Fed Sees Recession Lasting Through First Half of 2009

You have to take this news out of the Fed with a ton of salt, since they didn't see the recession or the housing crisis coming, despite the fact that they caused it by their money supply manipulations.

That said, according to minutes of the closed-door meeting of the Federal Open Market Committee on Oct. 28 and 29. The Fed governors and Fed bank presidents "generally expected the economy to contract moderately in the second half of 2008 and the first half of 2009, and agreed that the downside risks to growth had increased."

For a group that hasn't done too well on the forecast front, they do get into some detailed forecasts. The minutes, for example, also report that "Participants agreed that inflation was likely to diminish materially in coming quarters."

Given that the Fed is now printing money again, and that it will only take a lessening of the desire to hold cash balances that will re-ignite inflation, the Fed's expectations that inflation is likely to diminish materially is a very bold statement, and has a good chance of proving very wrong by mid-2009.

Fed Hiding Data On What It Is Accepting as Collateral on Bailout Loans It Is Making

Bloomberg News on May 21 asked the Fed to provide data on the collateral posted between April 4 and May 20. The Fed said on June 19 that it needed until July 3 to search out the documents and determine whether it would make them public. Bloomberg never received a formal response that would enable it to file an appeal. On Oct. 25, Bloomberg filed another request and has yet to receive a reply.

Thus, on Friday, Bloomberg asked a U.S. court today to force the Federal Reserve to disclose securities the central bank is accepting on behalf of American taxpayers as collateral for $1.5 trillion of loans to banks, based on the Freedom of Information Act.

According to Bloomberg, the Fed staff planned to recommend that Bloomberg's request be denied under an exemption protecting ``confidential commercial information,'' according to Alison Thro, the Fed's FOIA Service Center senior counsel. The Fed in Washington has about 30 pages pertaining to the request, Thro said today before the filing of the suit. The bulk of the documents Bloomberg sought are at the Federal Reserve Bank of New York, which she said isn't subject to the freedom of information law.

``This type of information is considered highly sensitive, and it would remain so for some time in the future,'' Thro said.


The Fed has lent $1.5 trillion to banks, including Citigroup Inc. and Goldman Sachs Group Inc., through programs such as its discount window, the Primary Dealer Credit Facility and the Term Securities Lending Facility. Which is above and beyond the $700billion approved by Congress in a bailout package.

More Fear Factors

As I have pointed out, M1 continues to show exceptional growth. I have taken this growth as a signal that sgnificant fear remains within the financial system.

Brad Setser looks at Treasuries versus Agencies, and sees the same situation:

The general flight out of risk by central banks is one reason why the Treasury’s bailout of the Agencies has failed to halt the central bank run on Agencies. The flight out of Agencies — and flight into Treasuries — over the past two months has been stunning. Last week continued the trend: central banks added close to $20b to their Treasury portfolio at the New York Fed while cutting their Agency holdings by $7 billion. That helps support the Treasury market amid all the new supply, but hasn’t done wonders for the market for Agencies.

Setser then takes a look at the Fed's balance sheet:

The changes in the Fed’s own balance sheet this week were driven by the growth in its new commercial paper facility — and rising bank deposits at the Fed. Right now the Fed has raised over a trillion dollars from the new supplementary financing facility and the rise bank deposits at the Fed. Those new funding sources — rather than the sale of the Fed’s holdings of Treasuries — have financed its huge lending to the US financial system and its large swap lines with the world’s central banks...

I increasingly suspect that one indicator that the financial crisis has truly turned a corner will come when the Fed’s balance sheet starts to shrink …

Federal Reserve Announces It Will Alter Formulas Used to Determine Interest Rates Paid on Required Reserves and Excess Reserves

As I previously indicated, the Fed Funds rate is not as important a factor in money supply growth as it was in the past, now that the Fed is paying interest on bank reserves. But, Bernanke does like to monkey with his "new tools". So we have a bit of Fed monkeying with the new tools, today.

The Fed announced today that it will alter the formulas used to determine the interest rates paid to depository institutions on required reserve balances and excess reserve balances.

Previously, the rate on required reserve balances had been set at the average target federal funds rate established by the Federal Open Market Committee (FOMC) over a reserves maintenance period minus 10 basis points. The rate on excess balances had been set as the lowest federal funds rate target in effect during a reserve maintenance period minus 35 basis points. Under the new formulas, the rate on required reserve balances will be set equal to the average target federal funds rate over the reserve maintenance period. The rate on excess balances will be set equal to the lowest FOMC target rate in effect during the reserve maintenance period. These changes will become effective for the maintenance periods beginning Thursday, November 6.

The Board judged that these changes would help foster trading in the funds market at rates closer to the FOMC's target federal funds rate.

Fed: 'Bailout' Loans Are For Insiders, Not Consumers

The Federal Reserve Board today alerted the public to instances of questionable solicitations directed at consumers. These solicitations promise consumers access to personal loans through a nonexistent Federal Reserve lending program.

