Saving the Federal Deposit Insurance Corporation

If they declare those payments to be on profit after bonuses they may find a groundswell of support on Wall Street. There is nothing like sticking it to the regional banks to consolidate the power of the few.

Look for another program from the Fed/Treasury to 'save FDIC' as part of the overall effort to maintain confidence and prevent a certain armageddon.

American Banking News
FDIC’s Deposit Fund May Need 25% of U.S. Banking Profit in 2010
August 23rd, 2009

With the 80th bank failure occurring in just the first eight months of 2009, the U.S. banking industry’s fee burden from the FDIC is continuing to be pressured as the Deposit Insurance Fund shrinks. Richard Bove, an analyst with Rochdale Securities, told Reuters in a report that the FDIC’s Insurance Fund may need to collect an amount that would equate to about 25 percent of U.S. bank industry pretax income in 2010 to stay afloat.

In the report Bove predicted another 150 to 200 additional U.S. banks failures before the current banking crisis ends. The FDIC will likely use special assessments against banks in order to raise the extra funds needed to secure the Deposit Insurance Fund’s integrity. Bove believes special assessments in 2010 could reach $11 billion in addition to the regular fees banks already pay.

The FDIC last levied a special assessment in the second quarter of five basis points on each FDIC-insured bank’s assets. The assessment is scheduled for collection on September 30.

When the FDIC released its final statement detailed the second quarter assessment it projected that the Deposit Insurance Fund would remain low, but positive through 2009 and begin to rise in 2010. However, FDIC Chairman Blair Sheila Blair said in that same statement an additional assessment may be required as early as the fourth quarter of 2009.

The Deposit Insurance Fund ended the first quarter of the year with a balance of roughly $13 billion. Since that time the FDIC has had to digest several large bank failures, such as Colonial BancGroup, which cost the fund about $4 billion.

The Deposit Insurance Fund holds a fraction of the $52 billion it had just a year ago, raising the odds of an upcoming special assessment to near certainty.

As seen recently on americanbankingnews.com, the FDIC is exploring its options for brining in investors to buy-up failed banks, thus easing the burden on the insurance fund. Investment from private equity firms has been the showcased proposal so far. The FDIC is set to vote August 26 on a relaxed set of guidelines that would entice private equity firms to invest in failed banks.

Henry Kaufman: The Road to Financial Reformation

Henry Kaufman is giving a very interesting interview with Kathleen Hays regarding his new book, "The Road to Financial Reformation."

Henry Kaufman Interview Regarding Financial Reform - Bloomberg Television 24 August

Or here on Youtube Henry Kaufman Interview Aug 24

Henry will also be presenting his ideas at a public lecture at the Museum of American Finance in NYC on September 22.

Sept. 22 Kaufman Lecture

Our financial crisis: What happened? How did we get here? What needs to be done?

Dr. Henry Kaufman — an esteemed economist and statesman — is one of the most preeminent financial figures of the day, with a history of success from the 1980s, when his firm, Salomon Brothers, ruled the bond markets.

In The Road to Financial Reformation, Dr. Kaufman, who has spent a lifetime entrenched in the world of finance, provides an insightful account of the history and impact of post-World War II financial markets on the economy-what happened, how we got to where we are today, and what needs to be done. Drawing on his vast breadth of knowledge and experience, Kaufman reveals the mistakes that got us into this debacle, the consequences — as they have not been fully realized — and how to put our derailed economy back on track. This book details Dr. Kaufman’s warnings and concerns expressed repeatedly throughout the last quarter century, and shows that what he predicted came to pass.

With his breadth of knowledge and experience, Kaufman details that this crisis was foreseeable (he saw it coming), and how we created this history-making financial crisis. He also explains the consequences still to come, and presents solutions on how we can recover and reform the markets.

Why Is the Fed Creating Excess Reserves in the Banking System and Paying Interest on Them?

There have been some interesting side discussions at various venues including Naked Capitalism about the recent essay which I had posted titled When At First You Don't Succeed, Bring in the Reserves.

Let me clarify some points.

Yes, banking reserves in the US are a function of the Fed's Balance Sheet, by definition, because they are in the narrowest sense merely an accounting function, an entry on the books of the Fed reflecting actions undertaken by the Fed.

With purpose, I put the formal definitions of Reserve Bank Credit and Reserve Balances at the bottom of each chart. I had hoped this would make that point clear.

The essence of the essay was to point out the enormous increase in bank reserves which the Fed has created through their "New Deal for Wall Street" style banking programs. Because of this, the Fed has created a new function by which it pays interest on banking reserves, which to my knowledge it has never done before.

It is a new function at the Fed, and it does serve a important purpose. The purpose is to place a 'floor' under interest rates, in the face of a surfeit of liquidity which the Fed has created, and which shows up in the Adjusted Monetary Base, the Reserve Bank Credit figures, and so forth.

