FedUpUSA

Archive for March 8th, 2010

Breaking the American Bank – Banking Propaganda and Using the American Middle Class as a Credit Card for Wall Street Excess. How About we let the Average American Borrow from the Federal Reserve at 0 Percent and cut out the Loan Shark?

Posted by mybudget360

Banks are showing their true colors and what little regard they have for the average American.  As they advertise with cute and friendly faces assuring consumers they are looking out for their best interest, behind their backs they send in a locust of lobbyist onto Washington to do everything in their power to gut any sensible financial regulation.  The vultures are picking off every piece of what used to be the middle class.  This is the model of the new banking and financial system that many will have to contend with.  Americans have seen their access to loans and credit contract at the fastest pace in history while banks have now opened up an unlimited credit card with the taxpayer paying the bill for too big to fail.  Banks are doing their best to create a narrative that “if we didn’t bailout the banks then the world would have ended storyline” but the vast majority of Americans did not support the banking bailout.

If you want to see how quickly credit is contracting take a look at this:

The chart above merely highlights what you already know. Banks no longer trust the average American.  While they based all their bailouts on the idea that taxpayer money was needed to keep banks lending this has been a lie.  In fact, banks need the money to plug the hole that their toxic assets are burning on their balance sheets.  You can also look at the amount of credit card offers you are getting in the mail to gauge how quickly the market has changed.  No longer do banks want to give credit out (that is, unless it is government backed like mortgages which they are all the more willing to lend out).

The U.S. has over 8,000 banks with the large concentration of assets in 10 banks.  These banks continue to use bailout funds to plug the problems from the boom years.  But this is not in the best interest of average Americans.  If Wall Street and politicians were honest, the bailouts would have been labeled as a massive charity to the elite of the country who made disastrous bets over the past decade.  The public takes the lumps while Wall Street actually gets richer.  While banks don’t want to reel in their spendthrift ways, Americans are pulling back:

Americans are now having to save more and more of their money as is expected in a tough economy.  Yet banks are back to gambling in the stock market while shutting down lending to consumers.  Banks are playing the poor me card by arguing that with too much tight regulation, they can’t make loans because they are worried about future balance sheet problems.  Thanks for telling us after you took the public money under false pretenses!  But this is all a political ploy to steal from the working class.  With so many people just unable to even service the debt and rising bankruptcies, banks are now going after good customers who pay their bills on time each month just because they are running out of “options.”  Don’t be fooled.  They are reaping billion dollar profits because they are using excuses to squeeze the golden goose dry.  How about we allow the typical American to borrow at the subsidized low rate from the Federal Reserve directly?  Why in the world do we need banks to operate as loan sharks in between?  What we need is to transform the banking industry into a utility model.  A model designed to serve the people, not the banks.  After all, why should they get the privilege of borrowing at criminally low rates while everyone else has to pay the interest and subsidize their gambling adventure?

Even after all the correction in the market American households still carry an inordinate amount of debt:

A giant portion of income simply goes to pay off debt.  A large part of the debt is interest or money the banks can suck out of the neck of middle class Americans.  Banks live off this margin.  Take for example a $100,000 30 year fixed rate mortgage at 6 percent:

Principal:             $100,000

Total Interest:   $115,838

In the end, you are paying more than the initial cost and all that interest goes to who?  What purpose does it serve?  Banks are delusional and want the public to believe in the propaganda that they need to charge a higher rate because of “risk” in the loan.  Are they kidding?  We already know that they are being supported by the entire Federal Reserve and U.S. Treasury.  They can make the most insane kind of bets and ultimately the taxpayer will eat the bill.  And keep in mind many of these banks are borrowing at low levels from the Federal Reserve.  Why not allow the public to keep some of that interest?  How is this bad?  If banks were lending their own money it would be a different story but they are not.  They are creating a dishonest narrative and most Americans are not buying it because they operate in reality and not some parallel universe where you can create something out of nothing.