Under this fraudulent scheme, targeted individuals are told that that they can work through a broker to access a Federal Reserve program that extends sizable secured loans to consumers. Consumers are encouraged to deposit large sums of money into a bank account, under the guise of a security deposit, in order to receive the purported loan.

The Federal Reserve is advising consumers that it has no involvement in these solicitations and does not directly sponsor consumer lending programs. The matter has been referred to the appropriate authorities for action.

On the other hand, if you are Goldman Sachs, the $10 billion should be in your account shortly.

Wall Street Knows A Gift Horse When It Sees One

Today's climb of 889.35 points, or 10.9%, in the Dow Jones Industrial Average to 9065.12, included gains in all 30 of its components.

The catalyst for the move: News that sales of longer-term commercial paper soared 10-fold after the Federal Reserve began buying the corporate paper.

Companies yesterday sold 1,511 issues totaling a record $67.1 billion of the debt due in more than 80 days, compared with a daily average of 340 issues valued at $6.7 billion last week, according to Fed data. The Fed began buying commercial paper from companies yesterday.The central bank probably absorbed about $60 billion of the total, said Adolfo Laurenti, a senior economist at Mesirow Financial Inc, according to Bloomberg.

It's possible the Fed sterilized this buying, but if they didn't money supply is gong to rocket.

The Coming Collapse Of Treasury Security Prices

FT has a solid article this morning on the huge Treasury offerings that will be required because of the "bailouts".

Among the points made:

Before the recent upheavals, the US budget deficit for the fiscal 2009 financial year starting this month was estimated between $400bn and $450bn. Some economists now expect that figure to reach $1,000bn, which would be a record. That will push Treasury debt sales sharply higher...

“It is pretty conservative to say that the cost of the bail-out will be $1,000bn and by the time all the programmes have been tallied, it could be $2,500bn,” says Jamie Jackson, portfolio manager at RiverSource Investments...

This is all going to mean greater frequency of issuance and a return of previously discontinued issues such as the three-year note and possibly the seven. At a minimum, dealers expect the return of the three-year note, which was suspended in May 2007. The sale of 10-year notes is expected to move to a monthly schedule from being sold twice every quarter at present. New sales of 30-year bonds are seen occurring every three months...

From a logistical standpoint, the quarterly sale of debt in November and this week’s sales are a major test for the thinning ranks of primary dealers. These are the banks and securities broker-dealers that participate in Treasury auctions.

From 20 primary dealers at the end of 2007, Bear Stearns, Lehman Brothers and Countrywide have fallen by the wayside this year. The list will shrink to 16 once Merrill Lynch is absorbed by Bank of America.

Fewer dealers at a time when banks are preserving their balance sheets before the end of the year has contributed to an erosion in liquidity for buying and selling current and older Treasury securities. That backdrop could lead to poorly received auction sales, with yields for new notes being awarded at much higher levels, driving up the cost for the Treasury and taxpayers...

Tom di Galoma, head of trading at Jefferies & Co says: “No one has any balance sheet room and supply is a concern for the rest of the quarter.”..

Treasury in recent weeks has been selling securities in a buyers market as the flight to quality has caused enormous demand of Treasury securities. This will all change when the market stabilizes. Not only will there be less demand for Treasury securities, but there is likely to be major liquidation of currently held Treasury positions. A flight from Treasury securities is a very real possibility. This will also have negative ramifications for the dollar.

The only way to stem the collapse of the Treasury market would be for the Fed to step in and become an aggressive buyer of Treasury securities. This would be an exceptionally inflationary move. Bernanke has been running an erratic money supply operation since he has taken over, so it is impossible to guess how inflationary he is willing to get to protect Treasury rates. It is likely to result in a combination of some Fed buying coupled with a climb in rates.

The noose on government money operations is tightening again. For savvy traders, it will be a huge money making opportunity. For the average Joe, plumber or not, it will be a lower standard of living as rates climb, inflation climbs and Treasury borrowing crowds out private sector borrowing.

On The Huge Spike In The Fed's Balance Sheet

Bob Murphy emailed me to ask me my thoughts on the huge spike in the Federal Reserve balance sheet. This is an important enough topic that I will outline my thoughts in this post.

There has been huge coverage in the econ/blog world with regard to this spike--a lot of the commentary being confused or just plain wrong. Anyone, for example, calling the spike a major inflationary injection is way off.

The best coverage I have seen has come from James Hamilton at Econbrowser.

Here's one of the charts that everyone is getting worked up about.

Here's Hamilton's take on what is going on:

...the real action began last month...the Fed expanded its total asset holdings by $600 billion over the last 30 days, with less than a third of this going directly into reserve balances...

Reserves ballooned [immediately after 9-11] to $67 billion, as excess reserves simply piled up in some banks while others remained in need. Last week's spike of $171 billion was 2-1/2 times as big-- the breakdown of interbank lending last week proved more profound than that caused by the physical disruptions in New York in 2001.

