handful of us are ready to hear that the “emperor has no clothes” much less actually say it loud enough that anyone else can hear it.

And we have another “problem”. We’ve been brought up, if not traumatized, by our educational system, to think that we have to “know” all of the facts on all things before we can speak on any given matter. Well we don’t, and I think it is fair to say at this point that nobody else does. So what are we waiting for? And to be squeaky clean this is not a decision that anyone should allow anyone else to talk them into. Sorry to say, you’ve got to reach the plateau all on your own. What I’m trying to say might be easily communicated by the old saying “If it looks like a duck, if walks like a duck, and it quacks like a duck, then it must be a duck.” Folks, I think we have a genuine, honest to god, no fooling “duck” on our hands. Think about it.

So you might ask, “So what are you going to do about it mister smarty pants?”
We’ll I’ll tell you what I’m going to do about it by saying the following:

“Our Nation, meaning our very way being and living, is in near term Peril, period.”
(Webster: Peril, 1: exposure to risk of being injured, destroyed, or lost.)
Earl L. Crockett, March 11, 2008

And what to do, you then ask? Bernanke is the one to call the “meeting”, a meeting declared to be an inquiry into, and about, real “outside of the box” thinking and solutions. My preference would be that the”meeting” be held in the dark of night, in the basement of the Fed, sans politicians, with no public notice, and having a well stocked bar, as they will surely need it. My first call would be to Milton Friedman, but he’s not around any more. I would also add such industry types as Buffet, Gates, and Jobs along with the “Friedman’s”. Buffet because he is the most honest, no nonsense, knowledgably, business nurturing, human being known to me with the possible exception of my now deceased business mentor George Quist. Gates because he and Buffet are the two richest men in the world, and therefore have the most at stake financially. And Jobs because he is the most creative “outside of the box” thinker, designer, and implementer of ideas, and technology, on the Planet. You probably have your own ideas about who should attend. I think it would be a very interesting conversation to pursue. So…is this an”outside of the box”, presumptuous, and even strange idea? Of course it is, but desperate measures for desperate times. And as much as I dislike the word desperate, my dad would have said its’ time to call “a spade a spade”. Warm up your G-5’s boys and girls your country needs you.

Earl L. Crockett

I think we should take a step back & give a round ...

2008-03-10T16:34:00.000-04:00

I think we should take a step back & give a round of applause to Ben Bernanke. Whether you agree or disagree with everything he has done since August, I think you have to hand it to him for sheer inventiveness.

I largely view our situation as something which gathered itself over a long period of time - before Benanke inherited the reins.

If he can pull it off, I think we'll be praising him in a few years. Of course, all of this innovative shuck & jive might go down like a led balloon...then Gd help us, Bernanke first in line.

(& I'd just like to add that sending a Memo to a blog rocks! Earl, please keep being you - I'm serious!).

Interesting analysis...and it would be even more i...

2008-03-10T12:57:00.000-04:00

Interesting analysis...and it would be even more interesting if the "Fed" were a government institution. It is not. The Fed is a consortium of private banks, not an arm of the US government. How, then, does it "nationalize" anything?

It's an important observation on the structure of ...

2008-03-09T21:44:00.000-04:00

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.

March 9, 2008To: naked capitalism.comFrom: Earl L....

2008-03-09T18:30:00.000-04:00

March 9, 2008

To: naked capitalism.com

From: Earl L. Crockett

Re: Sat. March 8, 2008 article, “Covert Nationalization of the Banking System”

Through the Looking Glass, and Down the Rabbit Hole.

It seems that we’ve all been forced into having to think macro-economics to a new level. At least that is the case for me. And it has seemed in the last ten days as if I’ve gone through the “looking glass” and down the “rabbit hole” day by day with announcements like Bernanke’s suggestion to member banks that they consider a “reduction of capital” on mortgage loans in their portfolios, etc. In a way, and these matters are still trying to sink into my head, Bernanke is passing on his “28 day loan if you’re able to pay” “equity” infusion practices to member banks who would then would be making after the fact, voluntary, equity contributions to their mortgage loan holders by reducing a percentage of the mortgage loan rather than having to dump the whole loan amount into a “non-performing’ loan status. Not really a bad idea as bizarre as the idea first seems.

