Saturday, December 26, 2009

What NYT and Bill Gross Don't Get

NYT has a piece out on the extremely low interest rates that banks are paying.

They quote Pimco's Bill Gross as saying:
“What the average citizen doesn’t explicitly understand is that a significant part of the government’s plan to repair the financial system and the economy is to pay savers nothing and allow damaged financial institutions to earn a nice, guaranteed spread,” said William H. Gross, co-chief investment officer of the Pacific Investment Management Company, or Pimco. “It’s capitalism, I guess, but it’s not to be applauded.”

Mr. Gross said he read his monthly portfolio statement twice because he could not believe that the line “Yield on cash” was 0.01 percent. At that rate, he said, it would take him 6,932 years to double his money.
What Gross doesn't seem to get is that this is only at the very start of the yield curve. Roughly under 90 days where rates are extremely low AND this is NOT caused by the Fed. The farther you go out on the yield curve, the higher the rates are. The effective Fed Funds rate is 0.12%. This means that the Fed is NOT pushing rates below 0.12%, the market is. It is for all practical purposes an extreme desire to hold cash or near cash pushing very short rates down--not the Fed.

The government is thus not screwing the average investor by keeping short term rates too low. The market desire to hold short-term money is just huge, which is what is pushing the short-end of the yield curve lower.

Indeed, as ZeroHedge points out even the Primary Dealers are holding huge amounts of T-Bills as a proxy for cash:
T-Bill holdings indicate that this security class is still seen as a simple cash replacement. Oddly, the fact that PDs still have such historically high Bill holdings indicates that all is far from clear, at least at seen by the PD community. An odd observation: T-Bills hit a record on June 3, when over $90 billion in Net T-Bills was being held on bank balance sheets. Since then this amount dropped to flat by November and has since surged again.

Thus, it should be clear that the short term rate in and of itself is not the key factor. The banking system's ability to loan money out farther down the yield curve without repercussions of bank runs is the result of the fractional reserve system and the governments willingness to bailout any major banks that experience runs as a result of the crooked system. The Fed could do the same thing if the real short term rate was 10%, if it allowed the banks to borrow at this short-term rate (or lower) and lend out long.

Yes, the tax payer is getting screwed, but there is no special screwing going on. It has been going on since at least the start of the Federal Reserve System.

To misunderstand what is going on here has significant practical implications with regard to interpretation of the current positive yield curve and what it means for trends in the economy. I'll have a major comment on this Monday.

1 comment:

  1. From a community banker perspective...

    I find Bill Gross both brilliant at what he does and self-loathing of the system he participates in. He's an evil genius that I would not want to go up against, but he's not infallible.

    Just as in his business, banks work at paying no more than they have to for deposit funding and turn around to get as much as they can for their loans and investments.

    What would he have us to do? Pay more than we have to and take less than we should? That's the central government's game, not ours.

    The market keeps us honest, but if the apparatchiks in Washington take over everything, what is to keep them honest? The wise Mandarins have put things in such straits that the entire pricing structure of the financial system, in terms of risk, is severely distorted. The banks are only trying to keep on the right side of the distortion(s) while not getting clubbed to death by them.