Monday, June 23, 2014

US households' holdings of Agency and GSE backed securities went from over a trillion to effectively zero

The peak was in Q3 2008

*category includes non-profits, domestic hedge funds, private equity funds, and personal trusts

US Banks' Holdings of Government Obligations

US Depository Institutions now hold, as a percentage of their balance sheets, far more government backed assets (Treasuries + Agencies + GSE backed mortgage securities + municipal securities and loans + reserves at the fed + vault cash) than in recent history.

And despite the large purchases of treasuries and GSE backed mortgage securities by the Fed since the start of the crisis, US banks have also increased their holdings of both.  

Source: 2014 Q1 Flow of Funds, Table L.109  

Wednesday, December 11, 2013

Blinder's Blunder

In a WSJ Op-Ed today, former Fed Vice-Chairman Alan Blinder writes that the Fed should cut the interest it pays on excess reserves so that banks will have more incentive to lend them out:  

"At this point, you're probably thinking: 'Wait. If the Fed charged banks rather than paid them, wouldn't bankers shun excess reserves?' Yes, and that's precisely the point. Excess reserves sitting idle in banks' accounts at the Fed do nothing to boost the economy. We want banks to use the money."

The topic was discussed at the Fed's most recent meeting, as noted by the minutes:

"...most participants thought that a reduction by the Board of Governors in the interest rate paid on excess reserves could be worth considering at some stage, although the benefits of such a step were generally seen as likely to be small except possibly as a signal of policy intentions." 

Blinder's idea sounds good - but it's based on a misunderstanding.  The presence of so many excess reserves is an accounting by-product of the Fed's asset purchases; it tells us virtually nothing about the state of bank lending or whether banks are "us[ing] the money". This identity was nicely described by NY Fed researchers Todd Keister and Jamie McAndrews in a 2009 paper.  

Lets hope the current FOMC understands how this works.  

Friday, November 22, 2013

ECB's Asmussen: "banking union is just the first start" toward fiscal union and then political union. "And that is what we are going to do in Europe"

Interviewer: ...[I]s there a message about the European Central Bank, about its mission, its goals, and its outlook, that you want to make sure this audience understands before you get on the plane and head back over the water?


Asmussen: ... We are deeply convinced that we need to integrate Europe further, where we have an incomplete monetary area. It’s in economic terms an unstable equilibrium. And we need to move this construction to a new stable equilibrium, and this in my view means more integration. And banking union is just the first start. We then need to continue… a true economic union, a fiscal union, a democratically legitimized political union, so to really, to complete EMU. And if one is not willing or not able to go down this route, it can be both, willing and able, then we will disintegrate. This could lead in economic terms to a stable equilibrium, but in my view at much lower welfare levels. So I would really say, let’s go down the whole way, banking union is just the first step. We should not stop there. I of course know all the skepticism towards more European integration. I can read polls as you can read polls for the European elections. But in my view political leadership is not that you look at the polls, say, ‘oh this is very difficult, the people don’t want it, so we don’t do it.’ I think political leadership is exactly the opposite, that one has a goal, explains why this is a good goal, names the pros and the cons and then simply then goes out and fights for it. And that is what we are going to do in Europe.

Wednesday, October 2, 2013

Euro Zone Capital Flight - NY Fed Blog Post - Award for Solving the Riddle

The New York Fed, on its well-written blog, Liberty Street Economics, has posted Capital Flight in the Euro Area - NY Fed Research.   The post describes capital flight in the euro area during the crisis, and the accommodation of the flight in the Target2 payment system.   Their description is hard to square with the graph below which shows capital flight from Spain to be negatively correlated with the level of stress.   For example, capital flight in a low stress month, March, was four times as large as during November, the highest stress month in the period shown.  The data for all of 2011 and 2012, for Spain and Italy, more broadly show unexpected timing of capital flight.

We will pay $5,000 to the first person who, in the next week, correctly explains the conceptual error in the blog post that is highlighted by this riddle.  (Persons who have heard the explanation from us aren't qualified for payment but are most welcome to respond.)   Please submit answers to  

Thursday, July 18, 2013

From the Archives, this circulated in April, 2010 - A Parody of the SEC's Goldman Sachs Complaint. (The footnotes are factual, as is the Bloomberg quote on Paulson and the graph of subprime prices.)