On the macro side I’ve wound up with note pad sheets with 10 and 11 zeros spread across my desk having to think in “Trillions” for the first time in my life, and I am 70 years old. Here are some of the numbers that I’ve come up with:

It is reported in the last few days that there are 900,000 homes presently in foreclosure. Taking a “what if” and/or “bigger than a bread basket” business approach, lacking any “for certain” data, I’ve assumed a $200,000 to $400,000 per home amount for those homes in foreclosure. So…current non-performing mortgages industry wide could be in the range of $180 billion to $360 billion. If the current estimated national bank equity is “2.0 Trillion”, as given in the above referenced article, then this would be a 9.0% to 18% industry wide reduction in total bank equities/assets, and as suspected in the above article these amounts are probably tilted in the direction of a few “big time” lenders rather than being industry wide. Now this is a big impact for sure, but then one could ask why has Bernanke seen fit to lay out $140 billion in Jan. and Feb. 2008 (I think), $200 billion in March, with the further advice that this could go on “for another six months”? If you add these potential Fed “loan” numbers through the “another six months’ the number comes out to be $1.540 trillion which is approaching 75% of the “bank industry-wide equity”.

I think the answer might be in the following:

“Economy.com estimates 8.8 million homeowners, or about 10 percent of homes, will have zero or negative equity by the end of the month. Even more disturbing, about 13.8 million households will be "upside down" if prices fall 20 percent from their peak. The latest Standard & Poor's/Case-Shiller index showed U.S. home prices plunging 8.9 percent in the final quarter of 2007 compared with a year earlier”.

If you apply the former hypothetical “$200k to $400k per house” numbers to the potential near term foreclosure homes the numbers become $1.76 Trillion to $3.52 trillion (8.8 million homes), on to $2.76 trillion to $5.52 trillion (13.8 million homes). My guess is that these are the numbers that Bernanke has written on his office blackboard.

While my natural proclivity is far from being a “nay-say-er” or “down-side-bottom feeder”, it does looks to me like our national banking system is approaching bankruptcy, another “through the looking glass and down the rabbit hole” distinction. And, and this is a very big AND, if that happens then what can be said about the Federal Reserve itself to say nothing about our whole economy? My advice to myself, and to all of you, is to pay close attention to what the “Standard & Poor's/Case-Shiller index” says about home prices for the first quarter 2008 that will come out sometime in April. And yes I do understand that a lot of this mortgage debt has been “laid off” to International markets, but that number is presently “unseen” by me from my position at the bottom of the “rabbit hole”.

I applaud “naked capitalism”, and the many respondents for their “to the bone” knowledgeable assessments of “what the hell is going on?” with our economy. My only question of Bernanke is his same day announcement, a week or so ago, that followed and was seemingly in support of Bush’s “were not in a recession it’s only a slow down”, press release, causing none other than Warren Buffet to announce the next day “We’re in a recession”. Thanks Warren! A former Stanford Business School graduate (circa 1983) intern, and then associate of mine, Steve Garfink, had Bernanke as a Prof., and says “Bernanke is a really smart guy.” I certainly hope so! And I also hope that Bernanke has “This Could Happen” written boldly in the middle of his office black board under the above statistics. But as much as I try, I can’t see what he could do about it.

Earl L. Crockett

NotNOW, Yes, there are no doubt limits to risk int...

2008-03-09T16:48:00.000-04:00

NotNOW,

Yes, there are no doubt limits to risk internalization. Perhaps it is part of the modern psyche to avoid nonlinearity and countervailing pressures, so I wonder to what extent the expand(ing) operations will impact interest rate differentials and whether they speed or retard the fed's move towards a zero bound funds rate?

In a larger sense I'm inclined to see these attempts to control and mitigate as no more than responses to growing financial uncontrollability, and responses which, last instance, must compound exactly that which they attempt to control. I doubt that permanent crisis management can ever be permanent while, same time, am sure there are systemic limits to accumulation of fictitious capital.

ctmm-I didn't mean to imply that I support such a ...

