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Wednesday, May 27, 2009


banks are delevering

via yves smith -- i think one can safely pass over the jeremiad of john taylor to the meat of the observation passed on by the wall street examiner: the banks, lacking access to borrowers, are delevering wholesale. this being so, smith noted that the massive treasury auctions of recent days are countering massive private sector deflationary contractions in money and credit outstanding.

[T]here is a big assumption [in Taylor's preceding concerns], namely, that the Federal government leverage is in addition to Fed/private sector borrowings. If the economy is deleveraging, and the government borrowing is offsetting that effect, it could be salutary (I'd vote for the objective being to dampen the deleveraging, not to try to counter it fully).

The Wall Street Examiner argues that, contrary to popular opinion, serious deleveraging is happening now, and is also showing up in the Fed's special facilities (no online source):

There was little news of substance in the Fed’s balance sheet data last week. It shrank a bit, as the Fed’s direct buying of GSE and Agency paper wasn’t enough to offset the shrinkage in Alphabet Soup programs. The problem seems to be an unwillingness of market participants to borrow and take on risk. No amount of Fed pumping will fix that problem. Zero interest rates at the short end aren’t helping as both individuals and institutions are forced to dip into principal, or in the case of corporations and governments, sell more debt or equity, to pay the bills. I don’t see how the Fed will be able to reverse this trend. Furthermore, we are rapidly approaching the point where the market can no longer oblige those who would raise money to pay their expenses. The Fed can’t keep everybody afloat. ...

The PDs [Primary Dealers] receive the full benefit of the Fed’s Treasury and Agency purchases since those transactions are directly between the Fed and PDs, while the MBS trades generally are not. They clearly did not use that money to support prices in the Treasury market....

The Fed’s buying was enough to keep a bid under the stock market, but not enough to keep propping Treasuries.

Fed credit outstanding virtually collapsed in the week ended April 29, with reductions in alphabet soup programs outpacing direct Fed purchase of securities by nearly 8 to 1. The biggest reductions were in the major programs, TAF, CPR, PDCF, and currency swaps with FCBs. Banks’ deposits at the Fed were commensurately reduced. The Fed’s lending programs appear to be collapsing because the banks are deleveraging furiously.

The CP market has also shown big declines in outstanding credit. Since this also impacted the Fed’s CPR program, it’s apparent that companies have little interest in borrowing. The Fed is pushing on the proverbial string, but as long as the Fed is pumping cash directly into the veins of the Primary Dealers, there’s a good chance that the stock market will continue to get a bid for the time being. However, I expect that to change as the supply pressure on the Treasury market builds, and as Big Finance and Big Business continue to attempt to raise equity capital and sell junk debt. Under the circumstances if the Fed is unable to prevent the shrinkage of its balance sheet, crisis conditions will return.

Ironically, the media pundits have been worried about exactly the opposite problem — inflation as a result of the Fed not having a plan to reduce its balance sheet when the economy begins to improve. If the Fed’s current bout of shrinkage continues, inflation will be the least of our worries, and we can forget about an economic recovery any time soon.....

The Fed is still pouring cash into the coffers of the PDs, and they are using some of it to buy stocks, hooking a new round of suckers in the process. We need to be vigilant, and be ready to jump off the train at the first sign that it is about to go
back into reverse.

The one bit in the reasoning that isn't clear to me is how further debt and equity sales, which will entice buyers away from Treasuries, is consistent with deleveraging (unless the missing bit in the logic chain is that even with those actions, the net effect is serious deleveraging).

yves is a bit late to pick up this report from WSE, and since the april 29 h.4 federal reserve bank credit outstanding has again topped up to previous high levels. but the graph shown here outlines the basic analysis being forwarded. even as total reserve bank credit (blue line) rises, we can see all manner of the fed's 'alphabet soup' liquidity facilities declining in use -- that is, the banks and firms utilizing them are reducing their dependence, ostensibly through a rapid deleveraging. this was resulting, from december 2008 to february, in a shrinking of the fed's balance sheet. to counterbalance the decline in the alphabet soup and the fed's balance sheet size, the fed is accelerated purchases of securities, increasing its portfolio size (red) particularly by soaking up agency debt (red dotted).

the ostensible purpose of maintaining the large fed balance sheet is seen in comparing reserve credit to reserve balances with federal reserve banks -- fed asset purchases are maintaining the excess reserves of the banking system and (it must be hoped by ben bernanke and others) facilitating the potential for credit creation, preventing a contraction in high-powered (though currently idle) money supply.

some banks are also gamely pursuing their profitability through the PPIP, driving up illiquid but high-yielding securitized assets as noted by david goldman, lobbying for rule changes to allow them to gobble up what they can while passing any potential negative consequences on to the taxpayer. this paints a picture of big banks seeking high profitability rents while the system in general unwinds its leverage onto the government.

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