Money Drying Up, Central Banks Respond

donsutherland1 · 09-16-08, 09:42 AM

This morning, the New York Federal Reserve Bank announced, “Shortly, the Desk will arrange a large overnight repo. The Desk stands ready to arrange further operations later in the day, as needed.” This infusion of cash into the money markets likely reflected the repetition of yesterday's dramatic and ominous tightening of money overnight.

Bloomberg.com reported:

The cost of borrowing in dollars overnight more than doubled to the highest since 2001 as the collapse of Lehman Brothers Holdings inc. and credit downgrades of American International Group Inc. led banks to hoard cash.

The overnight dollar rate soared 3.33 percentage points to 6.44 percent today, its biggest jump, according to the British Bankers' Association. The rate was 2.19 percent a month ago and 2.15 percent last week. Lehman filed for bankruptcy yesterday after succumbing to mounting credit-market losses.

Often, in the past, as a panic approached its peak, money seemingly was nowhere to be found. Liquidity disappeared as fearful lenders all but ceased making loans or honoring counterparty transactions.

For example, in the aftermath of the Panic of 1873, which led to a 65-month recession, the Comptroller of the Currency revealed:

The call loans [overnight loans], amounting to more than $60,000,000, upon which the banks relied to place themselves in funds, in such an emergency [withdrawal of deposits were entirely unavailable, because the means of the borrowers were to a great extent pledged with the banks, upon the sale of which they relied to replenish their funds. These collaterals in ordinary moment could have been sold, but at the time no market could be found, except at ruinous sacrifices… The suspension of currency payments followed, and was at first confined to banks of New York City, but afterward extended to other large cities, because the new York banks could not respond to demands of their correspondents in those cities, and these in turn could not respond to the demands of their correspondents.

Following the start of the Panic of 1907, the Comptroller of the Currency released a report that declared:

On Oct. 26 the New York Clearing House banks decided to issue Clearing House certificates for use in the payment of balances, and to limit, if not suspend, the shipment of currency to out-of-town banks. In this the New York banks were followed by those of the other central reserve and most of the reserve cities. The result was to at once precipitate a most serous bank crisis and a famine of currency for payrolls and other necessary cash transactions. All domestic exchanges were at once thrown into disorder and the means of remittance and collection were almost entirely suspended. Money has been withdrawn and hoarded by individuals, corporations, and even more, perhaps, by the banks themselves, all of whom at once drew and held all the money of any kind they could obtain, often really in larger sums than needed.

Following a bout of high inflation that followed the end of World War I and a banking/currency crisis in Britain in 1919-20, credit dried up in the U.S. On July 27, 1920, The New York Times reported, “There is very little time money [short-term loans] to be had anywhere. Yesterday one big lender put out about $1,000,000, to mature on Aug. 30, at rates ranging between 8 ½ percent, and 9 percent, and the money was snapped up quickly.” At the time, the call money rate had soared to 10 percent. All of this occurred in the midst of a recession that sharpened dramatically toward the end of 1920 and culminated in a severe bout of deflation.

These episodes, among others from the historic experience, suggest that the big rise in overnight loans is worrisome. It is no surprise that the Federal Reserve and other central banks worldwide are responding by injecting liquidity into the financial system. The statement released at the end of the FOMC’s meeting today will almost certainly reaffirm the Federal Reserve’s commitment to address financial market strains as needed.

Summerwind · 09-16-08, 10:21 AM

Good morning, I was wondering your opinion on this piece, especially the part quoted below. I don't normally consider Kos a decent financial reporting device, but this paragraph below is curious. donsultherland1, what do you make of this, and why have the cut off on Jan30, rather than the tax year end of Dec31? Granted, if this scenario as presented in the article were to seem likely, the new prez could just get into office, get a new chairman and extend that deadline into the future, but that actually seems worse to me.

Also it seems that if the banks are being allowed to used FDIC insured liquid assets to cover losses, then in the end, isn't the Fed still guaranteeing the purchase from a different angle?

