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camistocks (< 20)

"The Banks are broke"

Recs

9

February 24, 2008 – Comments (7)

There is a chart swirling around on bear blogs that is supposed to show, how so called non-borrowed reserves of banks have gone negative, indicating they are broke and rely on the Fed for reserves. And that you should even pull out your deposits!

First here's the chart:



http://thoughtsfromthetrenches.blogspot.com/2008/02/weekly-report-25th-february-2008.html


But let's dig deeper. Helped from an article by Caroline Baum :

-Banks require a certain amount of reserves, as cash or on deposit at the Fed, to meet withdrawal demands. These are so called required reserves. If the banks hold more than what's required, these reserves are called excess reserves.

-If the banks obtain their reserves via open market operations from the Fed, they are called non-borrowed reserves. Open market operations are when the Fed buys or sells securities (usually Treasuries) from the primary dealers (very big banks who are allowed to deal directly with the Fed). This is done to affect the Fed Funds rate, the rate at which banks can borrow reserves from each other overnight against collateral. These operations usually last one or two days. They are also called repurchase agreements or repos.

Banks can also lend money (=reserves) to each other for longer than overnight (1, 2, 3 months etc.) at the so called London Interbank Offered Rate or LIBOR.

If however the banks borrow the reserves directly from the Fed from the discount window at the discount rate (also against collateral), they are called borrowed reserves.

The Fed doesn't care if the banks get their reserves directly from the Fed or via the interbanking market at the Fed Funds rate or LIBOR.

Last year banks were reluctant to lend money to each other longer than overnight, to keep reserves and balance sheets stable for year end. This showed up in the huge spread between the Fed Funds rate (money overnight between banks) and the LIBOR rate (money for longer). That doesn't mean however that they didn't lend each other anymore. They just had to pay more, or a higher rate.

So what's up, why the sudden drop in non-borrowed reserves?

The Fed has recently introduced the Term Auction Credit Facility (TAF), where banks can borrow for 28 days (instead of a few days)

From Wikipedia: the Term Auction Facility, enables the Fed to auction a set amount of funds to depository institutions, against a wide range of collateral. Auctions held on December 17th and December 20th released $20 billion each in the form of 28- and 35-day loans, respectively.[4] On the December 17th Auction, bids began at 4.17% and ended with a rate of 4.65%, substantially below the discount rate. The Fed received over $63 billion in bids and released the full $20 billion to 93 different institutions.[5]

For the TAF the Fed accepts a wide range of collateral, like mortgage backed securities, CDOs etc. not just Treasuries. In fact almost every junk. Also, any bank can come not just the primary dealers. The idea was to get banks borrowing without having to tap the discount window. The discount window is regarded as a facility that is being tapped by banks in distress, since they can't get funds from the cheaper fed funds rate. So banks are reluctant to use it because it will be made public. So as to not be regarded as potentially in trouble, they will pay high rates in the interbanking market.

http://en.wikipedia.org/wiki/Term_Auction_Facility

Since reserves from the TAF are also called borrowed reserves, and every bank has chosen this facility (long term cheap money instead of very short term money), the so called borrowed reserves have vanished. Since they now have borrowed more than they need the number is now even negative. Apparently it's just accounting stuff. So currently there are total reserves ($42.1b) minus TAF credit ($60b) minus discount window borrowing ($109m) equals non borrowed reserves of minus $18b. So today the chart would look even weirder...

http://www.federalreserve.gov/releases/h3/Current/

If the Fed would reduce the discount rate below the Fed Funds rate, banks would probably go to the discount window.

Conclusion: banks have enough reserves, in fact excess reserves of around $20b, if I interpreted the data correctly (correct me if I'm wrong!). There is no doubt that there is a financial crisis and probably the Fed wanted to make sure that as many banks as possible have adequate reserves and more.

7 Comments – Post Your Own

#1) On February 25, 2008 at 12:01 AM, camistocks (< 20) wrote:

Some additions and overlooked mistakes:

-I forgot to post this quote which is commenting the chart:

Colin Twiggs of Incredible Charts produced the chart, which saved me having to do it. You have seen this chart in my previously written articles. Clearly the situation has deteriorated at a rapid pace and is much more serious than the credit scare last August. US banks have no reserves; they are for all intents and purposes, broke. In fact they are beyond broke and as I suggested last year banks are now sub-prime. 150% of the reserves at depository institutions are borrowed. That can only mean one thing, the banks have "lost" 1.5 times their original non borrowed reserves. Not only have they lost what they had, they went on and lost half as much again. If you or I did that, we would be bankrupted and probably arrested for attempting to defraud the lender.

