My questions are:

1) How long can this be maintained?

2) What will be required to rectify this situation on the banks' part? Asset sale, capital infusions?

3) When is the TAF money owed back to the Reserve? Can it be "rolled" like commercial paper? What conditions would prevent the banks from rolling the paper?

4) What is a time frame in which this resolves positively or negatively?

Gen,
is this the same issue that Mish wrote about?
http://globaleconomicanalysis.blogspot.c....

Quote:

Here's an interesting excerpt from the book Investing Public Funds by Girard Miller about borrowed reserves.

"Another useful indicator of the Federal Reserve's relative monetary policies can be found weekly in the Federal Reserve data. A key statistic is the net free reserves or net borrowed reserves line item. This statistic measures the degree to which depository institutions have found it necessary to obtain funds in the Fed Funds market and through the Fed discount window in order to obtain required reserves.

During periods of central bank credit-tightening operations, the depository sector might find it necessary to borrow funds to meet reserve requirements. This practice results in net borrowed reserves, which shows as a negative number. Conversely, if ample funds are available through the banking system to meet reserve requirements, banks can become net lenders of reserves through the Fed Funds markets"

Given that the Fed is not in a credit tightening mode, we must look for a better explanation. Here it is: Banks in aggregate have now burnt through all of their capital and are forced to borrow reserves from the Fed in order to keep lending.

Total Reserves for two weeks ending January 16th are $39.988 billion. Inquiring minds are no doubt wondering where $40 Billion came from. It's a good question. The answer is the Term Auction Facility. You can see that figure in Table 1 of the H3 release (not shown).

Were it not for the Term Auction Facility, banks would have had to raise $40 billion in capital by selling assets or some other means. We will look at "other means" in just a moment.

For now, the Fed is not disclosing who is borrowing under the Term Auction Facility, probably out of fear that people just might find out what banks are capital impaired and by how much.

Also,
Thx for ALL you do!

Thanks for digging into this KD.

I am sure there is a perfectly good explanation.

Figured it out. What bothers me more than the negative number is that the total banking reserves in this country are only about $40b. That is less than one month's trade deficit. That has been going on a long time. The sole purpose of TAF seems to be to take TP off the hands of the banks and convert it Fed debt. A bit of financial legerdemain. Good idea in that it is a cheap way to prevent insolvency by the feds. Still this is a socialism of the banking system.

Oh and it would seem that this is a 20x leverage on debt by the banks. We have gone from a 10% reserve requirement to 5% to negative. Nice work if you can get it.

It would seem that the feds think they have dodged a bullet. This is not over. That is the real problem.

...and monolines are still solvent.

stardust anyone?

Here's the Mish post:

http://globaleconomicanalysis.blogspot.c....

from CR comment line:

Quote:

The reserves have been spent because banks have expenses. They haven't had any significant income from other banks since August. CP is dead (banks lending to each other) so the banks turn to TAF to avoid closing their doors, or telling customers 'We're out of cash this month.'

As the Fed sends in emergency money, the value of the dollar drops.....

Unless their infusions are (a) revolving, so they don't create any net increase in money, or (b) the dollar losses from write-downs more-or-less match the money created by the Fed.

If the Fed is playing this game just right, they will increase the money supply to match the write-down loses that are made public every Friday.

If they blow it, we have either hyper inflation or a deflation spiral.

Let me make sure if I understand this. If later today, 20 million people try to withdraw $2000 each, it's lights out?

Another (later) CR comment line offering:

Eoghan on Calculated Risk 2/04/08 wrote..

I’ve spent quite a bit of time looking at this and trying to figure out what’s going on, so maybe I’ll be able to shed some light. I don’t think the situation is as dramatic as one might think on first glance – but there does seem to be something slightly odd going on.

The first thing to focus on is the definition of reserves. As you rightly say, the reserve requirement is the proportion of what you deposit that is ‘held back’ in reserve – ie held in cash by the bank in a vault somewhere. The other thing that counts as a reserve is deposits held by a (commercial) bank at the Federal Reserve. As you rightly point out – if you accept the concept of factional banking at all, then you should be comfortable with this.

In % terms – I believe the reserve requirement is 10%, but there are a number of different exceptions for different types of account, and of course physical dollar cash has no reserve associated with it, so it’s not surprising that reserves as % of the monetary base is less than 10%.