Ace Portfolio Selection Inc., Parody

ACE Portfolio Selection, Inc.        
Regulated by MIA1          (Maryland Insurance Administration - )

Sublime Securities Fund       
(c) 2007

Our Firm

We select sublime securities for our clients and ourselves.  We have dedicated substantial resources to the analysis of sublime securities and have one of the world’s largest portfolios, outside of Federal Reserve System regulated banks.  We are proud of our record, having taken no write-downs on any of the securities we have purchased.2

We seek to purchase entire portfolios of sublime securities opportunistically with particular focus on motivated sellers.  We believe that the ability to purchase entire portfolios provides us a significant price advantage because of the certainty it provides the seller.  We prefer to negotiate directly with sellers in order to garner detailed information on their analysis from the process of suggesting, discussing, deleting and replacing securities in the prospective sale.3 

We value our reputation.4   We believe in our analysis and we often invest more in a transaction than all of our clients combined.5

While all investment strategies have risks, our strategy has some unusual risks.  Clients should carefully review the Risks section.

Saturday, June 8, 2013

Bundesbank Letter to German Constitutional Court - English Translation

The following is an English translation of the Bundesbank's letter to the German Constitutional Court that was published by Handelsblatt.  We welcome comments on translation issues and otherwise.

Bundesbank                                                                                              December 21, 2012

Statement to the Federal Constitutional Court of Germany regarding the lawsuits with file reference 2 BvR 1390/12, 2 BvR 1421/12, 2 BvR 1439/12, 2 BvR 1824/12, 2 BvR 6/12

A.  Introduction

Within the Monetary Union of the European Union, the monetary policy framework is given by the Maastricht Treaty and the legal acts based thereon. The general principle is a stability-oriented monetary policy with the goal of price level stability which is implemented by independent central banks and to whom monetary government financing is prohibited. This reflects the experiences of those central banks which prior to the Monetary Union were independent, and able to ensure monetary stability  with a focus on price level stability. The narrow and clearly defined mandate of the central bank system recognizes the  particular constellation of the Monetary Union: a community of countries which have assigned responsibility for monetary policy over to the supranational level, but which continue to decide on fiscal and economic policy primarily at a national level, and which deliberately did not enter into a liability or transfer union. Within this scope, the protection of the common monetary policy, from, for example unsound government financing of some member states,  is ensured by the exclusion of liability for other member states, the prohibition of monetary government financing as well as the independent role of markets in the evaluation of the solvency of member states of the Monetary Union, which derives from their individual fiscal responsibility. The latter is expressed by the respective risk premia governments incur when borrowing on capital markets.

The financial and economic crisis since 2007 as well as the debt crisis in some member states of the common currency area since 2009 witnessed a considerable enlargement of the range of monetary policy instruments employed, and a strong expansion of the balance sheets of Eurosystem central banks. With these measures, the Eurosystem has made a substantial contribution to the containment of the crisis. The Bundesbank endorsed many  of the measures taken. However, the Bundesbank considers some decisions as very problematic, and has also publicly stated its criticism.
Against the background of the arguments and views newly presented during the cases at the Federal Constitutional Court of Germany, the Bundesbank hereby completes its statement. This statement focuses on the purchase of government bonds by the Eurosystem, the  TARGET2 balances, and the resulting risks of losses for the federal budget.

Thursday, June 6, 2013

Why is the Legal Documentation for OMT Important?

In today's ECB Press Conference, the FT's Michael Steen asked whether the legal documents for OMT were available.  

Draghi's answer:

The second point, about the legal documentation on the OMTs, is that it is ready and is about to come out. Not today, no, but frankly, you ask me this question every time and I cannot really see the issue. What is the issue about that? Anyway, if it becomes an issue it is ready to come out. If it has to be an issue it is ready to come out. We never thought that it would be an issue.

You can also see Draghi's response here at around 29:45. 

In connection with the Greek bonds that the ECB bought, the ECB claimed an inability to accept pari passu status as a result of the prohibition on monetary financing.  However, the ECB claimed to be able to be pari passu in OMT.   So the documentation is important.   In its original press release on OMT the ECB commented:

Creditor treatment

The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.

The ECB has yet to "clarify in the legal act concerning [OMT]" in what way it will accept pari passu treatment with private creditors.     

Since it may require analysis and feedback, a release earlier than possibly during a crisis is sensible.   What is the benefit of the ECB's opacity on this straightforward matter?

[Update 2013.6.9:  Perhaps the ECB doesn't want to provide clarity before the BVerfG decision.   FAZ reports that the ECB has communicated to the court that the program is limited.   The ECB is also trying to create rules that keep OMT from appearing to circumvent the prohibition on monetary financing that could be triggered by buying right after a primary bond issuance.]

