Earlier I wrote on the need for a clearinghouse mechanism to staunch the inter-bank lending problem. I saw the video where Hank Paulsen announced direct cash injection into banks which is “Do Sweden” but he did not address – as Professor Paul Krugman noted [and I averted to earlier this week – though it seems like years ago] the issue of inter-bank lending. The G-7 did not help with a wimpy communiqué that said nothing.
The issue as I see it on inter-bank lending is how do you force banks to deal with each other? As a general rule absent some civil rights requirement there is to my knowledge no “mandatory inn keeper” rule as a general principle. Under the “innkeeper rule” anything created or regulated by law must be opened equally to all without distinction subject to justification for refusal to serve. The rule developed as to public accommodations – maybe it should be extended to banks.
I also wanted to give some thoughts to that as well the fact that people need to start thinking about how to recreate the traditional pension system with defined benefit guarantees. The 401(k)-IRA as a substitute for and not as a supplement to traditional pensions and Social Security Era is – and should be – over. The 401(k)-457-IRA as a supplement to traditional pensions and Social Security Era has to start NOW
Prior to the Paulsen statement, today’s big event was today was the day when the Lehman Credit Default Swap day of reckoning came due. Sellers of credit-default protection on bankrupt Lehman Brothers Holdings Inc. will have to pay holders 91.375 cents on the dollar, setting up the biggest-ever payout in the $55 trillion market. Based on the results, sellers of protection may need to make cash payments of more than $270 billion.
Because as of today [and we don’t know what is or has happened in the Fed meeting Tim Geithener is having at the NY Federal Reserve Bank] no one knows exactly how much is at stake because there’s no central exchange or system for reporting trades. It’s that lack of transparency that has increased the reluctance of financial institutions to do business with each other. As an example, more than 350 banks and investors signed up to settle credit-default swaps tied to Lehman. In terms of others about to fail, AIG, Fannie Mae and Freddie Mac are government institutions so there is a far lesser risk there.
If you watch CNBC late night – if you can stay up – the experts primarily in Europe have noted that because stock markets are the only way to get cash to meet these positions is to raise cash from those markets. In a seller’s market asset prices decline – it is that simple. In addition, the normal pace of redemptions is such that brokers wait till the end of day to execute orders so stocks fall at the end of the day. If stocks rally at the end of the day that means that the Warren Buffets are on the prowl.
In terms of where we are at, I believe that we are going to see in the next week or so the complete end of the hedge funds system as we know it because they are running out of cash and the managers want to save themselves and retire to the Caymans or wherever. Insurance companies and banks can go to the Federal Reserve [the discount window] or use the commercial paper market where it is still functioning to meet protection payments. However, fund managers or hedge funds, once they’ve used their cash, have only one option which is to sell assets.
As such, next week you may well see some more death watches in that market because of Credit Default Obligations. Besides CDS’, you have collateralized debt obligations (CDO’s) that sold credit-default protection may lose money as defaults erode their ability to withstand losses. I think CDO’s are reinsurance of CDS’s, i.e. they insure CDO’s as the CDOs pooled the CDS’s and then soled off pieces with varying risk.
Standard & Poor’s [and they may end being the subject of major lawsuits] has ratings on 1,889 CDOs that sold credit-default swap protection on Lehman. Pieces of 1,526 CDOs sold protection on Washington Mutual. More than 1,200 made bets on both Fannie and Freddie. The Icelandic banks that failed this week were also often included in CDOs created during 2006 and 2007.
Rather than creating all these instruments it probably made sense to create a wholesale FDIC for the banks and insurance companies. This is what happens when you substitute the market for government regulation.
The Wall Street Journal reported that the Federal Deposit Insurance Corporation and the other players are thinking about a proposal to insure all US bank deposits. In terms of the idea of no FDIC limit on bank deposits, at this point it is basically meaningless because as of today probably 85% of all US deposits are now insured – though it will mean more capitol flowing to US banks.
