There has been some talk recently about whether the US should sell the gold it has in Fort Knox, as a way of offsetting the budget deficit.
There are reasons to suspect that the gold in Fort Knox may not be there. GATA has shown evidence of a very active program of the government leasing gold to so-called “bullion banks,” as a way of generating a return on an otherwise stagnant asset. However, in spite of that, let’s assume for the moment that the gold either is there, or can be readily recovered.
Governments and central banks have a history of holding gold, for good reasons. In World War II, a number of countries that the US government did business with would not accept dollars in payment, nor would the US accept their currencies. Many war supplies could only be purchased with gold; it was a major medium of exchange during a period of shortages and substantial uncertainty. In that sense, it is a strategic asset.
[[MORE]]Another reason central banks hold gold is in case of a currency collapse. If the dollar becomes worthless, having a large store of gold would allow a “reboot” of some kind.
In fact, I would like to suggest that the reasons central banks hold gold are the same reasons individuals should; not as an investment per se, but as a form of insurance.
This also suggests that selling the central bank’s gold would be a bad idea without other substantial changes happening first. If anything, I would argue for the reverse. Since we are clearly in the middle of a long-duration crisis, it would seem like the time to increase insurance, rather than eliminate it. However, the situation might change if the US were to adopt gold as currency again; not by backing the dollar with gold, but by repealing the legal tender laws, not taxing gains on the sale of gold, and allowing it to circulate on a by-weight basis as an alternative to the dollar. In that case, it’s possible that the resulting durable wealth of the people might be able to take the place of the central bank’s holdings – whereas if the gold is simply sold, the most likely buyer would be other central banks (as happened when central banks in Europe sold their gold).
In addition, the oft-repeated meme that the government “stole” the gold from citizens doesn’t paint the full picture. It’s true that FDR required people to turn in their gold. However, they were given paper money in exchange – money which could be spent in the same way as gold. It was the subsequent act of devaluing the dollar that was the real theft, as inflation is today.
Showing posts with label Banking. Show all posts
Showing posts with label Banking. Show all posts
Monday, 23 May 2011
Friday, 3 December 2010
The cause of the financial crisis: government policies
There's been a lot of talk lately that the financial crisis was caused by a "failure of Capitalism," and that the solution is more regulation.
I believe government policies were the primary cause of the crisis, and that more regulation will make things worse, not better. I found a very interesting hour-long talk by John Allison, formerly CEO of BB&T Bank (a large bank in the southeast), where he lays out an argument that supports this view, and thought it might be of interest to summarize it here. In case you're not familiar with Allison, he's one of the few good and honest bankers out there.
http://www.youtube.com/watch?v=aSxA-vtjRx0
Here's a summary of his arguments:
[[MORE]]Federal Reserve
The government effectively nationalized the monetary system in 1913 with the creation of the Fed. Now that the government owns and controls the monetary system, so if there's a problem, they must be involved.
Before the Fed, most banks were leveraged about 1:1. After the Fed, commercial banks were leveraged 10:1, and investment banks were 30:1.
In the early stages of the crisis, residential real estate values fell by 20% in the US. That destroyed $500B+ in capital in the financial services industry. At 10:1 leverage, that destroyed $5 trillion in liquidity (lending capacity). Appx $200B of that capital was eventually replaced, though, so the net loss of liquidity was about $3T. There is a fear now of another $100B decline in RE values, which would be another $1T loss of liquidity.
Starting in the 1960s, the Vietnam war plus Johnson's Great Society plus a desire to not raise taxes resulted in the government using the Fed to print much more money. That eventually led to high inflation in the early 80s. Savings & Loans financed fixed rate mortgages with certificates of deposit (CDs). When interest rates were raised to fight inflation, the S&Ls costs went up hugely on the liability (CD) side, and they got killed; many S&Ls failed, eventually leading to the S&L crisis.
FDIC
When WaMu went under, the FDIC covered uninsured depositors, which caused WaMu debt holders to suffer huge losses. As a result, the capital markets for banks were effectively destroyed, since investors saw that they had no legal rights with regard to the Treasury, the Fed and the FDIC.
Pick-a-payment (negative amortization) mortgages were a product that was only made possible by the guarantees afforded by the FDIC. All of the major players have failed (Countrywide, WaMu, Golden West).
During the S&L crisis in the 80s, the FSLIC forced S&Ls to hedge their interest rate risk. However, that can't be done with home mortgages, since the banks can't force a prepayment. When interest rates eventually fell, the S&Ls lost billions more on their hedge positions. The FSLIC also strongly encouraged S&Ls to enter the commercial RE business. Since they had no experience in that business, even more S&Ls failed in the early 90s.
