“Want of Quant”
by David Stockman
“The basic stimulus to the intelligence is doubt,
a feeling that the meaning of an experience is not self-evident.”
– W.H. Auden, “Introduction to The Protestant Mystics”
“Folks, I’m getting ready to deliver the Keynote Address at the 2019 Irrational Economic Summit on Thursday Evening. (You can catch it here via livestream…
) But I’m having a difficult time keeping up with what’s happening inside an increasingly desperate Acela Corridor.
Yesterday, in a speech and Q-and-A period at a National Association of Business Economists conference, Jerome Powell said the Federal Reserve is going to start buying bonds again, soon. It is, according to MarketWatch
, “adding bank reserves to the financial system to avoid a recurrence of the unexpected strains seen in short term money markets last month.”
It’s “quantitative easing,” folks, and we’re now so deep in the Federal Reserve’s monetary puzzle palace that Bubblevision has come to believe capitalist prosperity depends upon monetization of the public debt. “QE” is an absolute financial fraud: the swapping of something (treasury debt) for nothing (central bank credits plucked from thin air). That the economy rides on it is unmitigated humbug.
we opened a loop that’s “as close to a free lunch as exists in the real world,” the Fed’s payment of “interest on excess reserves,” or “IOER.” Let’s close the loop on this circular scam… Here’s what’s going on: The Federal Home Loan Banks (FHLB) have been parking their excess liquidity at the effective funds rate with eligible commercial banks. Those commercial banks, in turn, arbitraged them into the slightly higher “IOER” play by depositing them with the Fed.
Hapless private savers put their cash in money market funds, which pay essentially nothing, per writ of the Fed Reserve. These money-market funds, in turn, purchase Federal Home Loan Bank (FHLB) paper for a meager yield. So, the FHLBs can park their excess liquidity at precisely the Fed’s target rate, thereby affording regulated banks a 10- or 20-basis-point windfall arbitrage.
This isn’t an exaggeration. Fully $506 billion, or 50%, of the FHLB system’s total liabilities of $1.01 trillion at a recent typical date came from money-market funds, which were, apparently, grateful to receive dirt-cheap yields because the debt paper of the FHLBs is implicitly guaranteed by Uncle Sam.
Of course, the FHLBs are careful to disclaim any legal obligation – since one doesn’t actually exist. Then again, exactly who are they pretending to fool? The 12 combined FHLBs have capital of just $55 billion, or 5.5%, of the $1.05 trillion of system liabilities. So, it’s clearly not the financial strength of the FHLB system that generated a rate of 1.75% in late September on its short-term discount notes; it was money-market manager confidence that, when push comes to shove, the FHLB paper will be bailed out by Imperial Washington, just as was the paper of Freddie Mac and Fannie Mae during the mortgage crisis 11 years ago.
They tiny orange tips of the chart below are all that’s left of the traditional fed funds market – that is, of buy-sell transactions between banks with excess reserves and banks with reserve deficiencies.
The question recurs… How in the world do the geniuses domiciled in the Eccles Building think these infinitesimally small transactions have any impact whatsoever on the nation’s $21 trillion economy or the $85 trillion global economy with which it’s inextricably linked by the day, hour, and second?
Certainly, the blue portions of the bars don’t wag the GDP dog, either. They represent nothing more than Uncle Sam’s credit – FHLB’s implicit guarantee – being shuffled around Wall Street, where slices are captured by the likes of JPMorgan Chase & Co. (NYSE: JPM), Bank of America (NYSE: BAC), Citigroup (NYSE: C), etc.
Moreover, this Potemkin Village of a federal funds market is completely overshadowed by the real money markets, as represented by the $4 trillion dealer market in repurchase agreements (repo) and their counterparty mirror (reverse repo).
The repo market is where Wall Street funds its yield-curve speculations and the authorized Treasury dealers fund their inventories of Uncle Sam’s debt emissions. Since, in theory, overnight and other short-term funds are fungible, the Federal Open Market Committee’s attempted pegging of the vestigial fed funds market is supposedly an indirect way of pegging rates in the drastically larger multi-trillion-dollar repo and related unsecured credit markets, as well.
Of course, why the Fedheads believe that providing Wall Street dealers with cheap repo carry and yield-curve speculators with a negative cost of carry has anything to do with jobs, growth, and prosperity they do not say…
They never do say. They do call it “accommodation.” What’s being accommodated is Wall Street. No Main Street business or household funds itself, directly or even indirectly, in the repo and related money markets.
Here’s the skunk in the woodpile. The Fed’s pointless money-market rate-rigging scheme can only be sustained if demand for funds does not outrun supply. For about eight years after the financial crisis of 2008-09, that condition generally held. That’s because the Fed and other central banks drained supply from the bond pits via “quantitative easing” and sequestered them on their bloated balance sheets. At the same time, a cyclical decline in government borrowing tamped down the rate of new supply from about 10% of GDP in 2009 to a low of -2.4% in 2015.
But then came the King of Debt into the Oval Office… The Donald caused the deficit to soar to 5% of GDP at the very top of the business cycle, even as the Fed belatedly embarked upon a tepid effort to shrink its hideously bloated balance sheet.
It resulted in a perfect storm. About $750 billion of cash was drained from the bond pits under “quantitative tightening” until the combined effect of the Tweeter-in-Chief and Wall Street’s Christmas Eve hissy-fit brought on the Powell Pivot and the early termination of “normalization.”
Alas, the latter only made things worse. It was a signal that a new round of QE was just around the corner, stimulating demand for repo-funded speculation in the debt markets. And that came just as the recent two-year suspension of the debt ceiling permitted the U.S. Treasury to replenish its depleted coffers, thereby draining upwards of $200 billion from the bond pits.
The result was the recent breakout of the repo market, where yields temporarily soared to 10%. That sent the whole rigging scheme into an instantaneous cocked hat and caused the Fedheads to hastily trot out a $75 billion overnight repo line to put a cap on money-market rates to go along with its various floors (“ON-RRP” and “IOER”).
Worse still, it caused Wall Street and its megaphones in the financial press to demand that these hastily assembled emergency 24-hour loans be made permanent so that Wall Street won’t be blindsided again.”
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