The other thing about reserves is that they are not the same thing as capital. Reserves are held to provide liquidity – they don’t guarantee solvency. They’re held to ensure that, in the normal course of business, the bank has enough immediately liquid assets (cash) to pay out any depositors who show up looking for their money back. Of course, given that the reserve held is a small % of deposits, there is no way the bank would be able to pay back everyone at once. A bank can have adequate liquidity but be insolvent (the Japanese banks in the 1990s). It is also possible for a bank to have inadequate liquidity but be solvent (Northern Rock in the UK, last year). So reserves are not a good measure of how strongly capitalized a bank is. A very strongly capitalized (safe) bank and a very weak (likely to go bust) bank will hold the same % of deposits as reserves.

With all this in mind, let’s take a look at the Federal Reserve data you linked to (http://www.federalreserve.gov/releases/h.... Current/). Table 1 shows non-borrowed reserves declining to -$8.751 billion on Jan 30th as you mentioned. However, look at the definition of ‘non-borrowed reserves given in the footnote. This is – “total reserves less…. Borrowings of depository institutions from the Federal Reserve”. Banks don’t tend to hold more reserves than they have to. Hence, as you’ll see in the table, total reserves and required reserves track each other closely – in other words excess reserves (column 4) are small. So non-borrowed reserves is roughly = required reserves + about $1.5 billion of excess – “Borrowings of depository institutions from the Federal Reserve”. It’s clear from the table that Requred Reserves have not changed much recently – ie US banks have generally the same amount of deposits as they had previously and are hence required to hold the same amount of reserves against them. What has changed is ‘Borrowings of depository institutions from the Federal Reserve”. This has increased by $50 billion due to the introduction of the TAF, where banks are allowed to borrow term money from the Fed. The TAF has increased from 0 to $50 billion in the space of a month. This has, arithmetically, driven ‘non-borrowed reserves’, defined as above, below zero.

Does this matter? No. Firstly, reserves are not capital. So this number tells us nothing about the capital adequacy of the US banking sector. By the way, if “Oliver Q.” (upthread) has any evidence whatsoever for his assertion that “The reserves have been spent because banks have expenses” I for one would love to see it. Secondly the definition of non-borrowed reserves is a bit weird – IMHO it’s comparing apples with pears – reserves being an ‘administrative’ quantity rather than a ‘real money’ quantity, whereas as the amount of money lent out by the Fed is a real number. So one minus the other doesn’t make a lot of sense.

The final reason why this doesn’t matter is – look at Table 2 – on the right hand side – “Vault cash (5)”. This column shows that the amount of cold hard cash held by US banks in their vaults has not decreased at all – they still hold $54 billion of cash and this number has actually increased over the last few weeks. This shows that the non-borrowed reserves numbers really is a bit of a red herring.

What I still think is a bit strange is that the TAF is now $50 billion - hence one would expect reserve balances with the Federal Reserve banks to be above $50 billion – the commercial banks submit their long-term paper into the TAF and are given cash balances in the Federal Reserve system. But the number is only $9.5 billion. While this is a bit strange the definition of column (4) is obscure enough that the $50 billion balancing item could be held somewhere else.

In short, while I think the numbers take a bit of getting your head around, they are not direct evidence of any fundamental problem in the US banking sector that we don’t already know about. Most importantly, reserves are not capital, and the difference between the two has to be held in mind.

Correct.

The key ratio is in fact the Tier Capital ratios.

Where is that available to us in real time, and if all is ok, can someone explain why we need $50 billion in TAF money (direct fed loans) out there?

Going to get more than 2k here in about an hour. :)

L

That is some scary **** Gen, you're on top of it!

Not necessarily.

Look, reserves are reserves.

The problem here isn't that the reserves are inadequate (they're not; required < available)

Its that the banks are lending into a locked market for "hard money". That's bothersome because if the market doesn't un-freeze it portends NOT bank failures but a massive liquidity contraction.

You know, that "debt default deflation spiral" that we've talked about?

Yeah, that.

Eoghan's post on Calculated Risk is correct. This number, by itself, means nothing about the solvency or liquidity of the banks.

It is just the amount of required reserves (which hasn't changed that much, meaning deposits haven't changed that much), minus the amount the banks have borrowed from the Fed.

We all know there has been $50 billion in borrowings against the TAF. The way this number is defined, it has to be negative, but it's just a calculated number based on two measurements that aren't much related to each other. If the TAF went away, this number would go positive.

What this doesn't tell us is whether the banks need to borrow to maintain their reserves, or if they're just taking advantage of some "below market" money.

The vault cash numbers seem to indicate that the banks have plenty of cash.

Look, a lot of the banks are serious trouble, but this particular "indicator" doesn't indicate anything important, nor does it help anyone understand the banking crisis any better.

Actually, no Jerry, it does tell us quite a bit.

It tells us that all of the required reserves are now TAF loans.