Just think of the billions charged in overdraft fees.  This is criminal.  Why not just default debit cards to stop once the account is dry?  Instead they want people that charge a $2 burger a $39 over draft “convenience fee” for this nonsense.  Are you kidding?  Most people don’t want this.  They find out the hard way and now billions have left the wallet of consumers for this nice little loan shark fee.  $39 can buy you lunch for a few days so this is nothing to laugh at when 38,000,000 Americans find themselves on food assistance.  The bulk of the billions are paid by the poor.  Good job banks for helping your fellow Americans.  Yet banks are leeches sucking the productive life blood out of the economy with gimmicks like this.  Time to break the banks up and turn them into utilities.

Take for example JP Morgan.  They announced a Q4 profit of $3.28 billion.  Where did they make their money?

“(Huff Po) JPMorgan’s biggest trouble spots were in consumer banking and credit card lending. The bank’s retail financial services division, which includes its mortgage operations, lost $399 million. That was worse than the final quarter in 2008, when credit markets had essentially shut down because of the collapse of banks including Lehman Brothers.

The company reported increases in mortgages that were charged off, or classified as uncollectible, including prime mortgages, the highest quality home loans. It also reported an increase in home equity loan charge-offs.”

Wait.  So mortgages are being charged off as foreclosures remain high.  And this has spread to so-called prime mortgages as the unemployment and underemployment rate remains at 17.9 percent.  So let us write off mortgages to average Americans.  Where in the world did they get those billions?  Maybe they made good money in their credit card unit:

“The credit-card lending division lost $306 million during the final three months of 2009. Results would’ve been worse had the bank not had a payment holiday in the period.”

More losses here?  So we’ve ruled out credit cards and mortgages which have become the life blood for Americans.  We’re running out of places to look for where they can make a $3 billion profit:

“Despite the ongoing problems with consumer banking, JPMorgan is still performing well because of its robust investment banking unit. As long as stock and bond markets continue to improve, the bank will be able to churn out profits and reward its employees handsomely.

JPMorgan’s investment bank earned $1.9 billion during the fourth quarter, while its asset management division generated $424 million in net income.

Fees from financing debt and stock offerings continued to surge in the fourth quarter. Debt financing fees jumped 58 percent to $732 million from the same quarter a year earlier, while stock financing fees climbed 66 percent to $549 million.”

And there you have it.  We are financing Wall Street’s wonderful gambling casino once again while the traditional banking model has collapsed.  How this isn’t the number one priority for the government and the people to fix is simply astounding.  How we have had no serious financial reform after 26 months of the Great Recession boggles the mind.

Squeezing the Last Drop of Productivity from the American Working Class – 18 Percent National Underemployment and why Wall Street and the Government are Cheering Your Financial Failure.

Posted by mybudget360

The American financial press cheered on Friday when “only” 36,000 jobs were lost in February.  This if you haven’t noticed now passes for good economic news.  The unemployment rate remained unchanged because the actual workforce continued to show a decline yet Wall Street somehow viewed this as positive developments.  And why not?  The middle class is under assault from every angle.  Things are so twisted with propaganda that many Americans now believe that the banking elite are actually looking out for the well being of American workers.  As news of the job losses somehow echoed as positive developments, more and more Americans are continually being kicked out of their homes from banks they helped to bail out.  Irony has no meaning to Wall Street.

And if we look at the details of the jobs report, it turns out that 17.9 percent of Americans are either unemployed or underemployed or flat out have stopped looking for work:

Source:  BLS

This wasn’t the only spin going on in the media.  Before the jobs report came out there was a preemptive flow of information trying to justify the job cuts by blaming it on the weather.  Yes, now instead of blaming the financial catastrophe on the actual perpetrators in Wall Street who systematically looted the American system and turned our economy into a giant casino that they leeched onto, we are now to believe people are losing their jobs because of the weather:

“(CNSnews) Ahead of Friday’s announcement, Goldman Sachs predicted that the storm might skew the job loss number by as much as 100,000 – a prediction that was embraced by officials in the Obama administration.

