Another Gross error.
Bank’s aren’t allowed to take what’s called ‘interest rate risk’ by borrowing short and lending long.
It’s the first thing the regulators and supervisors look for.
It’s the S in CAMELS ratings- Capital, Asset quality, Management, Earnings, Liquidity, and Sensitivity to interest rates.
Fed’s Low Rates Killing Credit, Slowing Recovery: Gross
By Jeff Cox
Feb 1 (CNBC) — The Federal Reserve’s zero-interest-rate policy is hampering economic recovery by discouraging bank lending, Pimco bond titan Bill Gross said in an analysis.
For banks, a healthy lending environment exists where they can borrow at low rates in the short term and lend at significantly higher rates over the long term, a situation that creates a profit through a positively sloped yield curve
In other words, Gross doesn’t know what he is talking about. He is not a banker.
See link above, if you want to go into more depth what Warren is referring to.
@Adam2, How do we end up with 30 yr. residental mortgages at 3.75%?
Dude! It’s called “disintermediation”! It’s what banks do! I just happen to remember that weird word from my Money and Banking classes 35 years ago.
that’s when people make loans directly, rather then banks making the loans
I also don’t know what I’m talking about, but didn’t high interest rates help to cause the economic boom of the 90s?
Even if banks were allowed to borrow short and lend long, why would the ZIRP discourage bank lending?
I think “Gross Error” (that’s his new name) is saying that at ZIRP there is little spread between short and long term loans, thus little opportunity for banks to borrow short and lend long.
Also I don’t see what you mean by “Even if banks were allowed to borrow short and lend long…”. They ARE allowed to do this, and that is one of the big problems with banks. Northern Rock was nowhere near the first bank to push it’s luck with borrow short and lend long, only to find that it’s luck ran out, i.e. short term funding became inadequate. Personally I’d ban maturity transformation (that’s the correct name for “borrow short and lend long”).
The initial effect of such a ban would be deflationary, but that’s easily compensated for by an overall increase in the money supply.
I should have said ‘US banks and probably others’ sorry.
and not that banks don’t violate the rules now and then, and even get caught now and then
“and not that banks don’t violate the rules now and then, and even get caught now and then”
Thanks for inserting this bit of reality into your description of current banking just in case someone may have forgotten SIVS and off balance sheet loans.
I recall reading a similar post on this site (without the caveat) just before the banking system exploded….
I’d hate to think the trustworthy banker just doesn’t exist….
both of those were permitted by the regulators at the time
I’d say the business of banks is managing maturity mismatch. Otherwise they would just be intermediating money lenders and borrowers?
In any case I don’t get what Gross is trying to convey. What has the ZIRP got to do with the fact that banks aren’t lending?
If they aren’t it’s because there are no creditworthy borrowers at the rate they want to charge, not because they can borrow from the Fed at 0%?
MamMoTh, Maturity transformation suffers from a “fallacy of composition” flaw. Everyone seems to gain from it. It raises interest rates for lenders/savers, it cuts interest rates for borrowers, and banks take their cut. It seems to bring benefits in that it minimises the amount of money the economy needs. The flaw is that it costs nothing in real terms to expand the total stock of money.
As to what Gross is “trying to convey”, I think he is saying that at ZIRP, maturity transformation is stymied, which reduces bank activity overall. As to whether he is right and whether that cuts bank lending, I’ve got doubts (like you).
There are three source of income for banks from their core lending business:
1. margin on assets
2. margin on liabilities
3. maturity transformation
It looks like B. Gross ignores 1 & 2 above saying that banks can only do 3. Ever.
No matter how you cut it, it looks quite bad for B. Gross. But then I wonder why anybody still listens to what he has to say after his well advertised bet on treasuries went belly up last year.
Not the first Gross error Bill has made. This from last Spring when I still worked at Thomson Reuters.
April27, PIMCO Makes a Gross Miscalculation, Rombach says… http://bit.ly/glYxgF
@Ed Rombach, Good clip. Where’s the Ed Romback investment fund?? 🙂
I thought this is was one of the problems that happened leading up to the financial crisis? Only for the non FDIC institutions?
So banks can’t borrow short-term to invest in treasuries long-term? How do banks with reserve accounts purchase treasuries – is it really just adding the tsy to the asset side and creating a liability as a govt deposit on the left (as shown here http://www.neweconomicperspectives.org/2010/11/yes-government-bonds-add-to-private.html )?
