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Saturday, May 20, 2017

Canadians copying Americans?


Well not in this case; no QE from the Canada central bank... as long as this remains the policy, they will continue to avoid a large scale crisis.





25 comments:

  1. Because Canadians actually have some sense.

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  2. Franko-

    How does voluntarily selling financial assets for a profit (QE from the private sector's POV) cause a financial crisis?

    How does exchanging one form of wealth for an equivalent one cause economic disaster?

    Banks own a small amount of TSY CDs themselves, but they own all the reserves basically by definition. So when a non-bank buys their TSYies.

    The bank's liabilities go down (TSY CD purchasers deposit account), the Banks assets go down an equivalent amount (Bank reserves).

    So no net change from the Bank's POV, just a smaller balance sheet in toto. During QE the opposite occurs, so bank liabilities and assets go up an equivalent amount.

    SO how is the second of these benign events supposed to cause a banking crises?

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  3. The member banks (fiscal agents) seek to maintain a fixed regulatory ratio (Leverage Ratio) between capital:assets

    1:10

    The regulatory ratio is not the bank's ratio of assets:liabilites...

    USTs previously held in customer accounts are not treated as bank assets...

    CB does QE then denominator goes up (reserve assets increase massively), numerator is constant, ratio goes down and away from target, so other components of denominator have to be sold (liquidation), allowed to quickly roll off (credit contraction), or otherwise be reduced... in order to maintain the 1:10 regulatory ratio..

    I'll draw you a diagram...

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  4. "The member banks (fiscal agents) seek to maintain a fixed regulatory ratio (Leverage Ratio) between capital:assets"

    OK so QE increases bank assets (reserves) but not its net financial position because of the equivalent increase in bank Liabilities (deposit accounts). It also doesnt affect the bank's capital position in the first instance thus reducing the capital:asset ratio from 1:10 to say 1:13.

    Got it. So in your narrative now the banks need to either shed assets or increase capital? Cant they jjust use the reserves (not considered part of bank capital I presume?) to buy some bank capital? After all, reserves are just demand despoits for banks at another bank.

    Still not seeing the logic or processs with how the above leads to financial crisis. Im not saying you're wrong because Ive never thought about this subject in this specific way before, I just dont see it yet. So correct me where Im wrong above and carry on with the explanation from this point.

    "USTs previously held in customer accounts are not treated as bank assets... "

    Obviously not, they are are a banking relationship between the TSY CDs account holder and the Fed\Tsy (aka not on the books of the person's commercial bank).

    "CB does QE then denominator goes up (reserve assets increase massively),"

    Right

    " numerator is constant, ratio goes down and away from target,"

    Yep, from 1:10 to 1:13 as I said above

    "o other components of denominator have to be sold (liquidation), allowed to quickly roll off (credit contraction), or otherwise be reduced"

    You dont "sell" checking deposits (which are all that reserves are for banks), you use them to buy something. Why wouldnt banks just buy the required capital with their excess reserves? This is the crux of my misunderstanding. I understand what you are saying about banks trying to reduce the capital to asseet ratio by reducing loans potentially (although there are a great many of different types of things in the "asset" category here. But I dont see you addressing the reasons why only one side of the equation can be changed (the asset side in your case)?

    If its a capital to asset ratio, and one of the inputs goes way up, there are 2 ways to rebalance the equiation, reduce assets OR increase capital. The way I understand your argument is that you are only focusing on the negative effects of reducing the asset side back to where it was before the injection. What is your explanation for why only one side of the equation is movable?

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  5. Here:

    https://twitter.com/i_deficit_moron/status/866285786257383424

    Initial response is a reduction of measured (blue line) away from target (green line) .... then regulatory control action to get blue line back to target green line asap.... this control action is a reduction of other assets...

    Canada has avoided this as has Australia hence those two nations are often pointed to as examples on how to avoid large scale crises....

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  6. "Why wouldnt banks just buy the required capital with their excess reserves?"

    You have to look at the characteristics of those response actions also in time domain...

    iow what is the frequency response of the reserve asset level adjustments (these imo are high frequency) vs. the frequency response of the capital account (imo low frequency)... this is called a frequency mis-match...

