What are our leaders going to do next about the state of the banks and broader financial system?
We have had the US bail-out (TARP) and various stimulus measures. We have had the European Bail-out. Or the announcement of it. It still isn’t quite through all the parliamentary hoops yet. And we have had the IMF giving itself greater powers of intervention including being able to tell nations to suspend certain democratic rights of its citizens and to issue its own IMF designated debt which it is hoping to increase up to a Trillion dollars or so.
We have had the financial regulation bill in the US passed but in such etiolated form that it is doubtful it will be much more than public-consumption window-dressing.
So the great question is WHAT NEXT? There has to be something because it is certainly not all fixed. Don’t let the ongoing rally in the stock market fool you. Even the most bullish would admit that the rally is mostly fuelled by HFT trades while money is still flowing out and into Bonds.
Which isn’t surprising because Bonds are where the action and the real profit is to be made for as long as uncertainty about sovereign debts persists. Which should be a while yet. The Dow is, I think, more political soap-opera than money making commerce. I think the banks might agree with that.
We have had lots of vague talk at G8 and G20 meetings but everything seemed to be more for pr purposes than likely to become a real policy. But since last week two things have happened which make me think we might have seen the first glimpse of the real policy
First there was Bernanke’s talk on Capital Hill when he mentioned (see Bernanke and the Wall Street Tumble) larger reverse repo auctions “with more counter parties“. At the time I didn’t get it. But then the Fed released a paper by some of its staff, that I have mentioned a few times recently, about the Shadow banking system and its pivotal role in the whole crisis.
Together they make me think that the Fed is getting ready to argue in public that the ‘real’ cause of the crisis was the difficulty of getting cash to the shadow parts of the system just when they were desperate for cash to keep running. This is the central thesis of the paper and explains Bernanke’s passing remark.
I want to suggest that we are going to see a major change in the relation of the FED to the shadow banking system. I think we will see the argument being made that the key to ensuring stability in markets is to allow large, or key, parts of the shadow system to borrow directly from the Fed. This might sound a little arcane but it isn’t. It would be rather major.
What this would do is allow the even less regulated parts of the global system to suck directly on the tax payers neck. The shadow system is where the melt down happened. It is where the insane risks were bought, sold and stock-piled. It is where the many debt insurers who turned out not to have any capital with which to honour their contracts all operated.
It is also HUGE. $20 Trillion in 2008. And it’s not called shadow for nothing.
Here is a little of what the fed paper had to say about the Shadow system.
activities were conducted from those on- or off-balance sheet corners of an FHC [Financial Holding Company – a BANK] and in a manner that required the least amount of capital to be held against them…. and were also conducted from jurisdictions that had the most lenient oversight (P.25)
Or, if you prefer,
capital requirements to manage these linkages and conduct the process prudently were circumvented through three channels of arbitrage. These were: (1) cross-border regulatory systems arbitrage, (2) regulatory, tax and economic capital arbitrage, and (3) ratings arbitrage. (P.29)
Which just means they chose the places with the deepest shadows in which offered the fewest rules and regulations, no accountanting oversight to speak of, the lowest taxes, lowest requirements of holding any capital and the most slap happy credit and bond ratings money can buy.
Now none of these arrangements has been changed. Neither the G8, the G20 nor the Financial regulation bill in the US felt it imperative or even important to get round to changing any of this. And the banks themselves have spent a lot of… ‘effort’ shall we say, arguing and persuading that ‘over-regulating’ the golden goose would harm its egg laying potential. No one seems to have noticed that since 08 it hasn’t laid anything but Chubby Brown Logs. Apologies to Chubby!
I think we will see, however, this idea being mooted in public more and more. Always in terms of it being the necessary, bold and decisive step that will stop the future ‘liquidity crises‘. That is after all the official line. This whole crisis was due to the bank system suddenly not having access to liquid funding. This paper refines that cardinal belief by saying that the critical part of the system which suffered a crisis of liquidity was the shadow system. And it suffered this destabilizing event because there was no efficient way of getting Central Bank funds to those parts as speedily as required.
So the way to make the whole thing safe and of preventing this liquidity crisis from happening again, we will be told, is to correct this regulatory black-spot. The ‘prudent’ thing will be to allow ‘more counter parties‘ to come the Fed discount window and even allow certain shadow institutions to come under FDIC protection.
It will be interesting, not to say frightening, if this is in fact where we are heading.