“The blizzards that affected much of the country during the last month are likely to distort the statistics,” Larry Summers, director of the White House’s National Economic Council, said in an interview with CNBC. “So it’s going to be very important … to look past whatever the next figures are to gauge the underlying trends.”

If the storm caused a skewing of job loss numbers I wonder how many job losses can be linked to Goldman Sachs and their casino style gambling in the derivatives markets and mortgage backed securities?  Then again, people should be happy that the unemployment rate remained steady at 9.7 percent even though more Americans are working part-time with no benefits and many others have simply fallen off the payrolls.  This is supposedly the new American dream for the middle class through the eyes of Wall Street who are selling capitalism but living in a world of corporate handout socialism.

There is a new show called Undercover Boss where a CEO goes undercover to work in the trenches with the proletariat.  As it turns out, the middle class is being worked to death and as we all know, the CEO can’t even do the job most workers do on a daily basis.  Even Henry Ford understood the interworking of the cars he was putting out.  In the end the CEO reveals his identity and gives a nice little handout to the worker and all is well in TV land.  The check is a token of what CEOs actually make.  This is the ultimate reflection of our trickle down economy where those at the top act like sociopaths and rulers of the universe but when it comes to doing the daily tasks of their company, they have no clue.  This is the de facto rule running on Wall Street.  In fact, CEO pay has grown outrageously over the past few decades as the middle class has gotten poorer:

Source:  American Progress

In reality, part-time employment has spread even to poor CEOs making 300 to 400 times the average American worker salary.  Poor CEOs and Wall Street executives need time off to enjoy their tax payer funded yachts and all expense hedonism trips to the Caribbean.  They would like to convince each other that the money they have is all through their will power and market prowess but in reality it is nothing more than being part of a corporatocracy and buying out the government with an army of lobbyist and insiders.  You have to be a self indulgent narcissist to take the economy to the brink of financial destruction in the case of many Wall Street firms and still reward yourself with outrageous bailouts.  The fact that average Americans are still not protesting in mass about this tells me that many actually believe what Wall Street is saying.  You see this when many would rather blame the working class for the ills of today than focus their energy where it really needs to go.

Wall Street loves this economic crisis.  They receive trillions in bailouts yet convince the public that what is occurring today is merely the “market” correcting itself.  So as most Americans have more and more troubles keeping up with their daily bills, companies are squeezing every little excess from those currently working.  Those that have jobs out of fear will work harder and probably demand less merit increases in the current economy.  After all, the head guy is only making 300 times what you make even though he can’t even understand the main function of the organization.  So what if the low level guy is selling toxic crap to some homeless person with no income and giving him access to a $500,000 loan.  These Wall Street tycoons are big picture thinkers and can’t be worried with the day to day operations of the proletariat unless it means turning it into a caricature for mass viewing and quick TIVO access.

You don’t think productivity actually increased?  Take a look at this:

Source:  BLS

This recession has been fantastic for productivity.  Just look at the above chart.  American workers have been doing their part during this recession.  After all, now you can hire a cadre of “contract” workers and not have to pay them one cent in healthcare support or even contribute to their pension.  Once the job is done you can kick them to the curb.  After all, this is capitalism so long as those at the top have managed to setup sweetheart deals and golden parachutes.  This is how the top 1 percent makes sure their hold on 40 percent of the nation’s wealth isn’t damaged.  And if you think financial institutions deserve this bailout money and their outrageous bonuses then companies like Circuit City or Mervyns would still be around today if that model applied across the board.  But this doesn’t apply to the general economy.  This applies to Wall Street and somehow the absurdity of it all still goes on.  The worst financial crisis since the Great Depression and not one solid reform has been enacted.  26 months of job losses and nothing.  Who is running the show?

