Central Banking in Practice

So, today the monetary base in the North Atlantic economies is 7% higher than it was yesterday--an annualized growth rate of 2100% per year.

This is indeed a significant liquidity event...

Comments

[Robert Jennings]

I'm trying to imagine what a Federal Employment Bank would look like in some alternative universe. Where BlumBerg could report that the FEB had increased the job supply by 7% to avoid a crisis in household confidence ... Post in SciFi ?

[jck]

The ECB added liquidity for one day...they will roll part or more of it day by day but nobody is expecting the add to be permanent.
There is a problem with some type of notes where once again people buying them, can't read a prospectus.

[Jay]

Um... By my calculation, 7% per day is 5.3 trillion percent per year. You really can't neglect interest compounding in this case.

[christofay]

Bernanke ordered the helicopters aloft. And we're just in the early stages of popping the levered innovative finance bubble. the levered innovative finance bubble was a special members only bubble for the 20 % of the 20 %; it was fed by the housing bubble but the participants don't mix.

[David in NY]

I get 53 billion percent (no?), but still pretty big.

[christofay]

Putting the Greenspan put, rates to fall soon. We are in LTCM squared or LTCM cubed

the last year plus of the shogunate what's Emperor Tax Cuts Bush going to do while we're in a deep recession/depression? his political team is definitely putting pressure on Helicopter Bernanke to cut rates and flood liquidity (more easy bucks)

[supersaurus]

% increase = ((1.07^365)-1)(100%) = 5.3e12%

or am I innumerate today?

[bigTom]

supersaurus:
Fortunately the fed does not work on Sundays, and I think not on Saturdays or holidays either. So that exponent of 365 would be quite a bit smaller (maybe 280 working days instead). That ought to take a couple of orders of magnitude out of the per year result.

[christofay]

A bubbling stock market popping and Ponzi hedge fund scams for the 20 percenters deflating, another reason for Shogun Cheney to do a bread & circus by starting a war on Iran.

[Stephan]

2100 obviously is 7 times 300. How much sense that makes as an annualized growth rate is another matter.

[D-Slam]

Brad was probably assuming the central banks add the same $ amount every day, not 7% per day (ie no compounding). Which is bad enough.

[glenn]

Bush, the Boss Man, says there are large pools, oceans practically, of capital. Liquidity, dude. Talkin' 'bout Seas of Tranquility. So, just chill. Have a Bud.

(forget one hand clapping. That sound you heard is one shoe dropping.)

[anne]

http://economistsview.typepad.com/economistsview/2007/08/paul-krugman-ve.html

August 10, 2007

Paul Krugman: Very Scary Things
Edited by Mark Thoma

Paul Krugman discusses the potential for problems due to the evaporation of liquidity from financial markets over the last few days:

NY Times: In September 1998, the collapse of Long Term Capital Management, a giant hedge fund, led to a meltdown in the financial markets similar, in some ways, to what's happening now. ... The Fed coordinated a rescue..., while Robert Rubin, the Treasury secretary..., and Alan Greenspan,... the Fed chairman, assured investors that everything would be all right. And the panic subsided...

What's been happening in financial markets over the past few days is something that truly scares monetary economists: liquidity has dried up. That is, markets in ... financial instruments backed by home mortgages ... have shut down because there are no buyers.

This could turn out to be nothing more than a brief scare. At worst, however, it could cause a chain reaction of debt defaults.

The origins of the current crunch lie in the financial follies of the last few years... The housing bubble was only part of it; across the board, people began acting as if risk had disappeared.

Everyone knows now about the explosion in subprime loans ... and the eagerness with which investors bought securities backed by these loans. But investors also snapped up ... junk bonds, driving the spread between junk bond yields and U.S. Treasuries down to record lows.

Then reality hit... First, the housing bubble popped. Then subprime melted down. Then there was a surge in investor nervousness about junk bonds...

Investors were rattled recently when the subprime meltdown caused the collapse of two hedge funds operated by Bear Stearns... Since then, markets have been manic-depressive, with triple-digit gains or losses in the Dow ... the rule rather than the exception for the past two weeks.