Housing Policy
When Fannie Mae and Freddie Mac (F&F) first came on the scene in the post-early-90s market, they drove many financial intermediaries out of prime mortgage markets, due to the government guarantees on debt that F&F had, which their competitors did not.
The Community Housing Act (CRA), passed by Congress, required 50% of F&F's portfolios to be in "affordable housing" -- which caused huge market distortions.
F&F were leveraged 1000:1 before they went broke, at which time they owed $5 trillion. That leverage, combined with the Federal guarantees, made their cost of capital well below their competitors'. As time went on, they also drove competitors out of the subprime market too, and pushed some of them, like Golden West, into the pick-a-payment business.
F&F made the broker origination model possible. Brokers fed Countrywide, WaMu, etc, who then fed F&F to meet "affordable housing" goals, which helped keep their support in Congress.
F&F are huge political contributors. Combined with the political desire to push "affordable housing," it was impossible to take any meaningful action against them, in spite of the fact that it was obvious years in advance that they were going broke.
Investment bankers created financial innovations under the belief that the Fed would keep the risk in the financial markets low. Eventually, the originate and sell model replaced originate and hold. Perverse incentives were created for originators, which encouraged first sloppiness, then outright fraud. On top of that, the ratings agencies made huge ratings mistakes. The investment bankers make irresponsible decisions based on "greedy", dumb, pragmatic thinking: i.e. short-term: irrational / lacks integrity / evasion / arrogance.
SEC
The SEC sets the accounting rules used by banks and large financial institutions. Changes in accounting policies artificially created fluctations in accounting results.
One of their rule changes was "fair value accounting," also known as mark-to-market. This concept is not in keeping with a free market, because it assumes a willing buyer, but not a willing seller. The result was that banks had to mark down assets to the value that deep-discounters were willing to pay, rather than keeping them at what they would be worth when the banks were willing to sell.
This impaired the market, because potential bank buyers couldn't be sure that huge markdowns wouldn't be required after they bought something; it generated accounting risk.
If fair value accounting was applied to all businesses in the US at year end 2009 as applied to financial intermediaries, 90% of them would be insolvent, given the lack of liquidity in the markets.
Another accounting system issue is the management of loan loss reserves. The normal policy is to build up reserves in good times. But the SEC forced the use of mathematical models which prevented that approach. The models looked back at past experience. As a result, banks had very low loan losses going into the crisis. Many initial losses happened as a result of raising loss reserves -- which would not have happened if not for the SEC.
The ratings agencies (S&P, Moody's and Fitch) are a government sanctioned monopoly, backed by the SEC. They did a terrible job rating mortgage instruments. The market responded by saying maybe they also failed at rating all sorts of other securities; there was a loss of confidence in the rating system, and liquidity suffered as a result.
As an example, in the Auction Rate Municipal Bond Market insurance companies MBIA and Ambac provided funds to municipal projects such as hospital expansions. They also held a lot of mortgage debt. When mortgage debt ratings were found faulty, Ambac and MBIA's ratings remained AAA -- a failure of the ratings agencies. When this was noticed by the market, the source of funds for the insurance agencies dried up. Without sound ratings, how would an overseas investor expect to know whether some municipal project was financially sound?
The rating agencies also failed when it came to CDOs and related credit instruments. Investment banks split them into separately saleable groups. They were making money selling A, B and C traunches. Then the Fed inverted the yield curve. Borrowing short at a high yield in order to buy long at a lower yield meant there would be a loss.
The only assets the banks could hold that had a positive spread were the high-yielding Cs. The banks thought "the economy is projected to do well; just hold the Cs for now and sell them later." But the traunches were not rated correctly: A, B and C were really D-, F and F-. When the market started coming down, there were 100% losses on the Cs. Merrill Lynch, for example, got caught in this and took huge losses.
Misregulation, not deregulation
Regulatory cost was at an all-time high at the peak of the bubble in 2005 - 2007. Sarbanes Oxley (SOX) was supposed to eliminate fraud in the wake of WorldCom and Enron -- but the banking industry already had their own version of SOX imposed back in 1990 in response to the S&L crisis.
The banking industry spends about $5B/yr complying with the Patriot Act. No terrorists have been captured as a result, nor are any likely to be in the future.
