patrick.net

A little unclear above but "that link" refers to the negative non-borrowed reserves at the Fed. I had not seen the Fed feed “Recent Declines in Nonborrowed Reserve” until OO posted it today (thanks!).

OO asks: I think the only way of “reduction” is selling. I naively assumed redemption meant that the Treasury securities had reached maturity and were not rolled over/renewed. May be true for some of the issues, but this says otherwise:
In response, the Desk adjusted the composition of its portfolio to include a somewhat higher level of RPs and lower level of outright holdings, by arranging two redemptions of bill holdings at weekly auctions. In December, further redemptions were made and adjustments to outstanding RPs made as needed, to accommodate the impact of TAF loans and swap drawings on reserve supplies. Note that the net ~$40 billion reduction of SOMA was the result fo selling ~$50 billion and buying $10 billion over the year. Bear in mind that some of this is a result of trying to balance varying maturity dates.
Also, notice that the SOMA draw down was mostly a result of not purchasing as much as in previous years: Altogether, in 2007 the Desk bought $10.7 billion in 8 outright operations. In the preceding year, the Desk purchased $44.3 billion in 39 outright operations.

My gut keeps telling me that the “borrowed reserves” are a result of “deleveraging” in the fractional reserve system when a heck of a lot of money disappears overnight (read: housing bubble equity goes poof and the subsequent banks losses begin to affect the reserves). Then again, I never felt comfortable with the idea the banks borrow overnight to “top off’ the reserves (a normal operation) — now it appears they’ve borrowed the entire amount (again, don’t worry, the collateral is good… right?)

Penn and Teller.... yeah, ok, I can sleep soundly now knowing Penn and Teller say everything's OK.

Actually look up something called the Olduvai Theory if you want to know how things are likely to go. So far it's right on track.

NY governor Spitzer gives monolines 5 days to come up with outside funds or face breakup. He is worried about protecting municipal issuers.

http://tinyurl.com/28k6nx

So a forced breakup is coming, with the sweet smelling muni's in a healthy portfolio and the foul MBS stuff in another. The insurers are in a tough spot, they can't leverage and maximize the value of the muni's with so much uncertainty behind the valuation and risks their MBS. Who exactly is going to give them additional capital if it has a high probably of burning? The government might make the case of 'critical sector' and throw them cash, but even they are saying no more soup.

In my opinion, this is now the show. Monoline rating downgrade ripples through the valuation chain, and that crack in the dam we've been looking at is now spraying out water.

A chain of significant loss annoucements all over the place including pension funds, retirement portfolios, endowments, and foreign entities. Maybe even joe six pack's statement will be affected.

If this doesn't clench the sphincter, I don't know what else will.

Moderator, if you could take my 4:45pm comment out of moderation and delete the 4:48pm post (as it is a repost that lost most of the formatting).

I posted that H3 data from the Fed last week and I got the feeling from NVR that I was viewed as a nut. Now when more data comes out you guys then start to put your tinfoil hats on.

http://patrick.net/wp/?p=564#comments

This data is not hard to get and it is even easier to digest. You don't even need to look at the raw numbers. Just graph it in any excel worksheet all the data they have on their site going back as far as you please. The graph is not pretty. Seeing inflection points is more important than just the negative numbers you now see. The fed knows there is some serious risk and they are staying quiet about it until they decide their next move. I imagine their stress levels are running very high now.

In short the fed is scratching their heads trying to figure out how to get out of this mess without having to yell "Jenga!".

thenuttyneutron,

the funny thing is that the Fed actually issued a specific announcement just for the H3 data.

Psychologically, you'd never volunteer any explanations if you feel ok about the subject. If the Fed volunteered explanation on H3 without the public inquiring (at least at the Senate level, we peons don't count), that must mean they are extremely uncomfortable about it.

http://www.greenrushcapital.com/fed.html

Enjoy this little video.