Anyone who suggests that last week's ballooning reserve deposits represent inflationary pressure or the Fed monetizing the deficit simply doesn't know what they're talking about. Banks are sitting on the reserves, not withdrawing them as cash. When markets settle down, the Fed can and will absorb those reserves back in with sterilizing sales of Treasury securities, just as it did in 2001 or after the more modest spike in August 2007....

...we see that creating new reserves, as dramatic as it was, was dwarfed in magnitude by some of the other actions the Fed took over the last month...

I gather that the Treasury auctioned off some extra T-bills to the public, in addition to their usual weekly auction, and simply kept the receipts as deposits in an account with the Fed. If that were the end of the story and the Fed kept its total liabilities constant, it would result in a huge (completely infeasible technically) drain on reserve balances and currency in circulation, as banks sought to deliver reserves to the Treasury's account to honor their customers' purchases of the T-bills. So the Fed offset the supplemental Treasury auction with a matching purchase of private assets, such as the PDCF and AMLF, thereby temporarily delivering reserves to banks which the banks in turn could hand over to the Treasury supplementary account. The net result of such dual Treasury/Fed operations is that the newly created "reserves" would just sit there in the Treasury supplementary account doing nothing other than standing as an accounting entry. In other words, the device allowed for a huge expansion of the Fed's balance sheet without causing any change in currency in circulation or reserve deposits.

So there you have it. The flight to quality is resulting in the Treasury being able to raise huge amounts in the T-Bill market. By treasury depositing the proceeds at the Fed, it is the same as the Fed drawing these huge reserves out of the economy. Thus the Fed re-injects the funds by its its purchases through currency swaps, primary dealer credit facility operations and the like. Resulting in a non-event, from a money supply perspective, in spite of the huge increase in assets on the Fed's balance sheet.

The theory then is that when the flight to quality reverses itself, the entire operation will reverse itself. The T-bill owners will demand payment for their T-bills, the Treasury will draw down on its reserves at the Fed to pay off the T-bills, and the Fed will drain money from the system to offset the new money coming into the system from payments to T-bill holders by the Treasury. But, here's the rub, to drain reserves the Fed will have to sell off the securities it has purchased. It may be able to sell off its commercial paper, but who is going to buy the junk mortgage backed securities it has purchased? Thus, this could all turn out very inflationary once the Treasury needs to pull its deposit with the Fed.

Bottom line: Changes in M2 nsa money supply remains the best indicator of how much net-new money the Fed is adding to the system.

Going Global: Clueless Forecasts, Federal Reserve Style

TimesOnline headline, last week: Terror as Iceland faces economic collapse

As I have pointed out, New York Federal Reserve economists, McCarthy and Peach had no clue that the housing market was in a bubble.

Now comes word that Tryggvi Herbertsson, then an economist at the University of Iceland, and Frederic Mishkin, a Columbia professor at the time who would later become a Federal Reserve governor wrote a report in 2006 titled, “Financial Stability in Iceland“. The report states that “Although Iceland’s economy does have imbalances that will eventually be reversed, financial fragility is not high and the likelihood of a financial meltdown is very low.”

My reason behind posting these Irving "Stocks have reached what looks like a permanently high plateau." Fisher type forecasts is to emphasize that Fed members have no special insights into the economy, and it is absurd to think the Fed is going to somehow regulate against economic bubbles, when there is no evidence that they can consistently detect them. Further, the Fed doesn't appear to understand ABCT, which points the finger at the Fed as the main culprit in most bubbles.

Fed Gives Green Light To New York Fed To Pump Up To Another $37.8 Billion Into AIG

The Federal Reserve Board has authorized the Federal Reserve Bank of New York to borrow securities from certain regulated U.S. insurance subsidiaries of the American International Group (AIG), under section 13(3) of the Federal Reserve Act.

Under this program, the New York Fed has the green light from the Fed to borrow up to $37.8 billion in "investment-grade" (Yeah, right), fixed-income securities from AIG in return for cash collateral. These securities were previously lent by AIG’s insurance company subsidiaries to third parties (And apparently, the third parties don't want them as collateral, anymore).

For those keeping score, this is in ADDITION to the drawdowns to date of $85 billion under the original New York Fed loan facility.

Central Banks Coordinate Emergency Rate Cuts

Following crashing global stock markets, the world’s major central banks including the Federal Reserve, the Bank of England and the European Central Bank announced coordinated interest rate cuts.

In an emergency early morning announcement (7:00 AM ET), the Fed said it cut the Fed funds rate 50 basis points to 1.5 percent. It also cut the discount rate by the same amount.

"The Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates," said the Fed.

This can be seen as a somewhat cosmetic move by the Fed since they have been aggressively pumping money into the system in recent days, anyway. As we have pointed out, the Fed has pushed the funds rate far below the previous Fed target rate of 2%. Indeed, the Fed market activities in recent days has pushed rates even below the new target. From September 19, the Fed Funds rate has traded for the most part significantly below 2%.

