We wondered ever since the Fed established and then repeatedly increased the size of its Term Auction Facility, which now provides $150 billion of support to the US banking system, how the central bank would ever be able to wind down this program. It certainly can’t do it when the financial system is fragile, and banks will argue that the withdrawal will hurt their operations even when the economy is in better shape.
We aren’t alone here. Richmond Fed president Jeffrey Lacker has reservations about these new facilities (rather late, isn’t it?). Note, however, that at some are proving to be a success, in that usage is declining as market conditions have improved, specifically, the Term Secured Lending Facility and the Primary Dealers Credit Facility. But the TAF has grown rapidly, from $40 billion, which was seen as an extraordinary number at the time of its inception, to $150 billion in less than six months, and there no question that the Fed would increase it yet again if spreads in the interbank market signalled distress.
Gillian Tett comes to more or less the same conclusion based on her experience in Japan. From the Financial Times:
A decade ago I lived in Tokyo, where I wrote about Japan’s banking woes. For several nail-biting years, I watched as the Bank of Japan unveiled a stream of ever-more creative measures that were designed to combat the risk of a financial meltdown.
By the start of this decade, this crisis was – finally – ebbing away. So when I left Tokyo in 2001, I naively assumed that the BoJ’s “emergency” policies were destined to vanish too. Not entirely so. As Tadashi Nakamae, a Japanese economist, pointed out to me, one “emergency” practice from that era that has not gone back on the shelf is the idea that the BoJ should buy lots of Japanese government bonds.
Ever since the BoJ deployed this “temporary”, crisis-busting step – supposedly to help the banks – the Ministry of Finance has become fond of keeping long-term bond yields down. Thus, whenever the BoJ threatens to withdraw its JGB support, the Ministry blocks the idea on the grounds the move could unleash more financial turmoil.
It is a salutary tale that western policymakers would do well to note. In the past 10 months, as a financial crisis has swept through western markets, US and European central banks have also produced all manner of crisis-busting, money-market manoeuvres. And, perhaps unsurprisingly, some of these seem to have been copied from 1990s Japan…. the more I look at these measures, the more I wonder how the US and European banks will avoid the Japanese trap.
After all, if western central banks halt these emergency steps too fast, they could unleash turmoil again; but if they wait too long, they could breed a new form of financial addiction among private banks and politicians alike. And as any addict knows, addiction rarely disappears by itself. On the contrary, procrastination tends to make the problem worse, as habits become deeply ingrained – be that in Japan, or anywhere else.
The US Federal Reserve, for its part, appears to be keenly aware of this problem. And Timothy Geithner, New York Fed president (and himself an expert on Japan), has signalled his desire to avoid any Tokyo-style policy fudge by calling for a broader rethink of the regulatory structure. The Fed has also indicated that it will withdraw the generous liquidity support that it is providing to broker-dealers, after the Bear Stearns drama, by September.
But whether the Fed will actually meet this deadline remains an open bet. After all, brokers such as Lehman Brothers are hardly flourishing – and the prospect of the September deadline is already spooking the markets.
Yves here. If we don’t have a reversion over the summer, the Fed may be able to deliver on that promise, because, per the discussion, the use of the dealer facilities is waning. The TAF is the one the banks are hooked on.
Meanwhile, on the other side of the Atlantic, the European Central Bank has its own problems. The Frankfurt-based group has not set any deadline for scaling back its programme of emergency money market support. However, some officials are becoming concerned about the addiction patterns this is breeding.
More specifically, there is concern that private sector banks have little incentive to restart the mortgage securitisation market – precisely because it is so easy (and cheap) to get funding from ECB sources instead. But the ECB knows that if it tries to withdraw its aid before the securitisation market has reopened, it will face strong political criticism. Worse still, it could even hurt some banks.
Perhaps this dilemma will quietly resolve itself over time. After all, if banks recapitalise themselves over the summer and investors regain confidence, it should become easier to withdraw central bank support this year or next – or so the optimists hope.
But in the meantime I am told that many western banks are becoming increasingly creative about how they repackage their assets to get central bank support. Addiction, in other words, is not disappearing of its own accord. No wonder some bankers now joke that the “originate to distribute” model has quietly morphed into “originate to repo” pattern instead. It is indeed a difficult policy trap. Do not bet on an easy or smooth exit soon.
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Per Bloomberg: China’s government, which invests up to a third of its $1.68 trillion in currency reserves in Treasuries, is “not smart” to invest in U.S. debt and should seek higher returns, a former legislator said.
Also an article in the FT discussing Japan debt at 170% of GDP and the looming threat it poses…
The US may not have a choice on the rate front if the Sovs walk away…I imagine we will see a post from Sester on this comment – perhaps just hyperbole. hcina retail sales up 22% as well…
Geitner is in Fuld/Dimon/Friends back pocket – let’s not kid ourselves. The Fed has rendered itself incompetant and the market has lost its narrative, namely cut rates and stocks go up…
Tett is wrong that Giethner “has signalled his desire to avoid any Tokyo-style policy fudge.”
Here’s what Geither wrote in the FT just 5 days ago:
“The Fed has put in place a number of innovative new facilities that have helped ease liquidity strains. We plan to leave these in place until conditions in money and credit markets have improved substantially.
