Dollar Liquidity Swaps Become Permanant

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank announced on Thursday that their existing temporary bilateral liquidity swap arrangements are being converted to standing arrangements, that is, arrangements that will remain in place until further notice.
src: FRB Press Release

One might think they've been doing this for a while and finally made it official. Not so, at least not between the U.S. and Switzerland. According to the SNB, they stopped making this available back in February 2010 for a time, and then started up again on May 11, 2010. The Bank of England had a similar note about May 11, 2010. We're not sure what was specially about that day, but it's now permanently special.

Maybe they are making lots of money on this deal, or maybe they simply need it so much they finally admit they can never stop swapping currencies. One wonders if all the QE money is sloshing around so much the big brokers keep the Central Banks scrambling to keep the currency availability high for some HFT regimen in international bonds.

The Central Bank of Japan provided and interesting set of amendments revealing (at least for Yen/Dollar swaps) the Federal Reserve will set the interest rates without qualifications (they struck the methodology for rates and now just hand it over the the New York Fed.

Here are the links for further reading.
SNB Guidelines
CBJ Amendments
BOE Guidelines

Apparently the way to make money in publishing the news is to have a good database of past stories so you can paste the new name of the next story into your old copy. The folks over at MarketWatch appear to have taken the stories about the Greek debt crisis and replaced "Greece" with "Cyprus"

Seriously, don't these claims and fears sound familiar? To us it sounds like the same thing we read about when Iceland, Ireland, and Greece were set to destroy the E.U. and bring the global economy down with it.

"The problems may be worse than imagined, requiring changes to the bailout or making it unworkable."

"... the effect of capital controls ... will mean a prolonged recession which will make it impossible for [name_of_country] to meet its targets and repay its bailout debt..."

"the guarantee [plan_detail] is from the insolvent [name_of_country] government"

"...allocating losses to investors and bondholders may prove challenging in practice."

Source: 7 reasons Cyprus is more important than you think

Yup. Been there, done that. Time to go buy more high-yield bonds while the prices are cheap [again].

Shoot, Can't Get Free Money for Leverage Next Year

On one level, the subject statement is reasonably true. On the other level, the entity that does have access can simply make a loan to another entity that doesn't, using discount rate as 'cost basis' and some absurdly small spread as 'retail pricing'. Then, being a majority or sole owner of this separate entity's equity, provide profits back to the mother ship as dividends from it's equity stake in 'Best Year Placement Assets Selection Systems'

Never mind, as long as politicians retain bragging rights, regulators have something to toast, and investment banks can keep making markets, we can all sit back and make money on the next bubble adventure of the global bastardization of capitalism.

Three federal financial regulatory agencies on Friday issued guidance clarifying that the effective date of section 716, the so-called Swaps Pushout provision, of the Dodd-Frank Wall Street Reform and Consumer Protection Act is July 16, 2013. The guidance is being issued by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency after receiving inquiries seeking clarification about the effective date. Section 716 prohibits certain types of Federal assistance, such as discount window lending and deposit insurance, for certain uses to a swaps entity, subject to specified exceptions, with respect to its swap, security-based swap, or other activity.
Source: Federal Reserve Press Release

Banks Are Not Intended to be Safe Place To Keep Money

We've been seeing rules like this lately with the phrase "prohibits branches of banks … from operating primarily for the purpose of deposit production."

Let that sink in for a minute --- if you want to run a bank, you can do X, Y, and Z, and many other things, but if you have a primary purpose of attracting deposits, it's a no-no -- slap you on the wrist, bad boy!!

Now put on your consumer hat. Why do you put your money in a bank? Isn't the primary purpose to ensure your wealth is in a safe place so you don't have to stash a bunch of money in a steel, tamper-proof, fire-proof, locked-down safe, and then carry wads of cash around where thieves can separate you from your wealth when you go buy something? From your point of view, a bank's primary purpose is to be a safe place to keep your money.

But the bank is prohibited from primarily attracting your interest in their safekeeping services.

We can't speak for you, but that explains a lot.