2008-03-09T14:30:00.000-04:00

ctmm-

I didn't mean to imply that I support such a policy. IMHO, I think Fannie/Freddie should be allowed to default if it comes to that, and for that matter, so should Citi and all the other "too big to fail" institutions out there (if they really are providing such an invaluable service, then someone is willing to pay good money for such service, which means someone else will come up to provide that service. The invisible hand and all, right?).

As for your question about the difference between the bankrupt bank and the bankrupt person, it comes down to Trump's famous dictum "If I owe the bank a million dollars, it's my problem; if I owe the bank a billion dollars, it's the bank's problem". Especially when Wall St. has purchased the sympathies of our public officials and Main St. is viewed as nothing but outsourcing fodder.

One thing notably absent from this analysis, and f...

2008-03-09T13:47:00.000-04:00

One thing notably absent from this analysis, and from any speculation by any commenters, is this: How long can this game go on? Does the Fed have a bottomless pit of money? How long before the world wide dollar revolt?

Is the Fed merely rearranging the deck chairs? Personally, I think so. At some point, the child at the amusement park will ask for another ticket to ride, and mommy will have to say: "Sorry, son, there are no more tickets."

Hey Lune,That sounds great for the banks and all, ...

2008-03-09T12:27:00.000-04:00

Hey Lune,

That sounds great for the banks and all, but what happens when the average (and by average, I mean me) person notices that these arbitrary business entities can be endlessly bailed out by the government (ie. taxpayer)?

I mean, now that everything is digital, what's the real difference between a bankrupt bank with a pile of devaluing assets, and the average bankrupt person with a pile of devaluing assets?
...
I'm with you on thinking the "value of money" has been lost- but I suspect that it has more to do with the petro-dollar becoming the petro-ruble and petro-euro. I probably read too many "peak insert-commodity-here" blogs, but I seems like fiat currency only really works in expanding economies.

Wow. Fantastic find, Yves. I think the analysis of...

2008-03-09T05:16:00.000-04:00

Wow. Fantastic find, Yves. I think the analysis of what is happening (the conversion of suspect agency debt into liquid and secure treasuries) is spot-on, but I don't think the target of this largesse is the banks per se (although that's definitely a fringe benefit).

Could this instead be the govt finally caving on the implied guarantee of agency debt? While every govt official has officially stated that Fannie/Freddie do not have a govt guarantee, no one believes the govt would allow those markets to fail. This would be a way of nationalizing that debt pool without "officially" doing so. Think of the Fed as the govt's SIV, carrying agency liabilities in an off-balance sheet vehicle: technically, the debt is not on the govt's ledger but if any of the debt on the Fed's ledger were to default, it has already been replaced with treasuries which do carry an explicit guarantee.

In this scenario, the Fed must prepare for a not-insignificant amount of its repo assets to fail. While I agree the default risk on overnight treasure securities is virtually nil, the risk of default in 28-day repos of agencies is distinctly nonzero, especially as these repos will likely be rolled over every 28 days for the next couple of years until bank balances are repaired and agency spreads come back down to historical norms.

But perhaps that's the point: allow banks to exchange their agency debt into treasuries on a semi-permanent basis, have the govt. assume the risk of default on that debt during these dark days, then return the debt at par to the banks when the markets have stabilized again. (sounds like socialize the losses, privatize the gains, no...?)

yves,You know what this boils down ... huh, huh, d...

2008-03-09T03:16:00.000-04:00

yves,

You know what this boils down ... huh, huh, do yah?

As a society -- perhaps as a globalized tribe, we have lost the ability to define what money is, or what it represents. That could explain the problem with ratings models, valuation models and bubbles and this systemic meltdown/implosion, this Great Depression-like deja vu (all over again).

The journey of this information highway is perhaps resulting in information impact which in some way has warped or distorted our collective understanding of many dynamics -- as we are all brought together into a new world paradigm, with too many dynamics to understand. The speed of change and the hyper efficiency of expansion may have pushed this envelope too far too fast, and now dis-connected, we have fragmented blogs where people are hoping to explain change and discover why the government seems so .... retarded. We wonder why money is not making sense!