Are hedge funds and primary dealers the only entities (generally speaking) that do this then?
banks did get caught short liquidity as depositors stampeded in and out on rumors, but it was the fed’s job to provide any needed liquidity on demand, which it did only after a painful 6 months of fumbling around with ‘eligible collateral’ not realizing it didn’t actually need any collateral from member banks. they are already fdic ‘certified’
banks don’t generally purchase long treasury secs for their own portfolio
“banks don’t generally purchase long treasury secs for their own portfolio”
Why do you feel confident that some new investment vehicle hasn’t already been created?
i don’t know of banks ever purchasing long bonds for portfolio of any consequence
What about the european banks?
Haven’t they been massively purchasing government bonds since they had access to LTRO funding, thus helping bring down yields on Italian and Spanish debt?
pension funds domestic and foreign buy 30 year securities to match their liability structure
One of the news wires was running a story today about treasury allowing the auction of negative interest rates on short term securities since they were already trading that way in the secondary market. Perfect excuse for banks to start charging to hold your deposits! Now the banks have to pay the government to invest AND pay the FDIC to insure the deposits.
Ooops, I missed your comment before I posted mine below.
banks compete for deposits if they need them
It looks like Treasury is considering letting rates go negative.
Wouldn’t this eliminate the zero bound issues Gross talks about?
(Asking to anyone, because I can’t noodle that one through to conclusion….)
Will this be seen as deficit/debt reduction? Positive rates are outflows the Treasury, wouldn’t negative rates by implied inflows since maturity would be less than principal?
Agreed. It seems like an explicitly deflationary policy action.
“Bank’s aren’t allowed to take what’s called ‘interest rate risk’ by borrowing short and lending long. It’s the first thing the regulators and supervisors look for.”
More Mosler Misconceptions, as Citigroup Chairman Reed said, banks were making no doc and low doc loans everywhere and all over, many banks, and the regulators were championing them on and Reed said wall street still controls the politicians and regulators. Warren wants us to believe banks don’t do what they shouldn’t regarding this interest rate risk issue and the regulators slap them hard if they do.
Warren, seriously, how can you continue in the face of overwhelming evidence to frame this history as one of a few bad actors and a functioning regulatory system that just dropped the ball a time or two but is basically functional. During this mess I kept telling you about the Miami Loan officer who was giving what I considered illegal loans to his illegal alien friends. The whole system is corrupted, it relies on an ethical loan officer to make good loans, and even an ethical guy like you was pressured into making a bad loan to granny for a lawn mower and that was in a totally different environment where ethics still had some merit probably.
I sure scratch my head everyday about all these regulations, regulators, etc etc that you brush off as a small necessary part of your proposals but never seem to iron out the devil in the details of how we crush this greedy Patrick Bateman American Psycho corporate wall street culture that Citigroup’s Reed is in total jaw gaping shock hasn’t been discredited and arrested.
I just watched this movie called Shallow Hal with Jack Black and Gwyneth Paltrow and I think of you Warren, looking at nice sweet ethical regulators instead of what they really are! Brooksely Borne was threatened with homelessnes on the street if she didn’t do what summers, rubin, and greenspan and others wanted.
Would a shark struggling with vegetarianism swim with sharks while bleeding?
@Dave Begotka, http://www.zerohedge.com/news/former-mf-global-chief-risk-officer-sacked-doing-his-job-disagreeing-corzine
Warren says the regulators are in control, our system is basically functional except for a few bad actors, (or at least that seems to be his general thesis from his recent comments), but here is just more to throw on top of the evidence pile, when your risk control officers sounds the alarm in a way you don’t like, fire that loser and hush him up brooksely borne style. Costa Cruise Lines, we have another ship going down!
banks do not need to “borrow” in order to lend. So they do not “borrow short to lend long” and do not the “maturity transform”.
is this still MMT site?
@zanon, don’t long loans create short deposits, all the time?
@zanon, According to Citigroup Chairman REED, banks don’t even need to verify income, nor do they need to verify assets either, just show up and get your free money. Charles Hugh Smith Below has come to the Altar of MMT, but he is framing it in a negative way, we need to make him understand that all his accurate points below are a good thing and keep idle hands busy, otherwise he may be facing ww3 if he cotinues down the deficit terrorist path he is on.
Submitted by Charles Hugh Smith from Of Two Minds
Fraudulent Debt = Counterfeit Money
How is borrowing money based on fraudulent claims of asset value and future income any different from counterfeiting money?
Let’s compare three financial criminals. The first is an old-fashioned counterfeiter who doctors up paper and runs a printing press to produce fake currency.
The second criminal borrows money based on a fraudulent asset and phantom future income. For example, the criminal might obtain a credit card based on false assets and income, or borrow money against a property that is worth far less than he claims and base his credit on an inflated fantasy income he does not actually receive.
