Saturday, December 3, 2011

Bloomberg Can Do Better.

Secret Fed Loans Gave Banks $13 Billion,” where there’s no secret or gift.

Bloomberg must have spent a good deal of money forcing the release of the information used for the article. They seem very determined to make a story out of it. Unfortunately, although very interesting, what they found is far from headline material. Somewhere in the business section seems appropriate. Since the business section is Bloomberg’s bread and butter, it seems a good fit. However, the article doesn’t fit. It seems to have been written more to justify their effort to get the information (a definite public service by Bloomberg) than to present what the data show.

To illustrate why the article doesn’t fit as serious analysis, a few points are worth noting. The article’s use of terms like “bailout” when referring to loans might lead one to conclude that Bloomberg looks on loans as a gift. We all know better. Bloomberg isn’t a light weight when it comes to understanding the importance of financial data. The bond market is home turf for Bloomberg. Yet, the article leaves the impression of having been written by a backer of Ron Paul who objects to the Fed acting as a lender of last resort during liquidity crises. That’s unfortunate because the article attempts to raise two serious issues: were the loans mispriced, and should they have been disclosed sooner?

The Prices Charged for the Loans:

The first major issue is awkwardly implied by the title. While erroneously presenting it as a gift (i.e., gave banks), the article actually embodies a useful, but debatable, effort to determine whether the loans were mispriced. There are two problems with the effort:

First, someone should have reminded the author of the fact that the Fed essentially sets short run interest rates. The crux of how the Fed does it is by lending and borrowing at their target rate (technically they do it by buying and selling assets). Thus, the notion that they lent at below market rates is absurd. They’re trying to set market rates.

Second, during a liquidity crisis the Fed’s rates SHOULD differ substantially from what would exist absent their action. The mispricing of liquidity IS the problem they were trying to address.

Lest one conclude from these comments that the entire exercise was a wild goose chase remember the comment that getting the information was “a definite public service by Bloomberg.” Nothing said above gives the Fed a free pass to drop money from helicopters, to quote Ben. The Fed’s setting of interest rates is serious business. During a liquidity crisis it is particularly venerable to screw-ups.

So, the serious issue is did the Fed screw-up? At first glance one might conclude that the author is obfuscating the issue to facilitate a scandal-sheet-style presentation. It’s hard to figure out exactly what the data show because of the reporter’s editorializing. The article says “required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day.” But, at another point, it says “Fed had committed $7.77 trillion as of March 2009.” So, it isn’t exactly clear how much the Fed had out working for it on loan. My understanding is most of the loans were overnight repo- like arrangements. Thus, my guess is that the $1.2 trillion was a max.
Either way, if it only left $13 billion on the table, that looks amazing.

Again though, it isn’t exactly clear what the article means by “$13 billion of income by taking advantage of the Fed’s below-market rates.” I find it hard to believe the implication of $13 billion on $1.2 trillion. Given the way the Fed was pumping out liquidity, if they only left 1 percent on the table, more power to them. That, however, isn’t the way to look at it. If the loans were only earning a fraction of a percent, being off by 1 percent is a pretty big miss.

The bigger problem is the way the article tries to measure money left on the table. The objection seems to be to the fact that the banks earned ($13 billion by their estimate) on the money that was lent to them. That approach is a major shortcoming of the article. Earning money on the money they borrow (whether borrowed by taking deposits or pledging their assets) is what banks do.

In fact, Dodd-Frank, the Volker Rule, and a raft of other regulations dating back to the 1930’s attempt to force banks to rely on the very approach the article uses to measure mispricing (i.e., net interest margins). It’s almost as if the author objects to expansionary monetary policy. Usually expansionary monetary policy involves forcing down short-term rates thus steepening the yield curve and increasing net interest margins.

It seems the author has an implied assumption that the Fed should not take actions that allow the banks to profit. Seems more reasonable to assume that if the Fed can make a profit doing something that facilitates others making a profit, it has a better chance of success. People have an unfortunate tendency to let greed run amuck and thus pass up profitable opportunities simply because they can’t capture all the profit. The author seems to have fallen into that trap. Fortunately, the Fed is in the enviable position of being immunized against this particular form of financial folly by little things like the ability to print money. Lucky Fed.

So, the relevant question isn’t: How did the banks do? The relevant question is: How did the Fed do? As Bagehot pointed out a century or more ago, “During a financial crisis a central bank should lend freely against good collateral at usurious rates.” It will make a profit and end the liquidity crisis. That’s the relevant criteria.

Looked at from the proper perspective a few things about the article jump out. First, the author doesn’t seem to say how much the Fed made in profit. Guess he feels making a profit isn’t worth the effort unless it forces someone else to experience a loss. If one adds up the 190 loans shown on the table, the total profit to the Fed seems to be about $13 billion. One can’t back out a rate they charged directly from the article, but it looks to be about 1%. If correct, that’s, not a bad rate to earn on very short run (e.g., overnight) lending against collateral. It’s actually high.

If around $13 billion is the Fed’s profit, then the Fed’s profit is as great, or greater, than the profit the author thinks the banks made using the money. Since all but three of the 190 loans were profitable, all were short run, and all were collateralized (although in some cases the collateral was the equity of the bank as measured by its stocks price), the Fed wasn’t taking on the kind of risk the banks took to capitalize on the net interest margin.

