Category: Economy

Analysis of the global economy

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A year later everyone is catching on about Fed policy and net interest margins | Credit Writedowns

“As I wrote in April: If long rates are largely determined by expected future short rates, the longer short rates are at zero percent, the lower long rates will go. That’s toxic for bank interest margins…..

Now that we are seeing more movement down on net interest margins (BofA and Wells Fargo both showed margin compression for example), the mainstream media is finally catching on to the connection between Fed policy and net interest margins. You heard it here first though.”

via A year later everyone is catching on about Fed policy and net interest margins | Credit Writedowns.

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Bernanke Hangs Tough on Financial Reform

“Central banks certainly did not ignore issues of financial stability in the decades before the recent crisis, but financial stability policy was often viewed as the junior partner to monetary policy,” he [Fed Chairman Ben Bernanke] said. “One of the most important legacies of the crisis will be the restoration of financial stability policy to co-equal status with monetary policy.”

via Bernanke Hangs Tough on Financial Reform.

The problem with having two equal objectives is, when they conflict, which do you choose?

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Wells Fargo’s Margin Slips – WSJ.com

At Wells Fargo, based in San Francisco, net interest margin fell to 3.84%, the fourth consecutive decline. Wells Fargo blamed the problem on its inability to lend enough of the deposits pouring into the bank. The decline overshadowed a 21% jump in third-quarter net income, which rose to $4.1 billion, as Wells Fargo’s deposit base expanded and nonperforming assets fell. It said its growth in loans and capital was “solid.”

Wells Fargo shares sank 8.4%, or $2.25, to $24.42 in New York Stock Exchange composite trading at 4 p.m.

via Wells Fargo’s Margin Slips – WSJ.com.

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Fed’s Kocherlakota on Why Balance Sheet Expansion Need Not Be Inflationary – Real Time Economics – WSJ

I’ve mentioned how the Federal Reserve has bought over $2 trillion of government securities. It has funded that purchase by tripling the amount of deposits held by banks with the Fed — what are called bank reserves.

……. Banks have few good lending opportunities, and so they’re not trying to attract deposits. As a result, they are keeping nearly $1.6 trillion of reserves at the Fed in excess of what they need to back their deposits.

…… Some observers are concerned that ……. the banks’ excess reserves will serve as kindling for an inflationary fire. This concern would have been entirely appropriate three years ago. But in October 2008, Congress granted the Federal Reserve the power to pay interest on bank reserves. Right now, that interest rate is 25 basis points, or 0.25%. By raising that rate judiciously, the Fed has the ability to deter banks from using their reserves to create money, and through this mechanism, the Fed can prevent inflation.

via Fed’s Kocherlakota on Why Balance Sheet Expansion Need Not Be Inflationary – Real Time Economics – WSJ.

Monetary expansion through further asset purchases by the Fed (quantitative easing) would be ineffective, simply boosting the level of excess reserves held by banks on deposit at the Fed. Monetary tightening would be more difficult, but could be achieved by raising the interest rate paid on excess reserves in order to discourage banks from using their excess reserves. That would raise the overnight rate (fed funds rate) in the market and restrict banks from expanding their balance sheets.

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Fedex & UPS

Bellwether transport stock Fedex displays a bear market rally with a target of 80. UPS is even stronger, having broken out from its trading range of the last 2 months to signal a re-test of its 2011 high. Not enough to indicate an up-turn but encouraging all the same.

Fedex and UPS

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The Platypus blues – macrobusiness.com.au

Ms Luci Ellis, RBA Head of the Financial Stability Department:

Indeed, credit booms are very often part of the story in the lead-up to a period of financial instability. We published that assessment in the March and September Reviews. In the wake of that, we have sometimes been asked: how fast is too fast? Do we have a target for credit growth? Or for the ratio of credit to GDP? Or, perhaps, for housing and other asset prices? I can tell you quite plainly that we do not have numerical targets for any of these things. A target for credit growth, or any of these other variables, is not analogous to the RBA’s inflation target……….The distinction is simply that price stability is about inflation. So it can be defined as keeping inflation at an acceptably low rate. Financial stability is harder to define, but in essence it is about avoiding episodes when the financial system significantly harms the real economy.