There is an irrational belief in "models"; the risk in the tails of the assumed Gaussian curve aren't as small as the math would lead you to believe. Also, a 1% chance of something happening doesn't mean it will never happen.
Models don't capture human behavior, particularly under stress. The Fed's models did not predict a recession, much less one of the current magnitude. Wachovia and Citigroup both failed when using models to manage risk.
BASEL uses models to determine how much cash banks should hold. As a result, European banks had much less capital than US banks, so they went down even faster.
Regulatory compliance is a huge misdirection of management energy -- away from running their businesses effectively and safely to making bureaucrats happy who know little or nothing about the industry.
Banks regulators have actually tightened lending standards. The myth is that regulators are trying to encourage banks to make more loans. That might be true for the people at the top, but not the regulators. If you're a regulator, the worst thing that can happen is for one of your banks to get into trouble. So, there's a perverse incentive: be extremely conservative, including tightening credit standards.
I believe government policies were the primary cause of the crisis, and that more regulation will make things worse, not better. I found a very interesting hour-long talk by John Allison, formerly CEO of BB&T Bank (a large bank in the southeast), where he lays out an argument that supports this view, and thought it might be of interest to summarize it here. In case you're not familiar with Allison, he's one of the few good and honest bankers out there.
http://www.youtube.com/watch?v=aSxA-vtjRx0
Here's a summary of his arguments:
[[MORE]]Federal Reserve
The government effectively nationalized the monetary system in 1913 with the creation of the Fed. Now that the government owns and controls the monetary system, so if there's a problem, they must be involved.
Before the Fed, most banks were leveraged about 1:1. After the Fed, commercial banks were leveraged 10:1, and investment banks were 30:1.
In the early stages of the crisis, residential real estate values fell by 20% in the US. That destroyed $500B+ in capital in the financial services industry. At 10:1 leverage, that destroyed $5 trillion in liquidity (lending capacity). Appx $200B of that capital was eventually replaced, though, so the net loss of liquidity was about $3T. There is a fear now of another $100B decline in RE values, which would be another $1T loss of liquidity.
Starting in the 1960s, the Vietnam war plus Johnson's Great Society plus a desire to not raise taxes resulted in the government using the Fed to print much more money. That eventually led to high inflation in the early 80s. Savings & Loans financed fixed rate mortgages with certificates of deposit (CDs). When interest rates were raised to fight inflation, the S&Ls costs went up hugely on the liability (CD) side, and they got killed; many S&Ls failed, eventually leading to the S&L crisis.
FDIC
When WaMu went under, the FDIC covered uninsured depositors, which caused WaMu debt holders to suffer huge losses. As a result, the capital markets for banks were effectively destroyed, since investors saw that they had no legal rights with regard to the Treasury, the Fed and the FDIC.
Pick-a-payment (negative amortization) mortgages were a product that was only made possible by the guarantees afforded by the FDIC. All of the major players have failed (Countrywide, WaMu, Golden West).
During the S&L crisis in the 80s, the FSLIC forced S&Ls to hedge their interest rate risk. However, that can't be done with home mortgages, since the banks can't force a prepayment. When interest rates eventually fell, the S&Ls lost billions more on their hedge positions. The FSLIC also strongly encouraged S&Ls to enter the commercial RE business. Since they had no experience in that business, even more S&Ls failed in the early 90s.
Housing Policy
When Fannie Mae and Freddie Mac (F&F) first came on the scene in the post-early-90s market, they drove many financial intermediaries out of prime mortgage markets, due to the government guarantees on debt that F&F had, which their competitors did not.
The Community Housing Act (CRA), passed by Congress, required 50% of F&F's portfolios to be in "affordable housing" -- which caused huge market distortions.
F&F were leveraged 1000:1 before they went broke, at which time they owed $5 trillion. That leverage, combined with the Federal guarantees, made their cost of capital well below their competitors'. As time went on, they also drove competitors out of the subprime market too, and pushed some of them, like Golden West, into the pick-a-payment business.
F&F made the broker origination model possible. Brokers fed Countrywide, WaMu, etc, who then fed F&F to meet "affordable housing" goals, which helped keep their support in Congress.
F&F are huge political contributors. Combined with the political desire to push "affordable housing," it was impossible to take any meaningful action against them, in spite of the fact that it was obvious years in advance that they were going broke.
