The Oil Drum: Canada

44 comments on The Round-Up: August 10th 2007

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ilargi on August 10, 2007 - 2:32pm

Twilight, that may not be a bad thing to start thinking about.

To wit, from the article posted above:

The Fed is Keeping the Top Spinning

The Fed really only can do two things [..]. They can lower margin requirements for banks, the amount of capital they have to hold to make loans. That it has already driven to basically zero. So the Fed cannot allow banks any more “leeway” than it already has.

They can also perform open market money operations like REPOS and coupon passes. The Fed calls up big banks and buys their government bonds out of their portfolio. But they don’t buy them with real money; they buy them with credit newly created just for that purpose. The big bank can then lend that credit out in a much greater amount because the Fed only requires them to keep a small fraction of that credit to support whatever the bank wants to lend out. This is our wonderful fractional reserve system.

If everyone went to the bank to get their “savings” at once they would find that they could get out less than 1%.

Mish puts in in (somewhat) less severe terms:

Massive Surge in Sweeps
_{(High Rate CDs and other Moral Hazards)}

When Mr. Przybilinski tried to take his money out, the man in charge of Metropolitan Savings' assets informed him that there was only $200,000 left to withdraw -- the amount protected by the federal government.

School of Hard Knock Lessons

If a bank is offering above market rate interest on CDs and deposits there is a reason behind it. That reason is risk. And with excessive risk comes eventual disaster.

With credit spreads widening, margin calls being issued, and absurd lending to build condos in Florida and other places smack in the face of record inventories, there are going to be more bank failures like this.

Know and understand the FDIC limits or your life savings can be wiped out.

If you have money at a bank in excess of the FDIC limits, do something about it now, while you can.

Of course, the whole FDIC guarantee also rests on the assumption that not everyone comes callling at once. If that happens, forget about the whole thing, and about your $200.000.

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Gail the Actuary on August 10, 2007 - 6:11pm

The FDIC charges banks a tiny charge for the coverage of $200,000 per account. The FDIC has money to cover a handful of small bank failures, but not a wide ranging group of bakings failing at once.

If there are a lot of failures, I would think federal government would have to create enough money to cover their promises. If they are able to do this,this would seem to be inflationary. Is there are reason why this mechanism couldn't be used to offset the deflationary impacts elsewhere?

It would seem like a similar mechanism would work if Fannie Mae or Freddie Mac got into trouble, and the federal government bailed them out. This would also tend to be inflationary.

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ilargi on August 10, 2007 - 8:21pm

The US government doesn't have an endless access to money. They may move towards solving potential FDIC "mishaps" in an Argentina sort of way, freezing accounts, and allowing only withdrawals of a few $100 per week.

Fannie, Freddie, and Ginnie already hold a mountain of toxic empty paper. Now that the SEC has announced "audits" of Wall Street's biggest bankers and brokers, there will have to be some kind of "value" attached to securities, and perhaps even all derivatives. Will anyone ask to see the "Mae" family books? They're still working on the last 5 years' books at Fannie. Don't be surprised if a shredder does half the job.

There'll be an enormous pressure to prevent this auditing, so it might not be done properly, but if the SEC get anywhere near the truth, they will find it rottingly ugly. There are $trillions booked as assets that are worth nothing at all, that's what Merrill's abandoned auction of Bear Stearns goodies made clear a few weeks ago.

Banks, brokers, lenders, hedge-, mutual-, and pension funds, and insurance companies, all have vaults overloaded with derivatives. No-one knows the value, and no-one will volunteer to go check that out today. In the end, though, things are only worth what a buyer is willing to pay for them at the time you are forced to sell.

If the US government has any thoughts at all of bailing that waste out, they will find, fast, that they can't, it would drive really big nails into the coffin of what's left of the economy. Everything that's either in the ground, or nailed down above it, has been used as leverage to buy 10 or 100 times more of something, anything. That's the vital point of the sweeps principle, and MBS, and CDO, and all the rest of it.

With that kind of leverage, losing 10-20% of the value of your purchases is enough to lose the principal, the equity, the collateral. And then all you have left is debt, with zero equity.

And THAT is the reason why the $323 billion injected into the swine the past two days will have no effect. There's no equity left.

The biggest issue is not the $1-200 billion in subprime losses to come, it's what the securities based, leveraged, loaned/lent on the mortgages will do. That number is much bigger. It's Ponzi visits the pyramids.

And when it comes to the SEC trying to find the truth, last week the NY Post had this:

Investors hold about $6.5 trillion in mortgage bonds, the world's largest such fixed-income market, says the Securities Industry Financial Markets Association.

Meanwhile, Securities and Exchange Commission chief Chris Cox said the SEC is coming up with new, more flexible accounting rule interpretations that companies and others could use to avoid declaring their mortgage securities in default.

Know what? China doesn't have to sell their $1.2 trillion US paper to sink the American economy, they only have to demand an independent audit of it.