Two readers pointed us to very good post by John Hussman that goes through the Fed’s open market desk operations in detail, and then looks at similar work done on the European Central Bank’s activities (including its widely reported $500 billion liquidity injection). He concludes that in fact liquidity, meaning bank reserves plus money in circulation (the monetary base, which is what central banks control directly) has not increased.
This is remarkable, particularly since the powers that be have been giving the impression otherwise, that they have been responding to the seize up in the money markets and turning on the spigot. What gives?
First, let’s give the high points of Hussman’s conclusion and his supporting evidence:
Simply put, contrary to the impressions they attempt to create, neither the Fed nor the ECB have “injected” material amounts of “liquidity” into the international banking system in recent months. This is not a call for them to do so – to some extent their hands are tied by inflation pressures, currency risks, and profligate government spending (particularly in the U.S.). The problem is that by creating the illusion that they are doing something material – when the problem in the global financial system is not confidence, or liquidity, but solvency – the Fed and the ECB misdirect the attention of investors, provide false hope, and will ultimately do a great disservice to investors and to their own credibility…..
At present, the Fed has injected less than $20 billion in total “liquidity” since March – nearly all of which has been withdrawn from the banking system as currency in circulation. Normally, the Fed would have done a “permanent” open market operation by now, to finance this increase in currency demand (which predictably grows by $30-50 billion annually). But by constantly rolling over temporary repos every week or two instead, the Fed can act as if it is “doing more.”….In short, the Fed is doing nothing more than predictably rolling over its repos, but with great flourish as if something more is going on…..
Last week, the market shot higher on reports that the European Central Bank was injecting 348.6 billion euro (the equivalent of US$500 billion) of liquidity into the European banking system. The truth is that the ECB actually drained liquidity last week…..
Just as in the U.S., the bulk of the reserves in the European banking system are financed by the continuous rollover of repurchase agreements. In the Euro-zone, the total outstanding amount of these repos has been fairly steady around 450 billion euro. Also, as in the U.S., the ECB has moderately increased the amount of repos outstanding to cover the holiday period through January 4. Still, this increase has only had only minor effect on the 30-day average, and even measured daily, represents only about 38 billion in additional euro to cover the holiday currency demand for the entire Euro-area.
Despite the apparently enormous amount of last week’s 348.6 billion euro “main refinancing,” the fact is that it was a rollover of existing repos, not a “new injection” of funds.
What’s more interesting is what didn’t get reported. If you examine the ECB’s own data, you’ll find that as of Friday, December 14, the ECB had a total of 488.5 billion euro in outstanding “liquidity,” 268.5 billion euro of which was set to expire on Wednesday, December 19…..
At the beginning of the week, the ECB had 488.5 billion euro in net liquidity outstanding. By the end of the week, the ECB had 485.5 billion euro outstanding.
So here’s the blunt truth: the ECB drained 3 billion euro of liquidity last week! (boldface theirs)
The story reported and repeated ad nauseum on the financial channels was that the ECB “injected” the equivalent of US$500 billion of “liquidity” into the international financial system last week. The slightly more refined version was that Wednesday’s 348.6 billion EUR refinancing was dramatically higher than the 268.5 billion EUR refinancing that was expected.
The real story is that on Wednesday December 19, the same day the ECB did that 268.5 billion refinancing (isn’t it interesting that at prevailing exchange rates, it translated into a “headline number” of almost exactly US$500 billion?), the ECB also did a massive 133.6 billion EUR “liquidity absorbing” operation, which it then rolled over the next day and then into next week. (boldface theirs)
The final items to note are the transactions on 12/20/2007. First, the 48.5 billion “liquidity providing” transaction that day was a rollover of a long-dated 50.0 billion EUR repo from September. Next was the 10.0 billion EUR transaction on 12/20/2007, which I’ve marked with an asterisk. The ECB reference code on that transaction is “TAF07001.” This was the much publicized U.S. dollar “term auction facility” transaction coordinated with the Federal Reserve.
But look closer. That same day, the ECB entered a liquidity absorbing transaction of 150.0 billion euro. The net result was 48.5 + 10.0 provided, plus the 133.6 expired “absorbing” transaction, minus 50 billion expiring from September, minus the new 150.0 billion absorbing transaction = -7.9 billion euro.
