What losses?

26 Responses

1. Why is the Fed resisting an audit so strongly, when that is Congress’s prerogative, and it is driving a conspiracy theory viral? Bernanke wasn’t the Fed to be the chief regulator but seems to be against transparency. That’s not going down very well in this anti-Establishment political environment, where the perception is that the Fed is pwned by the bankers.

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   1. Tom,
      They (The Fed) already publish their “books” every week in the H.4.1 report that is normally released Thursdays after 4:30 EST here.

      Bernanke is probably trying to tactfully inform them/make them see that the audit would be redundant/a waste of time, thus saving them from embarassment. He is a politician. Resp,

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      1. Matt, the Fed balance sheet doesn’t reveal the various sources of the entries that came from dealings wtih the commercial banking system. This, as I understand it, is what Congress wants to see. The Fed is claiming that this violates the principle of Fed independence from political influence. On the other hand, Congress does have oversight responsibility, so the general perception is growing that the Fed has something to hide concerning a cozy relationship with financiers.

      2. But Tom,
         Shouldnt the $45B the Fed just sucked out last year and sent to the Treasury Dept. for prompt “shredding” and the probable $60B+ that they will suck out of US this year in mortgage interest we are paying to them that they will again send to the Treasury for immediate destruction be enough to cover all the “Maiden Lanes”,etc. and then some, even at 100% loss rate? Resp,

   2. Hi Tom,

      I had a different read on this whole transparency issue. If Bernanke is taking a lesson from the 1930s, one event that made the the whole banking system shut down was the publication of the names of banks that had received loans from the Reconstruction Finance Corporation. That happened in January 1933. In the weeks following the publication, there were many bank runs on the banks that were perceived as being weak by the public. In March, the whole banking system was shut down by Executive Order… and well, the rest is history.

      I don’t mean to imply that Bernanke’s worries are warranted. They shouldn’t be if the Fed lends in unlimited quantities to meet withdrawals by the public, but then again, we already know how much he really knows about how the system really operates under a non-convertible floating exchange rate regime.

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      1. good point!

   3. The Fed has already published more information about its balance sheet than Congress collectively will understand for the rest of their lives.

      Congress wants more counterparty detail, which any banker is reluctant to disclose, no matter who owns the bank.

      And the combination of the two means that if Congress does get its hands on additional counterparty detail, it’s a trillion to one shot they’ll interpret it properly.

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2. “And the funds to the banks necessarily never even went anywhere. They just sat on the fed’s books as excess reserves.”

   I view it somewhat differently.

   Given that TARP resides on Treasury books, it would seem likely that the marginal reserve effect would have been drained by issuing Treasuries. In fact debt issuance would have been necessary to avoid an overdraft at the Fed – unless the void is filled by taxes instead, and there’s no reason to assume that. In any event, in either case, the result is that TARP capital displaced deposit liabilities on the books of the banking system. The same net effect occurs with normal capital issues to the private sector, where system deposits are drained to pay for the issue. The banking system’s liability composition is reconstituted, without any immediate change in assets. In that sense, the capital funds “don’t go anywhere”, even in the normal case. Subsequent new lending creates new deposits, without any necessary “flow” of capital funds.

   Moreover, cumulative Fed asset activity (which doesn’t include TARP, except for one small piece) fully accounts for cumulative reserve expansion without any net TARP effect on reserves. The effect of TARP or other government initiatives on reserves is determined by the balance sheet of the consolidated government, not by the balance sheet of the commercial banking system.

   Also, in the above sense, banks don’t “lend capital” any more than they “lend reserves” (or “lend deposits” for that matter). The test of capital use is not tracing the “flow” of capital funds, but rather assessing whether or not the banking system assumed more risk compared to the counterfactual – e.g. more lending and deposit creation on a net comparison basis. That’s difficult to determine, since the counterfactual may have involved additional deleveraging and credit contraction, without much new gross lending.

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   1. JKH,
      You write: “the result is that TARP capital displaced deposit liabilities on the books of the banking system.”

      So:
      Treasury buys shares in Bank of America with $25B of newly appropriated Treasury Reserves that are offset (as usual) by auction of $25B of new Treas. securities >> Total System Deposits reduced by $25B (reduced by 25B to pay for Treasury Secs.), in fact if all of the 25B would have been deposited in BofA, BofA’s deposits could have fallen by 25B. But BofA wouldnt care about this deposit loss because the share sale allows them to increase their BofA capital account by the same 25B number, and now both sides of BofA’s balance sheet still balance. BofA’s required reserves would be reduced due to less deposits.

