This is a tale of two worlds. There is the Money World, and there is the Real World where you and I try to eke out a living. Obviously these worlds are connected, but that connection is becoming more and more tenuous.
Note: Treasury includes Fannie Mae, Freddie Mac, Ginnie Mae, etc.
This diagram is simpleminded, but I made it so deliberately. More and more, it is the connections between the Treasury, the Federal Reserve and the Big Banks that count in the markets. Gamblers (traders, hedge funds, private investment firms, etc.) depend on and feed off of those connections. To understand the Money World, let's go back to a Bloomberg report from May 3, 2010—
Banks are increasing purchases of U.S. government securities to pump up profits while lending to businesses languishes near the lowest levels since credit markets started to freeze almost three years ago.
Holdings of Treasuries and agency debt rose each of the past five weeks, an increase of $63.2 billion to $1.5 trillion, according to Federal Reserve data. At the same time, commercial and industrial loans climbed less than 1 percent to $1.27 trillion and are down 23 percent from the record high level in October 2008.
The Fed bankrolls the Big Banks through low (or zero) short-term interest rates. The banks buy treasuries and profit from the yield spread—
Keeping short-term [Fed funds target] rates low [between 0 and 0.25%] should be good for the stock market, and is particularly helpful to the big banks like Bank of America and JPMorgan. Their raw material is short-term money, which is effectively free right now. They can borrow at 0.25% or less, and then turn around and invest those funds in, say, a 5-year T-note at 2.50%, locking in an almost risk-free profit of 2.25%.
On big enough sums of money, this can be very profitable, and will help to recapitalize the banking system...
The heightened demand for Treasuries made possible by low Fed Fund rates decreases government borrowing costs. Government bond prices rise when demand for them is high, but yields (interest rates on the bonds) fall. Back to Bloomberg—
Low yields are helping taxpayers the U.S. Treasury. In fiscal 2009 ended Sept. 30, the U.S. paid $383.4 billion in interest on its debt, down from $451.2 billion the previous year, Treasury data show. That represented 3.2 percent of gross domestic product, down from 4.6 percent a decade earlier, when Bill Clinton was president and the U.S. had a budget surplus. The amount for fiscal 2010 through September was $201.9 billion.
The Fed underwrites the Big Banks who underwrite the U.S. Treasury—this is the Money World. OK, let's pause for a moment to ask where does the Real World of households & private businesses fit into all this? The Real World is nowhere to be found because the people living there are Down & Out—
“If you look at the economy you are either glass half full or glass half empty -- lenders are the latter right now,” said Keith Leggett, senior economist at the American Bankers Association in Washington. “There isn’t a lot of demand from creditworthy borrowers. You can lead a horse to water but you can’t make him drink. The environment has been made very favorable for borrowing but creditworthy households and businesses are still reluctant to borrow.”
There is little demand for loans in the Real World. Creditworthy—not to mention heavily indebted—households & businesses will not (or can not) take on borrowing risk because you never know when you may lose your job, or when increased demand for goods & services will justify expanding your business.
And the Money World connections just go on and on. The Fed made a profit of $46 billion in 2009, which they duly handed over to the Treasury—
The Federal Reserve reported a side benefit to its massive intervention into the financial system — a record profit of $46.1 billion last year on the central bank's investments.
But experts said that gain, which will be paid to the U.S. Treasury, could be offset by losses in the future when the central bank starts selling the Treasury bonds and other assets it has purchased in unprecedented amounts to try to stabilize the economy the big banks.
The Treasury made a profit of $6.2 billion by selling part of its stake in Citigroup—
The Treasury Department said Wednesday it raised $6.2 billion from the sale of 1.5 billion shares of Citigroup stock it received as part of the government's rescue of the bank. The government sold the shares at a profit as it seeks to recoup the costs of the $700 billion financial bailout.
The sales took place over the past month and represented 19.5 percent of the government's holdings of Citigroup common stock. Treasury said it has triggered a second round of stock sales through its agent, Morgan Stanley. That will involve an additional 1.5 billion shares.
And then there is the Fed's "exit strategy" from the massive money printing expansion of its balanced sheet. As far as I can tell, Josh Dowlut is correct when he says—
The Fed's exit strategy (see here) can be summarized as paying banks not to lend. Through increasing the excess reserve rate (the interest rate paid to banks with excess reserves-normally banks have to make loans to earn interest, but not anymore), offering term deposits, [which are] essentially CDs that pay interest on excess reserves, and reverse repos that trade bank's excess reserves created by the Fed for interest bearing securities, the Fed is engineering an environment where banks can make interest revenue without lending to anyone.
What happened to the old story in which zero interest rates and massive bank bailouts and the Fed's quantitative easing and enormous Treasury deficits would somehow benefit Main Street? That story is dead.
What is striking about all this is the degree to which the Money World is detached from the Real World. The only possible benefits to taxpayers (i.e. ordinary citizens) are the profits & decreased borrowing costs for the Treasury, but the idea that temporarily reducing Treasury outlays benefits Main Street is laughable. Laughable, that is, unless you believe that temporary programs which artificially push demand forward like Cash For Clunkers or the 1st-time Home Buyers Credit are not a joke. The proof is in the pudding: how's the Real World doing?
If you gamble for a living, you understand the Money World and how to make money from the shit that goes on there. Otherwise, that world is more and more irrelevant to your local economy & your life—
Forbes' Bob Lenzner shows us exactly how warped the bailed-out banking sector has become: Bob notes that six giant banks made $51 billion in profits last year, while the rest of the banking industry — the other 980 banking institutions — all lost money [taken all together].
You can be forgiven for not knowing that over 40,000,000 Americans are now receiving food stamps. You are forgiven because this astonishing statistic was hardly publicized. The Money World might as well exist on Jupiter as far as those people are concerned. Even if you're not receiving food stamps, that world probably exists in some other part of the Universe for you.
And one more thing: in mainstream media reporting, the Real World (or "the economy") is often conflated with the Money World. When you hear this bullshit, you need to ask yourself is this story about the actual economy, or is this story about the Money World?
There are two worlds which increasingly have nothing to do with each other. All this goes to show just how far gone we are in the United States. Unless you are a direct or indirect beneficiary of the Money World, I doubt things are going to turn out well for you.
Great article; thank you.
Posted by: Jb | 06/06/2010 at 09:40 PM