|Consolidated Statement of Condition of All Federal Reserve Banks|
|‘Other deposits held by depository institutions’ (total reserves at the Federal Reserve bank)|
|Fed balance sheet liabilities (In millions of dollars):|
|03/15/17 Third Fed rate hike
01/20/17 US President Donald Trump inaugurated
12/31/16 Investors poured a record $97.6 billion into U.S. equity ETFs since the U.S. election
12/14/16 Second Fed rate hike
11/08/16 Donald Trump elected US President
|12/30/15||2,208,683||12/16/15 Janet Yellen announces ‘liftoff’, the first rate hike by the Fed since June 2006, which closes the chapter on an unprecedented era of easy monetary policy|
|09/24/14||2,707,185||10/29/14 US Federal Reserve Chair Janet Yellen announced it is ending LSAP that added approx $4T worth of assets to its holdings ($2.4T UST + $1.7T MBS)|
|12/25/13||2,450,733||12/18/13 The Federal Reserve announced Wednesday it would start to taper its aggressive bond-buying program to $75 billion a month beginning in January|
|09/25/13||2,307,013||9/18/13 The Federal Reserve holds its asset purchase program steady, putting off any decision for tapering until later in the year|
|06/26/13||2,017,729||7/19/13 Ben Bernanke says the Fed could begin to taper its purchase of bonds later this year, if the economy continues to improve as Fed officials expect|
|06/28/12||1,491,988||9/13/12 FOMC announces continued LSAP beginning in September 2012 (“QEIII”)|
|09/28/11||1,608,996||9/30/11 FOMC announces re-investment of maturing MBS into UST ceased (to instead re-invest in more MBS to maintain MBS level)|
|06/30/11||1,622,395||6/22/11 FOMC announces re-investing principal to maintain total balance sheet $2.6T level|
|09/30/10||984,139||11/3/10 FOMC announces continued LSAP from November 2010 to June 2011 (“QEII”)|
|06/24/10||1,062,348||8/10/10 FOMC announces re-investing principal to keep levels current|
|12/29/08||819,404||3/18/09 FOMC announces Large-scale Asset Purchases (LSAP) to last from Spring 2009 – Spring 2010 (“Quantitative Easing”)|
|09/25/08||95,301||9/15/08 Lehman Brothers bank filed for bankruptcy, the largest in US history|
* (Note: This is an updated version of the original post from April 2016)
This article (link above) entitled “‘Helicopter Money’ Won’t Offer Much Lift” from Bloomberg/Newsrooom appeared today. It was written by Narayana Kocherlakota, now a Bloomberg View columnist, who also is the Lionel W. McKenzie professor of economics at the University of Rochester, and who also was the 12th president of the Federal Reserve Bank of Minneapolis from 2009 through 2015. In this article, Narayana Kocherlakota mentions “global central bankers’ quest for unconventional ways to stimulate weak economies”, with the old idea of dropping “helicopter money” directly to the people, or the gov’t, to spend. Knowing that this idea is more sensation than sensible, Narayana Kocherlakota then makes his most powerful point: “The government has all the borrowing and spending power it needs to boost the economy and get inflation up to the desired level, if only it had the will.”
Bingo…In a nutshell, he says exactly what is presently ailing most of the world economies.
Inspired by this, I emailed him. In lieu of a lack of will by fiscal policymakers, I offered my own unconventional idea for monetary policymakers that I personally believe would immediately work to remove the ‘specter’ of federal government debt, and restore confidence to consumers. This idea, in my opinion, would unleash that pent-up aggregate demand here in the US, and even more so if implemented in Japan, but this idea would not work in the Eurozone. Forget the EZ, with their incomplete setup, without a federal government bond (like the US and Japan), and also without a centralized, fiscal policymaking branch with strong authority (like the US and Japan), the troubles in the EZ will last a very long time…The only hope for any member state is to ‘exit’ the EZ, my guess Italy will be the first (?), get back their ability to issue sovereign currency, and reacquire that needed ‘adjustment mechanism’ that they had lost. I also thanked Narayana Kocherlakota for his public service and he was kind enough to reply back (and polite enough to gently put that he was skeptical of my idea). Here is my message and his reply:
From: <firstname.lastname@example.org> To: NARAYANA: Agreed that if fiscal and monetary policymakers were in sync, they could work together to generate inflation, but if not, instead of talking about helicopter drops (which would be politically untenable), I have another suggestion: ‘Quantitative Redemption’. The Fed has $2T in Treasury bonds on its balance sheet. Announce that starting today, $167 billion per month, will be, effective immediately, ‘redeemed’. Paid off. Ripped up. One arm of the federal gov’t (Treasury) issued those IOUs and another arm of the federal gov’t (Fed) bought them back. Instead of continuing to ‘impound’ these bonds on the Fed’s balance sheet (Peter paying Paul), by the end of one year, all $2T won’t exist anymore. Anybody that knows Treasury bond markets can guess what would happen next: This outright decrease in supply would bid up prices of Treasury bonds and pressure rates lower (Thus ‘QR’ done sooner would mean ‘QE2’, ‘QE3’, ‘The Twist’, and endless Fed jawboning would not have been necessary). Anybody that knows what Treasury bonds are also knows what this ‘redeeming’ of Treasury bonds means: Decreased ‘National Debt’ which decreases Groupthink’s perceived imminent ‘danger’ to the financial security of the country, and also decreases the need for any more Kabuki theater in Congress over raising the ‘debt ceiling’. Furthermore, anybody that knows what this telegraphed, intentional money creation means, can also guess what would happen next: Consumers and businesses would front run the approaching dilution, or reduction, in the purchasing power of their cash, and start making those purchases +/or investments that they had been postponing since the financial crisis of 2008. Instead of another helping of obstructionism, fiscal policymakers in Congress *could* get in sync with monetary policymakers, assist them by concentrating on boosting the economy, enacting productive, counter-cyclical fiscal policy measures, and generating inflation to the desired level…“If it had the will”.
Thanks for the comment.
I should think more about this –
but my first reaction is skepticism.
Suppose the Fed forgives all of this debt.
Would this make the Fed less willing to raise rates, more willing to tolerate inflation?
Maybe – but, as I say, I’m skeptical.