Tuesday, June 4, 2013

Three-Year LTRO - Claiming Undue Credit

Speaking in London Thursday
 (at 8:53), ECB President Draghi made the following claims about the impact of the three-year LTROs  (deviations from the ECB published text are in red  (published text): 

"In late 2011 and early 2012 we launched two 3-year long term refinancing operations which we called LTROs. These operations [Our LTROs]  gave banks sufficient reassurance that access to liquidity will not be a problem over a relevant planning horizon. We injected about €1tr, gross injection of liquidity with two operations which took place, one in January [sic] and the second in February of 2012.  60% of this has been repaid already. Without these operations, banks would have defaulted on their maturing obligations or would have discontinued and withdrawn existing credit lines to companies. One should remember that in the first quarter of 2012 230bn of bank bonds were maturing and more than €300bn of soveign bonds were maturing.  That's why banks in fact stopped giving credit starting in July of 2011, and that's where a good deal of the current credit crunch comes from.  The LTROs therefore helped to avoid a major credit crunch."

This is consistent with previous claims Draghi made about how the LTROs prevented a credit crunch due to refinancing difficulties in the first quarter of 2012:
  • "[E]specially the LTROs, basically avoided major disasters which were looming ahead of the funding crunch that characterised the first quarter of this year. As I have told you many times, there were bank bonds worth about €230/€260 billion falling due." December 2012
  • “Let us not forget that in the first quarter of this year, more than €200 billion of bank bonds fall due. So this decision certainly prevented a potentially major funding constraint for our banking system, with all the negative consequences this might have had on the credit side.” January 2012
  • “[W]ith the first LTRO, we avoided a major credit crunch.  I have already said that  €230 billion worth of bank bonds were coming due in the first quarter [t]he LTRO addresses the quantitative shortages and liquidity constraints of certain parts of the euro area financial and banking system.” February 2012

Monday, April 29, 2013

ECB Revenue in the Case of a Low Risk Balance Sheet

In order to assess the ECB's ability to replenish capital in the event of a large loss, we estimate the ECB's low risk revenue going forward. This measure excludes interest income from the purchase of sovereigns, but also the potential losses from those purchases. The result is expressed in terms of a function of the MRO rate (the policy rate).

The low risk income consists of:
  • The MRO rate applied to 8% of the Eurosystem's outstanding banknotes (73 billion* at the end of 2012).
  • Interest income on its all-in equity of €39bn; this includes capital and reserves, provisions and the revaluation account, at the MRO rate.
  • Interest on foreign exchange reserves minus remuneration of the NCBs at .85% of the MRO rate for those reserves. This totals about zero. (The ECB lost around 100 million on this in 2012.)
The low risk revenue of the ECB is €113 billion x MRO rate.
This is about €.85 billion at the current MRO rate.

TARGET2 Income
There is net income of zero to the ECB on its offsetting TARGET2 assets and liabilities to NCBs, except in the case of a TARGET2 loss to the ECB (e.g., from a country departure and repudiation). (The ECB does report an imbalance in its TARGET2 assets and liabilities that is derived from fx swap transactions, but these transactions are matched  and should earn the ECB no income; see note 6.2 in the annual accounts, link below.)

Wednesday, April 17, 2013

TARGET2 Loss Sharing - Applicable Treaty Provisions

A TARGET2 loss to the ECB might occur with the departure of a Eurosystem member accompanied by an expectation of less than full recovery of the TARGET2 liability.   

A loss recognized by the ECB would first be offset against the ECB's capital, reserves, provisions and perhaps the revaluation account.  Recognition of a large loss, such as might have resulted from a departure of the Bank of Greece from the Eurosystem, could leave the ECB with negative equity.   

ECB losses can be shared by the NCBs under Article 33.2 of the statute, pursuant to a Governing Council vote, in an amount up to the Eurosystem's monetary income for the year of the loss.   (It isn't clear whether the ECB can recognize parts of the loss each year in order to expand NCB loss sharing beyond the "relevant year" specified in the treaty.)

If the ECB has negative equity after an Article 33.2 vote to share losses, an addition to ECB capital might be considered.   Under Article 28.1 of the statute, a capital increase requires votes by the ECB's Governing Council and the 27 finance ministers of the EU, sitting as Ecofin.   The ECB vote requires a qualified majority: two thirds, capital key-weighted and half of the shareholders (Article 10.3).  Assent of Ecofin also requires a qualified majority.  Under simplifying assumptions, until March 31, 2017, a qualified majority for a proposal by the European Commission would require at least half of the countries, with 75% of weighted votes and 62% of population.   In contrast, a recommendation from the ECB would require two thirds rather than half of the countries (TEU, Provisions Concerning the Qualified Majority, Article 3).   Starting April 1, 2017, the Ecofin vote will require 55% of the countries with 65% of the population if proposed by the European Commission, and 72% if proposed by the ECB (TFEU, Article 238).