The rise of the part-time work force is nothing new as we become more and more like Japan.  Japan bailed out their financial institutions after their failed stock market and real estate bubbles popped and today, their working class is made up of one-third part-time workers:

“(LA Times) In the world’s second-largest economy, the global financial crisis has forced part-time workers such as Kudo to face a harsh new reality.

Over the last few years, temporary employees have gone from being a rarity in Japan to accounting for one-third of the workforce of 67 million. They enjoy far fewer protections than full-time workers — placing their necks squarely on the layoff chopping block.

By March, the government predicts, 85,000 part-timers will fall prey to haken-giri, or temporary-worker cutbacks — a relatively small number compared with U.S. layoffs but high for a nation where job security has long been a staple.

On Wednesday, embattled Prime Minister Taro Aso made the plight of part-timers a major piece of a proposed stimulus package. Aso pledged to create 1.6 million jobs, partly by turning part-time jobs into full-time ones.”

Japan’s headline unemployment rate is 4.9 percent.  Just like our headline unemployment rate, the devil is really in the details.  If we continue on this path part-time work may be all that is left.

Recessions, Depressions, and the Biblical Jubilee, Part Four

“The Math is Never Wrong” -Karl Denninger
– Jeff

Over the course of history, things change. Cultures change, technologies change, the accepted rules of legitimacy in governance change, relative levels of prosperity change, a lot of things change. But in the field of mathematics, nothing ever changes. Whether we are talking about pre-history, ancient times, medieval times or modern times, two times two has always and will always equal four.

Yet at the beginning of this Depression, which we are living through in the United States of America and around the world, with the evidence of history staring us in the face — from the Great Depression of the 1930s all the way back to Joseph in Egypt — we continue to believe and act as if, somehow or other, we are “special.” As if the vagaries of the past somehow don’t apply to us. As if “this time is different” (a subject we will explore in depth in Part Five of this series).

In recent times the economic phenomena — which God instituted the Jubilee Year to address in ancient Israel — has come to be called the Long Wave. A cycle which, like the Jubilee, recurs within the mean life span of a human being. It is a cycle that ends in a depression. Always and inevitably. That is, for any economy that does not have a Jubilee in place, patterned after the biblical example in Leviticus 25. (No one outside ancient Israel ever has, BTW.)

***

The Long Wave was first described in modern times by Soviet economist Nikolai Kondratiev. Its existence has also been detected by traders who make money in the financial markets by analyzing shorter-term patterns according to the Elliot Wave principle and other kinds of technical analyses.

However, mainstream economists of the Keynesian and Monetarist schools (the former in the United States tend to be Democrats, the latter Republicans) reject the notion that any such cycle exists. And because they are considered “mainstream,” axiomatically they are the ones with the most authority and influence over the economic policies of the government.

I believe the reason that mainstream economists remain blind to the existence of the Long Wave Cycle, is because they have failed to discover a reason for it that can be described by cause-and-effect mathematically. Or recognize it even when someone has set it right in front of their faces, like a marble on a plate.

It is Karl Denninger — a trader by profession who also publishes the award winning blog The Market Ticker and rides herd on The Market Ticker Forums — who I believe has the distinction of being the first person to describe the underlying cause of the Long Wave cycle. In terms that are not very much more complicated than 2 x 2 = 4. A matter of simple multiplication.

But Mr. Denninger has not only nailed down the cause of the Long Wave Cycle to a simple mathematical certainty. He has also published his findings far-and-wide. Which means that mainstream economists, Congress, the Administration, and the Central Bank in Washington, along the individual citizens of this nation, have no excuse. We swirling around the open drain with both eyes wide open. Willfully blind.

***

The basic mistake that ALL mainstream economists make, whether they are Keynesian or Monetarist, is the underlying assumption that economic output ALWAYS tends toward what is called Economic Equilibrium, fluctuating only according to the vagaries of supply and demand.