    You have to look at the corporate governance documentation of the banks... what do they have to do to get a capital raising approved? How long does that process take? who has to sign off and how often does that committee meet? etc...

    they have instantaneous (high frequency) discretion to adjust the other asset accounts while they do not have instantaneous discretion to adjust the capital accounts... raising capital takes a lot more time than adjusting assets...

    Same as if you drive under a bridge and listening to AM band you lose the signal while if you are listening to FM you dont.... there are deterministic reasons why that happens its not a stochastic outcome (not flipping a coin...)

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  7. "with their excess reserves?"

    As I understand it, the reserves are only transacted between the members and the CB as part of the interest rate setting function ... so they could not transfer balances within their bank from reseve assets to capital (raise capital) using reserves internally...

    So it ended up doing the TARP where Treasury came in and provided capital to the banks after a while.... so you had the Fed cause the large scale crisis with the $1T+ QE then Treasury providing about $350B capital to cover the new asset levels... banks have been working to return that capital over the years which is a large part of the sluggish macro problem...

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  8. A very good and interesting explanation. Thank you. So the determining factors are the definition of capital and its conversion/time relationship with bank reserves. That makes some sense.

    So what about the relationship between all of this and growth of the economy and lending? It's my understanding that bank lending has been fairly High since the crisis so how is this supposed to be have hurt Bank Lending? That lending would be higher without QE? Do even want more Bank Lending?

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  9. "Do even want more Bank Lending?"

    well that is part of how the system is operating so there is a dependency on it... it facilitates payment for new production so its pretty important...

    You have to get paid for your work renovating dilapidated properties for instance... so you go in and take it over and bring it up to code/quality and then if you were to sell it the lending facilitates your payment for the work you put in...

    I dont see anything wrong with it if it is managed/regulated by competent people...

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  10. Matt, how does a bank "shed assets." if a bank sells an asset it just exchanges it for another asset unless it gives it away.

    As long as acquiring capital costs less than the profit on lending, banks would increase capital if there were creditor worthy lenders?

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  11. " if a bank sells an asset it just exchanges it for another asset"

    Ok so prices never change?????

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  12. Tom they have to get rid of the other assets at whatever the price is they can get... which btw might be 0 bid...

    so they take losses or markdowns if they cant get rid of them... then the LR still returns to target...

    Say they are seeking to maintain 0.1

    they have 100 capital and 1000 assets...

    Fed comes in and jams 200 assets on them...

    They have to get the other assets down to 800 pronto... so they either liquidate at a loss or perhaps keep them and have to mark down the values by 200....

    Banks took big losses in the GFC.... basically they lost all of their income and then some..

    Its the same with FOREX....

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  13. "all prices are necessarily a function of what the govt pays for things OR WHAT THEY LET THEIR BANKS LEND AGAINST THINGS..."

    The prices of the assets HAVE TO come down either thru a realized sale OR an internal markdown in order to get LR back to target or "setpoint" in control terminology....

    THEY HAVE NO (short term) CHOICE...

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  14. Franko
    Banks took big losses because they were holding worthless mortgage-backed Securities paper that nobody wanted to buy. Which was the original impetus for QE to create a market for MBS because there wasn't one. Also they had tons of insurance that they took out on these products which AIG could not pay out when they all failed. That's the problem with financial assets are always just promises from another entity. So your net worth or value of your assets are totally dependent on some other Financial entities not going bust all the same time

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  15. Do even want more Bank Lending?

    There two aspects to the monetary circuits that are really two circuits.

    The first, from which most of the funds in use that are denominated in a unit of account (currency) come, is the banking system.

    The second is from government spending.

    The circuit is completed in the banking through loan repayment, so that credit is continually being extended and extinguished on balance sheets.

    The circuit is completed in government spending through taxation which extinguishes the government liability created by spending.

    The ratio between bank credit and government credit is an indication of the level of risk in the consolidated circuit.

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  16. I am still not convinced, Matt. I would need to see evidence from what banks actually did at the time that backs it up.