In the event of a Eurosystem dissolution, since no obligation to share TARGET2 losses among NCBs precedes the dissolution, there is no claim to make after dissolution.   Rather, TARGET2 is just a claim against the ECB.  As a result, in the event of a dissolution, TARGET2 claims are shared among NCBs only to the extent those losses could be offset against paid-in ECB capital.

Article 32.4
It has been argued by the Austrian Central Bank, Buiter/Rahbari and perhaps others that since TARGET2 liabilities resulted from monetary policy operations, they should be shared under Article 32.4.  This wouldn't be true for:
- ELA amounts, which can be large for a departing NCB.
- In the case of an exit, where the NCB's losses result from redenomination of its TARGET2 liability rather than from losses on collateral resulting from loans to failed banks.   A country might be exiting in part to preserve the viability of its banks in which case there wouldn't be 32.4 eligible losses.
- In addition, using 32.4, which pertains to member NCBs, to compensate for losses at a non-member NCB would be open to legal challenge.

Thursday, March 21, 2013

Loss Sharing in the Eurosystem - Excluding Target2 Losses

Monetary Policy Operations Loss Sharing Among NCBs

Monetary policy operation losses are not automatically shared among Eurosystem NCBs.  They are shared only pursuant to an ECB Governing Council vote, which need not be pro-forma.

The Governing Council may decide that national central banks shall be indemnified against costs incurred in connection with the issue of banknotes or in exceptional circumstances for specific losses arising from monetary policy operations undertaken for the ESCB. Indemnification shall be in a form deemed appropriate in the judgment of the Governing Council; these amounts may be offset against the national central banks' monetary income.
Despite the plain language that a vote is required, Eurosystem official publications claim that this loss sharing is automatic:  

Monday, March 4, 2013

Updated as of Q3 2012** French/German bank exposure to Spain and Italy

With data through the third quarter of 2012 the trend remains the same - French and German banks continue reducing exposure to Spain and Italy.  As a reminder - Data is from the BIS consolidated banking statistics table 9D which shows exposure on an ultimate risk basis.  The value is reported in dollars but it includes claims in all currencies.

Thursday, February 21, 2013

Eurosystem Seniority in OMT?

At the announcement of the ECB's "Outright Monetary Trasanctions" (OMT) in September an accompanying press release stated that any purchases by the eurosystem would not be senior to private creditors:

Creditor treatment
The Eurosystem intends to clarify in the legal act concerning Outright Monetary Transactions that it accepts the same (pari passu) treatment as private or other creditors with respect to bonds issued by euro area countries and purchased by the Eurosystem through Outright Monetary Transactions, in accordance with the terms of such bonds.

As of yet, there has been no clarification.  

Friday, November 30, 2012

Subsidized Haircuts in Eurosystem Refinancing

In his November 26 speech to the Hyman P. Minsky Conference in Berlin, ECB Executive Board Member Peter Praet said that the Eurosystem's collateral framework lets the private market decide which assets to post as collateral.  In contrast with the Fed's asset purchases, he argues, Eurosystem refinancing operations do not favor certain assets over others.

Asset purchases directly create scarcity in the instrument being purchased. This exerts an upward pressure on prices, and, through portfolio rebalancing effects, may also affect the prices of other assets. However, direct asset purchases involve a difficult choice for the central bank: it must take a decision on which assets to buy, necessarily interfering with relative asset prices and income distribution.
Collateralised lending involves such decision only at the level of the definition of the collateral and its eligibility conditions. This can also influence the prices of collateral, but the role of selecting which assets to buy or sell is essentially “outsourced” to the banking system, that is, to many private agents. Hence, collateralised lending leaves the price discovery process and the allocation of savings to market mechanisms.

Praet's description minimizes the Eurosystem's role in favoring certain assets over others.   The Eurosystem expresses a variety of preferences in the selection process for collateral.  Many of these preferences, expressed by the size of haircuts, may be similar to the private market.  But as the Euro area has seen increased volatility in its sovereign debt markets a haircut gap with the private market have emerged.

As an example, Spanish 2 year debt is haircut 3.5% at LCH and only 1.5% at Eurosystem operations.  Spanish 8 year debt is haircut 10.25% at LCH and only 4% by the Eurosystem.  If the LCH is any proxy for the rest of the private market it is not difficult to understand why Spanish banks have done more of their refinancing at the Bank of Spain as volatility (and thus private market haircuts) in Spanish sovereign debt began to rise late last year.  The subsidy, in comparison with the private market, is evidence that the Eurosystem does not "essentially 'outsource'" decisions on asset purchases.

Haircuts in eurosystem refinancing operations

LCH Haircuts as of 11/30/2012