      How does this reverse itself? BofA redeems the shares (gets them back from Treasury and tears them up) and Treasury increases its account at the Fed by 25B. BofA now decreaes it’s capital account by 25B. No change to system deposits. But BofA balance sheet still balances because (un)fortunately they have shrunk assets over this same period of time? resp,

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      1. Matt,

         Not really related to your question to JKH directly: Have you seen this: http://www.financialstability.gov/docs/TARP%20Warrant%20Disposition%20Report%20v4.pdf ? Released 20th Jan I think – updated till 31st Dec 2009.

   2. Matt,

      BoA “buys back” capital shares issued to Treasury (i.e. repays TARP), which reduces BoA’s excess reserve position. BoA’s balance sheet balances.

      BoA’s TARP repayment reduces system excess reserves, offset by an increase in Treasury’s account at the Fed.

      Treasury continues to deficit spend, which drains its account at the Fed (normally it would be going into overdraft from a flat starting position). That deficit spending and Treasury account drain restores system excess reserves to their level before the TARP repayment. Fewer Treasuries are issued during that period because Treasury wants to achieve the net drain on its account. The amount of fewer Treasuries issued equals the amount of the TARP repayment. During the same period bank deposit liabilities increase due to the dual effect of deficit spending on both reserves and deposits, without bond issuance draining both. Thus, the original treasury issuance associated with the TARP injection has been offset by a suspension (other things equal) of Treasury issuance associated with the TARP repayment. Total Treasuries issued cumulatively are now the same as they would have been without the original TARP injection. And the original destruction of bank deposits associated with TARP related Treasury issuance has now been offset by the creation of bank deposits during the temporary suspension of Treasury issuance. The result is that bank deposits are restored to the same level they would have been at without the original TARP injection, again other things equal. However, this assumption of bank deposit restoration assumes that the private capital replacing TARP has been generated internally from banks’ retained earnings. If some of that private capital has been generated by new capital issuance (as it has been), that will have the separate effect of reducing the level of bank deposits by the same amount, as is the case with any new capital issue, as described above.

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3. Matt,

   A simple relation to find bank capital is this http://mathurl.com/yabjbcy

   Its just a number to determine the amount that banks are allowed to lend. The Treasury increased bank capital by purchasing the banks shares as you can see from the equation.

   The reversing process is not straightforward. The Treasury sells the stocks in the market and it can be the bank itself who is buying the stocks. Banks meanwhile – before the Treasury sells the stocks, raise more equity and/or keep higher retained earnings.

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   1. Further, the banks can lend 12 times the capital but that doesn’t mean that the are constrained in any way. The true Horizontalist position is that banks always have enough capital and they manage this by setting the loan rates and retaining enough of their earnings.

      The capital adequacy requirements is based on a neoliberal myth that there will be too much money pouring in etc. Fortunately, credit money is still “horizontal” and only in a crisis is there a supply side issue – exactly at the time we don’t want it to happen – unfortunately.

      I don’t know who has the powers to impose and de-impose capital requirements but TARP could have been simply avoided by the Treasury making an announcement that capital adequacy requirements no longer apply – atleast doesn’t apply till the crisis is over.

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4. TARP Money Mechanics according to me:

   1. Even though it is true that the government spends first and then taxes and issues debt, operationally it’s a bit more complicated. The Fed and the Treasury hide this using the trick of “central bank advances” to member banks. I assume the Treasury issues debt first and then spends with the agreement of overdrafts at the Fed, which the latter cannot refuse.

   2. The TARP money wasn’t given at one go, only approved by the congress. Whenever, banks wanted the Treasury’s help, the latter would issue debt. The deposits in the banking system would go down and so does the HPM. The Fed makes a spreadsheet entry and increases the Treasury’s account by the money raised. The Fed also provides advances to member banks if they are in shortage for reserve requirements.

   3. The Treasury purchases bank shares – not from the market but by dilution – Warrents. Simultaneously, the Fed makes an excel sheet adjustment and moves HPM from the Treasury’s column to the rescued banks’ column. Banks’ capital increases from the proceeds (formula; http://mathurl.com/yabjbcy) and it is a coincidence that the proceeds happen to be HPM and that the increase in capital is also the increase in reserves.