My interpretation of this series of statements is that a fundamental flaw is at the heart of the RBA’s view of financial stability management. The RBA has specific targets for inflation and that is the single price (including assets) stability tool but has no targets or model parameters to govern financial stability. A big mistake not just of policy but market knowledge

via The Platypus blues – macrobusiness.com.au | macrobusiness.com.au.

Alarm bells should ring if household debt starts growing at 8pc to 10pc a year.

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Causes of the Crisis: Basel II

Why do they [European financial institutions] hold so much Greek government debt? Because under Basel II, implemented (outside the United States) in 2007, Greek government bonds, rated A-, had the same 20 percent risk weight as AA/AAA asset-backed securities in the United States. That is, until S&P downgraded Greek debt from A- to BBB+. That raised the risk weight to 50 percent, suddenly requiring 60 percent more capital from banks holding Greek bonds.

This appears to be the reason that the possibility of Greek default has led to fears of another banking crisis.

via Causes of the Crisis: February 2010.

The 20 percent risk weight required banks to only hold $2 of bank capital against a $100 security — at the 8 percent Basel rate for adequately capitalized banks — allowing 50 to 1 leverage compared to 12.5 to 1 on normal bank loans.

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Big Banks Are About to Get Blasted by the Volcker Rule :: The Market Oracle :: Financial Markets Analysis & Forecasting Free Website

Since a significant chunk of the big banks’ profits – especially that of Goldman Sachs Group Inc. (NYSE: GS) and Morgan Stanley (NYSE: MS) – come from various forms of proprietary trading, the Volcker Rule stands to cost the industry billions in revenue.

To prevent cheating, complex compliance rules will require that banks prove that all their trading activities are for clients’ benefit, and not proprietary. Compliance alone is expected to tack on another $2 billion in costs.

via Big Banks Are About to Get Blasted by the Volcker Rule :: The Market Oracle :: Financial Markets Analysis & Forecasting Free Website.

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Too-big-to-fail is here to stay

Lehman Brothers’ collapse in 2008 was intended to intended to teach financial markets that they could not rely on an implicit government guarantee for too-big-to-fail (TBTF) banks. What bondholders learned was the opposite: never again would an institution of that size be allowed to collapse because of the de-stabilizing effect on the entire financial system.

Rescue of Dexia by French, Belgium and Luxembourg governments is the latest example. Bond-holders received 100 cents in the dollar/euro. Markets are just too fragile to consider giving bondholders a haircut. Denmark earlier had to back down from forcing haircuts on bondholders when Danish banks found themselves shut out of funding markets. [WSJ]

Frequent calls for TBTF institutions to be broken up have proved ineffective. Instead the problem has grown even larger with post 2008 rescue/take-overs of Countrywide and Merrill Lynch (BofA), Bear Stearns and WaMu (JPM), Lehman (Barclays), and Wachovia (Wells Fargo) reinforcing Willem Buiters’ survival of the fattest observation.

Proposals to reduce systemic risk through adoption of the Volcker Rule, which would prevent banks form trading for their own account, are proving difficult to implement. The 298-page first draft offers few clear definitions of restricted activities, instead calling for suggestions or feedback.[Bloomberg] Drafters should consider turning the rule around, offering a list of approved activities that banks can pursue, rather than attempting to define what they cannot. I have great respect for banks’ ability to find loopholes in any restrictive list.

The Rule on its own, however, cannot protect taxpayers from future bailouts. It does not prevent banks from over-lending if there is another bubble. There is only one solution: increase capital ratios — and apply similar ratios to securitized assets. Increases would have to be gradual, as some banks could respond by shrinking assets rather than raising capital — which would have a deflationary effect on the economy. Changes would also have to be sensitive to the economic cycle. The easiest way may be to set a long-term target (e.g. 20% Tier 1 + 2 capital by 2030) and leave implementation to the central bank as part of its monetary policy.

Together with the Volcker Rule, increased capital ratios are our best defense against a recurrence of the GFC.

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