Daily Kos: State of the Nation

Quote:

BUSH'S "INAUGURATION GIFT"
The Bush Administration, in nothing less than a boldfaced effort to cast blame for our country's sorry economy upon their successor (and in a last-ditch effort to shrug off the now-apparent legacy of Bush being the worst President in U.S. history, on par with Herbert Hoover), casually announced that they now intend to dump all of this mess in Obama's (and our) lap come January 20th. (Actually, it'll be January 30th. Read below.)

Is your curiosity piqued? Everyone: "Assume the position..."

FEDERAL RESERVE ACT 23A
Again, courtesy of Ilargi and Stoneleigh at The Automatic Earth:

"...(The Fed) said it will temporarily allow commercial banks to extend liquid funds to their brokerage affiliates for assets that would normally be accepted in tri-party repurchase agreements.

It said this would be permitted only until January 30, 2009, apparently reflecting the Fed's hope that stressed repo markets would be operating more normally by then.

Bernanke Violates Federal Reserve Act Section 23A
Allowing banks to extend funds to their brokerage affiliates is in violation of Federal Reserve Act Section 23A.

Section 23A of the Federal Reserve Act ( Act ), originally enacted as part of the Banking Act of 1933, is designed to prevent the misuse of a bank's resources through non-arm's-length transactions with its affiliates and to limit the ability of a bank to transfer its federal subsidy to its affiliates.

--SNIP--

The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

Supposedly the Fed "will temporarily allow commercial banks to extend liquid funds to their brokerage affiliates for assets that would normally be accepted in tri-party repurchase agreements." For starters I doubt it will be temporary. But the main point is the Fed is taking steps that it knows to be blatantly illegal.

Just so you're clear here, the reference to "liquid funds" (by Ilargi, above) at our banks is a direct reference to CUSTOMER DEPOSITS. The funds that are insured via taxpayer's money by the FDIC,

donsutherland1 · 09-16-08, 10:44 AM

Summerwind,

I don't believe the Fed's decision had anything to do with imposing burdens on the next President or putting politics ahead of its responsibilities. The Fed's PDCF and TSLF temporary facilities were initially slated to be terminated in mid-September. On July 30, the Fed extended their existence explaining:

In light of continued fragile circumstances in financial markets, the Board has extended the PDCF through January 30, 2009, and the Board and the Federal Open Market Committee (FOMC) have extended the TSLF through that same date. These facilities would be withdrawn should the Board determine that conditions in financial markets are no longer unusual and exigent.

The PDCF provides discount window loans to primary dealers, collateralized by investment-grade securities. The interest rate charged is the primary credit rate (discount rate) of the Federal Reserve Bank of New York. Under the TSLF, the Federal Reserve Bank of New York conducts weekly auctions of 28-day loans of Treasury securities to primary dealers. Loans under the TSLF are collateralized by a range of government and private securities.

My guess is that the Fed wanted to maintain the facilities through the rest of this year. However, its first meeting in 2009 is scheduled for January 27-28, at which it will reassess the need for those temporary facilities, if it does not do so earlier. Therefore, it set the expiration date for January 30. If the Fed chooses not to act, the temporary facilities will be terminated a day after its meeting. If needed, the Fed would likely extend the existence of those facilities, perhaps into the summer (June 30th or August 31st?).

Also, Chairman Bernanke's term continues until February 1, 2010. Hence, he won't be replaced before then.

Goldenboy219 · 09-16-08, 11:24 AM

Supposedly, the NY Fed and AIG are in talks.

From CNBC:

Quote:

The government is once again considering providing American International Group with some sort of financial support, according to investment banking sources involved in the meeting.

The New York Federal Reserve is currently meeting to discuss the fate of the troubled insurance giant.

Reports of a potential bridge loan, helped shares of AIG pare losses, but the company's [AIG 2.79 -1.97 (-41.39%) ] shares remain lower Tuesday. Earlier the stock plunged more than 40 percent in the wake of a cut in the insurer's credit rating, which only served to heighten the concerns that it would file for bankrupcy and further upset the troubled global financial system.