Amen

I for one am willing to trust that the Fed underst...

2008-03-08T23:40:00.000-05:00

I for one am willing to trust that the Fed understands that it can't role this bank debt forever and has an exit plan in mind. I am also willing to accept the possibility that, what with the new mark to market rules, some banks may end up operating for several years on a technically undercapitalized basis (e.g. 3% leverage ratio).

The CDS collapse is likely to lead to a major shuffling of the capital deck. Do you really want the Fed to nationalize some "too big to fail" banks, only to find out that it closed down the stronger banks? I think the Fed needs to wait for CDS to sort itself out before developing a policy for putting an end to the crisis.

Yves,The trends in the TAF were clear, there was a...

2008-03-08T22:27:00.000-05:00

Yves,

The trends in the TAF were clear, there was a sequentially increasing number of bidders and higher bid to cover ratios if you check the series of press releases. Thhe article is right on about debt versus equity and it goes to the question of if a repo is permanently rolled is it a repo of a print? On the flip side the banks will not ramp their lending so the "liquidity" to he market concerns are misplaced. The Fed can shower money on everyone they want but that doesn;t mean you get a multiplier effect. Therein lies the problem. The ultimate end user is overburdened and incapable of taking on more. That is unless BIll gross gets his way and we all get 2% 30 year paper backed by the FHA. Joke.

Re: back to the pawnbroker analogy.....they only ...

2008-03-08T22:11:00.000-05:00

Re: back to the pawnbroker analogy.....they only take stuff that is salable, like jewelry, not your beat up couch.

I like the garage sale analogy better, because at the end of the day, after you mark-to-market and no one wants your sofa or underwear, you load that up and give it away to Goodwill, who then marks-to-market anything that has any potential value, and the "rest" is placed in the trash bin, where it goes to a dump, where people can still pick over that waste and recycle that back to other garage sales...gheeesh, dont you get it?

In the case of manure, you simply match the demand for unit output to the yield and sell futures and have SIFMA pump velocity!

Yves,By definition, if the stuff is salable, then ...

2008-03-08T21:11:00.000-05:00

Yves,

By definition, if the stuff is salable, then it can be sold. If it can be sold, then why aren't they selling it?

The answer is that they don't like the bid.

So the TAF auction and term repo are intended to save banks from having to sell agencies at bids that they don't like. This is different from subprime, where presumably there was no bid.

The reason the Fed wants to prop up agency bids is obvious: they want to stop a chain reaction of margin calls caused by deteriorating agency values.

Anon of 4:35 PM,I don't see how you can say the F...

2008-03-08T19:42:00.000-05:00

Anon of 4:35 PM,

I don't see how you can say the Fed isn't offering liquidity support on agencies. Look at its new $100 billion repo facility. Two of the three tranches are for agency or agency guaranteed debt.

Folks,

The issue is NOT so much the quality of the collateral the Fed is taking, the issue is the amount and the fact that it needs to offer this much. $100 billion is in Treasuries or agency-backed debt. The TAF, if you bothered checking the collateral table (for which I've provided links in previous posts) is stuff that is at least good in quality, and the Fed applies haircuts to market prices. This is far from "toxic waste." The Fed also claims to be conservative in what they are accepting, and can reject collateral

But back to the pawnbroker analogy.....they only take stuff that is salable, like jewelry, not your beat up couch.

I'm hearing that horse manure will now be traded a...

2008-03-08T19:26:00.000-05:00

I'm hearing that horse manure will now be traded as a fungible commodity, in addition to:

Urea
A combination of carbon, nitrogen, oxygen, and hydrogen (the building blocks of all life), urea is a potent fertilizer. Originally isolated from urine in 1773, it was the first organic compound to be synthesized in the lab from inorganic materials. Today, urea is a major industrial chemical (it adds flavor to cigarettes - yum).

Also See: Commingling of Commodities: All Commodities stored hereunder may be commingled and warehoused as one general lot of fungible goods and the Bank shall be entitled to such portion of such general lot as the amount of the Commodity represented by the Warehouse Receipt bears to the whole of such general lot of such Commodities.

