Sunday, February 15, 2009

Anecdotes of Deflation

Earlier this week, Mike Shedlock pointed out some very relevant articles in Have Your Cake and Lend it Too. Among them were:

Banks: Feds Telling Us to Keep Cash and Lend it

NEW YORK -- Banks that are being scolded by the government for not lending are blaming a new obstacle: The government itself.

Fearing more bank failures, federal regulators are forcing institutions to hold more money in reserve and scrutinizing loans. But bank executives complain that the extra oversight thwarts their ability to quickly pump billions of bailout dollars into the ailing economy.

Banks say they are caught in a frustrating Catch-22: How can they make more loans when creditworthy borrowers are scarce, their balance sheets are saddled with bad debt and regulators are hounding them to horde cash?

"We want to lend, but the regulators are flat-out telling us, 'Get your capital up.' Then there's Congress telling you to lend it all out," said Greg Melvin, a board member at FNB Corp., a Hermitage, Penn.-based bank that got $100 million in bailout money.

"Two arms of the government are saying exactly the opposite thing - it's ridiculous," added Melvin, who is also chief investment officer at investment firm C.S. McKee.


Four government regulators oversee the country's roughly 8,500 federally insured banks and thrifts: the FDIC, the Office of Thrift Supervision, the Federal Reserve Board, and the Office of the Comptroller of the Currency.

Regulators shut down 25 banks last year and closed three so far this year because their capital levels fell too low. Meanwhile, regulators have ordered several banks to stop lending until they get more capital.

But the credit crisis has made it harder for banks to raise private capital. And the government doesn't want to give bailout money to banks that might later fail.

The fact that there are four separate regulators in charge of ensuring sound banking principles, yet this crisis occurred anyway may strike some as odd. Especially considering the oft trumpeted cause of the crisis is "lax regulation." How many more regulatory bodies would have prevented the crisis? 5? 20? That answer is never given. They always just claim "more." That way when regulation fails again, they can still claim, "it wasn't enough." Not a bad little deal they have going for themselves.

That is to say nothing of the explicit role many of those regulators played in perpetuating the crisis in the first place via moral hazard, implicit guarantees of reckless activity, or wink-wink, nudge-nudge agreements with fraudsters like Bernie Madoff.

But I digress...

"I'm skeptical," Democratic Rep. Barney Frank of Massachusettes, chairman of the House Financial Services Committee, told The Associated Press in an interview. "If you're a bank that has TARP money, then you have more capital and you should be able to lend."

Frank said the Obama administration would push for more lending by banks that get bailout money. But others fear such efforts could backfire by forcing banks to lower lending standards.

Barney Frank is a idiot. After months of sitting on the financial services committee and pushing for bailout after bailout, he still can't figure out why troubled banks are asking for money. On a daily basis more and more of banks' assets become impaired requiring higher loan/loss reserves. When those impaired assets eventually default, the banks take the loss, drawing down their reserves. Complicating matters are trillions of "assets" being held off the balance sheet.

Any spare cash donated by generous taxpayers goes directly into the black hole that are these many trillions of impaired assets. So no, Mr Frank, if you are a bank and you have TARP money, you are no more able to lend than anyone else. You're immediately right back where you started minus a tiny fraction of your total impaired assets - soon to be replaced by further falling asset prices.

Ok, so the problem is that the bailouts just aren't big enough. Let's just shower the banks with trillions. Buy up every single stinking piece of garbage on and off their balance sheets - regardless of the cost. Then they won't have any choice but to lend the money. Right? Think again.

The following article reminds us that a loan is a two-way agreement. Somebody needs to be willing to take on the debt at interest on the other side.

MidSouth Loses Would-Be Borrowers as TARP Fails With Louisianans

Feb. 12 (Bloomberg) -- C.R. “Rusty” Cloutier of MidSouth Bank wants to heed President Barack Obama’s call to lend money. It’s his customers who aren’t paying attention.

Cloutier, chief executive officer of MidSouth Bancorp Inc. in Lafayette, Louisiana, received a $20 million cash infusion from the U.S. government on Jan. 9 and instructed loan officers to line up borrowers. Then he went on the road to make personal appeals at 14 town hall meetings.

“What we want to do is make people aware we have $250 million to lend,” Cloutier said Jan. 28 at the branch in downtown Lafayette. The 20 or so in the audience were outnumbered by bank employees handing out cookies and bottled water. Nobody asked for an application.

Try to picture that in your imagination. In mine "Rusty" is dressed up as a clown, juggling Mortgage Backed Securities on a unicycle to a background of circus music. The audience is unimpressed. Looking at each other. Shaking their heads. They don't even want the cookies, let alone another mortgage.

Outstanding loans and credits at commercial banks fell to $7.057 trillion in the week ending Jan. 28 from $7.266 trillion in October, according to the Federal Reserve.

