Courtesy of Aaron Krowne. Visit ML-Implode.com for coverage of issues affecting the mortgage market.
I have to congratulate Ben Bernanke for coming up with something to say that would take the sting off of his distinct “lack of QE faith” the market read into his statements the other day… with his new comments today. The effect was had, and I suspect that few dared to wade into the substance of the zaaaany plan he outlined, and of those who began, I doubt we will hear back from most — they will certainly go mad attempting to understand the scheme and its consequences. I may be resigned to that fate myself. But before they cart me off, let me get my thoughts down. Posterity can decide who is madder… me or Bernanke.
We discussed Bernanke’s sterilized “pseudo-QE” trial balloon plan in the today’s Radio Free Wall Street podcast and here are the main takeaways of that discussion, from my perspective:
(1) It’s not clear Bernanke actually plans to do this — he may just have been spooked by the stock market stumble yesterday and wanted to appear to plan to do something “supportive” for the market without being too inflationary. Hence the superficial appearance that the new money printing will be cancelled out by borrowing (“sterilization”). In other words, this all may just be particularly opaque jawboning.
(2) There is a glaring problem with this plan preventing it from being non-inflationary in practice: the cash from the QE would go to the Fed’s “primary dealers” (the insider’s cartel of investment banks that are in on all the Fed’s deals), whereas the “sterilized” money (taken back in to “cancel out” the QE) would come from the rest of the banking system.
In other words, money would still be handed on a platter to the most speculative segment of the market to go do what it pleases, and only the more “main street-connected” portions of the banking system would effectively have cash drained from them.
(3) The Fed would be creating a “maturity mismatch” that would make its balance sheet more unstable — the QE (buying of long-term Treasuries and/or mortgage securities) would be long-term, whereas the sterilization ops would be 28-day or similar “reverse repos” (think of these as the Fed selling short-term CDs to banks). So now the Fed would have to keep “rolling” these repos as long as it has the quasi-QE outstanding, all simply to provide a “liability” that matches up with the “asset” of the quasi-QE, to keep its net balance sheet from ballooning.
You might pooh-pooh this now, but the imbalance would be somewhat akin to the growing intra-eurozone imbalances building up in the TARGET2 settlement system which are starting to become a concern on the other side of the pond. The Fed is not supposed to have glaring maturity mismatches on its balance sheet; that is supposed to be the providence of soon-to-collapse investment banks. That certainly can do nothing to inspire confidence in the Fed.
As a result, people may start measuring the Fed’s balance sheet in different ways that defeat the purpose of trying to hide this new QE and the Fed’s balance sheet growth; e.g., looking at just the long-term vs. short term balance sheet views.
Ah, but the zaniness doesn’t even stop there.
Two additional reasons this new “pseudo-QE” operation is ridiculous come via the TruthInGold blog:
This maneuver now allows banks to first, go takedown more Treasury paper, thereby financing the Government deficit spending; and second, to a much lesser extent, gives the banks capital ratio room to issue more credit card debt and mortgages.
A little discussion on these: One isn’t reining in dollar creation very well if one’s primary purpose in creating new dollar ledger entries is to fund the marginal additional Treasury issuance being driven by the federal government’s deficit. You may be avoiding looking like you are giving cash to banks, but that’s just because they are giving (that much marginally-more) cash to the Federal government.
The second item is also interesting, because even assuming the Fed (somehow) didn’t put another dime into monetizing the deficit, buying securities (Treasuries, MBS, or whatever) from the banks and then “sterilizing” the cash paid out with reverse repos still leaves the banks with the same amount of assets on their balance sheet (and the Fed ends up with more assets, but also more liabilities, by being the other side of the repos). Well, these short-term repos with the Fed will undoubtedly count strongly towards core capital, and thus, banks will still be able to lend freely based on these holdings.
Even worse, if the banks offload dodgier securities (such as the more toxic varieties of commercial or residential MBS) to the Fed, then take reverse repos for the cash, they end up with the appearance of lower–risk assets for the same dollar amounts, which should actually allow banks to expand lending even more over what they could do before. This is hardly “sterilization.”
Of course, maybe that is what Bernanke really wants.
So it seems abundantly clear that Bernanke is more concerned with the overt appearance of a ballooning Fed balance sheet than he is with actually limiting inflation (specifically, the ultimate consequences of his elective monetary expansion). This figures: Bernanke made a big to-do of his grand plans in 2009 to exit from the Fed’s various QE operations (i.e. shrink the Fed’s balance sheet), but that’s turned out to be a lot of hot air. There’s simply no way out without unleashing crushing deflation. Bernanke must, at some level, know this. So the nutty professor has thought up a Rube Goldberg machine that allows him to continue digging himself deeper, but not officially (from the perspective of the Fed’s balance sheet, at least).
So (should he do this), he will be continuing to dig the Fed deeper… but will be extending a rope along the way, claiming the rope shows he’ll be able to pull himself back up. The problem is, the other end of the rope isn’t attached to anything; it’s just flimsily nailed to the point in the pit that reads “$3 trillion deep”, and given the meekest yank, will come fluttering down onto Bernanke’s shiny pâté.
EPILOGUE: For real monetary theorist wonks.: As I was reflecting on this insanity, it occurred to me that what Bernanke is really doing is trying to prevent dollars from descending down the “monetary pyramid” from high-powered financial assets to cash and hard assets. If the Fed ends up buying every doubtful financial asset in the universe, leaving everyone else with cash, it’s obviously “game over” — because the next question is “what do we do with all this cash?” Our financial economy has become a game of musical chairs, and the music will have clearly stopped. The dollars will then have to find hard assets to bid for, and that means inflation (probably hyper).
So what the Fed is doing is creating flimsy excuses for keeping the music going (i.e. providing the superficial appearance of a “sufficiently deep” financial economy to hold all those dollars seeking investment). It’s setting up even more rickety chairs so it looks like there will be a place to sit. But these are not chairs you’d really want to sit in, in a non-distressed situation. The Fed can probably keep doing this a little while longer, but eventually people will notice that there are far fewer genuine, stable chairs (solid investments in the financial economy) than there are players of the game (dollar-holders seeking to preserve value).
On a fundamental level, dollars are, after all, liabilities of the Fed. Since the gold window has been closed, the Fed has gotten away with these liabilities being “satisfied” by more dollars — specifically, more financial economy dollar-denominated assets (“you don’t want GOLD or anything concrete for these dollars — you can INVEST them and have MORE dollars later!”). That only works as long as shares in “Brand USA” are appreciating in value. But in a sustained economic contraction, it stops working. Everything is now on the Fed, and everyone is suddenly very uncomfortable because the Fed’s set themselves up to satisfy these all implicit liabilities in the form of all the dollars out there… but “they got nuthin’”.
Apparently, it’s going to be up to the market and the general public to end the con… because, like Matt Damon in “The Informant,” the Fed is never gonna stop its lies and deceptions.