So on the very day that the ECB engaged in a “coordinated injection of liquidity” through the new term auction facility, the end result that day was to drain 7.9 billion euro from the international financial system.
(boldface theirs)As a final observation, in the above chart, Bill Hester broke the ECBs repos into short-dated and longer-dated (greater than 16 day) categories. He observed that following the August turmoil in the financial markets, the ECB shifted the maturity of their repos from short-dated toward longer-dated transactions. Evidently, the ECB has been trying to provide somewhat more predictability to the banking system as to the availability of funds. This is an indication that they are at least trying.
What does this portend? The major central banks are making a show of adding liquidity, yet are not doing so. That says the real mechanism being used to make a substantive difference is policy rates, not infusions of liquidity.
Several possibilities, not mutually exclusive, may explain this course of action. The monetary authorities are no doubt concerned about inflation (the eurozone rate is above the ECB’s target; they held off from making a rate cut; the Fed, despite focusing on core inflation rates, no doubt has also noticed the increase in inflation expectations). Rate cuts and other actions tend to produce diminishing results, which might lead central bankers to want to hold some firepower in reserve. A hard-to-evaluate (in conventional frameworks) factor is the continued large scale operation of the carry trade, funded by near-free loans from Japan.
The regulators may feel the crisis is one of confidence, rather than liquidity (indeed, all signs are that banks have ample cash reserves; the problem is characterized as reluctance to lend). Thus, measures to increase liquidity would be inappropriate, while measures to signal support and willingness to depart from business as usual might be the right remedy. Or they could think the crisis has been exaggerated by banks and securities firms for self-serving reasons. These moves thus will keep legislators and the press from pressuring central bankers to do more.
But we also get to the interesting second layer: why do so few bother to look at the data? It takes some doing to net out the various transactions, but the information is there. Journalists have a weak excuse for not going there (too many stories, too little time) but it’s surprising and sobering that so few professional investors pay attention.
A final observation from Hussman:
As an additional remark, as I noted in mid-October, “we’re likely to observe a growing amount of what will wrongly be viewed as ‘cash on the sidelines’ and ‘money creation’ in the banking system. The problem is that the commercial paper market has dried up. If savers are not buying those securities as the proceeds come due, and a good portion of the borrowing is still somehow being rolled over, then it must be the case that the savers who used to own commercial paper are now saving in another form, and the borrowers who used to issue commercial paper are now borrowing in a different form. Most probably, banks will be the chosen intermediary, because savers view bank deposits as insured and somewhat safer than unsecured commercial debt.” This is a very predictable outcome, so be careful not to interpret, say, increases in M3 as being the result of “Fed liquidity.”
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Ok, a few problems here.
One, Hussman’s record is not good enough to credibly support the fact that he keeps understanding what’s going on, and everyone else is just completely clueless. He’s hopelessly smart, but it’s not credible that he’s as far ahead of the game as he thinks he is.
Two, the market presumably priced in a substantial expiration of those “August emergency repos”. The euro markets obviously thought that more of those outstanding repos would be allowed to expire, than were allowed to expire.
Three, especially concerning the Fed, how is Hussman arriving at his recent numbers? It seems to me that he’s (naively in my view) assuming all the August and post August repos have been matured and rolled over exactly as per their agreements, when we know for a fact that that hasn’t happened: in August, the Fed allowed significant repos to remain outstanding far beyond the repo terms, to “help out the banking system.”
Fourth, Hussman seems to have *no clue* about the FHLBs, which have dumped $300 billion of junk credit into the US economy in the past six months. That’s really where the action is, and although a lot of people might mistakenly attribute that to the Fed, from a private investor standpoint there’s no difference.
Fifth, if Hussman were right, a minority of hyperinformed players would know this, and would be acting on it. Meanwhile, the Fed would further shred its own credibility as that information disseminated further. It’s just an irrational play to make for all central banks involved.
Isn’t a temporary repo permanently rolled over equivalent to an injection of liquidity?
Shouldn’t be surprising if it is true and isn’t that relevant anyway. The only purpose in manipulating the size of the monetary base is to get the actual overnight rate trading closer to the target policy rate. If this requires additional reserves, changes in the distribution of reserves, or changes in the collateralization of reserves, so be it. The only thing that matters is the trading level of the actual rate relative to policy targets for both the Fed and the ECB. They do whatever it takes. The purpose of such ‘liquidity injections’ is to get rates where they should be relative to existing policy. Otherwise they change the target rate itself.
bad link to Hussmann’s article
Great post Yves.
