Bernanke not so anti-Greenspan, after all
I had been thinking of posting about the moaning of Ford CEO that the Federal Reserve should make the macroeconomy magical so his executives get their bonuses again, simply because it was so funny to have all of our intelligences insulted.
I accept Crazy Jim Cramer’s violent insistence that markets go one way (up or his, take your pick). He’s Wall Street – he’s doing pretty much what it says on the box. But Ford telling the Fed what to do is as moronic as Bush telling it what to do.
In any event, I was busy travelling, etc. (plus our semester begins tomorrow). Today’s was better still. From CNN (it’s the default news site on my mobile phone, so it’s handy when desperate on a 2½-hour bus ride):
The Aug. 20 letters from the Fed to Citigroup and Bank of America state that the Fed, which regulates large parts of the U.S. financial system, has agreed to exempt both banks from rules that effectively limit the amount of lending that their federally-insured banks can do with their brokerage affiliates. The exemption, which is temporary, means, for example, that Citigroup’s Citibank entity can substantially increase funding to Citigroup Global Markets, its brokerage subsidiary. Citigroup and Bank of America requested the exemptions, according to the letters, to provide liquidity to those holding mortgage loans, mortgage-backed securities, and other securities.
The rule in question is that no bank can lend more than 10% of its capital to its own brokerage arm – what we commonly call common fucking sense. It’s like not wanting you to re-mortgage your house and then use the money for that round-the-world cruise.
Having had to borrow half a billion on a 30-day loan from the Federal Reserve, these banks – having already maxed out that 10% – now get to send this money down to the brokers to cover their positions (commonly known as asses). In fact, they could send up to USD25bn, or 30% of capital, down the same tube. Back at CNN:
The Fed says that it made the exemption in the public interest, because it allows Citibank to get liquidity to the brokerage in “the most rapid and cost-effective manner possible.”
So, how serious is this rule-bending? Very. One of the central tenets of banking regulation is that banks with federally insured deposits should never be over-exposed to brokerage subsidiaries; indeed, for decades financial institutions were legally required to keep the two units completely separate. This move by the Fed eats away at the principle.
Sure, the temporary nature of the move makes it look slightly less serious, but the Fed didn’t give a date in the letter for when this exemption will end. In addition, the sheer size of the potential lending capacity at Citigroup and Bank of America – $25 billion each – is a cause for unease.
Expect the discount window borrowings to become a key part of the Fed’s recovery strategy for the financial system. The Fed’s exemption will almost certainly force its regulatory arm to sharpen its oversight of banks’ balance sheets, which means banks will almost certainly have to mark down asset values to appropriate levels a lot faster now. That’s because there is no way that the Fed is going to allow easier funding to lead to a further propping up of asset prices.
Don’t forget: The Federal Reserve is in crisis management at the moment. However, it doesn’t want to show any signs of panic. That means no rushed cuts in interest rates. It also means that it wants banks to quickly take the big charges that will inevitably come from holding toxic debt securities. And it will do all it can behind the scenes to work with the banks to help them get through this upheaval. But waiving one of the most important banking regulations can only add nervousness to the market. And that’s what the Fed did Monday in these disturbing letters to the nation’s two largest banks.
The last bit is the most important. One of a central bank’s key tasks is stability in the economy (including financial markets). Banks and their Frankencousins are the ones who Nick Leeson’d us into this bloody mess. These hooks don’t exist so that the Fed can go letting people off of them.
There’s also nothing I’ve seen about what is to be done if/when 30 days is up and these brokerage arms haven’t turned around (or at least secured themselves – remember that crack I made about you holding the bag full of shitty stocks and bonds? Yeah). If they need the Fed’s help now, they’ll need it just as much then, and then, and then, and..
As well as making us all less confident in these banks, and (in lay terms) big-B Banks, the balance sheets of the banks involve will automatically deteriorate, now that they’re sending money into risky debt directly. You know, it took Japan a decade and over USD1tr to get out of their recession.