According to the model that mainstream economists follow, depressions are far from regular, predictable, or inevitable events. Rather, they view depressions as economic aberrations. And the worst kind of economic aberration too, because of the damage an economic depression causes.

A depression therefore represents an aberration which — from the positions of power that mainstream economists occupy at places such as the Federal Reserve and the Department of the Treasury — they are fighting with all the fiscal and monetary tools that the government of the United States has at its disposal.

One problem. Their underlying assumption is WRONG. Depressions are in fact a regular, predictable, and inevitable phenomenon. Which is why the policies which the Federal Reserve and Treasury have followed and have cajoled the politicians in Congress into following, are not only failing abysmally during the current economic downturn. They are making it worse. FAR WORSE.

How? By neglecting the mathematics that the biblical Jubilee in Leviticus 25 addressed by canceling all debts every fifty years. The mathematics which show that the overhanging debt that looms over EVERY economy ALWAYS compounds faster than that economy’s output. A situation which, as Mr. Denninger points out in his blog post The Price of Capitalism, CANNOT be sustained.

Remember, everyone seeks a profit. Therefore, those who loan capital out will demand some price above the “risk free” return that can be obtained by simply sitting in the economy and lapping up the growth.Nobody will take an intentional loss as long as there are alternatives, and unless you steal people’s property, there are!

Therefore, there will always be a “spread.”

But look at what happens [see Figure 1]. In the first year, the “spread” between the two – the difference between the economic outcome and the lending price – is 3%. But by the fifth year that spread has grown to 21% and is accelerating rapidly – 21% is much higher than 3 x 5, or 15%.

In 10 years the spread is much worse – 63% instead of the “expected” 30%, and in 20 years its horrifying – 286%!

Why?

Because both functions are exponents (compound functions) and so long as people seek a profit it will always cost more to borrow capital than the rate of growth in the economy, as you must induce them to take a risk.

Left alone the overhang of debt will always “run away” and destroy the economic and monetary systems.

Therefore if we are to avoid a complete collapse of the economic and monetary systems there must be times when the “overhang” of bad debt defaults, lest it grow so much that nobody can make the payments and the economy is choked off.

That is exactly what has happened because our government intentionally prevented the defaults that were NECESSARY in 2000-2003 to restore balance between these two functions.

Now the pain is worse, and as you can see above, the longer you try to put it off the worse it gets. It’s bad now (about 10 years in); if we try to “kick the can” for another 10 years it will be catastrophic.

It should be as plain as the nose on my face, to anyone looking at Figure 2 who has an ounce of common sense, that an economy in which the debt is growing along the red line while the output of that economy is only growing along the blue line — that before long THE ABILITY OF THAT ECONOMY TO SERVICE ITS DEBT BECOMES IMPOSSIBLE. This graph is no aberration, however. It applies to EVERY ECONOMY THAT HAS EVER OR WILL EVER EXIST “until the day dawns and the darkness disappears.”

God commanded ancient Israel to observe a Jubilee year in Leviticus 25, so that there would be an ORDERLY liquidation of this debt overhang every fifty years. Obviously, with a date for universal debt forgiveness written in stone, no lender would ever set terms for repayment PAST the Jubilee year.

Which means as the Jubilee approached, the red line and the blue line in Figure 2 would come together in an ORDERLY fashion WITHOUT a depression. Unlike the financial panics and economic crashes that have characterized the Long Wave cycle for every other economy that has ever existed.

The chart of “Total Credit Market Debt as a Percent of GDP” (Figure 3) is illustrates a fact that every American citizen should be aware of and educated about. The chart shows the total debt of the United States economy, public and private, as a percentage of our yearly Gross Domestic Product (GDP, which is equal to our Gross Domestic Income, GDI) from 1920 to 2008.