Mr. Hussman has been on this for a number of weeks and few are paying attention. They should. He can back up his case with numbers. Although, as you wrote, one wonders if he is looking at the right hand while the left hand is doing the work. Cartman above addresses some of these questions. Thanks for helping us sift through the arguments.
Please keep up the good work. Happy Holidays.
Paul
“why do so few bother to look at the data?”
Very good question. It is particularly appalling in this case since all the data is out there.
I hate to generalize, but I think it is because often the facts do not jibe with a particular view or position that an author is trying to advance. Instead of reconciling the position to the facts, it is easier to distort the facts or ignore them altogether (see ridiculous post #1 above).
As to the matter at hand, it has been rightly pointed out that the problem is not one of liquidity, but rather lack of confidence. Only time and disclosure of where the losses are will solve this. The Fed, ECB and governments could force disclosure, but that is not politically expedient (at least in any large measure, for now). Providing the illusion of adding liquidity at least is doing something positive, although I guarantee you that none of the 21 primary dealers, or anyone who knows anything about credit markets, is fooled.
Also, US annual GDP is around $14 trillion. US banks move about $4 trillion per day. What is the total volume of open repos? Talk about moving a mountain with tweezers.
You have a bad link for the original Hussman article, it should be http://www.hussmanfunds.com/wmc/wmc071224.htm
The only part of the analysis with respect to the ECB that I find persuasive is the suggestion to look at the data.
Obviously some view this discussion in the context of deflation versus inflation rather than independently.
In fact what the ECB has been doing will not be decisive for this outcome, and its activity merits independent review.
Others have only recently begun to monitor the ECB’s activity and sometimes may not fully appreciate the important differences in its accounting from that of the Fed, with which they may be more familiar. The most basic of these is that there are monthly and quarterly seasonalities that require attention in order to avoid confusion from big weekly fluctuations.
The financial statement for the week ending this past Friday is delayed by both the Christmas holiday and the Eurozone holiday of Dec. 26 and is expected to be available tomorrow. It is recommended to factor this in to any conclusions on the state of play.
The last time I did an analysis, the growth of the ECB’s Eurozone Credit has trended significantly higher than that of the Fed during the past year. One word of caution on ECB data is, if you rely on their graphs, make sure the most recent data are included, as there can be a lag between the data publication and the updating of graphs.
Anonymous 909: “The problem is not one of liquidity, but rather lack of confidence.” Who are you, Mishkin? LACK of CONFIDENCE is a DIRECT result of banks being mutually aware of how deeply in trouble they are. There is not some “right” level of confidence, which markets irrationally run away from. The “lack of confidence” is not the “problem.” The problem is that the banks’ balance sheets are disasters. It is a SOLVENCY problem, NOT a “liquidity problem.”
The euro plunged the day the ECB made its move. Unless you are calling the second-largest market in the world “stupid,” the market for euros had priced in too many repo expirations.
Hussman defeats his own professed gospel by virtually ignoring what Pimco termed the shadow economy (let’s include the FHLB here – see FT article on the ramp in lending there and the notion that if someone will buy it FHLB is going to sell it). I also think it is important to consider that focusing too much on the “left hand to the exclusion of the right” is to endow a bit too much trust in the government. The government after all is on record as saying that it is their charter to provide for an “orderly” market. The gov’t has probably at this point accepted that the housing deflation is simply a runaway train. No chance to turn the tide with any action. Therefore, it becomes all the more important to protect the equity market at virtually any cost. There has been some shadow talk about a clause in the Fed charter which essentially allows it to purchase virtually any asset should the need arise. Therefore, focusing on Repo’s is to assume the Fed has devised its war strategy with a pistol alone. The very idea is ludicrous really. What should really alarm Hussman is the notion that the Fed has opened its balance sheet to perversion; that is to say it can / will take on any collateral and “poof” make the bad debt just disappear by replacing it with was la new fiat money? One can only deduce that at the heart of Hussman’s argument is a system that is essentially healthy and it is really just unwarranted risk aversion that is creating the problem.