Now, some people have taken issue with my bringing the notion of excess Reserves to your attention for a variety of reasons. Even the mighty NY Fed has written a paper which attempts to defuse the notion that the excess reserves are indicative of anything that might be impeding lending.

Let me be clear about this.

The excess reserves are absolutely indicative of the Fed's having added substantial amounts of liquidity to the financial system. If the Fed were not paying interest on reserves, this liquidity would crush their target interest rates, since the banks are loath to hold reserves that are not generating some return. This is what they do, generate a return on capital. Capital has a price, even if it is an opportunity cost.

By establishing a floor, the Fed is setting a more blatant artificial level for interest rates, moreso than merely tinkering with drains and adds to the system. They are offering a riskless rate of return, and crowding out other competing requests for capital. Not necessarily a bad thing, but a reality of what they are doing.

What would happen if the Fed raised the interest rate it pays on reserves to let's say, twenty percent?

Economic activity in the US would grind to a halt, as banks placed every available dollar idly with the Fed's program, eschewing all other deals, liquidating assets if necessary, to place capital where it would receive the highest risk adjusted return. In essence, the Fed would 'crowd out' all other transactions that offered a lower risk adjusted return.

What if the Fed subsequently lowered the interest rate from twenty percent to zero? It would then enable more lending from the banks, as they sought to deploy their capital at higher risk adjusted rates.

There are some by the way that claim the excess reserves are so high because there is no demand for loans. This is a point of view only supported by those who a) have no understanding of finance and b) are seeking to support an extremely odd and mistaken view of the economy which seeks to justify their bets on a serious deflation.

There is always a demand for loans as long as there is economic activity; what varies is the price! Money is not particularly inelastic; that is, there is a rather high threshold at which people say, "I have too much!" It is rather a question of price, relative to return. Make the opportunity cost high enough and they will come (or be fired).

I hereby assert that I will borrow ALL funds the Fed might loan to me with no collateral at zero interest, and gladly so, as long as the short term US Treasury bills are paying more than 25 basis points interest. I reserve the right to defer on this offer if the Fed should make the policy error of hyperinflation a reality.

I hate to make points like this in the extreme with distorted examples, but sometimes it is what it requires to pierce through obfuscation to common sense.

So to summarize, what is the Fed likely to do if economic activity falters?

They are likely to lower interest rates paid on excess reserves closer to zero. They could even charge a 'haircut' on excess reserves which would highly motivate the banks.

These are all things which have been discussed before, often in the context of consumers! In fact, it is well known among bankers that as the Fed lowers interest rates money flows out of lower paying instruments like bank deposits and money markets, and into higher paying instruments that might be deemed too risky at high rates of riskless return. Such higher paying instruments are known as "stocks" and "corporate bonds." As former central banker Wayne Angell gleefully chortled in 2004, the Fed can indeed drive the public out of their savings and money market funds and into the equity markets by manipulating interest rates.

Does the Fed always 'create' excess reserves? It may be more correct to ask, does the Fed always create money, since excess reserves are an accounting function.

No. Banking reserves normally lag the creation of money, which is accomplished by lending, either from banks or more recently by neo-banks like Fannie, Freddie, GMAC, GE and so forth.

But at a time when economic activity is contracting, and the credit markets were seizing, the Fed took the lead in money creation by "monetizing" various types of debt. And they are going to enormous pains to maintain 'confidence' in the system and in particular the US dollar and debt. But we may ask, at what point does the confidence game become a con game? I would submit that it is when the Fed and Treasury purposely intervene in markets, beyond their normal interest rate targeting, and statistics and spread disinformation to manage perception.

There are other ways in which the Fed might address the failure of the productive economy to 'pick up the ball and run with it.' But most, if not all, of them involve the monetization of something, which is what happens when the Fed (and US Treasury) are taking the lead in money creation and not the productive economy.

Deflationists do not want to hear this, and central bankers do not wish you to know this, but it is the major factor in a fiat currency that it can be created literally 'out of nothing.'

This is why we have said long ago, and repeated since, that the limiting factor on the Fed's ability to create money is the value of the US Dollar and the sovereign debt.

As long as there is debt which can be monetized, then the Fed can monetize it and create money 'out of nothing.' For now they are acting with some reestraint, and channeling that money primarily to their cronies in the banking system, still able to mask the effects of their monetary inflation. CFTC Moves to Rein In Small Investors From Commodity ETFs

But the time is coming when they will not. And as they did when they demanded $700 billion in bailout money, the financiers will once again make the Administration and the Congress an offer which they think that 'we' cannot refuse, if only because the Congress will not listen if we tell them what we wish them to do, again.

