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Negative Bank Reserves Rebuttal



February 09, 2008 – Comments (13)

First, I am not going to pretend to understand something that I truly do not understand.  And I also lack the interest to put the time in to study it well enough so that I have an level of understanding that I'd feel confident about.

In my reading I saw a couple references to negative bank reserves.  The first one passed my "meter," yet when I saw the topic again it got my attention in the sense that even though I don't understand it, I ought to be aware that there is "something" happening there that I should follow and see how it develops. 

Carolyn Baum wrote a complete rebuttal outlining that what happened is basically that there was a better deal in the discount window so the money went there.  Mish has written a response to her post, a long post.  He points out that dozens of banks will fail, as many as 2% according to one article cited (I can't stress this enough, if you have cash assets they should be spread between more than one bank and no bank should have more than $100k of your assets.) 

Another article points out that over 1/3rd of banks have commercial real estate that exceed 300% of their capital and almost 30% have have construction and development loans that exceed 100% of capital.  This wave of banking losses that are coming have yet to hit financial results and it has to put some banks under.  I am reading Mish as I post, interest, he repeats the part that I just wrote about.

Here is Mish's statement about the reserves:


"Here's the deal. Bank reserves are net borrowed. This comes at a time when commercial real estate is about to plunge and bank balance sheets are loaded to the gills with them.

This also comes at a time when social attitudes towards debt are going to impair Bernanke's ability to inflate. For more on social attitudes, please see 60 Minutes Legitimizes Walking Away, Changing Social Attitudes About Debt, and a Crash Course For Bernanke.

Finally, banks will not be going deeper to the "TAF well" as long as the rules state "All advances must be fully collateralized." Once collateral runs out, it's the end of the line."

 So, there is no way that I can look over the numbers that the Fed puts out and understand what I am reading without spending hours upon hours upons hours...  However, I do understand something like "bank reserves are net borrowed," and everything that is happening in the financial markets right now supports that.  Banks have gone from leverage of something like 12.5 to 1 up to 30 to 1, which essentially means they could be insolvent with a mere 3% default of loans.  Didn't real estate go down 6.1% in the last year?

The insane and incompete decline in reserves means that even a 1% default on loans means that banks have huge recapitalization requirements.  To my way of thinking, if the reserves were only 3%, then they need to replace fully 1/3rd of what they had.  Before this insane lending mania of the 21st century that leveraged banks to the hilt if they had a 1% default they would have had to replace about 1/8th.  You'd have to had 8% losses on your entire loan portfolio to see insolvency with the historical level of reserves.  Right now you only have to see 3% of your portfolio in losses, and I personally can't see how it will only be that piddly 2% at the high end estimate of banks that go under.  I think 2% is more likely a minimum...

13 Comments – Post Your Own

#1) On February 09, 2008 at 2:16 PM, camistocks (67.03) wrote:

dwot, please! Caroline Baum is very smart! I advised you not to listen or read permabears like Mish! He is an idiot! forgive me to be so blunt....

Even Warren Buffett stated that there is more than enough liquidity around! There is no credit crunch, no depression! Read this from the Canadian National Post.

In an exclusive interview with three Financial Post reporters, Buffett said “I am a huge bull on the American economy.” That quote comes at the end of the six-minute video you can view here [and is also posted now on You Tube].

After all the hysteria about the subprime mortgage crisis, Buffett’s take – right at the end of the main story in the Post – was cogent. Compared with 1982 when short-term interest rates were 21%, “this is not a tough period,” Buffett said, “We do not have an unavailability of credit to people who’ve got reasonable credit demands, and it’s not expensive. We’re not in a credit crunch for those who have sound deals.”



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#2) On February 09, 2008 at 2:45 PM, floridabuilder2 (97.93) wrote:

i'm not smart enough either.... but just in case, I cashed in my ultrashort financials and am waiting for the options expiration week to roll through this week.......  it is pretty obvious we are in a bear the question now is how long?


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#3) On February 09, 2008 at 2:47 PM, floridabuilder2 (97.93) wrote:

LMAO DWOT...... you have two zillion red thumbs and one green thumb PTEN?

too funny......... 

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#4) On February 09, 2008 at 3:50 PM, camistocks (67.03) wrote:

Why not just be fair and post Caroline Baum's website and article:

 How Non-Borrowed Reserves Became a Sexy Subject: Caroline Baum

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#5) On February 09, 2008 at 4:00 PM, GS751 (26.69) wrote:

I think it will be a lot long than people anticipate, into 2009 at least.

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#6) On February 09, 2008 at 5:32 PM, dwot (28.99) wrote:

Actually Camistock, he didn't really address that the $8.8 billion showing up negative was just a transfer to the discount window, completely skirted around that. 

And no where does she state that the banking system is healthy, indeed she sites that the massive losses are something to be concerned about, which is the same conclusions that Mish is making, only he is pointing out how banks access the federal money and that they need to put up assets to borrow.  The Citibank example is a very good example of how when you don't have any assets you can't use the discount window, and as losses continue, more banks have to scramble to raise capital.

You cut off the Buffett quote a little soon, "Mind you, despite his bullishness, he doesn't claim to have any crystal ball for the near future. Asked how bad things could get he confessed he had no idea -- "It could be pretty bad but we always come out of it." " 

I have looked at the data of how "we always came out of it" and it has simply created bigger and bigger bubbles.  I have simply read enough on historical bubbles to consider this bubble one quite different than anything in anyone's memory. 

Buffet is billions upon billions upon billions in cash right now.

