Uncertainty paralyzes U.S. banking system
– John Kemp is a Reuters columnist. The opinions expressed are his own –
Extreme uncertainty about the economic outlook and the depth of the recession has paralyzed normal lending activity by commercial banks in the United States and elsewhere. Even as the Federal Reserve has added liquidity and boosted bank reserves, the credit creation process has remained stalled as banks struggle to identify good borrowers willing and able to repay in a wide range of future economic conditions.
The attached chart is adapted from the Federal Reserve’s weekly H.8 release on “Assets and Liabilities of Commercial Banks in the United States” (https://customers.reuters.com/d/graphics/US_CRDT1108.gif).
It shows the ratio of loans, leases and interbank lending (risk assets) to vault cash, reserves and Treasury securities (safe assets) held by U.S. commercial banks. In essence it shows the commercial banking system’s appetite for risk and capacity for credit creation.
Credit is clearly cyclical. But the period since 1994 has witnessed a huge increase in credit extension and a massive rise in balance sheet risk overlaid with modest cyclical variations. Following a brief hiatus during the downturn of 2001-2003, explosive credit creation resumed and hit new heights in early 2008.
The ratio of loans, leases and interbank loans to vault cash, reserves and holdings of Treasury securities has increased from 2.4 in April 1994 to 3.2 in Apr 2004 and a staggering 5.3 in Apr 2008. Since the onset of the crisis, the lending ratio has plummeted to 3.5. It is the sharpest reversal in balance sheet composition since the 1930s.
In fact, commercial bank lending has increased slightly since the onset of the crisis. Increased loans and leases have offset a downturn in interbank activity. Some of this reflects the reclassification of investment banks as commercial ones.
Light at the end of the tunnel
– John Kemp is a Reuters columnist. The opinions expressed are his own –
After more than a year of denial, misdirected policies and a steadily worsening outlook, the past fortnight has witnessed a marked improvement. For the first time, there are reasons to be cautiously optimistic that the economy faces a recession rather than a prolonged slump, and recovery could get underway in H2 2009.
Markets share some of that optimism. The Dow Jones Industrial Index has risen 15.5 percent over four consecutive sessions, the most sustained rally since April 2008. It is not yet time to break out the champagne. But there are reasons to start looking through short-term weakness to focus on an eventual, albeit modest, recovery by the end of next year.
DENIAL AND MISDIRECTION
Regulators and much of the financial services industry have been in denial for more than a decade about the steady accumulation of risk within individual institutions and across the system as a whole.
Even when rising defaults on subprime loans caused the music to stop last summer, regulators and industry leaders failed to appreciate the structural nature of the crisis. There was much talk of isolated instances of poor risk-management and hope the downturn could be contained in the housing market and motor manufacturing.
Most thought the music would begin playing again after a brief pause, and the dance could resume much as before with only a few minor modifications.
The gov’t and its branches can work all the manipulations it wants. Until the consumer is replaced as the economic engine, the only thing that will get the economy growing again will be JOBS JOBS JOBS JOBS JOBS JOBS JOBS.
Will blind men ever see?
Deflation is a dangerous distraction (part 2)
– John Kemp is a Reuters columnist. The views expressed are his own – For part one of this column, please click here.
The current downturn and fears about falling prices are prompting a plethora of historical comparisons with previous periods, many with the Great Depression of 1929-1933, some based on a very shaky understanding of the historical record.
HISTORICAL BUSINESS CYCLES
The attached chart provides a long-term overview of developments in both U.S. output and prices for the last century using official data published by the Federal Reserve and the Bureau of Labor Statistics. To remove some of the month-to-month volatility, the chart shows the twelve-month percent change in both series for a rolling three-month period, providing a better indication of the underlying trend (http://customers.reuters.com/d/graphics/us_business_cycle.pdf).
Three points stand out immediately:
(1) The business cycle was much more pronounced in the first half of the period from 1913 to the early 1950s when there were massive booms interspersed with regular slumps. Year-on-year changes in industrial output of more than 10 percent and occasionally more than 20 percent were the norm.