The US stock market is one of those ten US economic ‘leading indicators’ that usually changes before the economy as a whole changes. The enclosed link above is a very illuminating ‘info-graph’. It’s kinda like a ‘Chutes and Ladders’ game board. The object of this game is to become the first player (Read: fiscal policymaker) to break away from the ‘federal-gov’t-is-the-same-as-a-household’ groupthink…
Just start at the left, follow along up and down with actual amounts of dollars sloshing in to and out of the private sector year over year (what economists call ‘vertical’ or high-powered ‘exogenous money’ and what MMT calls ‘dollar adds’ / ‘dollar drains’). As it all veers upwards, that means dollars getting consistently added to the private sector, as it all veers downwards, that means dollars getting consistently drained from the private sector, and then watch what happens next in the stock market (Spoiler Alert: It did exactly what it was told to do)…
Note that other than just those four ‘Clinton Surplus’ years, all the rest of the years on this graph are, at the same time, running both US budget deficits (the first two bars in each year) and US trade deficits (the second two bars in each year). Can you remember when we were all told that these so-called ‘Twin Deficits’ were so terrible, yet as you can clearly see, the economy and by extension the stock market weren’t always doing so terribly, in fact, there isn’t much of a correlation at all. There is a correlation however, to the economy and the stock market with the other deficit on this graph, the private sector ‘deficit’ (not to be confused with private sector debts like student loans, a home mortgage, or credit card balances due). Federal budget deficits and federal trade deficits are what everyone focuses on, and needlessly worries about, but the private sector deficit is the one and only deficit that we should instead be focused on, and actually be worried about. In the year 2001, the total private sector dollar drain, or their sustained ‘deficit’, since the 1990 recession, reached $1.787 trillion right before the economy fell into recession. This ‘indicates’ that going forward, fiscal policymakers should take action if private sector deficits reach that level again, but look what happened next. After proper dollar adds, or private sector surpluses, the economy recovers, but only a few years later, dollar drains, or sustained private sector deficits pass that $1.787 in the year 2007 again, and by much more. The result was the Great Recession. Only sustained private sector deficits that are allowed to build up are the actual danger to the economy, and only fiscal policymakers, working cooperatively, taking their cue from monetary policymakers, can prevent dollar drains from reaching critical levels. Furthermore, only people watching these private sector deficits as ‘leading indicators’, will have a good idea what that real leading indicator, the US stock market, will do next.
Not convinced? Take a look at these dates:
These dates above were the 6 periods in American history when the US federal gov’t had substantial yearly budget surpluses (decreasing total US federal gov’t debt) meaning, at the very same time, and by accounting identity, the US private sector was, to the penny, being subjected to the exact same amounts of yearly ‘savings deficits’ (increasing total US private sector debt). Next look at these dates:
These dates above were the starting years of all six economic depressions in U.S. history. Now let’s put all the dates together:
1817-1821 federal gov’t surpluses and the 1819 Depression
1823-1836 federal gov’t surpluses and then the 1837 Depression
1852-1857 federal gov’t surpluses and then the 1857 Depression
1867-1873 federal gov’t surpluses and then the 1873 Depression
1880-1893 federal gov’t surpluses and then the 1893 Depression
1920-1930 federal gov’t surpluses and then the 1929 Great Depression
Hardly…Now let’s connect the dots:
The Great Depression was the worst economic downturn in the history of the Western industrialized world, and why? It was not just because of a stock market collapse, but instead, it was because of a “money supply collapse” (quoting former Fed Chair Ben Bernanke in ‘Courage to Act’). When the federal gov’t is running a surplus, like it did in all the examples above, the federal gov’t is draining dollars from the money supply, out from the private sector. When dollars are being drained from the private sector for a prolonged period, then the private sector must start borrowing, or ‘deficit spend’ to maintain their same level of consumption in order to keep up their same desired level of savings. As you can see, all 6 economic depressions in US history were preceded by prolonged federal gov’t budget surpluses, or put another way, they were preceded by prolonged private sector savings deficits, resulting in prolonged private sector ‘deficit spending’. It is not continuous deficit spending by the federal gov’t that is unsustainable, it is continuous private sector ‘deficit spending’ that is unsustainable…
From the perspective of the private sector, there is no difference between the gold-standard era and the post-gold-standard era, because the private sector is not the issuer of dollars (no matter whether they are backed by gold or they are not). The private sector, because they are not the issuer of dollars, always goes into actual debt when deficit spending. However, from the perspective of the federal gov’t, the issuer of dollars, there is a stark difference between the bygone monetary system that had gold-backed dollars, and the modern monetary system that doesn’t have gold-backed dollars. US dollars today are not convertible to anything. US dollars today are not pegged to anything, they are free-floating, and they are issued by fiat. During the gold standard era, the federal gov’t could not just ‘issue’ gold out of thin air, but now the federal gov’t could just issue fiat out of thin air. Instead of the federal gov’t borrowing gold-backed dollars and ‘monetizing debt’ (financing debt by swapping IOUs for gold-backed dollars), the federal gov’t today issues newly-created fiat dollars and ‘monetizes deficits’ (reconciles deficits with ledger entries of non-convertible dollars). Before, federal gov’t deficit spending added to an actual outstanding debt of gold-backed dollars; now federal gov’t deficit spending instead just subtracts from the purchasing power of outstanding fiat dollars.
Unlike a household, that needs to balance a budget, the federal gov’t needs to balance the economy. Rather than worrying about ‘running out’ of fiat dollars, federal gov’t fiscal policymakers should be concerned about either strengthening a too-weak economy, or weakening a too-strong economy, whichever is needed at the time, to promote balanced growth. An economy with balanced growth creates as many jobs as possible, which then helps the most people as possible to earn dollars to pay for goods and services. In addition, fiscal policymakers must do what is needed to have the resources to be able to provide those goods & services in the future because THAT IS WHAT WE CAN ACTUALLY RUN OUT OF…
Today, in the post-gold-standard, modern monetary system, federal gov’t deficit spending ‘finances’ our savings (not the other way around anymore). If the federal gov’t isn’t deficit spending enough, then the private sector must keep ‘deficit spending’ more, meaning keep borrowing more dollars, and since unlike the federal gov’t, the private sector cannot issue dollars, THAT IS WHAT IS ACTUALLY UNSUSTAINABLE…
Monetary policy is just the anesthesia, and those monetary anesthesiologists, our central bankers, just keep the patient sedated. However, if those fiscal surgeons, our fiscal policymakers, do not then get to work, do not take productive, counter-cyclical measures, and just dither or bicker at each other while dollars keep draining from that patient, our private sector, then just like ZIRP & Consumption Taxes did in Japan, like austerity measures are doing in the EZ, and what sequestration is now threatening to do here in the US, as history shows, the US stock market will sooner or later follow accordingly.
NOTE: The above info-graph is a modified version of the original created by Chris Brown. Here is his latest updated version: US asset decline 1992-2015 Revision 7 on FEB 17 2016
Follow Chris Brown at the “Intro to MMT – Modern Monetary Theory” page on Facebook: https://www.facebook.com/groups/introductiontommt/
On January 29, 2016, Bank of Japan Governor Haruhiko Kuroda announced a negative interest rate, to take effect on Feb. 16, “to spur banks to lend in the face of a weakening economy”…
(Read: To punish banks for not lending.)
Next year, the Japanese gov’t plans to once again increase the Consumption Tax, or national sales tax to 10%, “to balance the federal budget”…
(Read: To punish everyone else with a ‘deflationary mindset’ for not spending.)