Further, as we pointed out yesterday, the Fed's new ability, to pay interest on reserves held by commercial banks at the Fed, dampened the need for rate cuts, as the technical ramifications of the Fed interest rate payments will allow it to add as much reserves as it desires at a given target rate, so long as the target is above the real interest rate for reserves. In comments later yesterday, Bernanke supported this interpretation of the ramifications of the Fed paying interest on reserves held at the Fed.

However, the market not grasping the intricacies of Bernanke's new advanced money printing ways, reacted strongly to the news of a cut in the old fashioned Fed policy tool, the Fed Funds rate. In overnight trading, after the emergency rate cut announcements, the Standard & Poor’s 500 stock index futures climbed by 2%.

Bernanke Confirms Ramifications Of Fed's New Ability To Pay Interest On Bank Reserves

In a speech today before the National Association for Business Economics 50th Annual Meeting in Washington, D.C., Fed Chairman Bernanke confirmed my earlier analysis today of the ramifications of the Fed's new ability to pay interest on bank reserves. From Bernanke's speech today:

The Federal Reserve has also been granted a new authority, the ability to pay interest on bank reserves, which will allow us to expand our lending as needed to support the system while better managing the federal funds rate...

The expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding. Recently, however, our liquidity provision had begun to run ahead of our ability to absorb excess reserves held by the banking system, leading the effective funds rate, on many days, to fall below the target set by the Federal Open Market Committee. This problem has largely been addressed by a provision of the legislation the Congress passed last week, which gives the Federal Reserve the authority to pay interest on balances that depository institutions hold in their accounts at the Federal Reserve Banks. The Federal Reserve announced yesterday that it will pay interest on required reserve balances at 10 basis points below the target federal funds rate, and pay interest on excess reserves, initially at 75 basis points below the target. Paying interest on reserves should allow us to better control the federal funds rate, as banks are unlikely to lend overnight balances at a rate lower than they can receive from the Fed; thus, the payment of interest on reserves should set a floor for the funds rate over the day. With this step, our lending facilities may be more easily expanded as necessary.

Bottom line, the ability to pay interest on reserves is a new highly powerful tool for the Fed to use. It will result in the Fed having the ability to increase reserves without necessarily changing the Fed Funds rate. This is not a taser gun, it is a bazooka--and has the potential to be a very inflationary tool.

Fed Funds Rate Cuts Have Become Irrelevant

A new litmus test has developed to determine how well economists understand the machinations of Federal Reserve operations.

Any analyst now calling for cuts in the Fed Funds rate, or forecasting further cuts in the rate, will fail the test.

Yesterday, the Fed announced that it will begin to pay interest on depository institutions' required and excess reserve balances.

The Financial Services Regulatory Relief Act of 2006 originally authorized the Federal Reserve to begin paying interest on balances held by or on behalf of depository institutions beginning October 1, 2011. The recently enacted Emergency Economic Stabilization Act of 2008 (The Paulson 'Bailout' Plan) accelerated the effective date to October 1, 2008.

The interest rate paid on required reserve balances will be the average targeted federal funds rate established by the Federal Open Market Committee over each reserve maintenance period less 10 basis points.

The rate paid on excess balances will be set initially as the lowest targeted federal funds rate for each reserve maintenance period less 75 basis points.

Paying interest on required and excess reserve balances changes the entire role of the Fed Funds rate with regard to Fed monetary policy, as long as real rates are below the rate paid by the Fed on excess reserves.

The Fed generally adds monetary reserves to the system through its open market operations, i.e., the buying of Treasury securities. This, in the past, had a downward impact on the Fed Funds rate, as the new money the Fed adds shows up as reserves at various banks. Thus, in the past, the more new reserves, the more the Fed Funds rate dropped, since the Fed Funds rate is a rate set by the loaning and borrowing of the reserves. With the Fed targeting the Fed Funds rate, most recently at 2%, the Fed was in effect frozen, by its own target, from adding more reserves to the system if the Fed Funds rate was already at 2% , since any additional purchases of Treasury securities would push the Fed Funds rate below the targeted 2% rate.

Recently, given the crisis environment, the Fed has ignored its own publicly stated Fed Funds rate target and added reserves that pushed the Fed Funds rate below 2%. Last week, the Fed Funds rate traded at 1.56%, 2.03%, 1.15%, 0.67%, 1.10%, respectively from the period September 29 to October 3. This is unusual. The Fed generally stays at its target. So under the old rules, if the Fed wanted to add reserves, it would more than likely cut the target Fed Funds rate below 2%, to keep the target in line with its actual operations. Now, however, with the Fed paying interest on its reserves at a rate near the target Fed Funds rate, the Fed can add any amount of reserves it wants and the Fed Funds rate won't go down, because the Fed is, in effect, simultaneously providing a floor to the Fed Funds rate at the near target rate, or at least the target rate for the excess reserves, since a bank will not withdraw reserves when the Fed will pay it for the reserves.