During the WORST of Great Depression, when under Hoover and FDR the federal government was taking previously unprecedented steps to counter a Long Wave downturn, our total debt in the United States at its peak did not exceed 240% of our GDP and GDI. But at the outset of our current Depression in 2008, our total debt in the United States was ALREADY at 350% of GDP. That was before the Obama Administration began taking its own unprecedented steps to counter this Long Wave downturn. Karl Rove in the Wall Street Journal notes that:

Consider that from Jan. 20, 2001, to Jan. 20, 2009, the debt held by the public grew $3 trillion under Mr. Bush — to $6.3 trillion from $3.3 trillion at a time when the national economy grew as well.By comparison, from the day Mr. Obama took office last year to the end of the current fiscal year, according to the Office of Management and Budget, the debt held by the public will grow by $3.3 trillion. In 20 months, Mr. Obama will add as much debt as Mr. Bush ran up in eight years.

What our government is attempting to do can be likened to an alcoholic who tries to treat his drinking problem by consuming alcohol at an EIGHT TIMES FASTER RATE. The only difference being that what the American people and the United States government are addicted to debt. It is our debts that are the root cause of our worsening economic problems, AND INCREASING OUR DEBT IS ONLY GOING TO MAKE MATTERS WORSE.

***

Alongside Leviticus 25, the first chapter of Ecclesiastes also points out the pervasiveness of what can be called cycles, or more accurately recurring themes, in the natural world:

Ecclesiastes 1:4-7
One generation passeth away, and another generation cometh: but the earth abideth for ever.The sun also ariseth, and the sun goeth down, and hasteth to his place where he arose.

The wind goeth toward the south, and turneth about unto the north; it whirleth about continually, and the wind returneth again according to his circuits.

All the rivers run into the sea; yet the sea is not full; unto the place from whence the rivers come, thither they return again.

The politicians, leaders in business and finance, and the American people have just begun a lesson — courtesy of “the school of hard knocks” — in the mathematical accuracy of the Word of God regarding the biblical Jubilee. The mathematics behind the cycles of expansion and contraction that govern human economies can no more be resisted by mere human beings than the hydrological cycle, the cycles of climate and weather, the orbiting of the earth, or the passing of the generations.

At this point credit markets are headed for what is called a parabolic blow off or a blow off top, which will be accompanied by long-term damage to our economy, from which it will take decades for the United States and the world to recover. The question is not “if” the blow off is going to happen, only when. Probably sooner rather than later, but either way as Mr. Denninger likes to point out, “The math is never wrong.”

Other Posts in this Series

• Part One
• Part Two
• Part Three

***

Is The Federal Reserve Insolvent?

Submitted by Tyler Durden

With Geoffrey Batt

The ongoing troubles at the GSEs are no secret: it is public knowledge that Fannie had a 5.38% delinquency rate at December, while Freddie just passed the 4% threshold in January; both continue to rise rapidly each month. The fact that the mortgage-bond spread has just hit a record tight is merely an ongoing artifact of the Fed’s endless meddling in the mortgage market, with the sole purpose of keeping rates artificially low, and preventing banks from being forced to take massive writedowns on their entire loan book. This is all well known. What, however, seems to have escaped public attention is what the impact of these delinquencies is on the one largest holder of Mortgage Backed Securities, the Federal Reserve. What also seems to have escaped the public is that the Fed is now the world’s largest bank, with total assets near $2.3 trillion. We provide a weekly update of the Fed’s balance sheet and while we briefly note the liability side, our, and everyone else’s, attention, is traditionally focused on the asset side. Yet a more detailed look at the liability side reveals something very troubling, specifically that the Fed’s capital, i.e. equity buffer, which as of most recently was $53.3 billion (a comparable metric for plain vanilla banks is their equity buffer, or Tier 1 Capital, or however the FASB wants to define it on any given day when it is covering up massive capital shortfalls) is in fact negligible and could well be substantially negative, if the Fed were to account for the rapidly rising level of delinquencies in its one largest asset holdings: the $1.027 trillion in settled MBS. And while there is no possibility of a run on the Fed, the reality is that the Fed now likely runs with a negative real capital balance, meaning that the US Federal Reserve is now essentially insolvent.