PIIGS - Propped Up By Hope

Maybe Governor Daniel K. Tarullo's testimony to Congress helped the stock market sell off yesterday. There's nothing better than a federal official making an official proclamation that "Europe is still in trouble, and it can mess up the U.S.,too. We don't expect another U.S. bank crisis, but ya never know!" That, of course, was a paraphrase. Actually, the direct quote was

...holding out hope that further financial disruptions can be averted

There ya go, Europe is propped up by hope!

Too bad the fed can't just get involved in more swap markets. Their excess profits are returned back to the US Treasury, and the last crisis not only earned $5.8 billion in interest on forex swaps alone, but cut the cost of federal funding from the flight to dollars.

It's good business being a central bank.

Over the life of the previous temporary swap program (from December 2007 to February 2010), all swaps were repaid in full, and the Federal Reserve earned $5.8 billion in interest. Finally, the Federal Reserve bears no market pricing risk in these drawings.

Analyzing Non-Borrowed Reserve Trends

Now this is interesting.

(click for full size)

Latest Observations from the chart. (full data series available from The Fed):
2009-12 968.670
2010-01 966.727
2010-02 1113.265
2010-03 1094.656
2010-04 1036.615

We see a drop from Dec. to Jan., but then a spike from Jan to Feb. It might not be coincidental the stock market was dropping after Jan. Money that flees equity risk may have been parked into the safety of bank deposits for a period of time, faster than banks were making loans. But Feb. to Mar. to Apr. we see either money has been flowing out of banks, or banks are lending more reserves into new loans.

It will be interesting to see in June what happens in May as this early May market turmoil reveals itself in the national metrics of bank balances. If the previous paragraph correctly identified cash flows, we would expect May's non-borrowed reserves to be up, based on the theory that retail investors sweep their proceeds into bank accounts and professionals sweep their proceeds into Treasuries.

Bank Lending Has Finally Resumed

Looks like the great deflation has finally hit bottom. Today the Federal Reserve reported Total Commercial and Industrial Loans rose for the 2nd week in a row after 16 months of weekly declines. Since Oct 22nd there have been only 11 weekly increases in total loans out of 77 weekly reports.

To be sure, this was a doozey, bottoming out at a year-over-year decline of 20%, the largest decline on record since this data was collected in the mid-70s.

Bank Reserves Continued Improvement

Finally, non-borrowed reserve growth took a small drop. Two key interesting points about this: 1) the fed was still slowly creating money as new reserves in March and didn't actually stop agency debt purchases until the 31st. 2) The drop means bank borrowing of free reserves grew faster than the fed was creating money.

Meanwhile, total borrowings from the central bank continues the steady decline. This means banks are unwinding some of the facility loans and using more of their own capital as backdrop against troubled loans.

We still believe fed funds will remain low for an extended period, but we continue to watch these reserve metrics for evidence that a turn of events is around the corner.

Fed Funds Rate History

During the last interest rate stimulated stock market recovery after the dot-com bubble popped, the federal reserve raised it's fed funds rate in July of 2004 (click the 'all' label above the chart). At that time, the market was just a bit over 1 year from it's bull market starting point in the late winter of early 2003. Just before the rate rose, the market had stalled and moved sideways a bit before making it's long run to the 2007 top.

Currently we are about at the same time frame from this markets launch point in the late winter of early 2009. With fed funds still sloshing around at the bottom of the barrel, and unborrowed reserves at astronomical levels, there's no reason to expect the funds rate to rise any time soon. The fed would have to sell everything they have into the repo-market to pull the excess reserves out of the system and get the funds rate to budge even a little.

So if they do want to raise rates, they're going to have to start some serious operations of a different kind to influence this market. Given Bernanke's propensity to come up with creative facilities for implementing policy, there's no telling how or when we will get some insight into their approach. Nevertheless, we are at a juncture where one would expect some kind of policy shift soon, or at least a stock market that takes a breather.

Another reason to anticipate something soon is the closed-door meeting of the board of governors that happened on Monday the 5th. On the weekend that link had the announcement of the unscheduled meeting under special rules of privacy. As we write, it's been removed. Nothing special came out in yesterdays March 16 meeting notes, so we presume the consequences from that meeting won't be known now until the actions are ready to implement.

