Ben's Printing Continues

A: In mid-late 2007, I decided to change the tune of this blog from daily discussions of Manhattan real estate, to the credit crisis. Now, its weeks before 2009, the credit crisis continues, the fed has taken unprecedented measures, and I will start to incorporate the effects of such policy into this site. Why? Because there are NO free lunches and with such drastic measures taken the best we can hope for is as few unintended consequences down the road. Many seem to think that with every bailout (FNM, FRE, Autos), with ZIRP policy, with every financial rescue (AIG/Citi), with every shotgun marraige (Bear, WaMu, Wachovia, Countrywide), with 18 credit lending facilities, with massive fiscal stimulus, that we are providing the necessary medicine to beat this deflationary spiral and will come out of it with no side effects. Yes, people actually believe this. I don't.

What will the unintended consequences be?

Moral Hazard; both corporate and consumer?

Losing our now Friendly Foreign Funders?

Giving way too much power to the Fed?

Dependence on Credit Facilities / Fed Support in Markets?

A Lost Decade by not allowing the process to play out?

Much Higher Rates way down the road?

More low quality home purchases by forcing rates to ultra low levels incentivizing to buy when they shouldn't so they don't miss the 'rate of a lifetime'?

Runaway inflation down the road?

Mortgaging our future to get by now?

Funds wasted or mismanaged via distribution and applications to what monies were supposed to be used for; leading to ineffectiveness of rescue packages thus far prolonging the process

What unseen consequences do you foresee as a result of massive fiscal & monetary stimulus plus measures taken by the fed to recapitalize the financial system and avoid systemic disruptions?

I discussed Ben's Printing in late NOV, and then Ben's Printing Take II a few days later to show you the surge in the % Change y-o-y of the St. Louis Fed Adjusted Monetary Base. On the third look, we can see the surge continues:

You are going to hear alot of this type of talk going forward on CNBC and other financial blogs as we start to see the effects of 'printing' by the Fed. As we all know, the fed took on a ZIRP policy last week, leaving no more room to cut rates. The above chart is a bit misleading in the sense that it does not take into account the destruction of about $1Trln in the global shadow banking system as toxic derivatives lost much of their value. We saw this as writedowns on the books of financial firms.

So, Ben drops money from the helicopter in an attempt to recapitalize but until the fed starts buying real assets directly from the primary dealers, it was just wavering around. Which brings us to quantitative easing. Quantitative easing basically refers to the fed buying treasuries or asset backed securities from the primary dealers, taking the securities onto their books and crediting the receiving bank with the proper deposits. This 'printing' basically results in newly minted dollars (not really fresh made, but credits in the digital world) entering the financial system.

The talk of Ben buying longer term treasuries & large amounts of agency debt / MBS as part of the quantitative ease, has brought down rates substantially; which is what the fed wanted to do anyway but didn't succeed with rate cuts all the way to 0%. Anyway, it's clear the fed will do whatever they can think of to stop this crisis, putting unintended consequences on the side burner for now.

Right now, banks reserves seem to be surging as they hoard cash. This has led to many politicians yelling & screaming that the first dose of TARP funds was not used the way they were told it would be, and that lending has not resumed the way they were told it would by using these funds. Is anyone really that surprised? Mish has called this from Day 1 and the logic is sound:

Banks are hoarding cash because defaults are rising, unemployment is rising, and it simply makes no sense to lend. Bank balance sheets are already stuffed to the gills.

Ask yourself, do we really want banks to just throw out this money to those that really need it, those that shouldn't get it, and businesses whose products are not selling? Would that be the cure for what ails us? Banks are not lending because credit quality is deteriorating, not rising, consumers are starting to save, not spend, unemployment is rising, not falling, defaults are spreading to higher quality debt classes, not tightening, and banks STILL have tons of toxic securities left on their balance sheets. Don't get me wrong, I don't want to see anybody suffer in hard times. But I also understand WHY & HOW we got into this mess to begin with, and continuing EZ-Money policy and giving a loan out to those that shouldn't get it is NOT the answer to our problems! The house of debt is dangling on a weak foundation and propping it up with more bad debts almost ensures a collapse later on.

In this environment, as Mish says, it just doesn't make much sense to lend. But this is not the American way, so public figures will demand answers and bank CEO's will be bobbing & weaving!

In my humble opinion, the second round of TARP will be used just like the first round, to inject capital directly into the banks via a community hand out to avoid singling out any one troubled firm. More companies will line up for access to this second round, and there will likely be less to go around for everyone. But the big banks will get the highest capital injections as they need the cushion the most. This doesn't solve the balance sheet assets problem though, so I would not be surprised to see TARP 2, or some type of RTC, to be announced down the road to buy distressed assets directly from the big firms; especially Citigroup. First recapitalize, Second clan up toxic assets. If this occurs, I would probably be a buyer of the bank stocks.

Right now the fed is only buying high quality MBS and agency debt in its quantitative easing, or at least what they perceive as 'high quality'. What does that mean anymore anyway, 'high quality'? What happens when prime starts to behave like subprime? We are already seeing Prime Jumbo Securitizations being downgraded by rating agencies. And what about commercial? Ugh, commercial, if 2007 was subprime, and 2008 was bailout nation, 2009 may be commercial/prime. Yesterday Moodys warned that $110 Billion of US Commercial CDO's face possible multi-notch downgrades due to deteriorating conditions. Certainly, this seems to be the problem that doesn't go away.

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