The banks must be restrained, and the financial system reformed, and the economy brought back into productive balance, before their can be a sustained recovery.

When At First You Don't Succeed, Bring In the Reserves

Someone asked why Bernanke seemed so positive about the US recovery, and what he would do if his prediction turned out to be incorrect.

The first answer is rather straightforward. He is 'jawboning' or trying to increase confidence in the system to motivate businesses to spend and consumers to buy. The Fed can only set the playing field, but the players have to be confident enough to take the field. We think he is underestimating the neglect that the American consumer has taken over the last twenty years in terms of their overall poor condition (real income), and the disrepair of their equipment (household balance sheets), not to mention the rocks and snares and pitfalls remaining on the field from the gangs of New York and the economic royalists.

But let's assume Bernanke's first major gambit does falter. What is he likely to do next?

Beranke's Fed does have a printing press, and he has been using it as we all know. Here is a chart showing the expansion of the credit side of the Fed's Balance Sheet. This is from the top line labeled "Reserve Bank Credit" from the weekly H.41 report which is becoming more popularly followed these days. If one adds the Feds gold holdings, currency in circulation, and Special Drawing Rights, we get the Total Factors Supplying Reserve Funds.

http://www.federalreserve.gov/releases/h41/Current/



So what would Ben do for "Plan B?" Would he merely add more programs, expand the Fed's Credit Items even more aggressively?

There was an important function added to the Fed's bag of tricks during this crisis that has not received sufficient attention perhaps: their ability to pay interest on reserve funds on deposit with the Fed from the Member Banks.

As can be seen from this next chart, this amount is now substantial running close to a trillion dollars. A portion of this would be characterized as 'excess reserves.' The Fed should be able to motivate banks to use these reserve by adjusting the riskless interest rates they pay.

This was a much desired tool by the monetarist Fed because it enabled them to expand their Balance Sheet and add a significant amount of credit to the banks system immediately, but to keep 'a bit of a leash' on the downstream effects of this liquidity even after it was deployed.

As the Fed's interest rate remains sufficiently high, the reserves, especially the excess reserves, remain in the banking system, and are not deployed actively as loans and inflationary additions to the financial system.

The Fed issues an H3 report, Aggregate Reserves of Depository Institutions and the Monetary Base. In their latest report, they characterize $708.5 Billion of these reserves as 'Excess Reserves.'

So, what we might expect to see is the Fed, as the banking system stabilizes after perhaps some new programs and credit facilities, begin to slowly unleash these excess reserves by reducing the interest to the Member Banks, which would lower the bar and motivate them to engage in more commercial loan activity.

We think one problem is that the banks have more options than merely keeping their excess capital at the Fed or loaning it out to private companies.

Certainly Goldman Sachs has shown that it can defy all the odds and make millions each day by aggressively playing the equity, bond and credit markets. It is also more likely that banks would be inclined to invest their excess capital through acquisitions of other banks, which might represent a moral hazard in creating fewer, and more "too large to fail" institutions.

Therefore we might see the first serious moves towards financial reform before the Fed begins to really unleash the liquidity which they have created in the banking system.

There is of course also their monetization of Treasury Debt, to support the stimulus programs being run from the fiscal side of the US financial apparatus. That would be included in the expansion of their Balance Sheet, and we would expect that to continue on at the very least indirectly, if not overtly on the Fed's balance sheet.

An Aside on the Gold Stock of the Fed

By the way, one method the Fed might use to immediately expand its Balance Sheet would be to recognize that their gold stock is significantly undervalued.

In the H.41 Report, the Fed shows a credit of $11 billion dollars in Gold Stock held primarily in New York, Chicago, Atlanta, and San Francisco, with lesser amounts at each of the Regional Banks. This gold is part of the collateral against the Federal Reserve Notes in circulation, and has been valued at an official rate of $42.22 per troy ounce for many years.

1. Gold held "under earmark" at Federal Reserve Banks for foreign and international accounts is not included in the gold stock of the United States; see table 3.13, line 3. Gold stock is valued at $42.22 per fine troy ounce

By calculation the Fed has 261,511,132 fine troy ounces on its books. If the Fed revalued their gold stock at a more reasonable market price of let's say $1000 per ounce, then this would immediately add $261 billion to the Fed's Balance Sheet IF the gold is really held by the Fed without encumbrances.

One has to wonder why the Fed has never taken the revaluation on its Balance Sheet for gold since the value of $42.22 is so clearly an historic artifact. They perform much more market based calculations for the Special Drawing Rights and their Foreign Exchange holdings. One certainly does not need to sell the gold in order to monetize it, since that has already been accomplished, albeit at a much lower rate.

One can only wonder.

Federal Reserve H3.1.2 US Reserve Assets