Money Multiplier and Velocity

Can you have GDP growth without debt growth? Is debt contraction (monetary deflation) a sure sign of economic contraction? Apparently the common perception is no and yes: without debt expansion we are doomed. While we believe at SBC that these events can exist for a period of time, we don't believe they are forgone conclusions of some necessity borne out of some fundamental economic equation.

John Mauldin has produced for us some excellent analysis on this topic. We don't like predicting the future, but we conclude from his recent work that GDP growth does not have to be negative nor small.

First let's look at some conclusions from The Multiplication of Money. We believe it's a mistake to conclude a nation can't have economic growth without credit growth. If we understand the money multiplier correctly, it measures growth of debt; how much M0 money (reserves) gets converted into M1 money (via loan origination). It doesn't measure how many times the dollar from wages and income changes hands. In fact, if we pay cash for something and the business we trade with pays cash, and that business pays cash, and their business, and on and on down the line, all kinds of GDP is being created without any debt growth, either in M1 or M2. Economic activity without debt growth is very possible. It's how the world operated before fractional reserve banking was invented.

What we've described there is money velocity. Mauldin has another excellent description of that in the recent weekly newsletter titled The Implications of Velocity. In it he presents an example of one kind of GDP growth.

"Having learned from their parents, they immediately become successful and start doing $100,000 a month themselves. GDP rises to $14,000,000."

Wait, how did they get their hands on the money to conduct trade? If mom and dad gave them the money, mom and dad had to give up spending it themselves. If the bank loaned them the money from fractional reserves, the velocity doesn't have to change for everyone to stay at the same level of income, since everyone still has all their money to spend and the new kid on the block has newly created money from fractional reserves. For sure, this is how economies have grown in modern times, giving someone future money to spend today.

So let's take a look at the velocity equation. Notice P=MV does not have debt as part of the equation, except to the extent debt is a component of M. Since GDP transactions are conducted in real physical cash or checking deposits, the monetary metric to use is M1. The astute reader will notice immediately that one can conduct transactions with credit cards and bank loans. True, but since we are presuming an economy where debt is not growing, those don't count. They either get offset by someone paying down loans, or by the person paying off the loan (credit card) at the end of the month with cash or M1 money.

Furthermore, for those who spend cash on debt repayment (pay down car loans, mortgages, etc) we need to realize those payments are M1 asset transfers from debtor to creditor. They don't affect the M in the velocity equation, either.

In fact, Mauldin shows M2 is not growing as M1 has recently. Since M2 is not directly spendable money, it appears the nation is churning the money in demand deposits and cash (GDP is not zero) instead of loading it into savings vehicles (M2 is not growing with M1). Unwinding debt would do this. As pointed out above, debt pay-down is nothing more than an M1 asset transfer from debtor to creditor. If the creditor then uses it to pay down their own debt, it too is another asset transfer of M1 from debtor to creditor. This creditor to debtor pay-down cycle can go on for some time. It can happen any number of times, all the while reducing "total debt". Does that alter velocity or GDP? Not necessarily.

At some point a creditor is payed and decides not to reduce debt, either because they don't have any in the first place or they are comfortable with the debt they have. If they save it, the money appears as M2 growth. If they spend it, it appears as a contribution to velocity and GDP.

It seems apparent, then, that if M1 is growing and M2 is not, and GDP is not contracting, that M1 money is being used to buy things with cash or pay down debt (or bury the bills in a can in the back yard.) There really aren't any other things one can do with money but to spend it, save it, or pay off debt.

People don't spend M2. It might be a funding source for spending, as people cash in the CD or transfer money out of a money market. It may also form the basis of confidence for spending, since one can buy on credit and pay it off when the CD matures or when they chose to redeem Money Market funds. But M2 itself is not directly spendable. It only represents the confidence of spending what is available in M1 or new debt. One can think of it as a source of "respending". If one writes a check today and something else comes along to entice the person later, one always has that M2 savings to use for the purchase. Nevertheless, all commerce takes place with M1 money.