AIG, one of the world's largest insurers, is the latest company to be convulsed by a mortgage and credit crisis that this week led to a bankruptcy filing by Lehman Brothers Holdings [LEH 0.22 0.01 (+5.33%) ] and the sale of Merrill Lynch [MER 19.85 2.79 (+16.35%) ] to Bank of America [BAC 27.78 1.23 (+4.63%) ].

Government Once Again Considering AIG Bailout - Financials * US * News * Story - CNBC.com

donsutherland1 · 09-17-08, 12:04 PM

More on the money front...

From Bloomberg.com:

U.S. stocks tumbled as bank lending seized up in the wake of the government's takeover of American International Group Inc., raising concern that more of the nation's biggest financial companies will fail...

Yields on three-month bills sank to at least a 54-year low and a measure of corporate borrowing costs surged to the highest since the crash of 1987...

U.S. Treasury three-month bill rates dropped to as low as 0.233 percent and the so-called TED spread, the difference between what the Treasury pays to borrow for three months and the amount banks charge each other for loans, widened by 0.70 percentage point to 2.89.

donsutherland1 · 09-17-08, 04:16 PM

As credit markets suffered a fresh seizure, this time with the TED (Treasury-Eurodollar) spread widening to almost 300 basis points, stocks experienced another vicious sell-off, while gold spiked by $70 per ounce to finish at $850.50 per ounce.

The S&P 500 closed at 1,156.39, down 57.21 points. That is its lowest close since May 13, 2005 when it closed at 1,154.05. Since reaching its peak on October 9, 2007, the S&P 500 is down 26.1%. In inflation-adjusted terms, it is down 29.8%.

The Dow Jones Industrials fell to 10,609.66, down 449.36 points. That is its lowest close since November 9, 2005 when it closed at 10,546.21. Since reaching its peak on October 9, 2007, the Dow is down 25.1%. In inflation-adjusted terms, it is down 28.8%.

Separately, in what could be the strongest indication to date that an Resolution Trust Corporation-style solution to purchase toxic mortgage-related securities may be under discussion, Senate Banking Committee Chairman Christopher Dodd suggested that the Fed already possesses existing authority to act as an “effective Resolution Trust Fund.” He added, “Debating whether or not you’re going to set up some new agency or bureaucracy in government is a nice point but I don’t think we have the luxury of waiting another year.”

donsutherland1 · 09-18-08, 06:47 AM

In coordination with the U.S. Federal Reserve, five leading international central banks committed to injecting up to $247 billion in liquidity to assure the continuing functioning of the world's financial system. Today, CNN reported:

The package of up to $247 billion comes from the European Central Bank, the Swiss National Bank, the Bank of England, the Bank of Canada and the Bank of Japan.

The injection of cash, which amounts to an expansion of up to $180 billion in available funds, is an effort to fuel economic activity...

"We're very grateful that the rescue package has been put on the table, because frankly the world's inter-bank markets are just simply not working in the manner that they should do," said David Buik of the BGC Partners brokerage firm in London. "There's a wholesale mistrust ... amongst everybody."

The Federal Reserve announced:

Today, the Bank of Canada, the Bank of England, the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank are announcing coordinated measures designed to address the continued elevated pressures in U.S. dollar short-term funding markets. These measures, together with other actions taken in the last few days by individual central banks, are designed to improve the liquidity conditions in global financial markets. The central banks continue to work together closely and will take appropriate steps to address the ongoing pressures...

The Federal Open Market Committee has authorized a $180 billion expansion of its temporary reciprocal currency arrangements (swap lines). This increased capacity will be available to provide dollar funding for both term and overnight liquidity operations by the other central banks.

The FOMC has authorized increases in the existing swap lines with the ECB and the Swiss National Bank. These larger facilities will now support the provision of U.S. dollar liquidity in amounts of up to $110 billion by the ECB, an increase of $55 billion, and up to $27 billion by the Swiss National Bank, an increase of $15 billion.

In addition, new swap facilities have been authorized with the Bank of Japan, the Bank of England, and the Bank of Canada. These facilities will support the provision of U.S. dollar liquidity in amounts of up to $60 billion by the Bank of Japan, $40 billion by the Bank of England, and $10 billion by the Bank of Canada.