Since 1950, the cycle has been much more muted. Only twice in the last 50 years has output grown briefly by more than 10 percent year-on-year, and only once has it shrunk more than that amount.
Don’t merely create jobs to end the crisis, create wealth to end the crisis. But don’t create wealth for the fat cats who got us here in the first place by safeguarding the enormous salaries of corporate executives. Instead, create wealth for all the people by building infrastructure that will either save energy (improve roads in cities to reduce rush hour traffic jams, improve electric transport infrastructure to reduce losses from moving electricity from source to end usage) or produce energy from inexhaustible, but local, sources (wind, solar, geothermal, tides, waves).
The jobs creating the infrastructure will turn the economy around, the savings, and new production, of energy will pay for the infrastructure investment, and all of us, and our children and grandchildren, will get the benefit.
Biofuels run into trouble
– John Kemp is a Reuters columnist. The opinions expressed are his own – Despite a promising start, the U.S. experiment with renewable fuels is facing a serious challenge next year. Falling gasoline consumption, lower pump prices and contradictions within the federal government program are intensifying existing pressures on ethanol distillers and farmers already struggling to cope with over-capacity and collapsing margins.
ETHANOL ENTHUSIASM
Between 2000 and 2007, production of fuel ethanol quadrupled from 1.6 billion to 6.5 billion gallons, and the industry is on course to distill a record 9.3 billion gallons in 2008.
Ethanol production is not really economic at oil prices below about $60-70 per barrel (prices of grains and fats for ethanol conversion and processing costs are too high relative to oil). So the original boost to ethanol came from its use as an oxygenating additive in reformulated gasoline, rather than as fuel in its own right, when a number of states banned the use of MTBE.
As oil prices breached $50 in late 2004 and continued to climb steadily higher over the next four years, ethanol’s properties as a fuel suddenly became more attractive. Blenders began to use ethanol as a cheaper (partial) substitute for conventional oil-derived blendstocks in making gasoline.
Prompted by national security concerns and encouraged by lobbyists for the farm sector, U.S. legislators tried to accelerate the use of ethanol by mandating a minimum ethanol content for all gasoline produced or imported into the United States.
The centerpiece of the government’s intervention is the Renewable Fuel Standard (RFS) which sets a steadily increasing minimum volume of ethanol that must be blended into the nationwide gasoline supply each year.
quote: For $100 the auto Industry can make any vehicle a Flex Fuel Vehicle capable of running on Gasoline or any blend of ethanol..
the flex fuel sensor for a GM costs $500, the larger needed injectors cause worse atomization, and less accurate fuel air mixtures. GM gets away with this because it lets the vechile get %20 worse fuel economy. They trade these MPG costs to other vechiles to stay under the cafe cap.
G20 summit shows lack of resolve
–John Kemp is a Reuters columnist. The opinions expressed are his own–
The G20 summit must be considered a disappointing failure, even by the relatively low expectations set for the event. Leaders produced a long agenda of further studies, reports and work, but failed to provide a clear direction or tackle even the most fundamental decisions.
On the key issues, leaders displayed a worrying irresolution. Without unambiguous instructions from the top, discussions between finance ministers and officials will prove protracted and risk getting bogged down in detail. Negotiations between officials can fill in the details; they cannot make the kind of fundamental choices about strategic direction that leaders avoided at the weekend.
A SENSE OF HISTORY
The summit has been bedeviled by comparisons with the Bretton Woods conference in 1944. Intended as a rhetorical device to restore confidence by suggesting governments were taking bold action in an unprecedented spirit of agreement, the ghost of Bretton Woods has raised impossible expectations and distracted both leaders and officials from the real issues facing the global financial system:
(1) The three-week conference at Bretton Woods was the culmination of more than two years of detailed work at official level and more than a decade studying the issues. There was substantial prior agreement about the problem (poorly coordinated monetary and fiscal policies, leading to payment imbalances and protectionism) and the solution (a gold-exchange system, with multilateral surveillance of national policies, and national reserves supplemented by IMF drawing facilities on a conditional basis).