We conclude that it is not a forgone conclusion that we must have economic stagnation if we have debt contraction. It's not even certain that we will have weak economic growth. Whether we do or not really depends on the velocity of money. If those with money have confidence to spend it, and if they relearn how to live within their means, we could have very healthy GDP. The problem we have with the common public data is that they predominantly provide statistics representative of the Losers; those who've botched it; those who are financially illiterate. While we have no hard data to prove it, we believe those people make up the minority of the American public.

Isn't it interesting how many advocate that people live within their means and that the nation would be stronger if we didn't rely on debt for economic well being? Has anyone even provided a picture of what that transition would look like? We don't want to sound too proud or arrogant, but maybe we just did.

Now what fiscal policy can do to this aspect is another matter. We'll have to look for evidence to that effect somewhere else.

Before you scoff at our conclusion, take another clue from chaos theory. Mauldin points out a very useful lesson from the book Ubiquity: Why Catastrophes Happen. The conclusion is that stress points are built into the fabric of human existence. The implication is that it almost doesn't matter how one responds to a crisis. The long term consequence is that complacency and comfort will set in, preparing the way for the next build up of critical mass to produce another crisis. Now if you can't tell when you are there at the precipice, how can you tell what the fundamental change is that is setting up the next generation for a fall? If you knew when the fundamental change was taking place, one presumably could prepare a plan for the consequences of the complacency that follows. But in fact these things are never clear until they become hindsight.

Now YOU Can Have Bank Reserves, Too.

"As an additional means of draining reserves, the Federal Reserve is also developing plans to offer to depository institutions term deposits, which are roughly analogous to certificates of deposit that the institutions offer to their customers."
(Source: Ben Bernanke's exit strategy testimony)

We have to hand it to this guy, he is one of the most creative bankers in history. In just two sigmas the American people can sink their claws into Federal Reserve excess reserves. Now all we need are 15 million savers willing to lock up their full FDIC insurance allocation in these new instruments, which will probably pay diddly-squat interest.

Of course money market accounts will have direct access, too, so the consumer angle is actually not that important, provided consumers feel compelled to put their money into money markets paying diddly-squat instead.

The real problem with bank reserves is that they don't provide a rate of return. The only way to entice the free market to park their money in reverse repos is to make them more attractive to alternative investments. So this plan can only work if interest rates rise (to attract capital into these instruments) or velocity of money remains low (velocity being the basis for high reserve balances as a threat). If velocity picks up, price inflation will also, and rates will naturally rise. The trillion dollar question is how quickly can rates stifle inflation forces, or will the lag between price increases and rate increases be a kind of self-accelerant of velocity. The feed-back loop could be phenomenal.

But that's all just speculation, isn't it? No doubt the creative genius of Bernanke will devise a plan for that at the right time. Of course Greenspan didn't stop the dot-com bubble, and Bernanke didn't stop the real estate bubble, so it's pretty hard to imagine what will provide Bernanke with the incredible insight and forethought to recognize how to prevent the next bubble. One thing is for sure, it ought to be interesting.

In July of last year we had similar comments on the exit strategy. One might want to compare notes, both ours and Ben's, to see how things have changed.

The Fed Did Not Raise Rates

Did the Federal Reserve just come out and surprise the world with a "rate hike"? Technically, yes. It all depends on what "is" is. Read the official press release.

Notice this isn't really changing the fundamentals. What really happened was they removed some of the recent "emergency" measures.

On August 17, 2007, the Federal Reserve reduced the spread of the primary credit rate over the FOMC's target for the federal funds rate to 1/2 percentage point, from 1 percentage point, and lengthened the typical maximum maturity from overnight to 30 days.

As we pointed out in "Credit Spreads Expected to Narrow", the business cycle is alive and well. The Federal Reserve basically just sent out a press release to that effect. They've restored the spread and duration to pre-crash conditions. Yea, the spread is still not quite there, but hopefully you get the picture.

This is a change at the discount window and TAF, not fed funds. Bernanke is pushing up that rate to force banks to suck up the fed funds and entice other bond holders to find repurchase funding in the commercial paper markets. We predict it won’t have any impact on lending costs just as they say (since fed funds are still over-supplied), but to the extent the public believes this is something big, there’s some good shorting opportunities for the next day or two.