All of these reciprocal currency arrangements have been authorized through January 30, 2009.

SouthernDemocrat · 09-18-08, 10:42 AM

Donsutherland,

What do you think about the Fed's essentially running out of money?

Quote:

The Fed had close to $800 billion of Treasuries at the start of the year. Last week the Fed had $479 billion in Treasuries, of which $200 billion was pledged to the term securities lending facility, the facility whereby the Fed lends its Treasuries to dealers in exchange for agencies, mortgage-backed securities and other non-Treasury collateral.
If the Fed lends $85 billion to AIG(AIG Quote - Cramer on AIG - Stock Picks), the Fed's Treasury holdings will be down to $195 billion. The tally is so low that it is becoming imperative for the Fed to take actions to enlarge its balance sheet.

Crescenzi: Fed's Treasuries Running Out - page 1 of 2 - TheStreet.com

It seems as though the well is drying up in terms of what the Feds can do going forward. It seems to me that the Fed's "sterilized" options are almost depleted and going forward actions left available to them could spur inflation. Your thoughts?

oldreliable67 · 09-18-08, 10:57 AM

Quote:

Originally Posted by SouthernDemocrat

Donsutherland,

What do you think about the Fed's essentially running out of money?

Crescenzi: Fed's Treasuries Running Out - page 1 of 2 - TheStreet.com

It seems as though the well is drying up in terms of what the Feds can do going forward. It seems to me that the Fed's "sterilized" options are almost depleted and going forward actions left available to them could spur inflation. Your thoughts?

Your question wasn't directed at me, but I thought I'd point out a couple things anyway. Hope you don't mind.

One, the last paragraph in your cited article, read:

Quote:

There should therefore be no fear about the Fed's ability to continue to provide capital for the financial system.

Which is, of course, true. But not necessarily or only for the reasons Crescenzi gave. The principal reason it is true is the Fed's ability to be funded by Treasury, as witnessed by the bill auction yesterday. As summarized by CNBC...

Quote:

The US Treasury Department announced a new program aimed at helping the Federal Reserve manage its balance sheet in the wake of the various forms of liquidity the Fed has made available to market participants over the last several months.

Just minutes after the announcement, Treasury announced an auction of a $40 billion, 35-day cash management bill. The auction will end at 1 PM EST today.

In a statement, Treasury said it has established a Supplementary Financing Program (SFP) "at the request of the Federal Reserve" under which Treasury can auction Treasury bills that will "provide cash for use in the Federal Reserve initiatives".

A Treasury official said the SFP would help the Fed "better manage" its balance sheet needs.

While the Fed has always been able call on the Treasury for needed funds, this is, AFIK the first time it has ever done so. Formalizing this important facility for the Fed should allay any lingering fears about the Fed running out of ammunition.

In terms of any impact on inflation, that continues to depend on what the Fed does with reserves.

Update: Treasury has just announced three CMBs (cash management bills) that fall under the Supplemental Financing Program. These are a 7-day CMB ($40B), a 45-day CMB ($30B), and a 59-day CMB ($30B), for a total of $100 billion. Note that while the Supplemental Financing Program is initially for $100 billion, there is no reason that the cannot be expanded as needed. What this would/will do to the deficit and outlook for macro policy is another question.

donsutherland1 · 09-18-08, 11:02 AM

As Oldreliable67 responded first and I agree with his assessment, I'll only add to the Treasury's providing funds to the Fed. Today, Bloomberg.com reported:

A day after Fed officials seized control of American International Group Inc., the Treasury yesterday acted at the Fed's request to fortify the central bank's balance sheet with $100 billion in new cash. Fed officials can use the proceeds to pump money into financial institutions fearful of lending to each other, or to catch the next insolvent bank that's unable to raise capital.

I would add that at some point should the Treasury's borrowings grow enormously, that could adversely impact the Treasury's borrowing costs, and that increase in costs would have a macroeconomic impact.