The BOJ’s move, “is similar to the ECB’s first foray into negative rates in June 2014 and the tiered measures put in place by the Swiss National Bank”…
(Read: The BOJ’s move is similar to the reeking smell of desperation as in the Eurozone and as in the US, also suffering from weak growth, due to a lack of productive, counter-cyclical fiscal policymaking that has resulted in non-productive, pro-cyclical ‘austerity’ & ‘sequestration’ policymaking.)
P.S. It’s like completely incompetent people are running gov’t…Hmmm, why does that sound familiar (?)
(Read: Why Trump might become president.)
Encl. Here is what all central bankers would sound like (if their fiscal policymakers were also on the same page as them):
1 FEB 2016 BANGKOK POST – Thailand’s central bank, the Bank of Thailand, will forgo further interest rate cuts to “concentrate on stabilizing the nation’s currency, because in the current market, government spending has far more potential to drive economic growth than monetary policy does. In a situation like this, fiscal policy is much more effective than monetary policy for stimulating the economy overall“, Thai central bank Governor Veerathai Santiprabhob said. Thailand Finance Minister Apisak Tantivorawong added, “I believe we are heading in the right direction. If we want to improve the domestic purchasing power we have to focus on ways to boost the purchasing power of the vast majority of people. Moreover, since low-income earners are the most vulnerable sector of society, they are the most deserving of government aid,” he said. Recent measures reflect the Thai government’s concern over the impact of the slowdown of the Chinese economy. Mr Apisak said China’s cooling economy had heavily hit the export sector and affected other sectors along the economic chain, so the Thai government has sought to ease the impact by injecting liquidity mainly to low-income earners and accelerating investment in megaprojects.
The book: ‘The Big Short’ by Michael Lewis, financial journalist and nonfiction author…
The movie: ‘The Big Short’ directed by Adam McKay, ‘Funny or Die’ website co-founder.
The book: One of the ‘shorts’ was Mike Burry @ Scion Capital.
The movie: Christian Bale plays Dr. Michael Burry, an eccentric ex-physician turned one-eyed Scion Capital hedge fund manager, who has traded traditional office attire for shorts, bare feet and a Supercuts haircut. He believes that the US housing market is built on a bubble that will burst within the next few years. Autonomy within the company allows Burry to do as he pleases, so Burry proceeds to bet large against the housing market by first asking Goldman Sachs, and then other banks, to create a derivative known as a credit default swap, or CDS, which is a custom-made insurance policy, on specific subprime debt, hand-picked by Burry. This newly-written policy, this derivative contract, effectively creates an underlying, mirror-image, ‘synthetic’ duplicate of that chosen subprime debt with as much devastating loss potential as those subprime securities that they are insuring, or guaranteeing to cover in the event of default. These CDS would pay off for Burry if the housing market crashes and the subprime debt his policies are ‘derived’ from, become worthless. The banks are more than happy to accept his proposal for something that has never happened in American history, believe that Burry is a crackpot, and therefore are confident in taking the other side of his bet.
The book: One of the ‘shorts’ was Steve Eisman @ Greenwich, Connecticut-based FrontPoint Partners LLC, under Morgan Stanley.
The movie: An errant telephone call to FrontPoint Partners gets information about subprime CDS that are betting against the housing market into the hands of Steve Carell playing “Mark Baum”, an idealist who is fed up with the corruption in the financial industry. “Mark Baum” and his associates @ FrontPoint Partners, an arm’s length under Morgan Stanley, invite “Jared Vennett” from Deutsche bank to explain and possibly solicit these CDS, despite not totally trusting him. In addition, “Mark Baum” further believes that most of the mortgage securities are overrated by the bond agencies, especially now with this new information from “Jared Vennett” that banks are dangerously blending an alarmingly increasing amount of subprime mortgages together with AAA-rated mortgages into bundled debt securities known as collateralized debt obligations, or CDOs.
The book: One of the ‘shorts’ was Charlie Ledley & Jamie Mai @ Cornwall Capital.
The movie: Charlie “Geller” and Jamie “Shipley”, who are minor players in a $30 million start-up garage company called “Brownfield”, also get wind of “Jared Vennett’s” subprime CDS prospectus on the matter. Wanting in on the action but not having the official clout to play, they decide to call an old friend, retired investment banker Brad Pitt playing “Ben Rickert” – actually based on Ben Hockett, a banker who had previously worked at Deutsche Bank – is also pessimistic about the banking industry, and joins forces with his erstwhile neighbors Charlie and Jamie to help out establishing “Brownfield”. These three groups, these three ‘big shorts’, Scion Capital, FrontPoint Partners, and “Brownfield”, work on the premise that the banks are stupid and don’t know what’s going on, while for them to win, the general economy has to lose, which means the suffering of the general investor who trusts the financial institutions.
The book: One of the ‘shorts’ was John Paulson.
The movie: John Paulson, the most notorious ‘big short’, wasn’t in the movie.
The book: One of the ‘longs’ was American International Group (AIG).
The movie: There was no significant mention of AIG.
The book: One of the ‘longs’ were the proprietary traders @ Bear Stearns & Lehman Brothers.
The movie: There was no significant mention of Bear or Lehman’s duplicity in manipulating subprime debt prices, only scenes that described their demise.
The book: One of the ‘longs’ were the German institutional funds in Dusseldorf that were buyers of subprime securities that didn’t beware.
The movie: There was no significant mention of German fund managers that bought these toxic mortgage assets in the movie, except that they too took heavy losses.
The book: Morgan Stanley was also one of the ‘longs’. Firmly believing that wagers on the housing market were safe bets, Morgan Stanley’s Howie Holden was heavily long AAA-rated tranches of CDOs (the slices that were backed by solid mortgages), along with other proprietary traders at the firm, but at the same time, in…
The movie: “Mark Baum” at Morgan Stanley’s hedge fund FrontPoint Partners buys CDS that bet against all mortgage debt, from low-rated subprime debt to AAA-rated mortgage debt from Deutsche bank’s “Jared Vennett”. Meaning “Mark Baum” is betting against his own firm’s long positions in mortgage debt, so his desk’s gains will not only come from the financial carnage of the American people, but his own fellow employees. A scene in the movie depicts him finding out from his previous assistant, now working for Morgan Stanley’s risk department, the extent of the mortgage CDO losses, 10x more than he imagined, of the other traders at his firm. Coming from a family with a history of suffering from depression, this devastates “Mark Baum” psychologically, and even when eventually proven right, he instead sulks, and out of guilt delays taking profits, nor ever says ‘I told you so’.
The book: One of the ‘longs’ was Greg Lipman @ Deutsche Bank. Deutsche Bank’s proprietary trader Greg Lipmann was at first long subprime tainted CDOs along with other desks at Deutsche to initially get involved in the subprime market. Lipmann then, in….