Investment bankers created financial innovations under the belief that the Fed would keep the risk in the financial markets low. Eventually, the originate and sell model replaced originate and hold. Perverse incentives were created for originators, which encouraged first sloppiness, then outright fraud. On top of that, the ratings agencies made huge ratings mistakes. The investment bankers make irresponsible decisions based on "greedy", dumb, pragmatic thinking: i.e. short-term: irrational / lacks integrity / evasion / arrogance.
SEC
The SEC sets the accounting rules used by banks and large financial institutions. Changes in accounting policies artificially created fluctations in accounting results.
One of their rule changes was "fair value accounting," also known as mark-to-market. This concept is not in keeping with a free market, because it assumes a willing buyer, but not a willing seller. The result was that banks had to mark down assets to the value that deep-discounters were willing to pay, rather than keeping them at what they would be worth when the banks were willing to sell.
This impaired the market, because potential bank buyers couldn't be sure that huge markdowns wouldn't be required after they bought something; it generated accounting risk.
If fair value accounting was applied to all businesses in the US at year end 2009 as applied to financial intermediaries, 90% of them would be insolvent, given the lack of liquidity in the markets.
Another accounting system issue is the management of loan loss reserves. The normal policy is to build up reserves in good times. But the SEC forced the use of mathematical models which prevented that approach. The models looked back at past experience. As a result, banks had very low loan losses going into the crisis. Many initial losses happened as a result of raising loss reserves -- which would not have happened if not for the SEC.
The ratings agencies (S&P, Moody's and Fitch) are a government sanctioned monopoly, backed by the SEC. They did a terrible job rating mortgage instruments. The market responded by saying maybe they also failed at rating all sorts of other securities; there was a loss of confidence in the rating system, and liquidity suffered as a result.
As an example, in the Auction Rate Municipal Bond Market insurance companies MBIA and Ambac provided funds to municipal projects such as hospital expansions. They also held a lot of mortgage debt. When mortgage debt ratings were found faulty, Ambac and MBIA's ratings remained AAA -- a failure of the ratings agencies. When this was noticed by the market, the source of funds for the insurance agencies dried up. Without sound ratings, how would an overseas investor expect to know whether some municipal project was financially sound?
The rating agencies also failed when it came to CDOs and related credit instruments. Investment banks split them into separately saleable groups. They were making money selling A, B and C traunches. Then the Fed inverted the yield curve. Borrowing short at a high yield in order to buy long at a lower yield meant there would be a loss.
The only assets the banks could hold that had a positive spread were the high-yielding Cs. The banks thought "the economy is projected to do well; just hold the Cs for now and sell them later." But the traunches were not rated correctly: A, B and C were really D-, F and F-. When the market started coming down, there were 100% losses on the Cs. Merrill Lynch, for example, got caught in this and took huge losses.
Misregulation, not deregulation
Regulatory cost was at an all-time high at the peak of the bubble in 2005 - 2007. Sarbanes Oxley (SOX) was supposed to eliminate fraud in the wake of WorldCom and Enron -- but the banking industry already had their own version of SOX imposed back in 1990 in response to the S&L crisis.
The banking industry spends about $5B/yr complying with the Patriot Act. No terrorists have been captured as a result, nor are any likely to be in the future.
There is an irrational belief in "models"; the risk in the tails of the assumed Gaussian curve aren't as small as the math would lead you to believe. Also, a 1% chance of something happening doesn't mean it will never happen.
Models don't capture human behavior, particularly under stress. The Fed's models did not predict a recession, much less one of the current magnitude. Wachovia and Citigroup both failed when using models to manage risk.
BASEL uses models to determine how much cash banks should hold. As a result, European banks had much less capital than US banks, so they went down even faster.
Regulatory compliance is a huge misdirection of management energy -- away from running their businesses effectively and safely to making bureaucrats happy who know little or nothing about the industry.
Banks regulators have actually tightened lending standards. The myth is that regulators are trying to encourage banks to make more loans. That might be true for the people at the top, but not the regulators. If you're a regulator, the worst thing that can happen is for one of your banks to get into trouble. So, there's a perverse incentive: be extremely conservative, including tightening credit standards.
Tuesday, 23 November 2010
U.S. banks will close 5,000 branches, Whitney says
Not to mention cutting 80,000 jobs....
From: http://www.bloomberg.com/news/2010-11-22/u-s-banks-will-close-5-000-branches-in-18-months-whitney-says.html
US banks will close 5,000 branches, Whitney says
U.S. banks will close 5,000 branches in the next 18 months as they face profit declines from decreased loan demand and lower fee revenue, said Meredith Whitney, the former Oppenheimer & Co. analyst who now runs her own firm.