@Nutty

Apologies if I came across in any way inappropriate, I think my written language comes across too strong sometimes. My concern about the banking system is real and genuine, I think I was a little too obtuse in my questions. Educate me, what are you seeing that I'm not. That's why I'm here; nearly everyone here has way more knowledge than I in these areas. I've not taken the time to try to digest the reports themselves or graph the data, as you have. Explain to me what it means, as I've never liked to get too deep in the numbers stuff, and don't understand what the numbers implicate.

My question still stands, is it really possible for our banking system to collapse, or can't the Fed just effectively hand out more money. I'm naive in this matter. They control the money supply, no? I sincerely don't understand this piece; I think I'm missing something.

In short the fed is scratching their heads trying to figure out how to get out of this mess without having to yell “Jenga!”.

lol and agreed. I guess we have to laugh at this mess, sometimes I feel like it weighs heavy. Imagine what Ben feels like, I suspect he'll be looking awfully old soon, this thing is going to age the man.

Well you know when you are leveraged up on a house after putting 5% down and then the house's market value drops by 10%, you have in effect destroyed that money. The thing that is occuring now is not exactly the same, but it is similar.

Just watch the video and eat some popcorn. It explains it better than I can. When I saw this H3 data and looked at all the historical data from the fed, I got a lot of pucker factor. Grab that data and graph it. You will see some interesting trends with historical economic events. This H3 data has never gone negative till just a few weeks ago. That is SCARY.

thenuttyneutron says: Well you know when you are leveraged up on a house after putting 5% down and then the house’s market value drops by 10%, you have in effect destroyed that money.

For about the fifty billionth time, THE MONEY IS NOT DESTROYED. It is a zero sum game. You have transferred the full sales price to the seller. The system comprised of the buyer, seller and bank still has the same amount of money no matter what subsequently happens to the buyer.

Even burning down the house doesn't affect the money portion of the equation (it just removes the house from the equation, similar to the Broken Pane fallacy).

Brad you don't know what you are talking about. Read up on some Econ 101 books and then come back to talk.

Define Deflation if you think it is a zero sum game. The Fractional reserve system creates money from nothing. We have a fiat currency and because of this, YOU CAN DESTROY MONEY. You think the fed can just fire up the printing press to fix this?

Money is nothing more than a representation of capital. Capital is NOT money. Capital is something that produces an economic good. A good example of Capital is farm land. A farmer can use that capital to make food which can be converted into money.

It is not a zero sum game because there is interest that has to be paid back to the banks. The interest is paid first before the principal. You end up having to pay back more than the original amount barrowed. Where does that money come from? Someone out there gets screwed and is unable to pay the money and interest back.

If you still think Money can't be destroyed, I have a tulip for sale. I hear they are the latest rage and will only go up in value.

I don't know if the banking system is insolvent or not, but tell me why I should keep my currency as a deposit in one of these institutions earning a paltry nominal 2% (before income tax) or less and soon to be zero.

Wouldn't it be more prudent to take the cash and toss it into a safe deposit box? How does the FRB (Federeal Reserve Bank) expect banks to attract deposits and thereby liquidity to banking system with rates heading to zero???

Federeal = Federal

If you have debt, it will make more sense to pay it off verses saving at 2%. If you don't have debt, then go buy yourself a nice car.

THE MONEY IS NOT DESTROYED
Help me out Brand. If the buyer defaults, the banks sells the house at a 5% loss. The bank is now out the 5% plus the lost interest revenues. This is money that can no longer be used to meet reserve requirements. I have no problem with banks creating money out of thin air (fractional reserve system), but when it is not put to productive use (or the borrower is not economically productive), bad things can happen.

Or are you arguing that the seller has been fully compensated (he's got his money and it will continue to circulate) and technically there exists an "account deficit" of 5% between the buyer and bank once the buyer defaults. Money is not really destroyed until the bank has exhausted legal procedures (ie deficiency judgement) and writes down the loan. Is that what you were getting at?