The movie: …goes rogue, unwinds his personal long positions, and starts soliciting Deutsche Bank mortgage CDS soon after getting wind of what Dr. Michael Burry is doing at Goldman. As a savvy proprietary trader at Deutsche Bank, Ryan Gosling playing “Jared Vennett” believes he too can cash in on Burry’s beliefs, and sells “Mark Baum” mortgage debt CDS, despite being bets against Deutsche’s own long positions in subprime tainted CDOs. Furthermore, unlike the CDS that Goldman sold to Dr. Burry, the CDS that “Jared Vennett” sells to FrontPoint Partners was his trading idea, and because the expected windfall will be so large, he shamelessly explains that Deutsche intends to rake in a huge mark-up for themselves when “Mark Baum” unwinds the position. In the movie, talking directly to the camera while smugly showing off his 8-figure bonus check, the cold-blooded “Jared Vennett” of Deutsche feels no remorse whatsoever that he personally profited off the financial ruin of fellow employees as well as fellow citizens.
The book: While practically everyone was somehow long or short during the housing boom, in a comically-tragic yet impressive display of financial engineering, Goldman Sachs played both sides of the subprime market to perfection. With newly-created, subprime credit default swaps (CDS), not only did Goldman ‘replicate’ the risk exposure of the most toxic of subprime debt by writing contracts insuring it to sell to their clients, the shorts, wanting to bet against it, Goldman then took these CDS contracts that they wrote, that placed Goldman at risk, and fraudulently laundered that risk TO THEIR OWN CLIENTS. By cleverly inserting Goldman’s newly-created subprime CDS inside legitimate, prime AAA-rated collateralized debt obligations (CDOs), so-called ‘Synthetic CDOs’…and immediately turning them around…selling them to their other clients…the longs, wanting to bet on subprime debt…Goldman was profiting from both the buyers and the sellers in the subprime mortgage market…the whole time…without taking any risk! Here’s how that worked: CDS, or financial insurance, is not the same as traditional insurance. You can write and sell a CDS, insure a financial product, to a person who is not the owner of the ‘property’ being insured. On Main Street, you cannot do that, you cannot insure a house against a fire and offer to sell the policy to someone other than the owner of that house, like an unfriendly neighbor, for obvious reasons. By law a home fire insurance policy must have what is known as ‘insurable interest’, but on Wall Street you can write a CDS, insure any bond, any debt instrument, owned by one person, and not only sell that contract to the owner of that bond, but to anyone else, and write as many contracts and sell them to as many people as you want. As a newly-created replication of that original debt, a newly-created ‘synthetic’ risk, these newly-created CDS multiply the loss potential. This is because the buyer, or holder of the original bond that the CDS is derived from (why they call CDS a ‘derivative’), plus all the sellers, or writers of any additional CDS contracts insuring that debt, all of those people lose money, a potentially devastating amount, if just that one, single, underlying bond defaults. Dr. Mike Burry asked Goldman to insure particular subprime debts that he had researched and concluded had the best chances of defaulting, not because he owned that debt, not because he had an ‘insurable interest’ in that debt, not to wisely hedge against that debt, but only because, like a cunning and unfriendly neighbor, he just wanted to bet against that debt. Worse than the guy that yells “Fire” in a crowded movie theater that isn’t on fire, this is like a guy that doesn’t yell “Fire” in a crowded movie theater that IS on fire because he would rather call his broker and make money off the carnage. Burry and Goldman couldn’t care less about the worldwide financial damage those subprime mortgages would inflict after burning down, only how could they multiply the damage, to profit immensely from it. To be fair to Burry and the other ‘big shorts’, at least they were taking a position, they had ‘skin in the game’, they were exposed to losses, the entire principal amount that they invested, if they were wrong about betting against the mortgage market, but Goldman cleverly was not taking any risk at all. Goldman wrote this insurance, this CDS, and sold it to Burry, the CDS holder. As the seller, or the writer of this insurance policy, this CDS contract, Goldman effectively created a replication of that debt, and Goldman was now temporarily exposed, Goldman was at risk, for this ‘synthetic’ debt, as well as, just as much as, the original holder of that subprime debt, that low-rated bond underlying Goldman’s contract. Goldman, instead of carrying this risk, this ‘synthetic’ exposure, that they just created for one client that wants to short subprime debt, then needs to lay it off on another client that wants to go long subprime debt. So the trick for Goldman was to devise a way to get clients to take, to become the writers, of these contracts. No client would ever agree to write a fire insurance policy on a single movie theater that had smoke coming out of it, but a client could be duped into doing just that if that very same contract was buried deep inside a diversified portfolio of randomly-selected high-grade bonds. That is exactly what Goldman did, they took actual AAA-rated mortgage CDOs that were paying bond interest from prime mortgage bond debt, inconspicuously blended in their newly-concocted CDS contracts insuring junk debts specifically picked by a ‘big short’, and unloaded it on another client that thought they were just investing in, going long on, mortgage debt. Previously AAA-rated CDOs, renamed ‘Synthetic CDOs’ because they contained newly-created ‘synthetic’ CDS contracts that were insuring subprime debt, was sold to Goldman clients like American International Group (AIG). That was Goldman’s grift, that was what you could call The Big Con. Instead of buying plain-vanilla CDOs yielding (mortgage bond) interest payments, a Goldman client, the mark, like AIG, were unknowingly buying financial weapons of mass destruction that were actually paying subprime CDS (insurance policy) premiums. Same difference if you were an investor seeking income and you were bullish on subprime debt, right (?) Sure, until the day that investor finds out after it’s too late that the CDOs that they just bought…from Goldman’s traders…contain risk on subprime debts…that were hand-picked by Goldman’s other client, a hedge-fund expert…who was convinced they would default….because those specific debts had the greatest probability to default….so that expert shorted those particular subprime risks… by replicating that dangerous risk…disguising it as an innocent little CDS…created inside Goldman’s laboratory…and because Goldman didn’t want to touch it with a ten-foot pole…quietly slipped that toxic subprime CDS into your CDO. While everyone from the buyers of these securities, to the regulators of these securities, to the credit rating agencies getting paid pretending to know how risky these securities were, Goldman kept profiting, with no skin in the game, as long as everyone kept drinking that housing-boom Kool-Aid…
The movie: Goldman Sachs is portrayed as only a counter-party, as Dr. Michael Burry’s broker, and that the Synthetic CDOs that Goldman later created and sold to lay off their own exposure to subprime debt was just an innocent ‘side bet’, like ‘people standing behind blackjack players making personal wagers.’
The book: Morgan Stanley proprietary traders avoided taking bigger losses on their long CDO positions by using inside foreclosure trend information to front-run the market. Merrill Lynch was able to sidestep losses in their long CDO positions by colluding with other banks to help “bespoke”, or freeze market prices of CDS at grossly inflated levels long enough until they could dump most of their losing positions on their own clients.
The movie: doesn’t specifically finger any bank, just ‘the crooks at the banks’. In separate scenes showing each of three big shorts exasperated and even terrified they were being conned while it took so long for the prices of their CDS positions to reflect actual market conditions.