    For example, the Fed did not mark to market the MBS it bought (for rb). That was the whole point, so that the banks would not have to sell at market and drive the market down, thereby threatening their own solvency, which would have led to bank resolution, which the Fed wanted to avoid.

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  17. Auburn I obviously disagree...

    Assets are worthless when if you try to go sell them, you get 0 bid...

    Lehman had plenty of USTs to use as collateral why didnt anyone engage?

    they didnt engage because any potential counterparty was already seeing their LR below target and could not take on any additional assets under any terms...

    Tom,

    "I would need to see evidence from what banks actually did "

    I have already provided that...

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  18. "I would need to see evidence"

    Did the prices not go down????

    This is not a stochastic process....

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  19. This would be like trying to explain osmosis and showing how the concentration on the one side of the membrane changed and then the person would say "I would have to see evidence..."

    ?????

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  20. Not that I would wish this but then lets see what happens up there if the BoC gets ants in their pants and thinks they should do some QEing to help in the current hiccup....

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  21. I have already provided that.

    I questioned it.

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  22. Did the prices not go down????


    The crisis hit before the big reserve add.

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  23. This would be like trying to explain osmosis and showing how the concentration on the one side of the membrane changed and then the person would say "I would have to see evidence..."

    No it would not if the osmosis model was not applicable.

    I am saying I see now proof that you have the right model here.

    You have a model. But it remains to show that it is the best explanation of a complicated situation where there are a number of explanations on the table. Some are not chiefly financial or economic but forensic, such as Bill Black's.

    There could be some truth to you model and explanation based on it, but why is that only just another factor in a complicated situation involving many factors converging.

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  24. Here is a scenario to consider. Prior to the crisis, banks were increasing loans for houses that were increasing in price, which drove up the assets of the banks issuing the loans, while also increasing their liabilities as the deposits funding the loans. As those deposits were transferred to other banks, the loan issuing banks would have to deliver rb. The cb would ensure that sufficient rb were available consistent with monetary policy — The fed was using OMO at the time since it was not yet paying IOR.

    This increase in lending led to bank assets (new loans and rb from OMO) stained the asset-capital leverage ratio and so banks had to either add capital or curtail lending. I don't see them shedding assets at a loss since that adversely affects bank capital.

    But doesn't seem to be the chief factor that resulted in the crisis.

    The problem dud not arise in the commercial banking sector but in investment banking. Bear Sterns and Lehman were investment banks. As a result of the crisis, the remaining investment banks were acquired by commercial banks or were converted to commercial banks.

    So the problem didn't arise initially from the commercial banking sector that is responsible for lending.

    The credit crunch began with Bear, owing to the failure of two of its hedge funds. This was a big hit to confidence. The actual crisis began with Lehman.

    Fuld had acquired too much mortgage debt with the purchase of five mortgage lenders in order to securitize the mortgages, many of which were dodgy. Lehman underwrote more MBS than any other firm. Rising defaults did them in and TPTB refused to rescue Fuld because capitalism.

    http://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp

    When Lehman went under, $46 billion was wiped out. Needless to say, confidence was shaken. There was uncertainty about other institutions and credit dried up.

    The short term commercial paper market froze, and this turned into a liquidity problem since firms use short-term commercial paper to manage cash flow.

    At this point government got involved, having recognized too late that is was a major blunder to allow Lehman to go down and that the entire global finance was at systemic risk.

    In order to restore confidence quickly, the Fed flooded the interbank market with rb and let the players know that unlimited liquidity would be made available until the crisis past. The big spike in rb began with QE1, when the Fed acquired a lot of the dodgy assets of the big banks at book value rather than market value to keep them solvent. Subsequent QE drove excess rb into the trillions, matching the tsys that the Fed added to its assets through market purchases. (In OMO the Fed purchases tsys from the banks temporarily while in POMO the Fed purchases tsys in the market open-endedly.)

    Congress got involved on the solvency side, since Bernanke refused to touch that as being beyond even the Fed emergency powers. The result was emergency measures like TARP and the temporary nationalization of GM and the AIG bailout.

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