This is more to do with normalizing the old methodologies than a real rate policy change. The daily Fed Funds market shows no signs whatsoever of "improving conditions" as far as market interest rates in ring-zero financing is concerned.

All through the policy changes leading up to market collapse the Fed Funds data revealed policy changes in the days leading up the public announcements. Expect to see something move there, too, before any real rate increases happens in monetary policy. As it stands the current news is just getting a few markets back to pre-crash normality.

Where did all this money come from?

Has anyone else been watching this and have a specific explanation other than "the banks aren't lending". Seriously, where did 400 billion dollars come from in the last two months?

Non-borrowed reserves in the last two months have jumped from around 400 billion to around 800 billion.

Who's pumping money into the banking system?

Oh, and did you notice the shaded recession period is in the past. Somehow we missed that announcement, but we did observe something similar on November 10th.

Contagion: Been There, Done That

If you haven't seen Commanding Heights, we highly recommend it. It goes best with a strong thinking cap so you can read between the lines and find the subtle nuances of cause and effect in global finance.

I part three in particular, they covered the Asian Financial Crisis that started from a small little economy, that through currency controls created the exact same financial situation we had last year (don't miss the entire city built from the ground up on debt financing to which no one ever moved in to populate!), and as the piper came calling and financiers decided they were no longer going to sing that tune, it spread to all the healthy nations in the region as electronic funds transfers sucked all the money out of the region, one nation after another.

The funny thing is, that time the money needed a place to park, so it fled to another emerging nation -- Russia. They didn't go into details on the underlying reasons for Russia's default on debt, but ultimately it lead to Long Term Capital's implosion.

And then Brazil was hard on its heals with another collapse in this game of financial dominoes, but was averted by a quick influx of bail out money as the signs of stress were about to crack.

In every case: bail out after bail out after bail out.

The difference in 2008 was apparently "they" (those with all the money under control) learned how not to make the same mistake. When credit stopped in 2008, the money this time went straight to U.S. Dollars. No messing around this time with some new emerging entity that offered hope and promise of the perfect utopia. Instead, get out, park the money in the one nation and one security most likely to not have a political revolution over the hub-bub, and wait it out.

So in spite of all the uproar over Federal Reserve emergency lending and government bail out of banks in 2008, it really was not unprecedented. It was exactly what was done the last time. The only difference being this time it was an internal massive bailout instead of foreign nation massive bailouts. We contend the labels on the entities in question are irrelevant. It's the same thing every time (remember the third-world financial bail outs in the 80s?) Apparently it's a necessary evil every decade.

There is nothing new under the sun. Watch it, learn to read the signs, and get ready for a repeat since the fundamental foundations, the global monetary systems, haven't changed one bit. The hard part is learning how to discount and ignore the incessant monthly claims that "it's going to happen again!! Sell now and protect yourself!!!"

Meanwhile, like last time, it appears the contagion has stopped spreading. See our other post today, The Financial Crisis of 2008 is Officially Over.

We left out one interesting link on those references though. Just as Brazil's contagion was contained by preemptive quick response, The Fed has preempted the Commercial Real Estate issues that are falling on the heals of this most recent global financial crisis. Like Brazil's non-issue of the 90s, we predict the present CRE "crisis" will also become a little known financial issue of 2010.

In a nutshell, banks can restructure the loans and won't be "criticized" for what otherwise would have been bad lending practices. It's now OK to carry bad debt on the books.

Just like Japan? Well, not exactly. Turns out we can learn another important fact from Commanding Heights. In the 90s, when Japan's banks were stuck with all those bad loans, one bold man stood up and suggested if they want to get out of the crisis they need to loosen up the over-bearing burdensome regulatory structure that was constraining the banks. He was quickly fired from his cabinet post, they refused to "fix" the systemic problem, and the lost decade ensued.