“If people thought the government would give banks money and they would turn around and leverage that and lend it, that’s not the way it works,” said Robert E. Litan, a senior fellow in economic studies at the Brookings Institution in Washington.

Ding, ding, ding. We have a winner! Indeed, that is not how it works. In a credit-based economy it works the other way. Banks make loans based on a multitude of factors, the loan is recorded as both an asset and a liability on their balance sheet. Later on, they go searching for deposits to satisfy capital ratios. Orthodox economists like Bernanke or Krugman and political hacks like Barney Frank see that A (bank lending) typically corresponds with B (total reserves). Therefore, by increasing B, A will naturally follow. This is wrong. Correlation does not imply causation. B simply piles up, because it's utility was a function of A, now absent.

Before I get too far out of my mathematical comfort zone, I'll again refer readers to Steve Keen's far more eloquent explanation of this phenomenon. If you haven't already, take a week off work and read it.

Complicating matters further, FDIC Shutters Four Banks in One Day

Loup City, Neb.-based Sherman County Bank, Cape Coral, Fla.-based Riverside Bank of the Gulf Coast, Pittsfield, Ill.-based Corn Belt Bank and Trust Company, and Beaverton, Ore.-based Pinnacle Bank were closed by regulators Friday, bringing the number of U.S. bank failures for 2009 to 13 and 38 total since the start of the credit crisis, the Federal Deposit Insurance Corp. said.

Total cost to the FDIC of these failures is $340 million. A relatively small number in comparison to the figures being thrown around lately. But the bigger issue is the precedent it sets for the other 8,500 banks.

Lost in all of this is the gross inconsistency of policy by the FDIC. If any of the large banks were to be somewhat truthful of their holdings, they would also be shuttered by the FDIC. However, because they have 1000s of lobbyists working for them and are well-connected, they qualify for a special status of "too big to fail." Those concerned about corporate oligopolies need look no further to find that the main (and only) enabler of such arrangements are governments themselves. Without government assistance, their size was never otherwise attainable.


- Banks are being told to lend and not to lend at the same time
- Banks cannot lend because their balance sheets are black holes of impaired assets
- Consumers and Businesses don't want to borrow - and can't even be enticed with free cookies
- Regulation does not prevent financial crises - it causes them
- Giving banks money and expecting them to lend it is a backward understanding of our financial system
- Monopoly is only possible with government favoritism of large firms

That's quite the list of accomplishments for a Sunday. I think I deserve a WeiƟbier.

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mike.montchalin said...

It seems natural to visualize banks beginning with depositors, then lending the deposits to borrowers.

But imagine an up and running bank: at the end of each day reserve requirements must be met.

Loans are made, then cash is raised.

So my elementary-school understanding of how banks work just got an upgrade.


mannfm11 said...

Good points Matt. The total misunderstanding of banking is what keeps it going. The nonsense they teach in money and banking isn't much of an upgrade over what is believed by school kids, namely the reserve nonsense. That applied at one time, but it is of only limited value today. Bank capital is what is important and I doubt the government put anything in banks but bonds owed them by the government,thus the banking system was recapitalized by IOU's. What a bank does is act as surety for credit, thus they create deposits for customers to pass around and guarantee the deposits will be made good. The problem a bank faces is having those deposits returned to the bank so they can keep it secret the money doesn't exist. The real problem arises over time when the liabilities of the banks, the deposits begin to exist in the accounts of one group, while their assets are owed by another group that can only pay the debts with the deposits that are now the property of the other group. Being the depositors can't spend all the money and don't need it to pay off debts, they begin to bid up asset prices. This gives some temporary relief to some that don't have the means of repayment in that their assets increase in value, thus they can mortgage their house and discharge their debts. Thus the bank has now created more money it can't repay, but they now have an asset to sell a depositor. The depositors eventually begin to bid on assets owned by others and the money merely changes accounts. I believe banking is always doomed to fail in this manner and the only way to keep it from being a depression in the end is to keep the size of the money supply limited and tax the banks out of most of their profits. There has to be some method employed of not allowing such a small group the right of creating the money supply of a country and in the case of the US, the money supply of the world.

EconStudent said...


One thing I still do not understand is why Canada seems to be fine in comparison with rest of the world.

Why isn't Vancouver and lesser extent, Toronto real estate bubble blowing up right now?

I think it is possible to walk away from a CHMC insured mortgage by declaring bankruptcy. If all these 0% or 5% down mortgages blow up, I am wondering if Canadian Federal government's AAA rating will be downgraded and/or the Canadian dollar go into a free fall due to the quantitative easing required to shore up the Canadian Federal government's balance sheet.

Matt Stiles said...

Canada is fine? That's news to me...

watching said...

EconStudent: Vancouver real estate started its decline last year and is poised for a complete meltdown this year. Just watch. Jobs are going too. BC is running a deficit. Its not going to be pretty.

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