The system was buttressed by a new multilateral development bank to help fund infrastructure and post-war reconstruction, and later by the General Agreement on Tariffs and Trade (GATT) to prevent a slide back into protectionism.
“But too many proposals in the document are either irrelevant or reveal a disinclination to challenge the status quo.”
True enough, Mr Kemp. But have you ever been to a G-7, G-8, G-20, IMF, World Bank etc. meeting where this did NOT apply?
Quantitative easing has begun
– John Kemp is a Reuters columnist. The views expressed are his own –
Quietly, without fanfare, the Federal Reserve has turned on the printing presses. The central bank is flooding the market with enough excess liquidity to refloat the banking system — and hopes to generate an upturn in both economic activity and inflation in the next 12-18 months to prevent the economy falling into a prolonged slump.
Since the banking crisis intensified in September, the Fed has been rapidly expanding the credit side of its balance sheet, providing an ever-increasing array of facilities to support the financial system (repos, term auction credit, primary discount credit, broker-dealer credit, commercial paper funding, money market mutual fund liquidity and term securities lending).
Total credit extended by the central bank has surged from an average of $885 billion in the week ending August 27 to $2.198 trillion in the week ending November 12. Credit extensions surged another $142 billion last week alone — mostly in form of increased term auction credit (+$114 billion) and other miscellaneous credits the central bank does not break out (+$41 billion).
Until fairly recently, the expansion on the asset side of the Fed’s balance sheet was matched by increased non-bank liabilities, mostly in the form of higher balances deposited by the US Treasury into its regular and special supplementary financing accounts at the central bank.
Since the Treasury was borrowing this money in the open market by issuing cash management bills, the impact of the Fed’s balance sheet expansion was being fully sterilized.
The Fed was providing liquidity in the narrow sense (helping commercial banks cover short-term funding problems arising from illiquid assets on their books) but not in the broader sense of inflating the money supply (money in circulation plus vault cash plus reserve balances).
Quantitative easing whereby newly printed notes are handed over to banks in the expectation that bank lending will be revived does nothing to solve the main problem of banking namely defaulting borrowers. The fiscal solution to defaulting borrowers involves giving an annual $1500 housing benefit to all United States citizens in reduction of their toxic bank overdrafts where appropriate, these toxic debts will then cease to be toxic.
TARP and Fed facilities unravel
–John Kemp is a Reuters columnist. The opinions expressed are his own–
LONDON (Reuters) – Experience shows financial crises escalate very rapidly, and need a swift and decisive response from policymakers to break the cycle of panic. Time to reflect, craft thoughtful policies and consider long-term consequences is a luxury policymakers generally don’t have.
But the problem with bold ad hoc responses is they often have unintended consequences. Individual policy actions may prove inconsistent with one another, fail to achieve objectives, and store up larger problems for the longer term.
Developments over the last week suggest the U.S rescue program has fallen into just this trap and is now rapidly unraveling.
The twin pillars of the rescue program are the multiplicity of liquidity and lending programs being offered by the Federal Reserve and the Treasury’s Troubled Asset Relief Program (TARP).
Both programs are now in deep trouble. In fact the various rescue packages risk becoming a textbook example of how poorly designed programs can fail to achieve their objectives.
LIQUIDITY EVERYWHERE BUT MAIN STREET
In fact it’s not clear what the bailout package was intended to do. The Administration spent months in blissful denial (‘strong fundamentals’ and all that) then upon slowly noticing the symptoms of the sickness — not the causes — cobbled something together in a panic. The current effort is akin to handing out tissues in a pneumonia ward and wondering why none of the patients is getting better.
Global recession has begun
— John Kemp is a Reuters columnist. The opinions expressed are his own –
LONDON (Reuters) – Yesterday’s bleak reports on the state of U.S and European manufacturing confirmed that a global recession has already begun.
The Institute of Supply Management (ISM)’s composite business activity indicator plunged for the second month to 38.9 – far below the 50-point threshold dividing expanding activity from a contraction, and the lowest level since September 1982 (see chart https://customers.reuters.com/d/graphics/US_ISM1108.gif).