“We are examining what framework of facilities will be appropriate in the future, with what conditions for access and what oversight requirements to mitigate moral hazard risk. Some of these could become a permanent part of our instruments. Some might be best reserved for the type of acute market illiquidity experienced in this crisis.”
Explicitly stating that the Fed is considering making some of the emergency facilities permanent is an awfully strange way of signalling a “desire to avoid any Tokyo-style policy fudge.”
Excellent article in the FT by Steven Roach on the new stagflation. There is zero collective will to impose further regulation, and the current momentum will fade not becuase it isn’t the correct course but because it is an impossible course. The US made a tactical decision decades ago and like it or not the US economy is hogtied to the finance based economy. Unless the US, which has demonstrated no capacity for pain, sees a neo great generation rise, there will be change period. Don;t bet on baby boomers, GenX is playing in the clouds and Gen Y is distracted by Playstation.
Any new regulation should be thought of in the same light as tax code reform. Cosmetic at best, closing one hole begets another.
S,
Please provide links to these articles
s,
Don’t be so confident the US won’t change course. Both on the Dem and Republican side in Congress populists have been gaining clout (e.g., Tester and Webb on the Dem side). If wages continue to stagnate while consumer prices increase, there’ll be political pressure to change various trade, immigration, and tax policies that make the current system of the US exporting financial instruments in exchange for importing goods and services. Likewise, if inflation becomes a big enough issue in China, the middle east, and other emerging markets, that could cause enough problems to change their policies that support this exchange of financial products for goods.
People who say globalization only goes in one direction are fooling themselves. It is cylical over time. It is possible for inflation and stagnant wages, or maybe something else, to throw a wrench in the works.
This is completely unrealistic. They may have been able to pull this off in Japan becuase it is one country and a cohesive culture, but it wont work for the entire western banking system. Which might as well include the entire global banking system.
The current global order is not going to survive.
The Geithner article is scary. So the Fed want to be the worlds lender of the last resort. The US’s new motto:
“Give Me Your Tired, Your Poor, Your Hungry and Your Crappy Debt”
Hey Yves,
Charlie Gasbagarino just referred to you and others that have critized LEH as “insane, moronic bolggers.” His comment was on CNBC at 1:10PM EST.
Anon of 11:09 AM,
The link to the Roach article can be found on our Links page for today.
Gasparino is talking his book. The MSM criticizes internet blogs and discussion forums because they are competition for the eyeball time the MSM sells its advertisers. The MSM is also rough on people who criticize their advertisers because the MSM has to look out for its advertisers who are banks, brokers, etc. The internet competes for eyeball time and the MSM knows it. Expecting the MSM to be rough on the major financial institutions is like expecting GQ or Vogue to be rough on the major fashion houses — not going to happen.
Banks will never be weaned off these facilities because (one more time now, chairman Bernanke) this is a solvency issue, not a liquidity issue. If it was a liquidity issue, then yes, as liquidity returned to the markets, the banks could be weaned off of govt-provided liquidity. But if it’s a solvency issue, there’s nothing in the world that will make those toxic bonds whole again. The banks and the Feds will keep rolling over the TAF until the government finally gives up and eats the losses.
Does anyone remember Anglo-American media in the early 90s berating Japanese financial institutions for not aggressively writing off their bad debts?
I’m not saying this is a complete answer, nor do I wish to poke fun at our contemporary manifestation of “do as I say, not as I do.”
We are WAAAAY beyond technical measures that could resolve this mess, so Mr. Geithner is wasting his time.
Indeed, it’s time for a massive bankruptcy reorganization and a Congress with the good sense to reconstitute the Bank of the United States. This alone, along with a return to a system of fixed exchange rates could stave off disaster. Otherwise, a Great Calamity probably is foregone conclusion.
By the way… I find similarities between Now and October 1987 uncanny. Thought you might like to know…
Someone is not smarter than a 5th grader.
TSLF increased $17B to $114B (from $97B) today.
Credit crisis over? That’s a laugh. These folks need to do some just a bit of leg work before writing.
IF [usage declining as market improves — patently false]
THEN [pointless conclusion]
I marvel at the dysogenous nature of this conversation. Is there any doubt left that the commodity bubble, which is costing the American consumer trillions, is the result of Fed and Treasury policy ?
What was the rational for our trade policy, again ? Becuase Brad de Long thinks it’s a good idea ?
JHC.
Shawn H,
I must note you provided no link. This is what Dow jones Newswire said Thursday late PM:
The Fed further contracted its Term Securities Lending Facility in which it lends out Treasurys against collateral to the primary dealers in an effort to improve liquidity in strained repurchase markets. The report Thursday showed term facility borrowings at $96.7 billion the week ended June 11, down almost $2 billion from the previous week.
The Fed does not publish the results of the TSLF auctions on its website, nor were any results of an auction Thursday on Bloomberg.
If I assume your information is accurate, given that rates at the short end of the curve jumped considerably this week, it would be no surprise if dealers were looking for the cheapest source of short -term funding offer. If you look at auction results through May, they were tepid. Any reversion in demand would have more to do with opportunism than need.
http://www.newyorkfed.org/markets/tslf/termseclending.cfm