Banks face an “uphill battle” in generating loan growth as consumers reduce debt and will receive less revenue from fees because of new regulations and the lack of a securitization market, Whitney, 41, said in a report dated Nov. 18 and obtained today by Bloomberg News.
[[MORE]]Whitney has said earnings pressures and new regulation will lead to some lower-income customers losing access to banking services. The number of households without access to the “traditional banking system” will rise to 41 million by 2015 from 30 million in 2009, she said in the Nov. 18 note.
“The most regrettable unintended consequence of some of the quickly written regulatory reform, we believe, will be the inevitable ‘debanking’ of the U.S. financial system,” said Whitney, who started New York-based Meredith Whitney Group after correctly predicting Citigroup Inc.’s dividend cut in 2007. “Fewer ‘bankable’ customers will contribute to the trend in fewer bank branches.”
Whitney also sees slower growth in investment banking. U.S. securities firms may cut as many as 80,000 jobs in the next 18 months as revenue growth slows, she said in September.
(continues)
From: http://www.bloomberg.com/news/2010-11-22/u-s-banks-will-close-5-000-branches-in-18-months-whitney-says.html
US banks will close 5,000 branches, Whitney says
U.S. banks will close 5,000 branches in the next 18 months as they face profit declines from decreased loan demand and lower fee revenue, said Meredith Whitney, the former Oppenheimer & Co. analyst who now runs her own firm.
Banks face an “uphill battle” in generating loan growth as consumers reduce debt and will receive less revenue from fees because of new regulations and the lack of a securitization market, Whitney, 41, said in a report dated Nov. 18 and obtained today by Bloomberg News.
[[MORE]]Whitney has said earnings pressures and new regulation will lead to some lower-income customers losing access to banking services. The number of households without access to the “traditional banking system” will rise to 41 million by 2015 from 30 million in 2009, she said in the Nov. 18 note.
“The most regrettable unintended consequence of some of the quickly written regulatory reform, we believe, will be the inevitable ‘debanking’ of the U.S. financial system,” said Whitney, who started New York-based Meredith Whitney Group after correctly predicting Citigroup Inc.’s dividend cut in 2007. “Fewer ‘bankable’ customers will contribute to the trend in fewer bank branches.”
Whitney also sees slower growth in investment banking. U.S. securities firms may cut as many as 80,000 jobs in the next 18 months as revenue growth slows, she said in September.
(continues)
Sunday, 28 February 2010
Money Creation and Destruction
When you take out a loan, here's what happens:
1. Let's say that a bank's first and only deposit is $1000 cash. That cash becomes "reserves." 90% of that amount becomes "excess reserves." Banks can only create new loans when they have excess reserves available.
2. A potential borrower comes to the bank, and puts up some form of collateral, such the deed to their house or car. The maximum amount they can borrow is equal to the bank's excess reserves ($900 in this case).
[[MORE]]
3. The borrower signs a note, which is a promise to back the loan within a certain time at a certain interest. The collateral is held by the bank in case the borrower defaults.
4. When the loan is funded, the proceeds are credited to the borrower's account. However, a very important point here: the loan is not funded from the bank's reserves. It is funded by creating new money, just for that purpose. As with all accounting transactions, there are two sides to this one. The other side in this case is the creation of an asset with the same value as the money created. That asset is the note.
5. The borrower makes payments on the loan. Interest goes to the bank as income, which they can then use to cover their expenses or to pay out to shareholders, as any company would. Principal goes to pay down the note. Banks don't just keep that money around and re-lend it at a later time. The money is destroyed when it's paid back, and then re-created later if/when needed for a new loan.
6. If the borrower defaults, then when the loss is recognized, the collateral is sold. If the collateral is worth less than the remaining value of the note, the difference is written off against bank earnings. In effect, the money representing bank earnings is destroyed. This happens because although banks can create money, they can't create their own earnings, and they are required to accept the consequences of making loans that don't get paid back (well, at least that's the theory, until gov gets involved via the FDIC, the Fed, TARP, etc).
Here's a video I made that gives a high-level view of the process:
http://www.youtube.com/watch?v=xNehYxy77RI
1. Let's say that a bank's first and only deposit is $1000 cash. That cash becomes "reserves." 90% of that amount becomes "excess reserves." Banks can only create new loans when they have excess reserves available.
2. A potential borrower comes to the bank, and puts up some form of collateral, such the deed to their house or car. The maximum amount they can borrow is equal to the bank's excess reserves ($900 in this case).