I think this is an entirely disastrous idea for reasons the Fed paper itself makes quite clear.
…private sector balance sheets will always fail at internalizing systemic risk. The official sector will always have to step in to help. (P.7)
So it seems even the Fed knows the pursuit of profit will always overwhelm any protestations of prudence and professionalism. The financial system will always fail to account for the risks it is running in persuit of higher profits, and when those risks blow up, the shadow part of the system will NOT be able to fund itself, and the tax payer will ALWAYS be told they have to bail them out. A cycle which enriches them and impoverishes us.
But in the name of ‘greater regulation and oversight’ we will in fact just bring the least regulated and least accountable parts of the shadow system closer to where they want to be. At the source of tax payer, free money.
Being given this ultimate back-stop will not make the system more stable. It will give the worst risk takers and least prudent players their very own gold plated government guaranteed get-out-of-debt-free card. If we are led down this path we will encourage greater risk taking and greater instability.
On page 12 of that linked paper we see shadow bank liabilities down to $16tn and traditional banks up to $13tn. Good place to start reading a few pages of it , with a nice graph, to get the general idea.
I take it you're refering to the Haldane speech. I read the summary yesterday. Looks very interesting if thre are clear differences between GB and US in ieas for how to curb and control the banks. Thank you for the link.
I have to go out today. Back tomorrow. I'll read the rest then.
Thanks again.
I haven't got a PhD? How will I understand this report?
Seriously though, reports like this show why the financial world is impenetrable to most rational thinking people. When explanation of the system has become a matter of opinion then everything hinges on who you trust.
I know the system is rotten, but I would like to be able to explain this convincingly to other people. I can see many more months ahead, studying the interpretations on this blog and forwarding links from other people before I can argue with confidence.
RichGB,
I am giong to post another more detailed piece on the Fed paper. It all hinges on Securitiization. Which you're right they dress up in all sorts of arcane terminology. But underneath it's not so complicated.
I hope to show you how they arrive at their conlusions but how their own evidence provides me with the means to suggest they are absolutely wrong and the polar oposite conclusion makes more sense.
But that's not till tomorrow. Got business to attend to today.
The fed paper actually !
Looks like Mr Peston is angry. I think he might have been reading some of Golem's posts:
http://www.bbc.co.uk/blogs/thereporters/robertpeston/2010/08/basel_allows_banks_to_play_the.html
Sorry for the above – I asked a lazy question about the origin of the Lloyds Group profits of £1.3bn that made the headlines today.
I was trying to work out where they came from, but having gone back and read some of your older posts I think I have an idea.
Tell me if I'm close: Lloyds has essentially been swapping it's bad debts for money at mark to market prices with the BoE and then using this money to buy Government bonds. The difference in rates of return on the toxic debt (zero) and on government bonds (3-4%?) is written up as profit. Also, the value of Lloyds own debts has decreased making it cheaper for them to buy them back IF they were to do so. This is also posted as profit.
Am I in the right ball park?
It seems no matter how much I read 'off-piste' I still struggle to decode the MSM's 'news'.
JamieGriffiths,
It goes without saying that I can't know for sure. BUT
Both of the htings you mentioned are likely to have contributed. I think it will also be th ecase that many of the loans they feared would default either haven't yet or not as badly as they feared. This last may turn out to be chimerical.
Many of the loans and securities 'not doing so badly' now are held in their 'not so bad' state by the suspwension of mark to market accounting, due to very low rates or, as in the case of much Commercial property still not at the moment when the debt has to be paid off.
Plus there has been a 'recovery' in those parts of the economy where we have pourted in all the bail-out money and where low rates have helped.
Proponents will say – you see we told you – the policies have worked.
I would say – at what cost to the rest of us and for how long.
This is political as much as economic.
Because all these loans and securities aren't going to perform any better when the unemployment rate starts shooting up, right?
And then the banks will demand another bail-out to get them out of another 'liquidity crisis', and our national debt will shoot up again, and the bond market will up the price of government borrowing and around we all go again.
Thanks for your response Golem – eagerly awaiting news on the book…
RichGB's link to Robert Peston at the BBC shows that the ranks of the doomsters have spread rather widely 🙂
Some of Peston's images are identical with Golems. Probably not plagiarism, there are obvious comparisons between aeronautics and crashing complex financial systems, the difference being that in the latter case the crashing can be postponed and camouflaged !