In summary, in the past, a cut in the Fed Funds rate was required to increase Fed open market operations to add reserves. This is no longer the case, now that the Fed will support the Fed Funds rate by paying interest on required and execess reserves AND it is has always been the actual adding of reserves, rather than the cut in rates that has fueled the economic boom times with the new money flowing into the economy.

Further, because the Fed has put in a spread of 75 basis points between what it will pay on required reserves versus what it will pay on excess reserves, there is increased incentive for banks to put the money to work and get it in the higher paying required reserve column versus the excess reserve column.

The Fed may cut the funds rate in the future for cosmetic reasons to calm the markets, but it is not necessary for the Fed to do so, given that it is now paying interest on reserves at above market rates.

Thus, any analyst calling for a Fed rate cut doesn't understand how the Fed works and the impact the new rule changes will have.

Fed Quadruples Dollar Availability To Foreign Central Banks

The international re-inflation has begun.

The Fed increased the amount of dollars that the European Central Bank, the Bank of Japan and other counterparts can offer from $67 billion to $247 billion ``to address the continued elevated pressures in U.S. dollar short-term funding markets.'' The Bank of England, the Bank of Canada and the Swiss National Bank also participated.

Following the announcement the cost of borrowing in dollars overnight dropped to 3.84 percent from 5.03 percent yesterday.

Under the new arrangements, the ECB doubled its limit of dollars it can get from the Fed to $110 billion and Switzerland's central bank can offer $27 billion, an extra $15 billion. New swap facilities with the Bank of Japan, the Bank of England and the Bank of Canada amount to $60 billion, $40 billion and $10 billion, respectively. The arrangements are authorized until Jan. 30.

The ECB said it would offer $40 billion ``for as long as needed'' in overnight funds to the region's banks. It will also increase by $5 billion the amount it lends for 28 days and 84 days to $25 billion and $15 billion. The Swiss National Bank will boost its 28-day auctions to $8 billion and the 84-day offering to $9 billion. Both were previously $6 billion.

The Bank of Canada said it has decided not to draw on its $10 billion swap facility at this time. The Bank of Japan, whose policy board held an emergency meeting today, said it will use its $60 billion as required by market conditions.

In auctions of their own currencies, the ECB today lent 25 billion euros in one-day money and the Bank of England 66.2 billion pounds in one-week loans.

-EPJ Newsdesk

What Happens If There Is A Run On Money Markets? Is There A "Money Market Mutual Fund Holiday" Ahead?

News that the  Reserve Primary Fund, the oldest mutual fund in the country with $64 billion under management, has broken the buck and frozen resumptions for 7 days, is not good.

Edges of panic are beginning to appear throughout the system. There is a flight to absolute safety. 3-month T-Bills are trading to yield 0.558% ( yield not seen since 1954!).  Gold, as I write, is up over $88.50.

Clearly, gold and Treasury bills are the only safe havens in investors eyes. If another money market mutual fund freezes redemptions, all out panic could ensue. How exactly does the government stop that panic? The possibility of freezing all money market funds in a "money market mutual fund holiday," à la the Great Depressiom "Bank Holidays", can not be ruled out. The Fed and Treasury would then buy themselves some time to pump money into the entire money market mutual fund system, somehow.

Pray it doesn't come to this, but if money market mutual fund redemptions begin to soar, I see no alternative.

-Robert Wenzel 

Paulson Statement On Fed Action Surrounding AIG

September 16, 2008
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Statement by Secretary Henry M. Paulson, Jr. on Federal Reserve Actions Surrounding AIG

Washington, DC--

Treasury issued the following statement by Secretary Henry M. Paulson, Jr. on Federal Reserve actions surrounding American International Group:

These are challenging times for our financial markets. We are working closely with the Federal Reserve, the SEC and other regulators to enhance the stability and orderliness of our financial markets and minimize the disruption to our economy. I support the steps taken by the Federal Reserve tonight to assist AIG in continuing to meet its obligations, mitigate broader disruptions and at the same time protect the taxpayers.

-EPJ Original Documents

Fed Loan To AIG Will Be 850 Basis Ponints Over LIBOR

The Federal Reserve Board is lending as much as $85 billion to rescue American International Group. The Fed will earn 850 basis points above LIBOR and will also receive a 79.9% stake in the company.

As of December 31, 2007, AIG listed $1.1 trillion in assets.

-EPJ Newsdesk

Fed's Statement On AIG

Text of the Federal Reserve’s statement on AIG.

The Federal Reserve Board on Tuesday, with the full support of the Treasury Department, authorized the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) under Section 13(3) of the Federal Reserve Act. The secured loan has terms and conditions designed to protect the interests of the U.S. government and taxpayers.

The Board determined that, in current circumstances, a disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance.

The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.

The AIG facility has a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.

-EPJ Original Documents

Will The Fed Sterilize The $85 Billion AIG Bailout?

It is very likely the Fed will do so, that has been the modus operandi of the Ben Bernanke Fed. 