But yesterday's announcement by BNP Paribas, a large French bank, that it was suspending ... three of its own funds was, if anything, the most ominous news yet. The suspension was necessary, the bank said, because of "the complete evaporation of liquidity in certain market segments" — that is, there are no buyers.

When liquidity dries up ... it can produce a chain reaction of defaults. Financial institution A can't sell its mortgage-backed securities, so it can't raise enough cash to make the payment it owes to institution B, which then doesn't have the cash to pay institution C...

And here's the truly scary thing about liquidity crises: it's very hard for policy makers to do anything about them.

The Fed normally responds to economic problems by cutting interest rates... It can also lend money to banks that are short of cash: yesterday the European Central Bank ... lent banks $130 billion, saying that it would provide unlimited cash if necessary, and the Fed pumped in $24 billion.

But when liquidity dries up, the normal tools of policy lose much of their effectiveness. Reducing the cost of money doesn't do much ... if nobody is willing to make loans. Ensuring that banks have plenty of cash doesn't do much if the cash stays in the banks' vaults.

There are other, more exotic things the Fed and, more important, the executive branch of the U.S. government could do to contain the crisis if the standard policies don't work. But for a variety of reasons, not least the current administration's record of incompetence, we'd really rather not go there.

Let's hope, then, that this crisis blows over as quickly as that of 1998. But I wouldn't count on it.

[Chris Jeffords]

I doubt the point of the post was the exact annual growth rate of the monetary base in the NA economies.

[PSP]

Fri morning's N.Y. Times online edition:

"The E.C.B. injected another 61 billion euros ($84 billion) into the banking system, after providing 95 billion euros the day before. The Federal Reserve today added $19 billion to the system through the purchase of mortgage-backed securities, then $16 billion in three-day repurchase agreements. The Fed also added money on Thursday."

I thought the Fed only bought and sold Federal debt. This says it is intervening directly in the mortgage-backed securities market. Is this as unusual as I think it is?

[bigTom]

As a non member of the economist class, I presume this is all just the chaotic re-setting of the risk premium. Right now the market can't figure out how large the spreads should be, and conservative investors don't want to gamble that they can determine where the new equilibrium will end up. I trust the monetary system managers will get this thing under control, with perhaps a few market excursions before the market reaches its new near-consensus again.

So how much damage will the delays of deals and payments in the near trem cause?

[Charles]

What was striking to me was the large size of the injection in Europe vs. confirmed losses there, compared to the relatively small size of the US injection. Why?

And why is the US so much more opaque than Europe on who is holding the poofy mortgages?

I am also concerned about exactly what securities the Fed is buying to lower the Fed Funds rate. According to Tanta at Calculated Risk, they are AAA agencies. Is there anything to prevent the Fed from buying even worse paper? Do we have a sense for what the real socialization of risk will be if the Fed has to hold those agencies indefinitely?

We in the US really are being given the mushroom treatment.

[christofay]

Charlie, have a tuna. I glanced at a headline on my Yahoo home page and it was "BS management sold early."

We, BS the bank not the mangement for example, can't put up real money in a credit squeeze; that's way it's called a credit squeeze.

As for Opaque, we have honor and integrity, baby, who needs openness.

[nemo]

http://tinyurl.com/3bhcut

Treasuries Decline as Fed Acts to Ease Credit Crunch Concerns (April 11)

"The U.S. central bank conducted its so-called open market operations earlier than usual yesterday, shortly after 8 a.m. in New York, lending $19 billion to dealers and accepting all forms of collateral. It later lent $16 billion and $3 billion. The central bank added $24 billion on Aug. 9.

"The central bank normally conducts so-called separate repurchase agreements in which it specifies Treasury, federal agency or mortgage-backed debt as the lowest-quality collateral acceptable, said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey.

"Yesterday's agreements accepted all forms, meaning that dealers probably delivered only mortgage-backed securities, enabling them to retain their Treasuries at a time when those securities are in high demand."