One can’t fault the Fed on the “make a profit” front. Could it have been more? It’s clear such an assessment would be a lot easier now than it was then. At the time, some banks tried to say “no thanks” to the terms and experienced some arm twisting; Lehman had just failed to get liquidity at a price they would accept; Paulson’s terms for AIG got eased by the next administration for fear they would bust AIG, and even the media, which now seems to be having second thoughts, was calling for someone to “do something,” as one headline read. Yet, despite how much more we know now, it’s still questionable. “Higher rates” certainly weren’t the cry of the mob in 2008 and 2009.

So, the Fed made a profit and got reasonable rates on their loans. What about “good collateral? That’s where the article ought to be focusing. During a major panic when the need to get liquidity into the system could have swamped good judgment, the Fed made 190 loans that are listed in the article, and only three lost money.

Any way one looks at it (e.g., 1.6% default rate by number of loans, what looks to be $79M write-off on $7.7 trillion in loans, $79M of the $1.2 trillion managed portfolio of loans), there is NO room for complaining. In fact, given the severity of the crisis, it’s amazing more institution weren’t insolvent. It truly was a liquidity crisis. The figures, $1.2 trillion and 190 institutions, illustrate how severe it was. But, by highlighting the severity, the article would provide justification for a lot more mistakes than 3 in 190.

When Should the Loans Have Been Disclosed If At All.

The second issue is also awkwardly implied by the use of “secret” in the title. It’s hard to take this too seriously. Who the heck didn’t know the Fed was lending money? At the time there was open discussion of the fact that the Fed was using alternatives to the discount window in order to avoid the stigma and potential runs that might result from the disclosure associated with discount window operations.

Some of the stronger banks were encouraged to disclose their use of the facilities so that the stigma wouldn’t automatically be attached to other banks when it was disclosed that they used the facility. There were announcements of new lending programs regularly. (It seemed like a regular Monday event on Bloomberg and CNBC). There were allusions to dropping money from helicopters and blasting it out with bazookas. Funny kind of secret, to say the least.

By hyping conspiracy images of secret deals, Bloomberg may get coverage, but it hardly advances a serious discussion of when should this information be disclosed. To their credit, they do present the counter argument: “The Fed, headed by Chairman Ben S. Bernanke, argued that revealing borrower details would create a stigma.” Unfortunately, the article’s handling of the information only reinforces the impression Bernanke was right. That’s unfortunate because the information, if analyzed objectively, instead of with an eye to headlines, could add to a public understanding of the issue.

In defense of the article, nothing is as offensive as the reaction of the political class. I just wish the article had bothered to point out the lies in the “No Clue: Lawmakers knew none of this,” posturing of politician trying to ride the populist dislike of banks. How can the author let politicians say they didn’t know? Perhaps the lawmakers didn’t know the Fed lends money to banks? I don’t buy it: even if one doesn’t think politicians are the brightest light on the tree, they’re not that uninformed.

The author set up the evidence that lawmakers certainly knew with statements like: “The Fed has been lending money to banks through its so-called discount window since just after its founding in 1913. Starting in August 2007, when confidence in banks began to wane, it created a variety of ways to bolster the financial system with cash or easily traded securities. By the end of 2008, the central bank had established or expanded 11 lending facilities catering to banks, securities firms and corporations that couldn’t get short-term loans from their usual sources.” The politicians knew.

Keep in mind the statement about Bloomberg doing a public service by forcing the disclosure of the information. With that as a starting point, the open issue becomes when should it be made public? The Bloomberg article was a surprise in that respect. It seemed to indicate that not enough time has passed for there to be a serious analysis of the information. Perhaps the right amount of time is after some portion of a business cycle, or just not during election campaigns. Either conclusion would be unfortunate.

Seems to me congressional hearings on the appointment of the next head of the Fed or Bernanke’s reappointment would be when the information will be most needed. However, often a Fed chairman offers a new President his resignation, if Bernanke follows that practice, it’s relevant to the new President’s decision. Similarly, if the new President wants Bernanke’s resignation before the Fed Chairman’s term is out, the information may be useful as an explanation for the President’s request. It will then be up to Bernanke to decide whether to serve in a hostile environment, and whether to defend his method of ending the liquidity crisis.

Followers of this blog are aware that it has argued that the Fed may be overshooting on liquidity injections (see: “Stimulus Can Backfire: Monetary Policy,” “The Fed Cannot Force Investors to Shift to a Different Risk-Return Profile,” “Speak Softly But Carry a Big Stick, Dr. Bernanke,” and “Operation Twist, Or Is It the Logic That’s Twisted?” for discussion and details), but during 2008 and 2009 liquidity injections weren’t overshot. This article confirms that during that period the policy was carried out quickly and efficiently. If anything, the Fed’s subsequent potentially ill-considered revisits to liquidity injections may indicate that the initial efforts should have been bigger.

Those who follow this blog also know that when discussing TARP (See: “TARP: A success not being acknowledged”), the advice has been “follow the money.” To illustrate, one comment was “One has to follow the money and check the accounting on any pro forma. Obama and governments don't use Generally Accepted Accounting Practices (GAAP). It is essential to follow the actual money flows.” That’s the only a way to penetrate the posturing associated with the financial policies. By forcing disclosure, Bloomberg made it possible to actually follow the money. Unfortunately, they chose a different path, and by so doing, they made it harder to “follow the money.”

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