Rather than print new money for its bailouts, the Fed has been using the Treasury securities in its portfolio, i.e. sterilizing the bailouts, but that portfolio has been dwindling of Treasury securities as the bailouts and  "special credit facilities" draw on that portfolio. Exactly one year ago, the Fed held $779 billion in  Treasury securities. As of last week, the portfolio holds $479 billion. An $85 billion drawdown of that portfolio takes it down to $394 billion.  Ouch. The portfolio has been cut in half in the last year. 

The Fed only has $394 billion for bailout sterilizations, after that the Fed has one option, money printing, with all its ugly inflationary ramifications.

-Robert Wenzel

Government May Take Control of AIG; $90 Billion Loan

The Fed is considering offering a secured bridge loan to AIG, and under the proposed rescue plan, the U.S. government may end up controlling the firm, according to a person familiar with the matter, WSJ is reporting.

UPDATE CNBC reports:

Sources put the size of the loan at $85 billion to $90 billion, adding that it will be secured and include incentives for quick asset-sales by AIG.

As part of the deal, the government will get warrants for most of AIG’s equity—severely diluting existing shareholders.

UPDATE 2 NYT reports:

Fed to Give A.I.G. $85 Billion Loan and Take 80% Stake

In an extraordinary turn, the Federal Reserve agreed Tuesday night to take a nearly 80 percent stake in the troubled giant insurance company, the American International Group, in exchange for an $85 billion loan, according to people with knowledge of the negotiations

-EPJ Newsdesk

FOMC Statement

Below is the full statement issued by the Fed's FOMC in conjunction with their decision to maintain the Fed Funds rate at 2%:


For immediate release

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent.

Strains in financial markets have increased significantly and labor markets have weakened further. Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth.

Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities. The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain.

The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Ms. Cumming voted as the alternate for Timothy F. Geithner.


-EPJ Original Documents

Fed Leaves Key Interest Rate Unchanged

The Federal Reserve said the strains on the financial markets have increased significantly, but it kept its key short-term interest rate unchanged at 2 percent.

But it went on to say that “inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities.”

-EPJ Newsdesk

Tone Deaf Federal Reserve Caused The Last 200 Point Drop In The Dow

A brief lull in market moving news is only now allowing us to catch a breath long enough to point out that the Fed caused the last 200 point drop in the market, yesterday.

The last drop came immediately after the Fed asked Goldman Sachs and J.P. Morgan Chase "to help make $70-$75 billion in loans available to AIG." WTF?

Is the Bernanke Fed totally tone deaf?

Earlier in the day,yesterday, the Fed Funds rate shot up to 6%, as banks were hoarding cash and just didn't want to lend to one another. The Fed had to inject $70 billion to force the Funds rate down to its 2% target. So we have a scenario where banks aren't even lending to one another, there are whispers that even Morgan Stanley and Goldman may not be able to withstand the panic,and the Fed goes out and asks Goldman and MorganChase to find $70 to $75 billion for AIG. I repeat the Fed had to inject funds because banks weren't loaning to one another and, in this crisis environment, the Fed asks Goldman and MorganChase to scratch up $70 to $75 billion for a firm on the brink of failure. C-L-U-E-L-E-S-S.

That's when the market tacked on the last 200 point drop in yesterday's 500 point decline.

-Robert Wenzel

Fed Injects $70 Billion to Push Down Federal Funds Rate

Following a surge in the Fed Funds rate, the Fed has added reserves twice today.

In an early market move, the Fed added $20 billion of temporary reserves to the banking system via overnight repurchase agreements. With the Fed funds rate still above target n the 6% area, the Fed added another $50 billion of temporary reserves to the banking system in a second overnight repurchase agreement.

-EPJ Newsdesk

Is No One But Me Watching The Fed?

Markets are crashing and talk across the board is of the various steps the Treasury, the Fed and the SEC are taking, BUT the one step that would reverse things is not occurring, and is not being discussed.

Federal Reserve M2 money supply growth dropped again last week. Three month annualized growth is at 1.5%. In March M2 was growing at an annualized rate of 12.5%.

There will be no end to the crisis anytime soon with the Fed maintaining its near zero growth money stance.

-Robert Wenzel

Alert: FOMC Meeting

The Federal reserve has a regularly scheduled FOMC monetary polcy meeting scheduled for Tuesday.

-EPJ Newsdesk

Paulson Statement on Lehman Brothers

September 14, 2008
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Paulson Statement on SEC and Federal Reserve Actions
Surrounding Lehman Brothers

Treasury Secretary Henry M. Paulson, Jr. made the following statement today:

I strongly support the actions announced tonight by SEC Chairman Chris Cox, Federal Reserve Chairman Ben Bernanke and market participants. These changes will strengthen and enhance our financial markets.

These initiatives will be critical to facilitating liquid, smooth functioning markets, and addressing potential concerns in the credit markets.

I particularly appreciate the efforts of market participants who came together this weekend and initiated a set of steps to facilitate orderliness and stability in our financial markets as we work through this extraordinary environment.