Edmund Conway and Ambrose E-P at the Telegraph are regular readers of zerohedge too.
This recent posting on zero hedge is quite interesting
The future recession in an ongoing depression
One for the doom-and-gloomsters. According to this the outlook for the UK is not exactly rosy even in comparison with the US or Europe.
Rob
http://www.nytimes.com/2010/08/07/business/07aig.html?ref=business
Golem, is there any realism in that the US and British tax payer can be fully reimbursed by the bail-out recipients or recuperate through sales of shares in the financial institutions?
Hello Lars,
When the NYT talks about AIG paying back $130 billion bail-out and the public making a profit the reporter is conveniently conflating a few things.
Paying back refers the the $20.5 billion in what is refered to later in the article as AIG's "credit line" and the $6 billion in interest.
If you look at what AIG has received for the sale of its various businesses such sales will never allow AIG to pay anyone back. They made loss selling th eunit to Met Life. And there was no sale to Pruduntial after the auditors got to peek beneath the bonnet.
AIG made a LOSS of $2.7 Billion in the last quarter which was supposed to be firmly part of a recovery wasn't it? I'm not quite sure how they are going to pay people back out of making a loss.
In the end, let's be charitable and say they do eventually pay back the $26.5 Billion. This has nothing to do with the $130 billion. Which mysteriously falls about $60 billion short of what I calcualte they were given. But lets leave that aside as well.
This main chunck of public expenditure is not considered anything AIG has to pay back. AIG is not going to pay back the $130 billion the tax payer spent on buying AIG's stock. That is considered a government investment which the government will gradually sell. Exactly as it is doing with its shares in CITI.
To make a profit the governemtn has tpo sell these shares for more than they bought them for. That in turn requires the stock market to be doing well. WHich it is relative to the low piont. BUT selling also requirtes finding a buyer.
And that is more of a problem. During all this rally there has been a steady decline on retail investors. They have been pulling their money out at a constant pace. Tghe rally has been almost entirely due to a small number of HFT selling back and forth. This is no longer a rumour or hypothesis. It is an accepted fact.
It is also a fact that these buyers will not be keen to buy AIG stock. So although the price looks healthy I doubt the government would find buyers for AIG stock it decided to sell. FOr that it i would require a foreign buyer like a sovereign fund. They, however, have been buying Chinese IPO's instead.
Then there is the problem of whether the stock market is going to stay as high as it is or grind down. I think the latter. Meaning there is a window of opportunity to sell the governbemtn;s stock holdings of AIG and CITI and GM. and that window may be slowly closing.
THEN there is the larger point. No one is including in their calculatoins of what the bail-outs have cost the tax payer, the cost of borrowing the money we spent to buy these stocks and bonds in these companies. No one is calculating the costs due to higher sovereign borrowing. No one is calculating the costs to people's lives of the cuts in care, health and education due to the costs of bailing out the banks.
To those who wanted to see the dismantling of the welfare state, of social housing, free medical care, quality public broadcasting, decent education and care for childrena dn the elderly, for people who thought all thses things were an outrage and should be demolished – then the financial impact of the bail-out so pulbic finances has been a god-send. They have achinced throufgh financial balck-mail what they had failed to achieve throught the ballot box.
For those who voted to defend and keep all the above things then there will never be any paying back of what is being destroyed.
That is what I think.
Hi Lars, you knew that would happen didn't you? No wily, smooth-tongued, Socratic rhetoric from Golem; just hard-to-dispute facts, one after another, like nails hammered in to a coffin. "You dead banks will remain as nature 'tended. Don't want no zombies in my 'hood."
Now that the insolvent UK banks are claiming profitability, I notice that Stephen Hester wants to wriggle out from under government control. Perhaps there is some legitimacy to the Government's desire to split up big banks?
Holding breath … no, I'm still sceptical.
Have a great weekend!
Buffy the bank slayer – a sequel? No?
I'd watch!
Yes, Mr GolemXIV, and these figures should be easy book-keeping facts, so that the journalist will not be fooled by the PR. At any point in time, one should be able to show the journalist the ledger, and say, "look, this is the AIG balance", this is how much money was spent on AIG (or RBS), this is how much money has been returned, and this is how much still owing. Has nobody kept records of cash in and out on the individual bail-out recipients, whether credit lines or equity funding? That is very much needed now that PR departements sells stories about how much money the tax payer earns on the bail-outs…