Money is not destroyed, the buyer's wealth is destroyed in that example. Money and wealth are not the same thing.

that vid was scary

Peter Schiff must be moving into his bunker in the secret location right now.

There is a premise here that I have never commented on but have always disagreed with. "If a homeowner's house loses an unrealized gain of 100K the owner hasn't really lost anything." I like the discussion the three of you are having because it proves the point that wealth is actually the net worth of someone.

Ex Sunny,
Ever been to Costa Rica? It's not bad. Lot's of ex-pats there running busnesses like book stores and such. I hung out with several americans. One guy taught surf lessons and had a surf board rental biz. The guy had an american wife, two little blond kids and two maids ironing clothes and cooking. He paid an attorney about 100 bucks every 6 months to get a stamp on his visa/passport, then he was good for another 6 months.
It's not all gravy there but a couple of years there would make some interesting chapters. Costa rica has no military and puts the money saved into education. They have a 98% literacy rate, pretty good for 3rd world.

The Tica's will treat you proper.

@ Malcolm

Yeah, I'm going to look at a sweet car this weekend!

Cheers,
Paul

A few words on the japanese experience of how they deal with the disappeared money.

First of all, all the banks stopped lending money out. That stopped the bleeding. Second, the banking system went into a lock-up state, which meant, nobody was going after anybody's ass. A banking client, as long as he could make ANY payment, any, I mean, not even enough to cover the originally agreed interest, would stay on as a performing loan. There would be minimal write-offs, as long as someone was paying anything. It was like what we do here, extending a 90-day freeze to the foreclosure process, except that in Japan it went from 90 days to 900 days or longer.

Thus, revaluation of banking asset was delayed indefinitely. As long as a company was not out of business, the loan extended to that company was considered active and sound, regardless of payment. Even if that company went out of business, someone could still acquire whatever was left and the bank would do anything to classify that loan as valid.

The lock-up was very much the same as here. There was no liquidity problem from the Bank of Japan to the major banks, which had almost unlimited backing. There was a liquidity problem from the banks to the lenders. So at a retail level, liquidity evaporated. However, at wholesale level, the government was indeed capable of pumping money.

But again, as Paulson says, if this (way of money printing) doesn't work, we will make adjustments (we will try another way of printing).

I've actually thought of that ponzi scheme and am surprised it was never tried here. Technically a bank could just say, no payments and just accrue the interest. On paper it would look great until time for the balloon payment at the end, but hey that's what extension fees are for ;)

I'll admit that I'm a bit confused by the term DESTROYED in this context.

Perhaps our friends Neutron and Brand can each define exactly what they mean by that word?
I think that might help, at least on my understanding.

I'm not trying to be smartass, here. Really. To me, destroyed would mean something like "removed from circulation", perhaps. But I'm just guessing. Any good wikipedia articles?

"How does the FRB (Federeal Reserve Bank) expect banks to attract deposits and thereby liquidity to banking system with rates heading to zero???"

Pretty much all money is deposited with one bank or another, unless you keep it in a cash in a matress. If you've got $100 in savings in a bank earning 1%, but you're sick of that return so, you buy some lemons to make lemonade (investment), where did the money go? Into the bank account of the lemon salesman. Same overall liquidity in the system as before.

If interest rates were 10% and you didn't think you could get that kind of return on your lemonade, and left your $100 in the bank, you've still got the same liquidity in the banking system.

But the fed though can inject cash (liquidity) into the system by buying bonds. They've then got the bond, and the banking system has the cash. The effect of buying bonds is to increase demand for bonds, which raises prices for bonds, which is the same thing as lowering it's effective interest rate. And that's why 'lowering interest rates' increases liquidity.

Way oversimplifying here, but that's the general idea.

we need to get all the illegal immigrants back that fled this country. We need them to buy more homes to bring the prices back up. Also, when these illegal immigrants are hired by the builders again, the illegal immigrants will spend money and prop up our economy again. This is one way to get taxes from the illegal immigrants, ie., we get property tax revenue. This will make the county supervisors smile with glee.