Today we are looking forward. This weekend's discussions made clear that both market participants and regulators in this country and abroad recognize the need to support market stability and remove uncertainty as they address current challenges.

I am committed to working with regulators and policymakers – including Congress – to take necessary and appropriate steps to maintain the stability and orderliness of our financial markets. And I will engage with regulators and policymakers around the world to that end.

Healthy capital markets are the backbone of a vibrant U.S. economy and critical to the well-being of our economy and American families. I am confident in the resilience of our capital markets, and in the commitment of U.S. regulators and market participants to work together through this difficult period.

-EPJ Original Documents

Statement From The Fed On Expanded Lquidity Facilities

The following was issued by the Federal Reserve Sunday evening, September 14, 2008:

For immediate release

The Federal Reserve Board on Sunday announced several initiatives to provide additional support to financial markets, including enhancements to its existing liquidity facilities.

"In close collaboration with the Treasury and the Securities and Exchange Commission, we have been in ongoing discussions with market participants, including through the weekend, to identify potential market vulnerabilities in the wake of an unwinding of a major financial institution and to consider appropriate official sector and private sector responses," said Federal Reserve Board Chairman Ben S. Bernanke. "The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets."

"We have been and remain in close contact with other U.S. and international regulators, supervisory authorities, and central banks to monitor and share information on conditions in financial markets and firms around the world," Chairman Bernanke said.

The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.

The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.

These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally.

Also, Schedule 2 TSLF auctions will be conducted each week; previously, Schedule 2 auctions had been conducted every two weeks. In addition, the amounts offered under Schedule 2 auctions will be increased to a total of $150 billion, from a total of $125 billion. Amounts offered in Schedule 1 auctions will remain at a total of $50 billion. Thus, the total amount offered in the TSLF program will rise to $200 billion from $175 billion.

The Board also adopted an interim final rule that provides a temporary exception to the limitations in section 23A of the Federal Reserve Act. It allows all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market. This exception expires on January 30, 2009, unless extended by the Board, and is subject to various conditions to promote safety and soundness.

-EPJ Original Documents

Fed Plans Expanded Lending Facilities

WSJ details the Feds role in the Lehman liquidation:

The Federal Reserve is expected to expand its lending facilities in the wake of the likely demise of Lehman Brothers, taking a wider array of securities, including equities, as collateral for its loans, say people familiar with the matter.

The moves, which potentially represent another landmark step in the Fed's efforts to address the deepening credit crisis, are expected to be temporary. They are meant to calm markets as they head into one of the most perilous trading environments in decades with Lehman's massive market positions on the verge of being unwound.

The key here is that this is likely another drawdown on Fed Treasury securities. In the last 12 months, Treasury securities are down by $300 billion. The Treasury only has $480 billion in Treasury paper remaining in its account. The drawdowns have occurred because the Fed has been sterilizing the capital infusions it has been making to Wall Street. That is, instead of printing more money, the Fed has been supplyng bailout funds by using its Treasury securities. At some point, if these bailouts continue, the Fed will be out of Treasury paper and money printing will begin in earnest.

And make no mistake about it, while Lehman, itself, is not being bailed out, Wall Street is. The expanded lending facilities will indirectly pay off those who hold demand obligations from Lehman and want out now. That's a bailout.

-Robert Wenzel

Bulletin: U.S. Government Assisting in Sale of Lehman Brothers

David Cho and Heather Landy of the Washington Post are reporting that the Treasury Department and the Federal Reserve are helping Lehman Brothers put itself up for sale. The details are not finalized, but sources familiar with the matter say the purchase is expected to be completed and announced this weekend before Asian markets open Monday morning.

The Fed and Treasury are talking to a wide range of firms and examining multiple scenarios for the sale of the investment broker, according to WaPo.

-EPJ Newsdesk

Paulson: Hopeful Stabilty In Housing Market By End Of The Year

Business Week just posted a Maria Bartiromo interview with Treasury Secretary Paulson. Here are key excerpts, including Paulson hinting at subtle pressure from China:

BARTIROMO: One fund manager said to me: "Look, the Chinese government, which owns billions in Fannie and Freddie paper, basically said to Paulson, 'We're not buying any more unless it is explicit that you are guaranteeing this.'"

PAULSON: That's not true. There was growing concern and questions about what Treasury was going to do, and we were reassuring investors. But I received no threats or anything as direct as you're suggesting.

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BARTIROMO: Most Americans just want to know when we will see this dramatic move stop the slide in home prices.

PAULSON: I'm hopeful we would have more stability in home prices by the end of the year, but I'm not prepared to project it.

Note: Stability won't occur for a long time unless the Fed reverses its current tight money policy. M2 money supply is growing at only a 1.8% annualized rate.

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BARTIROMO:One day after the market reacted positively to the Fannie and Freddie takeover, fears of Lehman's inability to raise capital led the S&P 500 to its biggest drop since February '07. Are there plans afoot for a takeover of Lehman?