[[MORE]]
3. The borrower signs a note, which is a promise to back the loan within a certain time at a certain interest. The collateral is held by the bank in case the borrower defaults.
4. When the loan is funded, the proceeds are credited to the borrower's account. However, a very important point here: the loan is not funded from the bank's reserves. It is funded by creating new money, just for that purpose. As with all accounting transactions, there are two sides to this one. The other side in this case is the creation of an asset with the same value as the money created. That asset is the note.
5. The borrower makes payments on the loan. Interest goes to the bank as income, which they can then use to cover their expenses or to pay out to shareholders, as any company would. Principal goes to pay down the note. Banks don't just keep that money around and re-lend it at a later time. The money is destroyed when it's paid back, and then re-created later if/when needed for a new loan.
6. If the borrower defaults, then when the loss is recognized, the collateral is sold. If the collateral is worth less than the remaining value of the note, the difference is written off against bank earnings. In effect, the money representing bank earnings is destroyed. This happens because although banks can create money, they can't create their own earnings, and they are required to accept the consequences of making loans that don't get paid back (well, at least that's the theory, until gov gets involved via the FDIC, the Fed, TARP, etc).
Here's a video I made that gives a high-level view of the process:
http://www.youtube.com/watch?v=xNehYxy77RI
Monday, 22 December 2008
Home mortgage modifications from Fannie & Freddie
Fannie & Freddie have started to offer mortgage loan modifications. As of the moment, the loan mod is voluntary. Accepting this ’solution’ means you:
* Acknowledge the full debt regardless of the value of the home
* Waive all rights to fraudulent or predatory lending claims in the future
* Turn your loan into a full recourse loan that could follow you for life even if you choose foreclosure down the road
[[MORE]]* Remain underwater, full-leveraged, renter for the rest of your life (in most cases)
* Will save no money at 38% housing debt-to-income ratio plus all other debts
* May not discharge any of this mortgage debt through any bankruptcy even after foreclosure
If widely accepted by home owners, this will ruin the American consumer and make housing a dead asset class for decades. If you are in a serious negative equity position when signing these forms, as most are, remember that you will:
* Never be able to sell your home
* Never be able to buy a new home
* Never be able to rent your home due to owner occupant provisions
* Be responsible for the full loan amount even if the value of your home keeps dropping for the next 10-years.
The 38% debt-to-income ratio on top of all of your other debt means you will save no money and live hand to mouth to keep this underwater roof over your head.
From: http://mrmortgage.ml-implode.com/2008/12/17/fanniefreddie-come-get-your-loan-mod-pay-for-life/
* Acknowledge the full debt regardless of the value of the home
* Waive all rights to fraudulent or predatory lending claims in the future
* Turn your loan into a full recourse loan that could follow you for life even if you choose foreclosure down the road
[[MORE]]* Remain underwater, full-leveraged, renter for the rest of your life (in most cases)
* Will save no money at 38% housing debt-to-income ratio plus all other debts
* May not discharge any of this mortgage debt through any bankruptcy even after foreclosure
If widely accepted by home owners, this will ruin the American consumer and make housing a dead asset class for decades. If you are in a serious negative equity position when signing these forms, as most are, remember that you will:
* Never be able to sell your home
* Never be able to buy a new home
* Never be able to rent your home due to owner occupant provisions
* Be responsible for the full loan amount even if the value of your home keeps dropping for the next 10-years.
The 38% debt-to-income ratio on top of all of your other debt means you will save no money and live hand to mouth to keep this underwater roof over your head.
From: http://mrmortgage.ml-implode.com/2008/12/17/fanniefreddie-come-get-your-loan-mod-pay-for-life/
Tuesday, 11 March 2008
Interest rate manipulation
The problem with central banks like the Fed is that they distort the markets by setting interest rates at artificial levels. That sends incorrect signals to investors and businesses. For example, low interest rates cause business valuations to rise, so stocks go up. Or apparently cheap money might allow a business to justify a loan or an expansion that wouldn't be possible if rates were higher. That's the boom phase. What happens next is that when the economy gets "overheated" (high inflation), the central banks raise rates. Things then start to unwind: company valuations drop, new loans are no longer affordable, etc. That's the contraction (recession) phase.
[[MORE]]
On a gold standard with full-reserve banking, interest rates are always set at free-market levels -- so businesses and individuals are receiving correct, undistorted information about the economy. Rates also tend to be more consistent. Longer-term planning becomes possible; 99 yr loans again become feasible, for example. The business cycle also goes away: no more booms and busts, because the assumptions underlying investments and other spending don't suddenly turn out to be untrue.