In terms of the SEC front, US stock exchanges want to impose a temporary ban on short sales for individual stocks that plunge, as regulators seek to rein in a practice blamed for forcing down shares of financial companies such as Morgan Stanley – assuming the SEC signs off which it probably will do. Under the plan, a stock that ends trading with a loss of at least 20 percent would be protected from short sellers for the following three days. I have a better idea – either re-impose the so-called “uptick rule” or simply bar most forms of short selling. While this may upset hedge funds, there may not be many around by the end of next week.
More relevant to the discussion is – as noted above – is the issue of inter-bank lending. The reason why inter-bank lending is way down is because – as Floyd Norris has noted –every bank suspects that every other bank did naughty things because they may have themselves and everyone is a gonniff [Yiddish for thief]. The irony of all this is that because of the run to cash a lot of banks are probably very strong – it’s just that no one believes each other.
People – and other banks – need to see that the other person is good for it. The reason that the Fed and Treasury need to inject cash into banks is the banks need to show that they have cash. David Reilly who writes for “Heard on the Street” at the Wall Street Journal besides cash injections states – and this is the Wall Street Journal – that “The government also needs to force banks to recognize losses they have so far ignored, require banks to provide fuller disclosure of holdings, push banks to lend to one another again, euthanize weaker banks while helping strong banks get stronger, guarantee deposits and backstop a portion of bank credit. Above all, the government needs to tell banks that they have to take part in a systemic solution. The time for negotiation by banks is over.” He note “Investors and banks have money. They are refusing to invest it because prices aren’t realistic, or they can’t adequately assess value because it is unclear which banks have enough capital.” Reilly did not say how he proposed people to do business with each other – I had opined earlier that it might be made a condition of being part of the Federal Resrve interest on reserve program.
The three-month London inter-bank offered rate [Libor] that banks charge each other reflects the reality. Libor for such loans climbed 7 basis points to 4.82 percent today. The rate in Tokyo, called Tibor, jumped to the highest since 1998 even as the Bank of Japan added more than $30 billion to the banking system. The overnight Libor dollar rate tumbled 262 basis points to 2.47 percent.
In this situation what we have now by default – and here I give some kudos to former Assemblyman Johan Klehs who carried the law – is the financial version of mandatory through dealer on guns. Under current federal law, if a and B live in discrete states, if they want to do a transaction with each other they have to go through a federal firearms licensee who takes possession of the gun and delivers the gun or returns the gun with the appropriate procedures.
In California all we did [Penal Code § 12072(d)] is turn the federal interstate model into an intra-state model. Under § 12072(d), however, the private parties to the transaction know each other and the dealer is a regulated broker serving as an escrow per Penal Code § 12071 and 12082.
In the financial system what we now have is essentially the Klehs Law thing without the parties in fact knowing who they are dealing with.
In Europe – because they also pay interest on reserves [and have for many years] – what is happening – per Bloomberg – is that banks [sellers-transferors] are depositing all the reserves they can with the central banks [acting as the gun dealer] and getting interest. The central banks are then turning around and using their discount windows to help banks that may face issues with the recipient bank(s) as gun buyers-transferees.
The effect of the financial version of Johan’s Law in Europe is to make Libor irrelevant. The European Central Bank (ECB) offered banks as much cash as they required for six days at 3.75%. The ECB also loaned banks a record $100 billion in overnight-dollar funds, allotting most of the cash at 5%, 350 basis points above the Federal Reserve’s benchmark rate. Today, it allotted four-day cash at 0.5 percent. The European central banks are making a profit on the difference between the two rates.
While the Federal Reserve under the “interest on reserves” process can – and may well be doing – do the financial version of “mandatory through dealer”, this role for the Fed is not one I am sure Team Bernanke signed up for. Essential to Johan’s law was that the parties knew each other but used the dealer as the escrow agent. Here, everyone is sneaking around which is not a good way to go – though the NRA must now admit that if this is good for financials it is good for guns and they should plaque Johan.