PAULSON:I can't comment on any specific company in the news today. I've got to hop, and I thank you very much.

-Robert Wenzel

Russia May Use Wealth Fund to Support Markets

Russia is considering using money from its national wealth fund and pension fund to support financial markets where necessary in the future, Alexei Kudrin, finance minister said on Thursday as the country’s stock market inched higher following moves to bolster confidence.

On Thursday the RTS index opened 0.5 per cent higher at 1341.32, having lost almost 12 per cent during the previous two sessions. The market fell 4.4 per cent on Wednesday as investors ignored bullish remarks by President Dmitry Medvedev and an injection of $10 billion by the central bank to alleviate a chronic credit shortage.

The Russians still need to learn a few things about capitalism, like A. You don't use pension fund money to prop up the stock market. In the old days stock brokers in the U.S. used to use their cash to prop up individual stocks, they would always fail, and
B. central bank monetary injections will only cause inflation.

What? You say the U.S. uses its pension fund money, aka Social Security, to prop up the Treasury securities market and the U.S.'s central bank, the Federal Reserve, prints money to bailout financial institutons. Oh well, never mind.

-Robert Wenzel

Does Someone Want A Worldwide Liqudity Crisis?

As I have pointed out recently, the Federal Reserve has just about stopped adding liquidity to the economy. Money supply growth over the last three months is down to 1.8% on an annualized basis. Earlier this year the Fed was pumping money out at double digit rates.

Now comes word that the Bank of England (BOE) explicitly ruled out extending its Special Liquidity Scheme (SLS), while the European Central Bank (ECB) is reportedly considering tightening its lending criteria. WTF?

Great Britain's Chancellor of the Exchequer, Alistair Darling, Britan's senior economic official said last week that Britain is facing "arguably the worst" economic downturn in 60 years which will be "more profound and long-lasting" than people had expected, according to UK's Guardian.

Cutting sources of liquidty while the economy is going into "arguably the worst" economic downturn in 60 years? Do you see something wrong with this picture?

The BOE and ECB have been provding huge suppliers of liquidity to British banks. The SLS is thought to have provided £50 billion or more, while the ECB has lent banks €467 billion.

Despite pressure from some British banks for an extension, the SLS will be closed to new applications from the week of October 20, the BOE said.

According to sound business cycle theory, central banks shouldn't be messing with the money supply at all, but when the central banks pump money in the system for decades and then pull the rug out on providing liquidity, something else is going on.

The fact that the Fed, the BOE and the ECB are all pulling liquidty at the same time, in the middle of a crisis, is not likely to be a coincidence. I'm not sure what the game plan is here, but it doesn't look good for asset values or the economy overall.

Alert: FOMC Meets September 16

The next regularly scheduled meeting of the Fed's Federal Open Market Committee, to set interest rate and monetary policy, is Tuesday, September 16.

On The Road To Depression

In the most recent example of the Fed watching the wrong numbers, directors at the Federal Reserve Banks of Kansas City, Dallas and Chicago sought quarter percentage-point hikes in the discount rate before an Aug. 5 policy meeting to keep inflation at bay, Fed documents released yesterday showed.

Current price inflation is the result of money printing over recent years. It has zero to do with Federal Reserve policy over the last three to six months. It takes a long time, often years, for Fed policy to be reflected in consumer price inflation.

At present, interest rates appear to be ABOVE real rates, since, as we have pointed, out before, money supply growth has slowed to a trickle. Any further hike in rates will simply tighten credit in the economy further and plunge the economy into a Category 5 recession/depression.

ECB "Competes Agressively for the Criminal Currency Market"

London School of Economics Professor Willem H. Buiter delivered a very controversial paper at this weeks Jackson Hole Conference. More on his full paper shortly, but check this out. In a footnote to his paper, Buiter contends that the ECB "competes aggressively for the criminal currency market":

The existence of currency is, because of the anonymity it provides, a boon mainly to the grey and black economy and to the outright criminal fraternity, including those engaged in tax evasion, money laundering and terrorist financing. The Fed has reduced its subsidisation of such illegality and criminality by restricting its largest denomination currency note to $100. The ECB practices no such restraint and competes aggressively for the criminal currency market with €200 and €500 denomination notes. When challenged on this, the ECB informs one that this is because in Spain people like to make housing transactions in cash. I am sure they do.

While a very good case could be made that some of the items Buiter lists as criminal are simply cases of individuals protecting their privacy, I never before thought of the ECB competing for this business, but I guess they are. So when it comes between the US and the EU on this tiny spot on the privacy meter, you now know who is your friend and who is not.

Ben The Blind

In a truly remarkable speech at the Federal Reserve Bank of Kansas City's Annual Economic Symposium at Jackson Hole, Wyoming, Fed Chairman Ben Bernanke demonstrated cluelessness across the spectrum of his remarks.

Let start at the top. Bernanke says:

The Federal Reserve's response to this crisis has consisted of three key elements. First, we eased monetary policy substantially, particularly a