[[MORE]]
On a gold standard with full-reserve banking, interest rates are always set at free-market levels -- so businesses and individuals are receiving correct, undistorted information about the economy. Rates also tend to be more consistent. Longer-term planning becomes possible; 99 yr loans again become feasible, for example. The business cycle also goes away: no more booms and busts, because the assumptions underlying investments and other spending don't suddenly turn out to be untrue.
Monday, 18 February 2008
Video: How Money is Created and Destroyed
I made a short video that summarizes the mysteries and magic behind the process of money creation and destruction.
Please have a look, and let me know what you think.
Please have a look, and let me know what you think.
Bank Non-borrowed Reserves
There was a recent opinion piece by Carolyn Baum on Bloomberg: How Non-Borrowed Reserves Became a Sexy Subject. While I agree with the basic facts presented by the author, I also think she leaves out a couple of important points, including why the TAF was created in the first place.
[[MORE]]
In reference to the fact that non-borrowed reserves for US banks have recently gone negative, she said:
Right. The Fed Funds market and the Discount Window both count as borrowed reserves. Non-borrowed reserves come from open market operations, where the purchase of treasury securities in the open market injects cash into the economy, which, when deposited into banks becomes reserves, since it's backed by government debt rather than commercial debt.
When the proceeds from open market operations are deposited into the banking system, they don't have a choice about whether to call those funds reserves. That's what they are, period. So the first thing that's interesting here is that banks needed to borrow more of their reserves than they have received through open market operations. Why would that happen?
The answer comes with a statement near the end of the article:
Exactly. Those losses destroy reserves. The only option banks have to replace the lost reserves is to borrow them. But other banks weren't lending much through Fed Funds, and the Discount Windows requires short-term, high-quality (AAA) assets, which were in short supply. So the TAF was created to fill the gap.
Open market operations probably could have been used to ultimately achieve the same effect, but the effect isn't instant, and the Fed has no control over which banks the resulting funds are deposited in. The fact that some banks have bigger problems than others was, I'm sure, another contributor to the creation of the TAF.
[[MORE]]
In reference to the fact that non-borrowed reserves for US banks have recently gone negative, she said:
Reserves can be borrowed (from the Fed's discount window) or non-borrowed (supplied via the Fed's daily open market operations). It matters not one whit to the Fed where the banks acquire the reserves they require. If they borrow directly from the Fed, they don't need to tap the interbank, or fed funds, market.
Right. The Fed Funds market and the Discount Window both count as borrowed reserves. Non-borrowed reserves come from open market operations, where the purchase of treasury securities in the open market injects cash into the economy, which, when deposited into banks becomes reserves, since it's backed by government debt rather than commercial debt.
When the proceeds from open market operations are deposited into the banking system, they don't have a choice about whether to call those funds reserves. That's what they are, period. So the first thing that's interesting here is that banks needed to borrow more of their reserves than they have received through open market operations. Why would that happen?
The answer comes with a statement near the end of the article:
Some of the concern is justified, he said, given banks' massive losses and writedowns on subprime loans.
Exactly. Those losses destroy reserves. The only option banks have to replace the lost reserves is to borrow them. But other banks weren't lending much through Fed Funds, and the Discount Windows requires short-term, high-quality (AAA) assets, which were in short supply. So the TAF was created to fill the gap.
Open market operations probably could have been used to ultimately achieve the same effect, but the effect isn't instant, and the Fed has no control over which banks the resulting funds are deposited in. The fact that some banks have bigger problems than others was, I'm sure, another contributor to the creation of the TAF.
Sunday, 13 January 2008
Original US central banks
Here's a quick summary of the original US central banks:
Bank of North America (formed before the Constitution was written) -- did not have its charter renewed by Congress, and closed in 1783
Bank of the United States, formed in 1791 (encouraged by Hamilton) -- fought by Jefferson, its charter was not renewed by Congress in 1811
Second Bank of the United States, formed in 1816 -- fought by Jackson, its charter expired in 1836
Jefferson's portrait is now on US $2 bills.
Hamilton is now on US $10 bills.
Jackson is now on US $20 bills.
Bank of North America (formed before the Constitution was written) -- did not have its charter renewed by Congress, and closed in 1783
Bank of the United States, formed in 1791 (encouraged by Hamilton) -- fought by Jefferson, its charter was not renewed by Congress in 1811
Second Bank of the United States, formed in 1816 -- fought by Jackson, its charter expired in 1836
Jefferson's portrait is now on US $2 bills.