Also, I like the idea of freezing prices on homes because the builders aren't making enough money. Selling a house for a million bucks that is built with cheap illegal immigrant labor doesn't have enough profit for the builders.

We also need to keep the prices fixed because the city councilmen and county supervisors still need to tack on extras in order for the developer to proceed, for example, a fire truck here, some public art there, etc. Our buyers don't really care about the extra cost these uncaring politicians tack on to the cost of a house.

yippee eye ah, yippee eye oh, it's a wonderful idea to freeze prices, else they could drop another 20-50%.

@OO

Thanks for the stuff on Japan, it cleared a few things up for me.

So to my very unclear question, the banks ultimately will not be shuttered, at least in the context of too big to fail. The sky will not fall. All will appear well in the empire.

What would have happened in Japan if their central bankers did not go zirp, and actually pursed an interest rate policy which more suitably aligned with the laws of nature. An accelerated asset deflation is the tradeoff, but maybe benefits of a healthier capital market.

What are our guys going to do different than Japan did, so we don't end up in an extended zero growth environment? An interest rate bounce off of ZIRP?

Neutron: if you were trying to prove that money was destroyed within the fractional reserve system, then that was a poor example. All that happened was the seller took 100% of the sales price, the buyer paid 5% and the bank gave the seller 95% (in return for future cash flow from the buyer). If the house value declined 10%, the asset value lost will directly affect the buyer from his personal net worth perspective. He now owns an asset worth X*90%, but still has a liability of X in addition to his monthly cash flow obligation.

But let us indeed consider the situation of foreclosure.

Pre-sale state: Seller (0K+house), Buyer (50K), Bank (950K+capital)
Post-sale state: Seller (1000K), Buyer (0K+house), Bank (0K+capital)
Foreclosure @ -10%: Seller (1000K), Buyer (0K), Bank (0K+asset@90%, capital - (asset*10%))

That is still a zero-sum system.

If you want to talk about fractional reserve "destroying" money, then you need to provide some specific mathematical examples. You've got a loose collection of concepts that are sometimes true on their own, but they need to be tied into a particular coherent situation. There are conditions in your original scenario in which money would be increased, notably if the seller deposits the full 1000K into a bank account, thus allowing a different bank to offer far more loans compared with the first bank's small loss of 50K.

NVR,

I don't think Japan, or US have a choice. They (we) have to go ZIRP.

When the bubble popped, nobody wanted to take on any loans because the only reason why you took on loans was that you expected the asset for which the loan was committed to go up. The only lever to sweeten the deal for the retail lender was to drop the rate to 0. Also, no country in the world can afford to have a systematic banking failure, so any government that faces the same situation as we do today and Japan did 18 years ago would opt for slow asset deflation rather than a fast one. That in itself is the law of nature.

However, things may work slightly differently here. First, Japanese individuals were very conservative. There was no 0-down, Neg-Am, Ninja mortgage loans in Japan in 1990, they had 100-year mortgage instead but you still need to commit your son's income. Most of the aggressive borrowing happened on the business level. Second, it has a culture of "shame". It was considered a social disgrace to file for bankruptcy, and Japanese are more risk averse when it comes to taking up loans.

I personally believe that ZIRP may stir things up a bit faster in the US because Americans are less risk averse. Also, when US consumer machine shuts down, the whole world will be impacted so the leakage of dollar carry-trade will be smaller (not to say there won't be any dollar carry-trade opportunity), making reflation a bit easier.

OO, that's an excellent post and I take no issue with any of it.

I'm curious as to what you think we are facing here. Do you see any de-coupling from EU or Asia coming? You feel we will not stagnate ala Japan, what are the timeframes you are thinking?