If Benny and Timmy had nationalized the banks in the U.S. to "solve" our crisis and put massive layers of regulation on them (as if you can implement "Soviet Union Economics" and create vital capital formation) then we would have been destined for a lost decade in the U.S. as well. Instead, we have a much better chance of getting back to normal, which is setting ourselves up for another crisis in the teens of the 21st century just like the previous three decades.

The Financial Crisis of 2008 is Officially Over

On Friday of last week:

The Federal Reserve Board announced Friday that a temporary exemption to the limitations in section 23A of the Federal Reserve Act, instituted as part of the response to the financial crisis, will expire as scheduled on October 30, 2009
(source: 2009 Banking and Consumer Regulatory Policy)

Then today:

9 of the 10 Bank Holding Companies (BHCs) that were determined in the Supervisory Capital Assessment Program (SCAP) earlier this year to need to raise capital or improve the quality of their capital to withstand a worse-than-expected economic scenario now have increased their capital sufficiently to meet or exceed their required capital buffers. The one exception, GMAC, is expected to meet its remaining buffer need by accessing the TARP Automotive Industry Financing Program, and is in discussions with the U.S. Treasury on the structure of its investment
(source: 2009 Banking and Consumer Regulatory Policy)

Update 11/18/2009

In light of the continued improvement in financial market conditions, the Federal Reserve Board on Tuesday announced that it approved a reduction in the maximum maturity of primary credit loans...
Prior to August 2007, the maximum available term of primary credit was generally overnight. The Federal Reserve lengthened the maximum maturity first to 30 days on August 17, 2007 and then to 90 days on March 16, 2008...
(source: Federal Reserve Press Release)

Money Supply Blog

The Financial Times has a blog on Money Supply around the world. We haven't yet formed an opinion about it yet, but the graphic (logo?) is slightly innacurate in our estimation. That scafolding and framing holding up the nations should be a house of cards, not steel. Steel is SO-O-O 19th century!

How Ben Bernanke Saved the World

Subtitle: "How I Learned to Land a Helicopter", by Ben Bernanke

The title is past-tense for posterity's sake. This link needs to be remembered in the future when reality testifies on Ben's behalf. Fortunately for Ben we can never know what might have been -- we only know what he claims would have been if not for his policy, and must believe reality is better no matter how bad it is in fact, when the facts are in.

This, though, is his expose on how he plans to keep the world from hyperinflation after the biggest creation of fresh dollars the world has ever seen. Download a copy for posterity before the Wall Street Journal archivists cut off the link.

This isn't very reassuring: "we can raise the rate paid on reserve balances as we increase our target for the federal funds rate."

It's reassuring if all one cares about is ensuring that interest rates rise. We'd really like to know how the next upward move in fed funds isn't going to create a financial shock like all the others in this present generation. Granted, inflation is under control as measured by CPI and a few other choice tools, but 9+% unemployment is approaching historic levels, so this last fed funds move failed on the employment objectives. And apparently wiping out American investors' wealth is an acceptable outcome (as happened in the dot-com bust and now the real-estate bust) since it isn't a policy mandate to target preservation of American 401(k) accounts.

Furthermore, it doesn't address the bank's fiduciary duty to shareholders. How are banks going to justify tiny ROI when fed-funds level of yields are earned on an ever growing pile of reserves? This is going to pressure banks to use reserves for higher-yielding assets. To keep bank stockholders from rebelling, the rate on reserves is going to have to be higher than fed funds. This program will create a ceiling for fed funds, not a floor. Small banks without large in-house investment departments like Goldman and Morgan (recently converted to banks) are going to demand yields that match ROI garnered from their securities market operations. Equity investors will not stand for ROI in single digits. If banks can't make loans to business, they will seek out returns in other markets like securities.

As taxpayers, we're not very reassured. It is certain this board of governors won’t make the same mistakes as their predecessors, but equally certain the mistakes they do make will be costly. One can always offer the blind assurance that it would be worse with any other option. But of course you can’t prove what might have been. You can only have faith. When it comes to faith in the central bank policies, our only faith is that they will create a boom-bust cycle just like they have for generations. As for us, we’ll prepare for the inevitable disaster in what ever form it comes in the next business cycle bust, including the potential of having to pay 80% tax rates on inflation-induced capital gains for the "rich" (where rich is defined as anyone not a ward of government social programs) to pay for the next Keynesian stimulus devised for the consequential bust of present-day quantitative easing.