Hamilton is now on US $10 bills.
Jackson is now on US $20 bills.
Thursday, 20 December 2007
How to abolish the Fed?
G. Edward Griffin, in his book "The Creature from Jekyll Island", outlines a plan for eliminating the Federal Reserve. Although I don't agree with his bi-metalism, it's otherwise a well thought-out approach, and nothing in it would be especially time consuming. Here's a short summary, modified slightly to reflect a gold-focused approach instead:
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- Repeal the legal tender laws
- Define a "new" dollar in terms of gold
- Restore free coinage at the US Mint (where you can bring in raw gold and exchange it for gold coins)
- Pay off the Federal Debt with Federal Reserve Notes created for that purpose
- Freeze the supply of Federal Reserve Notes
- Pledge the government's hoard of gold to be used as backing for all FRNs in circulation
- Determine the weight of all gold owned by the US Government and calculate the total value of that supply in terms of new dollars
- Determine the number of FRNs in circulation and calculate the new dollar value of each one by dividing the value of the precious metals by the number of notes
- Retire all FRNs from circulation by offering to exchange them for new dollars at the calculated ratio
- Convert all contracts based on FRNs to new dollars at the same ratio
- Issue gold certificates. In exchange for FRNs, recipients will have the option of taking coins or Treasury Certificates, which are 100% backed (the certificates will become the new paper currency)
- Abolish the Federal Reserve System. It would be possible to allow it to continue to operate as a check-clearinghouse, but not as a central bank
- Introduce free banking. Banks should be deregulated and cut loose from Federal bailouts. The FDIC and other similar organizations should be phased out. Banks should be required to keep 100% reserves for demand deposits
Friday, 9 November 2007
Distortions in China
China has a widely-quoted 10%+ annual growth rate, and a weak currency. Lots of exports. What's not so widely reported is that they also have something like a 40% default rate on loans -- it's all a house of cards. Growth is easy when borrowing is cheap and easy, but they're suffering now because of the increasing prices of imports used for raw materials.
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A weaker currency increases exports. Temporarily. China keeps their currency suppressed because they need the inflow of cash to keep their banking system from collapsing (due to the 40% loan default rate). They are in a deep hole that's going to be very difficult to climb out of.
China's artificially weak currency is a big issue. The reason the Chinese are being pressured to float their currency is because its artificial weakness substantially distorts the market, and causes people to make decisions that they wouldn't otherwise make.
Even today, it's still considered a smart business move to close down US-based manufacturing and move it to China. If people really understood how the economic situation is badly distorted and how fragile the Chinese banking system is, they would definitely think twice (which is why the banking aspect is close to being a Chinese state secret).
The press seem to be focused on the problems from the short-term perspective of US businesses, which is why they emphasize prices. Long-term, if the US wants to "win" against Chinese imports, one could argue that we should let them continue to abuse themselves. The problem is that they are also abusing the rest of us in the process.
Of course the Chinese aren't the only ones playing the distortion game. For example the US government distorts many widely-published statistics that are relied on by many to guide investments, timing, etc -- things like the CPI, GDP, unemployment (did you know that real unemployment in the US is around 12%, real inflation is around 10% and that we are already in a recession?).
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A weaker currency increases exports. Temporarily. China keeps their currency suppressed because they need the inflow of cash to keep their banking system from collapsing (due to the 40% loan default rate). They are in a deep hole that's going to be very difficult to climb out of.
China's artificially weak currency is a big issue. The reason the Chinese are being pressured to float their currency is because its artificial weakness substantially distorts the market, and causes people to make decisions that they wouldn't otherwise make.
Even today, it's still considered a smart business move to close down US-based manufacturing and move it to China. If people really understood how the economic situation is badly distorted and how fragile the Chinese banking system is, they would definitely think twice (which is why the banking aspect is close to being a Chinese state secret).
The press seem to be focused on the problems from the short-term perspective of US businesses, which is why they emphasize prices. Long-term, if the US wants to "win" against Chinese imports, one could argue that we should let them continue to abuse themselves. The problem is that they are also abusing the rest of us in the process.
Of course the Chinese aren't the only ones playing the distortion game. For example the US government distorts many widely-published statistics that are relied on by many to guide investments, timing, etc -- things like the CPI, GDP, unemployment (did you know that real unemployment in the US is around 12%, real inflation is around 10% and that we are already in a recession?).
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