Tuesday, June 24, 2008
bank credit contraction and monetary aggregate growth
i was surprised as the current model portfolio composition -- heavily overweight the united states. there's a compelling case made that the BRIC economies are in liquidity challenged environments and will see difficulty (this i don't disagree with) but the opposite case is made for the US. sentiment is poor, liquidity is improving.
sentiment is poor -- right, i agree. but liquidity is a catalyst?
this led to some discussion, and i can summarize the opinion of the investment as follows: federal reserve action has resulted in pronounced m3 growth, which has fostered a steepened yield curve. these are taken as signs of successful liquidity creation. such conditions have -- citing 1982, 1990 and 2003 -- been excellent long entries.
while i broadly agree with the general scenario and think the ideas fertile, unfortunately this doesn't ring true to me. i posited an alternative:
in the previous examples, sentiment wanes, capital migrated from risk to cash in anticipation of disaster as a sort of systemic loan-loss reserve, but disaster did not materialize -- therefore, capital was redeployed and risk taking was rewarded.
what of the case where disaster does materialize -- where the hoarding of sideline cash in a systemic loan-loss reserve is never redeployed because it ends up covering losses?
there was no answer for this.
i unfortunately got to mish's offering today after that meeting, and with it paul kasriel's latest commentary. i earlier noted the stalling of monetary aggregates in britain and the united states. as kasriel says:
... [L]et's take a look at what commercial banks have been doing with their loans and investments. Chart 2 shows that in the 13 weeks ended June 4, loans and investments at all commercial banks were contracting at an annual rate of 2.25%. It is true that bank credit growth ballooned in 2007 as banks were forced to take on credit that had originally been financed in the commercial paper market. But we seem to be over that "hump."
that is, the migration of off-balance sheet vehicles back onto bank balance sheet (a la citibank) has caused outstanding bank balance sheet assets to rise dramatically in 2008. that has been offset on the liability side by desperate searches for deposit funding -- one which the flight to safety has helped to satisfy as funds brought out of collapsing asset-backed commerical paper markets largely found their way into bank time deposits, money markets and short-term treasuries -- in order to avoid capital ratio impairment.
this is exactly what it sounds like -- an increase in the balance sheet leverage employed by banks. these are forced loans, not the kind that support healthy economic growth and not really credit or monetary aggregate growth at all. it is instead simply a reaccounting of previously granted credit as it forcibly migrated fron the shadow banking system onto bank balance sheets (what has been called "reintermediation"). indeed i think, even as m3 skyrocketed, actual bank credit had been slowing, probably stagnant at best -- and now that formerly hidden bank exposure has been largely made visible and included in m3, the bank credit and monetary aggregate measures kept by the fed will now show contraction, as kasriel and mish say.
since the flight to safety has abated, however, we've instead more recently seen banks selling equity stakes in an effort to raise actual capital even as their newly-returned-to-balance sheet assets were written down to continue to support balance sheet growth.
now, it seems that financing window is closing on the banks -- and the first true asset sales are underway. these will be forced into highly nervous and illiquid markets, result in highly deleterious marks for remaining assets, but are becoming completely necessary as those nefarious assets seem to find a way to confound and disappoint even the pessimists quarter after quarter -- as the housing bust continues to accelerate, as the commerical real estate bust accelerates, as a consumer-led recession characterized by the worst figures in the history of the conference board's future expectations index sets in. though the banks have done their best to push these assets onto the balance sheet of the federal reserve and the european central bank, they still own them -- and no one at the fed has said anything about destroying the central bank's balance sheet and monetizing their gone-to-hell SIV leftovers. to the contrary, the hawks are playing hardball and traders expect rate hikes in what i see as an echo of 1931.
with the prospect of burgeoning bank failures and FDIC receiverships now on the near horizon, it seems to me increasingly that -- while monetary aggregates have grown and institutional money market funds have grown rapidly out of fear -- this does not in fact present a liquidity boom. rather, these are better thought of as systemic loan-loss reserves which will be used as systemic deleveraging progresses. i may of course be very wrong, but i fear there's very little market fuel to be had here.