-In the second paragraph, just after the link "Caroline Baum" it should say "Banks ARE REQUIRED TO HOLD a certain amount of reserves..."

-LIBOR is always a bit higher than the Fed Funds rate, to make up for the risk.

-in the paragraph after the link to the wikipedia article on TAF it should say: Since reserves from the TAF are also called borrowed reserves, and every bank has chosen this facility (long term cheap money instead of very short term money), the so called NON-BORROWED reserves have vanished.

-currently (2/13/2008) there is $102m borrowed from the discount window, not $109m

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#2) On February 25, 2008 at 5:08 AM, DemonDoug (32.44) wrote:

This is the key:

"For the TAF the Fed accepts a wide range of collateral, like mortgage backed securities, CDOs etc. not just Treasuries. In fact almost every junk. Also, any bank can come not just the primary dealers. The idea was to get banks borrowing without having to tap the discount window. The discount window is regarded as a facility that is being tapped by banks in distress, since they can't get funds from the cheaper fed funds rate. So banks are reluctant to use it because it will be made public. So as to not be regarded as potentially in trouble, they will pay high rates in the interbanking market."

All collateral before had to be federal t-bills.

Bottom line? The fed is now monetizing all this bad debt.  Which is why you've seen gold and silver and oil and everything that has a set limit of supply shoot through the moon.  All this crap that should go to die is creating a highly inflationary environment.  Eggs at my local store have gone up 50% in the past 6 months.   This is a direct result of the Fed's manipulations as a currency creator.  BTW if gdp growth is 2% and inflation is 3%, are we really growing, or are we just inflating the currency to pretend like we are growing when in fact we are contracting?  Sales in January were up on oil sales - because of higher prices.

Tell me this isn't going badly cami.  Tell me.

Got oil? 

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#3) On February 25, 2008 at 11:06 AM, camistocks (< 20) wrote:

Doug, well as you can see from my CAPS picks I have all the usual suspects for inflation: golds, oils, commodities!

As for food inflation: blame ethanol and the developing countries who want to eat better food, since they can afford it. The Fed can't do anything about it.

BTW I own CALM, an egg producer, so I am profiting from you directly, thanks! hehehe ;-) 

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#4) On February 25, 2008 at 8:22 PM, ChrisGraley (29.86) wrote:

Wow! thanks for letting me know this one. If everybody thinks inflationary commodities are high now, wait till all that so called collateral dries up and the FED has no choice but to keep printing money.

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#5) On February 26, 2008 at 12:56 AM, abitare (72.06) wrote:

I think the next asset bubble will be food and other commodities.  The FED has to create these bubbles  in order  to give Wallstreet  a reason to exist.  It is  like a gov contract.

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#6) On February 26, 2008 at 10:45 PM, camistocks (< 20) wrote:

The Fed is part of the banking system, so they won't let the banks and Wall Street go under. I just try to make money in this "jungle".

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#7) On February 29, 2008 at 7:07 PM, camistocks (< 20) wrote:

Here the official commentary from the Fed:


February 08, 2008
Recent Declines in Nonborrowed Reserves

The H.3 statistical release indicates that nonborrowed reserves of depository institutions have declined substantially since mid-December to a level that is now negative. This development reflects the provision of a large volume of reserves through the Term Auction Facility (TAF) and has no adverse implications for the availability of reserves to the banking system.

By definition, nonborrowed reserves are equal to total reserves minus borrowed reserves. Borrowed reserves are equal to credit extended through the Federal Reserve's regular discount window programs as well as credit extended through the TAF. To maintain a level of total reserves consistent with the Federal Open Market Committee's target federal funds rate, increases in borrowed reserves must generally be met by a commensurate decrease in nonborrowed reserves, which is accomplished through a reduction in the Federal Reserve's holdings of securities and other assets. The negative level of nonborrowed reserves is an arithmetic result of the fact that TAF borrowings are larger than total reserves.

http://www.federalreserve.gov/feeds/h3.html#73

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