@Peter P

Way OT. Very good read on Michelins recent and unprecendented ratings of restaurants in Tokyo, they have been granted double the number of star worthy restaurants as Paris, astounding the French. Interesting the devotion of chefs towards the preparation and care of fresh seafood. Probably all old news to you. Todays washington post.

http://tinyurl.com/2dll2x

Yeah. I guess wealth is what's destroyed.

No Costa Rica for me. That place is one invasion from all those ex-pats ending up in the stewpot. No, thanks.

Europe or "internal exile" which in Solzenityn-istic terms means I stay in the areas within the US where the Empire is weak. Boondocky places, you know?

Some very good discussions of how things are likely to go here. "Neither a borrower nor a lender be" Ben Franklin advised us, we'll finally be taking his advice seriously.

Thanks NVR! :)

Food is never OT.

This is getting very comical

Due to budgetary constraints, the Economic Indicators service (http://www.economicindicators.gov) will be discontinued effective March 1, 2008.

Economic Indicators.gov is brought to you by the Economics and Statistics Administration at the U.S. Department of Commerce. Our mission is to provide timely access to the daily releases of key economic indicators from the Bureau of Economic Analysis and the U.S. Census Bureau.

http://www.economicindicators.gov/

Hmm, after M3, economic indicators, what other statistics will start to go...move long move along, your American sheeple, nothing to see here, enjoy your life.

oops, got moderated again. What are the trigger words again please?

http://tonto.eia.doe.gov/dnav/pet/hist/a103600001m.htm

Based on the last recession of 1990, it looks like gasoline consumption is indeed quite inelastic, it took 4 years last time for the US drivers to adjust their usage down 5-10% depending on seasonality. It is showing the same inelasticity this time.

Jim Rogers is not entirely crazy when he predicts $200 oil, US drivers are energy traders' best friends.

I went to the Fed Reserve website in the video posted by nuttyneutron, and it's not getting any better. As of 2/13, non-borrowed reserves deteriorated another 10,000 million. In a week. Total non-borrowed is now at -18009 million.

HopeNow turns to Project Lifeline turns to Project WTF turns to Project FB turns to Project OMFG!

I guess Ben will be cutting rates pretty soon.

http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/weill/demise.html

This will give a bit of history on how we got here. The Glass-Steagall Act was passed back in the days after the huge losses of the depression. This act was created to prevent the stuf we see now. Had we not taken apart bit by bit, we may not have even gotten to the point where we are at.

I am only 27 years old and was in way way shape or form responsible for the lack of regulation or this mess. I rent and owe money only for my student loans which are only $8,000. I will be held accountable however. This type of crap drives people like myself to put off having kids. This is the biggest tradgedy of all. Society needs young adults like myself to make kids for the future of the country.

The loopholes exploited by the banks in this law back in the 80s occured just about the time I started learning about the concept of money.

http://en.wikipedia.org/wiki/Basel_II

The banks as a whole are in trouble. Now the big question, which ones are ok?

http://www.mercurynews.com/ci_8269028

From bad to 'worst' for Santa Clara County home sales
NUMBER OF DEALS AT 20-YEAR LOW; MEDIAN PRICE FALLS FROM JAN. '07

Due to budgetary constraints, the Economic Indicators service (http://www.economicindicators.gov) will be discontinued effective March 1, 2008.

When the data stops responding to torture, simply make it go away.

Someone seeking to buy a median-price home in Santa Clara County, for example, would need a household income of $170,352, presuming the buyer made a 5 percent down payment and had a 30-year loan at 6.63 percent, the study said.

And a renter of the county's average one-bedroom apartment would need to work full time making $20.69 an hour to afford the $1,076 monthly rent.

The study, titled "Locked Out 2008," assumes buyers and renters would spend just 30 percent of their incomes on housing costs - the amount housing experts and the mortgage industry have traditionally considered appropriate.

However, the study said, 46 percent of Santa Clara County's renters and 42 percent of its homeowners spend more than that on housing expenses. The trend is similar in other Bay Area counties.

http://www.mercurynews.com/business/ci_8258524