The book: For the crimes committed that caused the 2008 Credit Crisis, ONLY ONE PERSON went to jail.
The movie: predicts that the blame would go to ‘the immigrants and the poor people’ who caused the housing bubble and shows the only person, Kareem Serageldin, an Egyptian-born trader at Credit Suisse, the only person that went to jail for crimes committed in the 2008 World Financial Credit Crisis.
Meanwhile, over in Staten Island, NY, a black man named Eric Garner died. He choked to death…while resisting arrest…on the charge of selling loose cigarettes…for a dollar each. (Take a knee and ponder that.)
NOTE: This is not an exact description of the events leading up to and causing the 2008 Credit Crisis, only my side-by-side comparison of both the book and the movie, The Big Short, which pushes a narrative that the ‘big shorts’ were geniuses, or even prophets. In reality, many other people also knew that there was a dangerous housing bubble, over-inflated with borrowed money, about to burst, and positioned themselves accordingly (i.e. for every single home buyer during the housing boom that was convinced home prices would go higher, there was a seller that wasn’t). The ‘big shorts’ were good at their jobs, but the timing of their bets was even better…
The movie also veers away from incriminating any of the banks, unlike the book, which puts most of the blame for the nationwide, unbridled greed just on the banks, and especially Goldman. At the end of the day, the actions of the banks may not have been criminal, but they were certainly mistakes, and the banks have been punished for those mistakes. On April 11, 2016, Goldman agreed to pay a fine of $5.1 billion to the US Department of Justice (DoJ), part of a January 14, 2016 settlement reached with the US gov’t for Goldman’s role in ‘miss-selling’ mortgage securities in the run-up to the financial crisis. The settlement also “preserves the government’s ability to bring criminal charges against Goldman and does not release any individuals from potential criminal or civil liability” as per the Justice Department…
At this writing, at least three European banks remain under investigation over their role in the mortgage-backed securities business: UBS Group AG, HSBC Holdings Plc and Royal Bank of Scotland Group Plc. In October 2016, DoJ authorities demanded that Deutsche bank pay a $14 billion fine for ‘miss-selling’ mortgage securities. The threat of the fine (an amount almost as much as Deutsche’s entire value) had pushed the bank’s shares to record lows, and in December 2016 officials at Deutsche reached a $7.2 billion settlement. Hours later, Swiss lender Credit Suisse Group AG announced a $5.2 billion settlement. Barclays Plc balked at the amount sought, and on December 22, 2016 the DoJ sued Barclays for fraud over its sale of mortgage bonds…
For breaching a variety of financial regulations that led to the credit crisis, twenty of the world’s biggest banks have paid approximately A QUARTER OF A TRILLION DOLLARS in compensation in the last seven years, according to Reuters. A fifth of that amount came from just six US financial institutions alone, with the largest settlement, $16.7 billion, paid by Bank of America Corp (who bought ailing subprime lender Countrywide Financial for $2.5 billion in January 2008). Aside from ‘miss-selling’ mortgage securities, these banks and other financial institutions were fined “for misdeeds ranging from manipulation of currency and interest rate markets and compensating customers who were wrongly sold mortgages in the US or insurance products in Britain.”
The 2007–2008 global financial crisis, the worst financial crisis since the Great Depression of the 1930s, is now the textbook case-study on why federal regulators can’t give the free market’s ‘invisible hand’ sole control over the sword of capitalism.
Bearish market sentiment is at a five-year high, so should you be feeling the same?
Look at the previous peaks on this graph: Short Interest near five year high
The US Treasury bond downgrade in August 2011…The Euro zone crisis in ’12…Last week’s and last summer’s Shanghai Composite Index selloffs.
Market sentiment is usually considered as a contrarian indicator, a good thing to bet against, especially when it is more extreme. Very bearish sentiment is usually followed by the market going up more than normal. Buying low-cost, broad-based, index funds when they are on sale is an easy way to get rich.
There are tons of delusional things said on the airwaves these days. Most are a simple variation that rhymes with a similar doomsday theme. One example, since our federal government’s debt is so unsustainable, before the entire US economic apparatus implodes, we should abolish the Fed, and go back to a gold standard, blah, blah. Sometimes I can’t tell the difference if these people are actually serious, or are they just hoping for ‘likes’ on their Facebook page, looking for orders on their websites, playing us for ratings, or maybe even pandering for primary election votes. If that’s the case, then I think these people are brilliant marketing geniuses…
That is not always the case with some claims, however. A bizarre statement I heard recently to substantiate an accusation of federal financial finagling was that the Clinton surpluses were a hoax, and that instead of those four years of surpluses, each of them were deficits. If you search ‘Clinton surplus myth’, you will see that there are many people that actually believe this. The main rationale of the ‘Clinton surplus myth’ mentality (which defies accounting reality) is that in each of those four Clinton surplus years, the total public debt, commonly known as the national debt, increased, and thus, that cancels out any ‘surplus’. How could there be a federal budget surplus, they claim, if total federal gov’t debt rose? How could the gov’t borrowing more money in one year be called a surplus in that year? More specifically, they ask how can the gov’t say there was a Clinton surplus of $237 billion in fiscal year 2000, if the total national debt that year increased $18 billion?
I will attempt to explain why, first, with a short answer. The reason why, is that instead of the US federal gov’t borrowing that $18 billion from someone else, the US federal gov’t borrowed that $18 billion from itself. The US federal gov’t has two books, or two set of ledgers, one that counts debt borrowed from others (“on-budget”), and another that counts debt borrowed from itself (“off-budget”). Spending $18 billion that you got from someone else’s pocket in exchange for an IOU that went into someone else’s pocket (“on-budget”) is an outright loss of money, and considered a liability, but spending $18 billion from your own pocket in exchange for an IOU that went into your own pocket (“off-budget”) is considered both an asset to yourself and a liability to yourself of equal amounts that, at the present moment, cancel each other out. ‘At the present moment’ is the key to why the Clinton surpluses were real. If you spend money today, money that is in your own pocket, but money that is earmarked for something else, some future expense, then that is not deficit spending, it’s not a loss, nor a liability, not yet, not until that day, that day when that pending “off-budget” expense is realized. For example, if you won at poker, but before you spent the winnings, your wife made you write an IOU for the same amount payable to her, does that ‘intra-household’ IOU negate your winnings (?) It’s the same accounting construct on the consolidated federal balance sheets. Social Security and the federal gov’t, are two different pockets, but on the same pair of pants. That is why that “off-budget” debt in the year 2000 was not part of the “on-budget” surplus calculation, because that $18 billion increase in total national debt was not borrowed by the federal gov’t from others (which is an immediate liability), it was borrowed by the federal gov’t from itself (which isn’t yet a liability). When the federal gov’t ‘borrows’ from Social Security, it is ‘borrowing’ from itself, not from others, and why pending “off-budget” debt doesn’t negate any actual “on-budget” surplus.