Also, in regard to The Fed accepting manure as collateral: Release of Commodities: For greater certainty it is hereby stated and agreed that the Collateral Manager shall not allow the release of any Commodities unless it has received written instructions from The Fed stating the person to whom the Commodities shall be released and the date and manner of such release, notwithstanding alternative or contradictory instructions from the Depositor.

What's the big commotion? I've said for months wh...

2008-03-08T19:10:00.000-05:00

What's the big commotion? I've said for months when push comes to shove the Fed will discount anything the major banks offer it, even horse manure. TAF, 28 days, repos, what are you talking about? IT DOESN'T MATTER! The Fed will buy whatever paper the banks tell it to. Stop immersing yourself in insignificant details.

for this TAF operation of FED absorbing toxic wast...

2008-03-08T19:04:00.000-05:00

for this TAF operation of FED absorbing toxic waste onto its system, does fed rate need to go lower? 0.75% or 1% cut??

Yves,The Fed is not offering liquidity on agencies...

2008-03-08T16:35:00.000-05:00

Yves,

The Fed is not offering liquidity on agencies--it doesn't like the market direction and is offering price supports. The problem is not that banks need liquidity and now can pledge agencies to obtain it. The problem is that the value of the bank's agencies is dropping, and the banks keep acquiring agencies as their prime brokerage clients get squeezed and can't meet margin calls. The Fed is looking to prevent fire sales of portfolios and the attendant hits to bank capital. They can't accomplish that long term, unfortunately, any more than they can move the FX markets. Once again, handyman Bernanke sees a few days of things he doesn't like in the market, and rashly steps in to fix it. Good luck to him in trying to maintain the price of 32x leveraged agency portfolios.

Note that this operation is not resulting in an in...

2008-03-08T16:02:00.000-05:00

Note that this operation is not resulting in an increase in the "liquidity" in the banking system. What the Fed is offering via the TAF will be matched with draining reserves via open market operations (which are done with Treasuries).

So what it is trying to do is a surgical operation, directing liquidity to the sector of the market (agency securities and mortgages) that is most in distress.

Just think of TAF as price supports for the family...

2008-03-08T15:58:00.000-05:00

Just think of TAF as price supports for the family farmers of Wall St.

Um...I have an imperfect understanding of finance ...

2008-03-08T15:35:00.000-05:00

Um...

I have an imperfect understanding of finance at this level.

If I understand correctly, you're saying the FED is willing to act as a bottomless lender that is unlikely to ever call in loans.

Won't that result in even more inflation and foreign countries dumping their dollar holdings?

If we actually built anything in america, this might not be so bad, but with 65% of our oil being imported (to say nothing of the endless stream of consumer goods), is this just a new, bigger bubble to absorb the other bubbles?

Outstanding analysis & right on. A debt isn't a de...

2008-03-08T15:09:00.000-05:00

Outstanding analysis & right on. A debt isn't a debt if the lender never calls it... but that doesn't mean it isn't a 'liability'. Sword Of Damocles Financial would be an appropriate name for some of these 'new' firms.

Re: it accepts propositions from dealers in three...

2008-03-08T14:43:00.000-05:00

Re: it accepts propositions from dealers in three collateral “tranches.”

One would hope The Fed is able to come to terms with accounting in regard to FASB 157 and 158, both of which were delayed last year. These FASB accounting issues are related to mark-to-market disclosure and valuation.

The collateral transfers in question here are simile-like, i.e, we have corporations dumping toxic waste into our drinking water, while The Fed lowers the parts per billion accountability levels.

The Level 3 mark-to-market accounting is to help us plain farm folks understand more about the derivatives and behind the scenes illusions, e.g, Level 3 speaks of unobservable assets, which need to be valued at current market rates. Why then, as citizens of America are we being placed in a position where accounting rules are not being used, not being implemented or used to help strengthen our economy. It seems to me, this is a matter of National Security, and if we allow a bunch of crooks to keep dumping toxic junk into our system, we will all be impacted by the insidious nature of this cancer!! Get real, these crooks need to go to jail and we need to see people in this government resign for contributing to false and misleading information and fraudulent accounting practices!!