I have a green thumb floridabuilder?  I thought I killed all the plants I tried to look after...  I am not sure how I ended up with that green thumb there fb...

GS751, I think even longer than 2009.  By the time things work into the market people will be scared of the market and it will take a while to work through the changed psychology. 

The declining rates have been leveraging the economy every step of the way down, and that leveraged growth is equally leveraged the other way when risk gets repriced.

Buffett is correct that credit is still cheap and that it is still available to credit worthy candidates, but the problem is there are lots that are looking for credit and cant get it. 

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#7) On February 09, 2008 at 6:53 PM, abitare (29.91) wrote:

Buffett is no "bull" on the US dollar:

"If the current account deficit continues," the Oracle of Omaha, Mr. Warren Buffett, reminded us yesterday, “the dollar will be worthless five-10 years from now.”

“Insanity consists of doing the same thing over and over again and expecting the same result,” the sage spake. “In the United States, the cause, in my view, of the declining dollar is the current account deficit, and the trade deficit being the biggest part of that...

“I don't know what it will look like in the short term, but force-feeding the rest of the world $2 billion a day is inconsistent with a stable dollar.” In a Q&A session with the Financial Post, Buffett admitted he had made “several hundred million” bucks buying loonies over the past year, a position that he also admitted he regretted leaving.

Today, Buffett says he currently owns only two currencies: the embattled greenback and Brazilian real. The dollar, suffice to say, hasn’t been treating him well. Buffett didn’t disclose when he bought reals, so we can only guess how he’s done on that one…

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#8) On February 09, 2008 at 7:26 PM, dwot (28.99) wrote:

Canada will go into a recession as well, but we have room in our budgets for the economy to decline.  We've been paying down our debt after we spent 10 years getting it under control.

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#9) On February 09, 2008 at 7:34 PM, dwot (28.99) wrote:

I just read what credit looks like for those without AAA rating.


The Falling Knife of Credit Spreads

Let's talk about credit spreads for a moment. The "spread" is the difference you pay, typically over LIBOR (or the London InterBank Offered Rate). LIBOR is the most important interest rate in the world, as massive amounts of debt are set according to it. Let's say you are an AAA-rated borrower. Last summer you might have been paying as little as 3.84 basis points over LIBOR. If LIBOR was at 5%, you would be paying 5.0384%. There was very little premium for what was considered risk-free money.

Today you are paying as much as 1.89% more.  Granted, 3-month LIBOR is now at 3.10, down 2.16% over the last six months, due to aggressive Fed, Bank of England, and ECB (European Central Bank) action. Thus your net cost of funding is the same, but only if you are AAA. There are actually very few AAA borrowers in the world. Let's look at how your costs may have risen if you are still barely investment-grade at BBB.

Now you have a problem. Your costs may have risen from a mere 1.45% over LIBOR to as much as 13%! The spread on some junk bonds is running as much as 18%! (All this data can be had at This is a credit market that is in serious trouble. No one wants to lend unless they can be sure of getting repaid, so the price of risk is rising rapidly.

Interestingly, there are many who actually benefit. For example, I am involved with some hedge funds in Europe that use modest leverage. We borrow at a fixed rate over LIBOR. Our spread has actually done down, as well as actual LIBOR going down. So we are well ahead of where we were last summer in terms of borrowing costs. It is an ill wind that blows no good to at least someone. Those borrowers with solid balance sheets find their costs going down.

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#10) On February 09, 2008 at 7:53 PM, mickeyc21 (29.93) wrote:

DWOT I have a lot of respect for your stock picking prowess and I read Mish regularly.

However your rebuttal of the reserves issues reads more like someone that believes the issue is real. This chart from the Fed couldn't be more blunt:

Where the Mish gets it spectacularly wrong is on the issue of collateral. He has not done the research on WHAT collateral is being accepted. Normally you have to use top quality collateral to borrow from the Fed. This is not the case now: the Fed is taking toxic waste loans as collateral because the fundamental issue is not liquidity it is solvency.

Camistocks your pro America bias is great but that quote is an incredibly subjective take on that interview. Forget what Buffett says, what is he doing?

What do you expect him to say on camera in response to a question like that?! "I think the US is finished"?!! Buffett is not the down home guy that people like to think he is. He is an incredibly shrewd operator like the rest of Wall Street. Far more shrewd obviously for convincing the world he is a regular joe depsite one of the largest financial hauls in history.

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#11) On February 09, 2008 at 9:42 PM, dwot (28.99) wrote:

Actually, I think I make it clear that I don't understand the issue, and that I saw it come up twice.  I think it is something to watch and to consider.  I've seen that graph twice, which is when I first mentioned it in a blog.  I still don't understand it.

What I do understand is the degree to which banks have leveraged lending and that leverage is a double edged sword, it has been ridden up and now comes the ride down and I can't see it being very much fun and people are going to be enormously hurt. 

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#12) On February 10, 2008 at 2:59 AM, camistocks (67.03) wrote:

What the bears don't get is that the Fed will simply change the rules when they think it is needed!

When they opened the discount window and the TAF auctions they stated that they would accept almost any kind of collateral, even CDOs and mortgage backed securities.

They also said they would be dealing with any bank that has some kind of collateral, not just the primary dealers.

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#13) On February 10, 2008 at 1:33 PM, dwot (28.99) wrote:

And what you are not getting camistocks is the level of debt.  You can only change the rules so many times, which they have, before the debt catches up and starts making the rules for you.

The debt will be making the rules, not the fed. 

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