This tells us that the "hard money" that is normally behind debt initiation has departed. If this does not return, and soon, debt initiation will grind to a halt.

The Fed cannot be the source for debt initiation; $50 billion every two months for how long? That won't continue for very long, because it effectively means that trust is gone, and this will shortly be recognized by Mr. Market.

When it is, it won't be pretty.

I've updated the blog entry so that people understand what this really does mean.

Its NOT a marker of imminent bank insolvency, as you correctly note.

It IS a marker of a potential deflationary credit-initiation collapse.

another comment:

Quote:

I’ve spent quite a bit of time looking at this and trying to figure out what’s going on, so maybe I’ll be able to shed some light. I don’t think the situation is as dramatic as one might think on first glance – but there does seem to be something slightly odd going on.

The first thing to focus on is the definition of reserves. As you rightly say, the reserve requirement is the proportion of what you deposit that is ‘held back’ in reserve – ie held in cash by the bank in a vault somewhere. The other thing that counts as a reserve is deposits held by a (commercial) bank at the Federal Reserve. As you rightly point out – if you accept the concept of factional banking at all, then you should be comfortable with this.

In % terms – I believe the reserve requirement is 10%, but there are a number of different exceptions for different types of account, and of course physical dollar cash has no reserve associated with it, so it’s not surprising that reserves as % of the monetary base is less than 10%.

The other thing about reserves is that they are not the same thing as capital. Reserves are held to provide liquidity – they don’t guarantee solvency. They’re held to ensure that, in the normal course of business, the bank has enough immediately liquid assets (cash) to pay out any depositors who show up looking for their money back. Of course, given that the reserve held is a small % of deposits, there is no way the bank would be able to pay back everyone at once. A bank can have adequate liquidity but be insolvent (the Japanese banks in the 1990s). It is also possible for a bank to have inadequate liquidity but be solvent (Northern Rock in the UK, last year). So reserves are not a good measure of how strongly capitalized a bank is. A very strongly capitalized (safe) bank and a very weak (likely to go bust) bank will hold the same % of deposits as reserves.

With all this in mind, let’s take a look at the Federal Reserve data you linked to (http://www.federalreserve.gov/releases/h.... Current/). Table 1 shows non-borrowed reserves declining to -$8.751 billion on Jan 30th as you mentioned. However, look at the definition of ‘non-borrowed reserves given in the footnote. This is – “total reserves less…. Borrowings of depository institutions from the Federal Reserve”. Banks don’t tend to hold more reserves than they have to. Hence, as you’ll see in the table, total reserves and required reserves track each other closely – in other words excess reserves (column 4) are small. So non-borrowed reserves is roughly = required reserves + about $1.5 billion of excess – “Borrowings of depository institutions from the Federal Reserve”. It’s clear from the table that Requred Reserves have not changed much recently – ie US banks have generally the same amount of deposits as they had previously and are hence required to hold the same amount of reserves against them. What has changed is ‘Borrowings of depository institutions from the Federal Reserve”. This has increased by $50 billion due to the introduction of the TAF, where banks are allowed to borrow term money from the Fed. The TAF has increased from 0 to $50 billion in the space of a month. This has, arithmetically, driven ‘non-borrowed reserves’, defined as above, below zero.

Does this matter? No. Firstly, reserves are not capital. So this number tells us nothing about the capital adequacy of the US banking sector. By the way, if “Oliver Q.” (upthread) has any evidence whatsoever for his assertion that “The reserves have been spent because banks have expenses” I for one would love to see it. Secondly the definition of non-borrowed reserves is a bit weird – IMHO it’s comparing apples with pears – reserves being an ‘administrative’ quantity rather than a ‘real money’ quantity, whereas as the amount of money lent out by the Fed is a real number. So one minus the other doesn’t make a lot of sense.

The final reason why this doesn’t matter is – look at Table 2 – on the right hand side – “Vault cash (5)”. This column shows that the amount of cold hard cash held by US banks in their vaults has not decreased at all – they still hold $54 billion of cash and this number has actually increased over the last few weeks. This shows that the non-borrowed reserves numbers really is a bit of a red herring.

What I still think is a bit strange is that the TAF is now $50 billion - hence one would expect reserve balances with the Federal Reserve banks to be above $50 billion – the commercial banks submit their long-term paper into the TAF and are given cash balances in the Federal Reserve system. But the number is only $9.5 billion. While this is a bit strange the definition of column (4) is obscure enough that the $50 billion balancing item could be held somewhere else.