The 11-point plunge in the index over the last three months (August-October) has been equaled on only four occasions since 1945 (1949-50, 1959-60, 1974 and 1980-81).
It dispels any remaining doubt that the United States has already entered recession – which the National Bureau of Economic Research (NBER) defines as “a significant decline in economic activity, spread across the economy, lasting more than a few months”.
The economy has been in trouble for more than a year. Manufacturing output peaked in July 2007 and had fallen 2.3 percent by August 2008 according to estimates published by the Federal Reserve. Private sector jobs peaked in November and were down 0.7 percent by August.
Repeat claims for unemployment insurance had risen almost 1 million over this period, and the number of people in desperate poverty receiving help under the federal government’s Aid to Families with Dependent Children (food stamp) program surged almost 2.5 million.
My worry is where these trillions of dollars being pumped into the financial markets coming from? I’m sure it wasn’t just sat in the ‘rainy day’ box.
Commodities and the Great Conundrum
– John Kemp is a Reuters columnist. The views expressed are his own –
By John Kemp
LONDON (Reuters) – By driving up long-term real interest rates, the forthcoming flood of U.S Treasury borrowing threatens to crowd out the amount of capital for investing in other asset classes, creating a much tougher environment for commodity prices over the next two to three years.
Like many other asset classes, commodity prices have benefited from an influx of funds in recent years driven by three related factors:
(1) The long-term downtrend in inflation, greater macroeconomic stability, and heightened confidence in fiscal and monetary policy since the early 1980s have resulted in a steady reduction in both nominal and inflation-adjusted interest rates. Real rates are down from +8.0 percent in 1984 and +4.5 percent at the start of 1995 to -0.5 percent in H1 2008, or +1.5 percent if rising food and energy costs are excluded (see chart https://customers.reuters.com/d/graphics/US_RLINT1108.gif).
As real returns on benchmark government bonds have shrunk, investors have shifted into higher risk asset classes (equities, hedge funds, private equity and commodities) in search of better returns.
(2) Current account surpluses from China’s export-related boom and OPEC’s torrent of petrodollar revenues have been smoothly recycled back into debt markets, private equity, hedge funds and other instruments in North America and Western Europe.
Replace tax with inflation? that’ll mean that the billionaires are effectively being taxed the same rate as the minimum wagers – This will just push more people below the poverty line, creating an even bigger drain on society. Sure, if you think that is a good policy, go for it.
The Fed as lender of first and only resort
John Kemp is a Reuters columnist. The opinions expressed are his own.
LONDON (Reuters) – The Federal Reserve has unveiled a dizzying array of new lending and liquidity support facilities over the last six weeks, but the diminishing law of marginal returns already looks to have set in. Each new lending and liquidity facility announced by the Fed is providing a smaller boost to confidence than the last.
The market is increasingly focused on how the Treasury and the Fed will fund the ever-expanding array of facilities, and the huge overhang of very short-term paper that needs to be rolled over into longer-term securities in a market that already looks queasy about the forthcoming flood of notes. Rather than multiplying the number of acronymned facilities further, restoring confidence now rests on solving two issues.
First, the market needs to see buyers for all this new Treasury paper that will have to be issued in the coming year.
The government is under pressure to line up support from overseas central banks and other institutional investors to continue supporting the market by absorbing a large share of the new issuance that will be required.
A much higher share may need to be in the form of Treasury Inflation Protected Securities (TIPS) to reassure buyers the government will not seek to inflate its way out of the problem.
Additional commitments on exchange-rate stability may also need to be given, at least implicity, to solicit strong foreign participation.
The financial crisis is “spinning out of control” not because “Authorities are behind” but because the top messed with the shelter of the bottom. It’s one thing to hike prices with low interest rates on luxury items, but it’s quite another to cause price bubbles on homes and food.
If you think the Govt is responsible for bailing any of you out, think again. We are not responsible for your mess. Step up to the plate and take your wild swings George, I’m tired of watching this game, I’m going home.
Why does not the governament creates small bank agencies to help the families?