TALF Fails Its Objectives

That title might be misleading. It fails the stated objectives, but some might wonder if the real objective is to ensure a steady stream of large transactional revenue for primary dealers.

According to the federal reserve:

The Federal Reserve created the Term Asset-Backed Securities Loan Facility (TALF), to help market participants meet the credit needs of households and small businesses by supporting the issuance of asset-backed securities...
Source: NY Fed

Notice on the July 16th facility, a full $0.6 billion in loans were requested. However, they weren't new loans. These were legacy securities. That means someone is putting up some old commercial real estate loans as collateral for cash, so they can do something better with them. It also reveals while they want to "support the issuance" of new securities, those working face to face with them aren't interested. There's too much junk in bonds they need to get rid of first.

One might argue, the proceeds from this loan might be used to fund new loans. While that's possible, its also possible they might be using the proceeds to fund payroll, pay bills, or who knows what.

But you see why the larger banks are in the money these days?

...Eligible borrowers must use a primary dealer...

The fee for the Fed alone is 20 basis points, or $1.3 million for this one operation on one day. No telling what kind of haircut the borrowers of the securities have to take with the primary dealers.

That also means one or more of the 17 dealers get piece of this action, even if they don't lend consumers a penny. One way to keep the banks solvent is to simply lend money back and forth between them; and you wonder if GDP is going to take off?

Maybe, maybe not. But one thing is for sure: those Goldman employees are going to be buying some pretty nice cars, clothes, jewelry, and other luxuries with their $386,395 annual salaries. Goldman is one of the primary dealers, and is no doubt making a boatload of money churning these legacy assets through all the facilities, not to mention the new bonds being issued by corporations, and the Federal Reserves direct purchase of securities.

As a matter of fact, Goldman is doing so well they confidently plan to issue around a billion dollars in unsecured bonds so they can leverage this new world of global liquidity. We don't yet what asset class is going to get that billion dollar stimulus injection, but something bubble somewhere is being pumped up.

Round 2: Smart Securitization

Here we go again, boys and girls. Let the music begin. Last one without a chair is out!

Thanks to the wonders of modern finance, we can now spread out the risks of debt defaults by repackaing instruments into ladders of risk. Sound familiar? Well, you're wrong. No sir, this is the new era of smart securitization. Unlike the last time this system collapsed, this time the wizards of finance are going to do it right. So says Geoff Smailes, managing director of global credit solutions at BarCap.

These new mechanisms are in some respects similar to discredited structured products such as collateralised loan obligations, which were widely blamed for fuelling the financial crisis. But the schemes' backers argue there are two significant differences. First, they involve the securitisation of banks' existing assets, rather than of new lending. Second, bankers argue that the new products do not disguise the transfer of risk.

"This is the world of smart securitisation… not securitisation for leverage and arbitrage"
(Source: Financial Times)

Darn, we sure wish we had contacts with their buyers. We've got a great idea to lease the Brooklyn Bridge. No, we're not talking about selling the Brooklyn Bridge. That's obviously an old con job. No sir, we just plan to lease it. That makes all the difference in the world.

Follow up on Fed Funds

Late in June we pointed out the Fed Funds market rates were rising, and had actually hit the upper limit of the target range. It appears to have been a normal month end, if not quarter-end, phenomena. Since then, fed funds have fallen back to the teens.

We can see from the Term Securities Lending Facility Options Program (TOP) that collateral pressures are expected at quarter-end dates (emphasis added).

The program is intended to enhance the effectiveness of TSLF (Term Securities Lending Facility) by offering added liquidity over periods of heightened collateral market pressures, such as quarter-end dates.

However, we can see also from the historical data that the TOPS program started out heavily over-subscribed, but has in the last two offerings been under subscribed. This is consistent with our June 16th observation that credit conditions have significantly improved.

We don't mean to imply the world economy is robust and healthy, but as Hussman often points out, we will take the facts as they come and adjust our opinions accordingly.