In short, while I think the numbers take a bit of getting your head around, they are not direct evidence of any fundamental problem in the US banking sector that we don’t already know about. Most importantly, reserves are not capital, and the difference between the two has to be held in mind.

and this may be of interst as well:

http://benbittrolff.blogspot.com/2008/02....

Yal, read the above (or go back and read the Ticker again - I basically put the above in there)

Basically this isn't a marker of imminent bank collapse, but it is a marker of potential imminent debt initiation collapse.

The latter doesn't bankrupt the banks, but it sure does squick the markets.

Gen, You have a title yet for your compiled tickers book?

Maybe one day it will be required reading in somebodies class.

Its funny, WW I veterans called it the War to End all Wars. But it was nothing compared to WW II.

In the same sense, it was called the Great Depression and it could never happen again because we have too many safeguards (i.e. Uncle Sam has unlimited borrowing power) and it could never happen again.

I'm wondering what will happen when the flow of borrowed money gets cut off to our government. Then the Great Depression won't be so great anymore as we are getting ready to wrap up the greatest Ponzi scheme ever devised (aside from non-stop population growth of course).

The money doesn't get cut off Guy, it just gets very expensive.

This ultimately forces the repudiation of "implied" guarantees - like entitlement programs.

Genesis,

If I understand what you are saying correctly, the banks either have to come up with the $50 billion in "hard money" necessary to pay back the Fed or the Fed has to keep rolling over the $50 billion in TAF every 2 months. However, this does not mean that the banks are necessarily insolvent because theoretically they may have sufficient Tier 1 capital to cover their losses (or they may not). However, if the banks are unable, in the very near future, to make a market in their held for investment portfolios such that they can put these loans back in their for sale portfolios and sell then them off (other than in fire sale conditions) then the banks will be unable to pay off their TAFs putting extreme pressure on the Fed to continue rolling over the TAFs. However, the rolling over of the TAFs merely serves to further undermine trust between the banks as their investment portfolios continue to deteriorate and they are forced to take further write offs against their balance sheets, thereby, further reducing available Tier 1 capital. Consequently, the banks will be unable to initiate additional lending leading to a potential deflationary collapse.

Is there anything I am missing?

That's pretty much correct.

Essentially, the last two months' worth of debt initiation has all been done on the back of the TAF - The Fed has replaced private "hard money" as the source for the reserves necessary to back that credit.

The problem with this is that you can't keep doing it for very long - the amount of money involved gets totally out of hand and so does The Fed's balance sheet.

The Bond market will simply not allow this to continue; it can and will react to this in a decidedly negative way.

Note that divergences are all over the bond market lately - it is already reacting to this problem.

Bernanke's foolhardy bull**** about "helicopter drops" of liquidity are all fine and well in a university environment, but fail in the real world, because Bernanke can't control the bond market.

When the Bond Market detects (as it has) that The Fed is the source of all current lending, and has been for the last two months, it starts to price in the potential for backstops (literal ones) for defaults in the Treasury Complex.

This is why, with the market down today, you have the TNX actually UP - it should be the other way around as people flee "into" bonds as the market declines, but its not happening.

Likewise, that 6% on the day 'rocket shot' in the TNX was due to the same phenomena.

Note that rolling over the TAF doesn't help - the TAF would have to continually increase in size, as each new loan requires new money behind it.

That of course cannot continue for very long because Government doesn't create anything - money creation - true money creation - is in fact caused by productive output. Yet the government creates nothing - it expends, not creates.

The wall in this scheme approaches at an extreme rate of speed, and the impact, if and when it occurs, will be extremely messy. The Bond market will effectively force the end of TAF expansion, and it appears it already has - The Fed has said they will roll over existing TAF loans, but note that they haven't announced any expansion of the TAF.

Why not? Because Ben knows that if the 10 does a rocket shot they're ****ed - mortgage costs go way up instead of down, as do all other long-term sources of money (e.g. LBOs, CRE, etc)

This totally negates what he's trying to do.

And additionally isn't there the problem that the more that is added to the total TAF, the riskier the collateral is that the Fed has to accept from the banks. And the greater the possibility that one of the member banks will eventually default on the TAF, thereby, forcing the Fed to eat bad debt. And if the Fed starts eating bad debt then game over.

Gen

re-read. many good points.

Didn't we have this starting in Aug ? and at some point they were able to absorb back all this liquidity they put in.

Now they are doing it via TAF and you are right this will need to continually increase in size unless new source of capital is found.

Don't they just hope that with all this noise the market for real estate and others will start heating up again creating more velocity for hard money which will be enough to get the credit market rolling again ?

They are buying time. that is all. it may work or it may not. as long as it does not work they will have to increase the pumping. until when ?