Now here is the long answer. The US federal government has a legislated accounting construct that is quite complex. Being hard to understand, like many other issues today and throughout time, it naturally tempts a certain amount of people to be suspect of it, especially if it fits their subjective narrative. First of all, deficits and debts are two separate things. Deficits or surpluses reflect current cash flow, like entries on an income statement. Debt is a cumulative measure, like entries on a balance sheet. The US national debt ($19 trillion at this writing) is a sum of two separate things. The US national debt is the sum of public-held debt ($14 trillion) and intra-gov’t-held debt ($5 trillion). These two ‘debts’ are not both liabilities, and why they are posted separately in two different “on-budget” and “off-budget” ledger books.
The US federal gov’t fiscal year begins on October 1st and ends on September 30th. In the fiscal year ending September 30, 2000, the US federal govt had a surplus of $237 billion, as per the front page of the Treasury Department’s ‘Monthly Treasury Statement of Receipts and Outlays of the United States Government’: https://www.fiscal.treasury.gov/fsreports/rpt/mthTreasStmt/mts0900.pdf
The total US national debt was $ 5.655 trillion on September 30, 1999 and $ 5.673 trillion on September 30, 2000, so that was an annual increase of $18 trillion: https://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt.htm
The total US national debt is the sum of the debt held by the public (“on-budget”) and the debt held by the gov’t (“off-budget”). The debt held by the public (owed to others) was $ 3.232 trillion on September 30, 1999 and it was $ 2.992 on September 30, 2000, so that was an “on-budget” decrease of $240 billion (The Clinton surplus). The debt held by the gov’t (‘owed’ to itself) was $ 2.423 on September 30, 1999 and $ 2.681 on September 30, 2000, so that was an “off-budget” increase of $258 billion, meaning a net $18 billion increase of both together, or, an $18 billion increase in the total US national debt: ftp://ftp.publicdebt.treas.gov/opd/opds092000.pdf (if that link doesn’t work try https://www.treasurydirect.gov/govt/reports/pd/mspd/mspd.htm or just google search “monthly statement of the public debt of the united states september 30, 2000” and in the TreasuryDirect website click 1999, click September, click Summary Adobe Acrobat, repeat for 2000)
The ‘Clinton surplus myth’ movement points out this net $18 billion increase in total debt, and of that total $258 billion increase in govt-held debt, they specifically finger a $246 billion entry figure found in the same Monthly Treasury Statement. To find it, scroll to ‘Table 6. Schedule D’, “Net Purchases”, “Fiscal Year to Date”, “This Year”, “Grand total”. This $246 billion is that year’s increase of intra-govt debt of off-budget items, mainly Social Security. What that means is the US Treasury took that year’s “off-budget” Social Security surplus, gave the Social Security trust fund an IOU in exchange for that cash money, and spent that cash money for other “on-budget” expenditures. The myth movement says that the federal gov’t surplus of $237 billion in 2000 would not have been possible without ‘borrowing’ the Social Security surplus. Only by ‘borrowing’ that fiscal year’s $246 billion off-budget surplus and by Treasury ‘trickery’ could that be called a fiscal year ‘surplus’. According to them, if there was an actual surplus, the national debt in 2000 would have come down, instead of going up $18 billion.
There is a difference when the federal gov’t has borrowed from itself (isn’t a liability), and when the federal gov’t has borrowed from others (is a liability), or more specifically, there’s a difference between “on-budget” and “off-budget” federal gov’t debt. What confuses everybody is that these two different types of debt are added together and called the national debt which makes them seem like the same types of debt. How are these debts different? During current “on-budget” operations, if the federal govt receives less money from individual federal tax withholding, corporate federal tax, etc., than it pays out while provisioning itself, running the country, etc., that “on-budget” deficit spending is financed with newly-created money. That newly-created money was approved by Congress and also was accounted for to the penny by selling additional “marketable” securities, or Treasury bonds, to the public. These additional Treasury bonds increase the federal gov’t debt “held by the public”. Furthermore, when the federal gov’t receives more money from “off-budget” operations, like Social Security payments deducted from paychecks, above what it pays out to those “off-budget” operations, like Social Security recipients, by law it must use that surplus to buy “non-marketable” Government Account Series securities, or what I personally like to call ‘pending’ Treasury bonds. These ‘pending’ Treasury bonds increase the federal gov’t debt “held by the govt”. These ‘pending’ Treasury bonds are placed in the corresponding trust fund for future redemption, and that surplus off-budget cash money is promptly spent on current on-budget expenditures. The sum of both those Treasury bonds issued and sold by the Treasury to finance on-budget deficit spending (debt held by the public), plus all those ‘pending’ Treasury bonds posted in off-budget trust funds (debt held by the gov’t) is the total public debt, or the national debt. The key difference is, only the marketable Treasury bonds issued that coincided with the newly created money to finance on-budget deficit spending are liabilities (because they already monetized an on-budget deficit). The non-marketable securities, or ‘pending’ Treasury bonds that are sitting in trust funds like the Social Security trust fund are not liabilities until they are redeemed by the trust fund (because they have not yet monetized an off-budget deficit)…
In other words, Treasury bonds held by the public and ‘pending’ Treasury bonds held within the federal government are both considered a debt, but both are not a liability. Only debt held by the public that financed on-budget deficit spending is reported just as a liability on the consolidated financial statements, the balance sheet of the United States government. Debt held by government accounts, or the intra-gov’t-held debt, is not (yet) reported just as a liability on the consolidated balance sheet of the United States government (not until it is redeemed by the trust fund). Using basic rules of accounting, not trickery, debt held by government accounts, or the intra-gov’t-held debt, is at the moment both an asset (to those trust funds) and a liability (to the Treasury), so they presently offset each other on the consolidated balance sheet, and why that fiscal year 2000 off-budget debt is separate from that fiscal year 2000 on-budget surplus.