   4. Banks are better capitalized because of this, not because of reserves or capital but the formualae allowing them to lend more. They however refuse to lend everyone because credit-worthy customers are less.

   5. When members banks want to return the TARP money, they have to bargain for the price with the Treasury.

   6. Before returning the TARP money, the member banks “raise capital”. Debt capital is rare so I assume they have complicated arrangements with equity investors and I do not think they went to the secondary market to do so. Payment from investors decreases deposits in the banking system.

   7. Once the Treasury and the member bank agree on the price, the Treasury hands back the warrant papers and the Fed makes a few spreadsheet entries to move HPM from the member banks’ account to the Treasury.

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   1. I would just add to #2 that the Fed does a repo or overdraft to make sure there are sufficient reserve balances to purchase the Tsy’s being issued or there was previously sufficient reserve balances due to prior lending from standing facilities, etc. So, again, even though the Tsy is required to have a positive balance in its account, the reserve balances to buy a Tsy security in the first place come from previous deficits (pre-existing Tsy’s that the Fed purchases to put reserve balances back so that Tsy’s can be bought) or non-govt sector borrowing from the Fed.

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      1. Thanks. Makes sense. The Treasury and the Fed work together a lot I guess – impossible to not do so and the BoJ papers are open about it.

      2. This point is also missing from the discussion on Keen’s site right now. No interest in getting into it there anymore, though, as MMT detractors there generally insist on (mis)interpreting MMT their own way regardless what anyone who actually understands MMT says.

      3. Scott,

         I noticed your latest efforts there. I think we’ve reaching the tipping point of diminishing returns at that particular location, in a disappointing way. Nevertheless, some of the readers have been attracted to visit the MMT sites as a result, I think.

      4. Do you have a link to the thread?

      5. “The Treasury and the Fed work together a lot”

         They have to – functionally, they are the same entity. A reserve add has the same effect whether it’s a fed repo or a treasury check. The people who do the grunt work both agencies understand this, even if their bosses don’t.

      6. Jim – yes in fact in India, the Reserve Bank is the Treasury. Swooned by neoliberal myths, they are talking of “independence”! Unlikely to happen. In fact, here the fact that government spending comes before taxes/debt-issuance is straightforward!

         Zanon – no particular thread – you can check the comments on the last 4-5 threads.

         Scott: patience! Even Wall Street doesnt get it and we don’t know who those commenters on SK’s blog are – they could just be high school science students.

5. good discussion!

   So does anyone in DC, mainstream economics, wall st, etc away from this website understand this?

   I’ve yet to see it discussed anywhere else.

   Are we the only ones in the world who get it???

   Seems no one in Congress, the Fed, Tsy, admin, any of the think tanks, etc. have any idea what they’ve actually been doing.

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6. On the other side of the coin, this is my vote for the blogging economist who persistently demonstrates the highest level of misunderstanding as to how the monetary system actually works. It is absolutely painful:

   http://www.themoneyillusion.com/?p=4002

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   1. I don’t know if Scott Sumner is the most clueless economist out there, I think his cluelessness is equalled by about 3000 of his colleagues, but he is the loudest. To his credit, he sticks to his ridiculous guns in a way that is internally consistent, never mind that it does not match reality in any way.

      And he has amassed more admirers, in higher places, that Mosler et al. He was name checked by Krugman shortly after he started blogging. The bloggers at marginal revolution and econlog, who have leveraged their online typing into gigs at the Grey Lady, routinely swoon at Sumner’s theoretical stylings.

      The modern day Academy in action!

      (And would you like some Global Warming with your Macroeconomics tonight?)

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      1. It’s painfully obvious from the pining away in his posts that Sumner lives to be acknowledged by Krugman. Together with the other blogs you note, they seem to have solidified into a cabal of ignorance, determined to be free of the operational and accounting realities of the monetary system, while fashioning Peter Pan escapades into irrelevant theory and drivel.

         BTW, following an earlier conversation with you, I posted my maiden comment on econlog, and apparently got banned for life as a result. My comment was something like:

         “I don’t see the difference between the Great Recalculation and Creative Destruction”.

         That was it. And I was dust.

         🙂

      2. Are you serious — that really got you banned for life?

         Zing!

         I salute you : )