First, we present the Fed’s assets broken down by key segments. The chart below shows the most recently disclosed asset holdings as per the H.4.1 statement. Of the $2.3 trillion in assets, the vast majority, or $1 trillion is held in MBS. As pointed out previously, this is only the settled amount – in reality the Fed has already purchased $1.22 trillion in MBS, which will settle over time. In practice, this merely means that the potential for asset impairment at the Fed is even greater by about 20%.The chart also shows what happens to MBS holdings if haircuts of 5%, 10% and 15% are applied.

Like any balance sheet, where there are assets, there are liabilities, and some version of capital/equity. The Fed’s liabilities are two principal components: currency in circulation, which has been at about $900 billion for an extended period of time, and the much more relevant recently line item called “Bank Deposits”, which has been popularized as Reserves with Federal Reserve Banks (or excess reserves). The Reserve line has increased from essentially nothing to nearly $1.3 trillion in the span of a few months. Furthermore, as more and more MBS purchased are settled, the excess reserve line will soon reach at least $1.6 trillion, if not more, if indeed Q.E. 2 is launched at some point in the future. The persistent discussions of potential inflation center precisely on the interplay between the green and blue blocks in the chart below: as long as the Currency in Circulation is flat, and Bank Deposits keep rising, the probability of inflation is slim to none. In essence, excess reserves exist only due to the Taylor rule implied negative Fed Funds rate. Should there be a material shift from green to blue, or from excess reserves to currency in circulation, that is when the hyperinflationary threat becomes all too real, as suddenly far too much money will chase a fixed amount of assets. This is also where the discussion about all the various mechanisms that the Fed has at its disposal to moderate tightening comes into play, whether it involves selling of assets, increase of the rate on reserves, or some combination inbetween (we point readers to yesterday’s paper from the Minneapolis Fed which discusses these options, and the caveats associated with each). While the asset reallocation debate is very interesting, it is not the topic of this discussion.

The one item on the balance sheet that is often ignored, is the Fed’s “Equity”, or as it is defined, “Capital.” As previously pointed out, this line item is currently $53.3 billion. It is shown graphically in the leftmost column of the chart below, which depicts actual Fed liabilities. Where the interesting part comes in, is when one analyzes what happens to the Fed’s capital when the abovementioned MBS haircuts are applied.

A 5% realized haircut on MBS alone would result in a complete elimination of the Fed’s capital balance. Applying a 10% or even 15% haircut, results in a capital deficiency of $50 billion and $100 billion respectively. This deficiency will grow as more and more MBS are settled, and as the serious delinquency rate on MBS keeps increasing (no danger in this moderating any time soon). 

Now in an environment, such as the one we live in today, when mark-to-myth is the new normal, and when banks are encouraged to come up with creative ways to indicate that their Residential and Commercial Loan portfolios are worth par (despite recent disclosures by the FDIC), to assume that the Fed would do something that lowly depositor banks are told not to do, would be folly. Yet, for those who prefer to live away from Never Never land, and brave this thing called reality, just what will happen if and when the Fed finally does disclose that it is, for all intents and purposes, insolvent?

The pragmatics among you will say: this is irrelevant, the Fed can just print more money and fill in any capital hole. Well, yes and no. As an increase in cash would have to be offset by a comparable increase in some asset, it is not that simple. For a refined analysis of what would happen in that moment of clarity when the world realizes the world’s biggest bank is broke, we turn to a presentation by Chris Sims, given before Princeton University, titled “Fiscal/Monetary Coordination When The Anchor Cable Has Snapped.” We encourage all readers to read this powerpoint cover to cover, as it discusses precisely the issues were are faced with today: namely a monetary policy that has run amok, seignorage, exploding excess reserves, the impact of these on “power money”, and, in general, a Fed balance sheet that is increasingly reminiscent of a drunk, rapid and schizophrenic bull in a China store.