So how does ‘pending’ off-budget debt (which isn’t counted in the 2000 surplus) become actual on-budget debt (that is counted in the 2000 surplus)? When any off-budget trust fund has a deficit in any given year, that trust fund needs to ‘finance’ that deficit. To finance that deficit, the trust fund will hand over some of their ‘pending’ Treasury bonds to the Treasury, and the Treasury will hand over newly created dollars. Newly created dollars means deficit spending, so just as in any on-budget federal gov’t deficit spending, those newly created dollars will be accounted for to the penny with a coinciding issuance of Treasury bonds. Those previously ‘pending’ Treasury bonds will become actual Treasury bonds. That previously ‘pending’ debt held by intra-gov’t will become actual debt held by the public. That previously ‘pending’ off-budget liability (caused by trust fund surplus savings) will become an actual on-budget liability (caused by trust fund deficit spending). Whether that given fiscal year has a total annual surplus or deficit will depend on actual liabilities (which depend on that year’s actual economic performance), not ‘pending’ liabilities (which depend on a future year’s hypothetical economic performance). To see the total debt, you look at the balance sheet, which is the entire, all-time, financial picture of the US federal gov’t from the very beginning. This total debt is the cumulative total of all the years up to the year 2000, made up of both the actual liabilities, or on-budget debt held by the public (money borrowed from others), and the ‘pending’ liabilities, the ‘pending’ off-budget debt held by gov’t (money ‘borrowed’ from itself). Conversely, to see the actual cash flow, you look at the income statement, which is the actual cash money flowing in and the actual cash money flowing out, or just the current, on-budget, actual cash flow that occurred in the year 2000. The bottom line of that US federal gov’t income statement shows that in that year 2000, the amount of actual cash money the federal gov’t took in was large enough to result in an on-budget fiscal year surplus. An increase in the total debt (+$18 billion) which includes a future-day ‘pending’ debt that is posted on the consolidated balance sheet doesn’t change the yearly income statement’s present-day bottom line cash surplus (+$237 billion). A cumulative balance sheet and a current cash flow statement are separate measures, of separate values, in separate time frames, and using separate rules of accounting. Comparing them together is like comparing apples to oranges.
The Clinton-surplus-myth mentality is yet another variation of the same theme, which is a gold-standard mentality that trips up many people when talking about the federal government. This outdated thinking from a bygone era contributes to a ‘federal-government-is-the-same-as-a-household’ groupthink (patterned behavioral and self-reinforcing group dynamic) that is widely pervasive today. Since leaving the gold standard for good in 1971, the federal gov’t is no longer like a household. In the post-gold standard, modern monetary system, when the federal gov’t, the issuer of dollars, ‘borrows’ dollars, it is not the same as when a household borrows dollars. As the saying goes, you can have your own opinions, but not your own facts. According to the Treasury Monthly Statement, in fiscal year 2000, the United States government had receipts of $ 2.025 trillion and outlays of $ 1.788 trillion and “the final budget results and details a surplus of $237 billion.” As per the nonpartisan Congressional Budget Office, the US federal budget was in surplus and the Public Debt, or “debt held by the public” (money borrowed from others) was decreased during Clinton’s second term. Rather than grasping this hard reality and instead preferring to deny the accounting science, the Clinton-surplus-is-a-myth movement wants to engage you in a childish ‘What came first, the chicken or the egg’ argument. It bothers them that Clinton took a Social Security surplus and shamelessly used it to get his budget in surplus.
I have a compromise to offer to The-Clinton-surplus-is-a-myth folks: I’ll admit to them that Social Security being in surplus gets all the credit for putting Clinton’s budget in surplus if they’ll admit that the American economy under the leadership of President Clinton was so strong that it put Social Security in surplus. If anyone says or posts otherwise, well, they won’t get a ‘like’ on their Facebook page from me.
eddie d <email@example.com>
Most of the nitpicking about the Federal Reserve bank over the airwaves today are variations of the same doomsday narratives that have rhymed over and over throughout time. The recent main themes are that the Fed issues too much debt / the Fed recklessly prints money that finances out-of-control federal gov’t deficit spending / the Fed is dangerously expanding the money supply, etc., that will soon lead to US Treasury bond default / the collapse of the dollar / hyperinflation, etc. Let’s take a step back from that picture and tune out the noise:
The Federal Reserve Bank doesn’t issue debt, or US Treasury securities. The Treasury issues Treasury securities, like bills, notes, and bonds, including Treasury Inflation Protection Securities (TIPs), and Floating Rate Notes (FRNs). Treasury securities make up the most liquid bond market on earth; are denominated in dollars, the world’s reserve currency of the world’s strongest economy; and why they are the global safe haven in times of economic storms. You don’t buy Treasury securities with cash, and you don’t get a physical delivery of a bearer bond anymore. You must have or open an account with a financial institution that accepts dollars, for settlement of payment in dollars for your bonds, and where your bonds will be posted, or electronically registered (because those dollars will remain within the dominion of the Fed, which wields independent power over dollars). The Fed is the banking agent of the US Treasury that settles Treasury bond auctions at initial offerings and settles Treasury bond trading between counter-parties in the secondary market, all via Fed wire. The Fed only distributes the Treasury securities.
The Fed doesn’t create money. The Fed only creates reserves. There’s a difference between money in the banking system and reserves in the banking system because money is always part of the money supply, but reserves are never part of the money supply. Reserves are like ‘pending’ money. You should think of Fed-created reserves as ‘pending’ money the same way you should think of Fed jawboning as ‘pending’ policy. For example, Open Market Operations are a frequent fine-tuning of monetary policy, but as Ben Bernanke calls it, “open-mouth operations”, or forward guidance, is more like ‘pending’ policy. The same goes for newly-created reserves, the Fed only telegraphs it’s desires.
The Fed doesn’t directly effect changes in the money supply. Everyone else directly effects changes in the money supply. The Fed only indirectly influences changes in the money supply, because reserves that the Fed prints or unprints are not part of the money supply. That’s why none of the Fed’s operations has any initial effect on the money supply. That’s also why the bond ‘kings’ and the hedge fund ‘stars’ were all wrong about extraordinarily loose Fed monetary policy automatically causing inflation. Everyone else causes inflation, not the Fed. The Fed can only indirectly influence an onset of inflation caused by everyone else, so what Professor Bernanke taught us was that accommodating Fed policy does not automatically cause inflation (but deflation, however, will automatically cause accommodating Fed policy). Whatever the Fed does, from normal open market operations, to providing backstop loans for toxic assets, to Large-Scale Asset Purchases (‘QE’), the Fed only creates new reserves, that are not money, nor part of the money supply. The Fed creates reserves and exchanges them for collateral (it always just swaps, or prints and unprints, reserves and collateral, always at the very same time and in exactly the same amounts). To accommodate the struggling US economy that is still wobbly from the 2008 Credit Crisis, the Fed is trying to accommodate the economy, which the Fed is hoping influences everyone else and causes inflation (2% to be exact). To encourage credit expansion, your creation of money, which would increase the money supply, the Fed has kept interest rates low, which has provided cheaper liquidity, but the Fed can only lead the horse (aggregate demand) to water (cheaper liquidity). Only nonfederal gov’t aggregate demand meaning you, households, businesses, local & state governments, that borrowing, that credit expansion, that conversion of reserves into newly created money; and adding to that mix, the federal gov’t also issuing newly created money from the Treasury after Congressional appropriation to provision the federal gov’t, all together, that drinking of the water, increases the money supply. Increased nonfederal govt aggregate demand and increased federal govt aggregate demand that leads to deficit spending creates money, and expands the money supply, not the Fed. In other words, everybody else creates the money, and increases the money supply. The Fed only facilitates everyone else to expand the money supply.