It is also curious on the final implication of savers opting out of CP and for direct deposits. is it fair to assume the implication in and of itself is for an expanding money supply via the reserve ratio system once banks free up the flow of capital (if)? Or is Hussman saying that the reallocation of savings to deposits is a contraction to money supply? The article in the C section of journal speaks to this with a note about the diminished lines of business likely to occur as a result of the drying up of the lending practices that drove top line over the past several years. Not sure where I come out on the implications/equilibrium?
Wow, look at the posts here on this and all the bees buzzing, that story has hit a nerve and obviously its not what the banking crowd wants to hear. I think there is a massive wave of hype being pushed by the market now to help smooth over this subprime illiquidity issue, where banks took on amazing risks and now they want bailed out..and they want good new pumped out to the media! Too bad the illusion is such a challenge, but with a few trillion of cashburn, someone will pay, and this will drag out a long time!!!
When Y2K became a non-crisis, the Fed decided not to roll over the repurchase agreements, banks called in the loans, and demand for dot.com and other technology stocks was undermined.
A three-year bear market followed. The Sept. 11, 2001 attacks added to the turmoil. Ultimately, almost $6 trillion in savings was wiped out over a three-year span; few fund companies took any defensive action.
This time around the Fed, along with some European central banks, are doing repurchase agreements, trading subprime mortgages for cash. This will window-dress the strongest banks’ balance sheets at year end (the repurchase agreements will be disclosed in the footnotes), helping the rating agencies to put a positive light on the banks.
While we’re harping on the Fed, anyone have a good explanation why for a good 2-3 weeks in August/Sept, the official target rate was 5.25% but the actual rate (as reported by the NY Fed each day) was kept around 5%? This amounted to an unofficial quarter point rate cut that no one called the Fed on. Is it their policy to do “stealth” rate cuts?! I thought the whole point of rate cuts was to announce them with great fanfare so the average investor thinks everything will be okay and start buying stuff again…
Fifth, if Hussman were right, a minority of hyperinformed players would know this, and would be acting on it.
Suppose such players existed. How exactly would they act on the information, and what plainly visible evidence would tell the rest of us that they were doing so? Don’t tell me there’s some liquidity index or Bernanke index that we can short…
> Suppose such players existed. How exactly would they act on the information?
They would be bidding up rates. The opposite has happened, something Hussman neglects to mention.
Yes, Most probably the system levels of cash in the various banking systems have not grown as much as the ‘headline’ numbers of ‘liquidity’ injections
Most MM dealers will know that you do reach a point where boosting up the system levels further will have no effect – all that happens is that the Bank’s Cash dealers leave it at their Local Reserve bank, as they have run out of credit lines, and have no capibility/authority to buy external assets in the current capital environment
However what IS important is the fact that the FED is doing term injections – somthing that they have not done in the past. It is going to a much wider range of counterparties.
If they were still doing their short-term injections, I’d expect that the banks prime dealers may have had issues getting the cash out into the banking system as 1) they have less capital to buy securities/lend cash & 2) borrowing short from the fed and lending term is now no longer viewd favourably fy their internal liquidity monitors
Wouldnt be suprised if the FED is also using other Central Banks in Asia & Middle East in a defacto lending mechanism.
The ECB has published its consolidated financial as of Friday Dec. 21, showing that Eurozone credit has ballooned to more than Euro 617 Billion.
This is 15.6% above the previous all-time high reached last summer and 37.0% growth in the past year.
Although the media reports of the ECB’s activity last week were gross journalistic malpractice even worse than usual, Hussman’s comments in respect to the ECB were more argumentative than reliable.
Of course, in coming weeks some of this will be taken back as is the pattern, but the growth trend is unmistakably significantly higher than that of the Fed.
Hussman may have the right answer, but could still be asking the wrong question. Slider On The Black seems to think that is the case:
http://siliconinvestor.advfn.com/readmsg.aspx?msgid=24164483
Mike
Clark,
Ahem, the ECB drained the blip up in liquidity you got excited about, and then some.
Your total (link?) 617 billion euros.
Per this link, the ECB will another 150 billion euros. 617-150 = 477, less than the 485.5 euros outstanding last week.
The question where the monetary base stands in the bigger picture is still open, but Hussman’s point holds.