The third criminal borrows money from the Federal Reserve at zero interest and extends a loan to a fraudulent borrower because a government agency has guaranteed the loan. Whatever income the lender receives is pure gravy, and whatever losses are incurred when the fraud is uncovered are made good by the taxpayer.
Since our banking system is based on money being borrowed into existence (i.e. fractional reserve), then how is creating money unsecured by either assets or income any different from actually counterfeiting bills? The outcome is identical: money created out of thin air.
If I fraudulently obtain credit based on bogus claims of future income, borrow a large sum and promptly squander it on consumption, then the lender has no recourse: there are no assets to grab and no income to tap. In effect, I had a good time at the expense of all holders of the currency, as my money-created-from-thin-air diluted the currency without adding any productive value.
The way the debt-counterfeit game is played in the U.S., the lender is also a financial criminal who exploits the moral hazard extended by Federal agencies. If you can’t lose money on a loan, then why not give money to fraudulent borrowers? As long as they pay enough interest to cover your origination costs, then the rest is pure profit.
@Save America, He seems almost there, if we could just convince him that the “productive value” that is added is the government being counter-cyclical to a depression/deflation and keeping employment levels moderated without wild swings, why is this so hard for him to grasp when he is 99% of the way there?
umm, what’s a 30 year fixed rate mortgage, funded by dda monies, if it’s not borrowing short and lending long?
the point is that banks have reserve requirement to meet. when it makes a loan, if the customer withdrawls the money, there will be a shortage of reserves if it didn’t have extra. It can then go to the discount window to replace them or the overnight market. is this correct?
Warren – I contacted Jeff Cox, the author of the Gross piece and told him what you said. But he got back to me and said you are wrong – that “maturity transformation” is absolutely allowed. What do you say?
ask him then what the S stands for in CAMELS when the fdic rates a bank
hint- sensitivity to interest rates
I understand but does ‘sensitivity to interest rates’ mean an explicit prohibition or a warning to be careful?
you have to have a model that shows what happens to earnings as rates rise and fall.
if it varies too much the demand adjustment or you face a downgrade and possible cease and desist order or worse.
don’t long loans create short deposits all the time?
yes, and then the term structure of rates adjusts until they match via market forces
Warren, ok but doesn’t this mean that a bank’s business is fundamentally to manage this inherent maturity mismatch to stay afloat and make a profit?
(I’m not sure what is exactly you disagree with Gross’ original statement, just checking my understanding)
a bank manages it’s assets and liabilities to keep interest rate sensitivity to a minimum
banks don’t make profits on the yield curve
“banks don’t make profits on the yield curve”
Ouch, that is a seriously strong statement. At the very least the stupid regulators, aka Basel 2, allow for interest rate risk in the banking book of up to 20% of bank’s equity. That is a lot of money to be made from the yield curve
if they guess right, and if the regulators allow them that max permitted leeway.
it’s just not that easy, as the yield curve reflects expectations for future short term rates
““banks don’t make profits on the yield curve””
and before it is too late I want to add that quite volume of that risk can be “mitigated” by internal models. Primarily an internal model of demand deposits. So now go and prove that your DD model is correct and does not hide any interest rate risk from regulators 🙂
more than understood!
“if they guess right, and if the regulators allow them that max permitted leeway.”
honestly, I am shocked at your views on banking. “Guess it wrong means” a trading loss and some poor soul being fired. “Guessing it right” is a bonus for management. And I do not even bother to comment anything on regulators permitting anything. They do not even understand what interest rate risk is and that is the reason why, on my “beer estimate”, 95% of banks abuse this measure.
Anyways, that is all “lol”
let me add it’s about whether the yield curve is a material source of bank earnings.
as a bank owner, previous bank employee/dealer, etc, I say Bill misses the point.
i don’t say that banks don’t ever take curve risk. and don’t forget i was the one who yelled fraud on the sub prime
thing when most all others were yelling lax lending standards. and my banking proposals are likewise sufficiently narrow
to minimize the regulatory burdens.
Harry Markopolos tried to tell all these good “regulators” for 10 years about Bernie Madoff, the regulators that are supposed to make our system functional, no one would listen and everything BLEW UP! Warren should take this as a lesson for his own crusade, probably in the big picture no one is really going to listen and everything is going to BLOW UP!
Jim is pleased to welcome Producer/Director Jeff Prosserman to discuss his explosive new documentary “Chasing Madoff,” the story of Harry Markopolos and his ten year struggle to expose Bernie Madoff and save investors’ life savings. Finding himself trapped in a web of epic deceit, the once unassuming Boston securities analyst turned vigilante investigator now feared for his life and the safety of his family, as he discovered no one would listen. “Chasing Madoff” tells the story the regulators hid from the public and which is still widely ignored by the media.