The Fed does not expand or contract the money supply. Everyone else expands or contracts the money supply when they print or unprint money. Thinking that the Fed prints money and expands the money supply is the same as thinking that the credit card companies print money and expand the money supply whenever you pay for a dinner with your credit card. Visa and American Express didn’t print the money and expand the money supply, you did. Visa and American Express only facilitated your printing of money and your expansion of the money supply (You ‘unprint’ that money and you contract the money supply if you pay your credit card bill in full at the end of the month). Instead of staring suspiciously at Visa or American Express, or at the Fed for ‘printing all that money’, people should step back from the picture. Your contraction or creation of money and the money supply only follows the Fed’s contraction or creation of reserves. The Fed draining or adding reserves in the banking system by itself is not the same thing as contracting or expanding money and the money supply, those are two separate things. The Fed can drain reserves from the banking system, but that isn’t contracting the money supply. If need be to achieve their dual mandate, the Fed tries to influence the contraction of the money supply, but the Fed can’t by itself, only you can. You destroy money and decrease the money supply when you deleverage, when you ‘unprint’ money that you previously ‘printed’ (i.e., paying off that credit card balance in full instead of just making the minimum payment and letting it ride). Going forward, in the unlikely but possible chance that the US economy suddenly overheats, the Fed would decide to sell those $4 trillion in Treasury bonds and mortgage-backed securities on their balance sheet, draining those $4 trillion in reserves the banks received when selling them, but again reserves are not part of the money supply. In that scenario, by draining reserves and increasing interest rates higher, the Fed only tries to slow the economy, to influence your actions, which the Fed hopes will cause a contraction of the money supply.
Instead of being a debt of gold-backed dollars like during the gold-standard era, every one of the newly created Treasury securities that the Treasury issues in the post-gold standard era is an accounting entry, a debit, that offsets a credit, or addition of newly created fiat dollars, distributed via the Fed, as instructed by the Treasury, after Congressional authorization, into the money supply. On August 15, 1971, when the gold standard officially ended, the ‘national debt’, something that had to be paid back, became the ‘national debit’, something that doesn’t have to be paid back. You have as much to worry about ‘paying back’ the amount of non-convertible fiat dollars the federal government has created and spent as you do ‘paying back’ the amount of oxygen your lungs have created and breathed. There is no ‘national debt’, no burden on your children, and no danger to the financial security of the country. Today, in the post-gold standard, modern monetary system, when the Treasury creates money, rather than adding to an outstanding debt of gold-backed dollars, it now subtracts, or debits, from the purchasing power of the outstanding national float of fiat dollars. Rather than financing the federal government’s deficit spending with our surplus of gold-backed dollars as in the past, today the federal government’s deficit spending finances our surplus savings of fiat dollars. The ‘national debit’ is a national treasure, and as long as you continue to have full faith and credit in the country, your standard of living will continue to rise for many more years to come.
Merry Christmas & Happy New Year
Traditionally, in a normal recovery, the Federal Reserve bank would start ‘normalizing’ rates with their announcement of an initial overnight Fed Funds rate hike (a ‘liftoff’) and reach, or ‘target’ that increase, that desired rate, by simply selling short-term Treasury securities (Treasury bills) to the banks (the ‘Primary Dealers’). Banks buying Treasury bills during these FOMC operations pay for the Treasury securities with their reserves held at the Fed. The more Treasury bills the Fed sells, and the more Treasury bills the banks buy, the more it ‘drains’ reserves from the banking system. As the reserves in the banking system diminish, this decrease in supply of reserves results in a greater demand, or interest rate, for the remaining reserves (the opposite of when there is a huge supply, or a glut, of reserves in the banking system, and the demand, or interest rate of the reserves, goes down). The Fed’s open market operations desk keeps selling Treasury bills, keeps pressuring prices of short-term securities in the bond market downward (which at the same time pressures short-term rates up), until the Fed’s target overnight rate is reached. However, due to the Fed’s extraordinary response to calm the 2008 credit crisis, this time it is not a normal situation. With $4 trillion in reserves now in the banking system that no one wants to borrow (or ‘the banks won’t lend out’ depending on your viewpoint), traditional FOMC draining would be like emptying a pool with an eyedropper while banks and nonbanks race to the bottom (lower yields) to compete for loan business.
Using two new programs, the Fed is employing a nontraditional way to target the overnight fed funds rate. The Fed now pays Interest On Excess Reserves (IOER) to the banks, which was legislated in the Troubled Asset Relief Program (TARP) signed into law in 2008 by President Bush. The IOER is paid to all reserves held at the Fed that are not currently lent to other banks in the Fed Funds market (where banks go for short-term financing). In addition, by adding non-banks since 2009, the Fed also expanded the eligible counter-parties that can do trades with the Fed in their Reverse Repurchase (RRP) agreement program. RRP agreements are the financial equivalent of a collateralized loan. The RRP program is effectively the same thing as paying IOER, but to nonbanks like Blackrock, Schwab, Fidelity, or Vanguard, sitting on trillions of dollars in money markets, a.k.a. the ‘wholesale funding’ markets (where corporations go for short-term financing). So instead of instructing the FOMC trading desk to sell Treasury securities to drain reserves to pressure rates up like in the past, on December 16, 2015, the Fed raised the IOER to banks (the new target overnight ‘ceiling’) to .5%; they raised the nonbanks RRP operations offer rate (the new target overnight ‘floor’) to .25%; and the Fed also announced they would accept up to $2 trillion in RRP volume (to leave no doubt that the Fed will drain every cent in reserves to slow an unlikely but sudden economic expansion and/or any sudden unwanted inflation if need be).
The world was saved from another Great Depression, thanks to the Federal Reserve Bank’s response to the 2008 Credit Crisis. Under the Fed’s leadership, the US banking system is far safer and much better able to handle a future crisis. The Fed today is now ready to step in and handle the trading volumes of the entire short-term financing, or wholesale markets, which seized during the past crisis, and widened the panic. In addition, there is no longer a regulatory blur between large banks and large non-banks as in the past. These entities can no longer maneuver around trading rules and Fed oversight. Today all large financial institutions that could pose a systemic risk to the banking system that would worsen a future crisis are now designated as Systemically Important Financial Institutions. SIFIs must now pass regular stress tests and hold greater cushions of capital against their leverage. The new ‘Volcker Rule’ prohibits SIFIs and all other entities that hold taxpayer-insured deposits from proprietary trading (speculating) with their own accounts, and also limits a bank’s connectivity to private equity firms or hedge funds that make risky bets with borrowed money. Furthermore, there will be no more controversial Fed ‘bailouts’ as in the past, because these financial institutions must now have ‘living will’ documents, or detailed instructions of their legally-binding dismantling in the event of insolvency. The US economy is slowly, but steadily going forward, and is now diverging away from all other world economies that are still stuck in neutral, a consequence of a lack of strong leadership outside the US. Despite the past progress and the continuing evidence that better days are ahead for the country, those with a conditional bias that the glass is always half empty and are still counting on the Fed’s ‘Keynesian experiment’ to fail will have to keep waiting.