Among other relevant things we note that as the author points-out that “Interest bearing deposits at the Fed do not (yet) count against the Federal debt ceiling” and “if substantial interest is paid on reserves, they could constitute a major leak in the US system for legislative control of debt creation or they are not backed by the full faith and credit of the US government, which has implications for inflation control” – the consequences here are material – with a $1 trillion plus in vacuum interest-collecting paper which in all other world would be counted toward the debt ceiling, the US debt subject to limit would increase from the $12.5 trillion currently to about $13.7 trillion. Add in $6 trillion from the GSEs and America is already at the dreaded $20 trillion threshold. And furthermore, what happens to the interest payments by the Fed should rates go up to 100 bps, 200 bps? On $1.6 trillion in excess reserves this is a material amount that would reinforce inflation in a circular loop, further justifying why the Fed is mortally worried about a rise in rates.

As for the topic at hand, we turn to pp 23-24 of the presentation:

• Central bank operations generate fluctuating levels of net earnings (seigniorage), most of which are turned over to the Treasury as revenue
• Central bank balance sheets sometimes go into the red. The Treasury may then recapitalize it by creating, and giving to the central bank, new government debt
• [The Fed's] Independence meant that the legislature and the Treasury did not complain [much] about seignorage fluctuations or about the effect of interest rate changes on the Treasury’s interest expense
• Fed can always “print money” to pay its bills.
• There is no possibility of a run on the Fed, since its liabilities make no conversion promise.
• A commitment to a path for inflation or the price level makes the balance sheet matter.
• Without Treasury backing, the Fed must rely on seigniorage to raise revenues, and that can conflict with inflation-control goals.

So here is the crux of the issue: the only way to deal with a mark-to-market of the Fed currently is to embrace monetization. It is no longer a question of semantics, of who promised what: it is the only mechanical way by which the Fed can dig itself out of a capital deficiency. With GSE delinquencies exploding, and with the Fed (and Congress) singlehandedly facilitating imprudent lender policy by allowing ever more borrowers to become deliquent without consequences, the MBS delinquency rate will likely hit 10% over the next 6-12 months. At that moment, someone will ask the Fed: “what is the true basis of your capital account?” And when the Fed is forced to justify a valid response, is when monetizaton will begin.

Since the market deals in expectation absolutes, all it would take for rates to breach the inflection point black swan and commence going up, is the mere possibility of open monetization.

What we hope to show with this exercise is that no course of action, even the one currently employed by the Fed, can continue in perpetuity: you can’t have infinitely low housing rates in an environment of exploding delinquencies, as even more MBS are onboarded on the taxpayer’s balance sheet. The reality is that inflationary conerns will come to a fore, and have a material impact on rates, the second all these speculations are voiced in a more reputable arena. At that point the game will be up; the Fed’s attempt to continue the status quo will be over, and the relentless rise up in rates will begin, culminating with the long-awaited Minsky moment.

As for the timing of this development? We will join the Bob Janjuah camp on this one. While few have the guts to take the money printer head on, doing so early is certainly suicidal. Yet with each passing day, all those who are fully aware that the Fed’s course is one of self-destruction, grow bolder, until finally one day a new class of investors – the Fed vigilantes will emerge, looking for cheap opportunities to make a killing (think ABX) on the other side of the “Fed trade”, which ultimately will lead to a systemic catharsis of unprecedented proportions.

At that point neither gold, nor lead will be in any way useful. Beta and gamma radiation will make sure of that.

ADMISSION By FDIC: Massive Balance Sheet FRAUD

Posted by Karl Denninger

Janet Is On It Again (Sovereign CDS)

Posted by Karl Denninger