Alistair Darling who is the British Chancellor of the Exchequer [the Treasury Secretary] is proposing for Central Banks to guarantee inter bank lending which maybe a good idea if the Federal Reserve acting as an escrow agent and it can somehow make banks do it. Darling wants countries to guarantee lending between banks by either turning central banks into clearing houses for the loans or having governments back them. In effect it is occurring now under the Klehs- Model via the Central Bank as acting as the counter party to each transaction except that it is all “hush-hush” because of the fact that there is no transparency in terms of who the sellers and buyers are.
Hank Paulson may have said No to Darling on some sort of guarantee – but then again that was today and by Monday it probably becomes YES. We do have a model in this country for doing it – it is called escrow and now the Wall Street Journal’s “Heard on the Street” columnist wants mandatory through escrow in effect which is the Innkeeper Rule for banks.
All this craziness and the rush to cash by banks [and others] is hitting the real economy and real people. Banks – at least at the regional level – appear to be lending solely – if they are – to people they have had some sort of retail relationship with and the Federal Reserve via interest on reserves. This is the first week it has been in effect and I wonder what the number was.
The US commercial bond market remained effectively comatose for the fifth straight week as the deepening credit crisis sent yields to record highs above Treasuries.
IBM, Southern California Edison and Detroit Edison were the only sellers of debt this week, raising a combined $4.75 billion. The credit slump has kept sales to a weekly average of $6.67 billion since July 1, compared with $22.8 billion in the first half of 2008. The shutdown in short-term debt markets prompted the Federal Reserve to commit to buying commercial paper to ensure companies can finance themselves. Even with IBM, SCE and Detroit Edison being rock solid no risk entities paid abnormally high rates. Banks – at least at the regional level – appear to be lending solely – if they are – to people they have had some sort of relationship with.
Also, Capital One Financial Corp. – which raised $200 million in September to cover future losses – said it will end financing of auto dealer inventories in New Jersey and New York later this month.
Capital One will keep financing dealers in Louisiana and Texas where it also has banking offices – aka has retail customers.
This is pile on pressure on new-car dealerships, which according to the National Automobile Dealers Association already face a rise in closures of as much as 40 percent this year. Retailers are paying higher interest rates to get cars on their lots under floor planning.
As one person noted, banks are seeing the bottom fall out of the dealership business and they don’t want to be caught sitting there owning a bunch of Chevys – instead of getting cash.
Dealers that sell cars from General Motors Corp., Ford Motor Co. and Chrysler LLC are having the most difficult time receiving financing, JPMorgan Chase & Co. and Bank of America Corp. remain leaders in providing financing to auto dealers. Without access to floor plan financing, most dealerships will be forced out of business. Captive finance companies are less willing to make floor plan loans to dealerships of different brands.
Credit availability for consumers wishing to buy cars already has been cut. Many lending companies have stopped offering leasing, and yesterday Regions Financial Corp., Alabama’s largest bank, told about 2,600 auto dealers that it will stop issuing loans through their businesses after Jan. 1.
In terms of the long term, it is very obvious that unemployment will increase and it is imperative that ordinary Americans have to come first. Incidentally, it is unclear as to non-financial institution types where all this cash being pulled out is going – other than into an FDIC insured account.
President Obama will have to stabilize the earnings of older Americans which mean’s rethinking income support systems. Senator McCain today proposed that the requirement that people start drawing out of their retirement accounts at age 70 be suspended – to the extent that they have retirement accounts – actually is not a bad idea because it may actually staunch the decline in stock prices.
But for the future this is a wakeup call which should create a mandate that every company put employees in a traditional pension system – either by allowing them to join a PERS type system or creating their own system. This “you’re on your own” mentality has not worked and it is time to go back to traditional pensions.
Since the mid 1980’s Irwin Nowick has worked for the California State Assembly and State Senate on a plethora of policy issues, most notably firearms legislation. He has been described as “The Assembly’s resident genius” by a former Speaker of the Assembly and is seen frequently in the Capitol hallways and offices assisting legislators in drafting and amending pending legislation.
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