Friday, May 14, 2010

A Succinct Enunciation of "The Problem"

On my prior post about the real problem evident in the big banks' perfect trading quarters, commenter "HT" weighed in with some thoughts that I thought were worthy of their own post.  I could probably write about 1500 words in response to this comment alone, but I think I'll just let it simmer for now, because it can stand on it's own:

"Sorry KD, I know you're working hard to understand the mechanics of the situation here, but isn't the real problem the inappropriately low Fed interest rate, not the banks that are able to benefit from a unusually tilted FICC environment?

And the low Fed interest rates are primarily due to the political desire to dampen the socio-economic impacts from many years of accumulated bad consumer borrowing behavior.

And that Tim and Ben know this policy is just giving money to the banks, even if that may not their direct intent? They might even be as troubled about this as you are?

But maybe they've played the scenarios and this is the best of the possible outcomes. That raising interest rates and increasing socio-economic stress at this moment would possibly result in public and congressional outrage directed at the Fed. That a congress that has not been strong in demonstrating its competency in understanding complexities of modern financial markets or macroeconomics may then take legislative action to cut back Fed independence and enact further restrictive policy measures on the US financial system.

And this endgame may be more damaging to the US in the long run than allowing the dynamic that you're appropriately critical of to just play out?

The banks are capitalizing on an unusual situation, but one that is rooted in the American citizen that is still relatively ignorant of their own role in causing the economic environment that's been created, and still has not faced up to their own personal accountability in taking on the pain required to restore health to our financial system. "

If I were going to sum that up in one sentence, I'd say that we're trading moral hazard for real economic pain. (We're gobbling a huge helping of moral hazard, in exchange for trying to avoid greater economic pain.)  Ponder that...

Thanks, "HT"



Anonymous said...

cmon, lets be honest. Maturity transformation is a classical business of banking. They can no do anything else, well apart from trading, but this. If this happens to be a sacred secret to some people out there then I feel really sorry for them.

Kid Dynamite said...

anon- check out the discussion that MR started in the comments of the prior related post:

Steve said...

Absent dissolution of the FED, they should take away its growth mandate and just leave it with inflation control.

The whole notion that a mere twelve individuals, in secret no less, can effectively set interest rates is absurd. The market should be setting interest rates.

Rattlesnakes don't commit suicide and the FED should be put out of our misery.

Anonymous said...

I think we make it too complex here. First, maturity transformation, regardless of whether someone likes it or not, is a fact of life. Then the question is whether FED can control the yield curve at all maturities.

Well, one could argue that FED can do it for treasuries but FED definitely can NOT do it for corporates. So corporate yield curve is defined by the market.

Next, is treasuries yield curve the place where banks make money? Banks can always borrow money at discount rate from FED and put into any treasury. So no luck here. Meaning banks make money from corporate yield curve. Does FED have any power over it? Clearly not.

So I would stop screaming about it. FED and Treasury could try to eliminate any uncertainty about macro-future and the yield curve would flatten either from short end or long end - problem solved.

Kid Dynamite said...

yes anon - good points - which is why, in the previous post, I was trying to explain that i think the profits came more from principal gains on securities (fixed income) held - largely Agency MBS - which were being purchased by the Fed!

maturity transformation aside, manipulation of asset prices and hundreds of billions of dollars of subsidies via bankrupt entities (FNM FRE) is certainly NOT part of the Fed mandate, and is (or should be) the cause of the outrage.

but I agree with you - it's almost impossible to find anyone anywhere writing those points, that the "borrow from the Fed at 0% and lend back to the Treasury at 3%" is both a) not unusual and b) probably not a very accurate description of what's happening either

ps - the corporate yield curve is not just "defined by the market" when the Fed is intervening in the market to the extent that they are! I think ZIRP alone, by definition (since people NEED return!), has a huge impact on all asset classes - including equities and the corporate yield curve.

Transor Z said...

Personally, I'm comforted thinking that Ben and the gang ran scenarios before determining that oligarchy is superior to a republic. All politics is local. And it's now located in communities you can't afford to live in -- ya peasants.

Anonymous said...

Like it or not, it's all just more proof that the "Emporer has no clothes". I hope I'm wrong more than anyone, but the signs are out there. Good luck to all.

Anonymous said...

Kid, FED can influence corporate yield curve over short periods of time but it clearly can not control it. You should ask not what effects FED actions had on corporate yield curve but rather why corporate yield curve is soooo steep. And the answer is that people do not want to put money at risk and arbitrage it, ie risks are still too high and yield curve is not steep enough

Kid Dynamite said...

anon @ 2:08 am: here's my point: there's a huge difference between 3% short term rates and 6% long term rates compared to 0% short term rates and 3% long term rates.

the curve in each scenario is 300bps, but in the second scenario you have MYRIAD unintended effects, because it forces capital into all other asset classes.

that's the problem - the consequences - intended, or otherwise, of ZIRP - which are little more than blowing more bubbles.

Matt Hill said...

HT wrote: "the American citizen that is still relatively ignorant of their own role in causing [the collapse] and still has not faced up to their own personal accountability in taking on the pain required"

The blame game - convenient but untrue. With record foreclosures and huge increases in bankruptcies since 2007, individuals that overextended themselves on credit have been held accountable, and their dependent children, etc have also felt the pain. With over 9% unemployment, many more citizens who never missed a loan payment have also taken on the pain. Even itinerant retiree savers trying to live off of safe payments from Certs of Deposit are penalized now by low rates. Subprime mortgages never had to be a systemic threat to the economy. It was the likes of AIGs appetite for CDS premiums and the failure of their investors (in inefficient free markets, I might add) to assess counterparty risk, that made the subprime market crisis a systemic threat.