Tuesday, March 24, 2020

Fed program to support corporate bonds


Fed allegedly going to buy corporate bonds to "help" this situation:




Article says:

The central bank is only buying investment grade corporate bonds, not high-yield bonds.

Only problem is S&P is downgrading all the big firms being effected all week:





Oh well....

23 comments:

sths said...

Hi Matt,

Was wondering if you would be kind enough to clarify something on your post.
Saturday, March 21, 2020
Fed crashing it again..


I'm with you until this part-

"So the risk asset component of the Depository's total assets A has to be reduced (in either price or perhaps quantity ... either is "bearish") so that then ex post of that adjustment internal to the Depositories, the Depositories come back into equality with the regulatory constant level ... (no figurative language EXCEPT "bearish")"

Could you flesh this out a bit more? Much appreciated.

Joe said...

Ok so what's all this mean.

Corporate bonds, bond-tracking ETFs, and MBS that were owned by banks (just banks?) are now on the feds books and the sellers receive reserves. So the fed receives the interests payments from these securities now?

And if any of these bonds or MBSs default, is it the Fed that takes the loss? (well "loss", since when you have the magical money computer, a loss doesn't really mean anything).

Since this intends to support the price of corporate bonds, does this help lower interest rates for newly issued corporate debt ie cheaper debt financing for corporations?

With Japan owning 80% of their ETF market. What's that mean really, big-picture wise?

Joe said...

With these corporate bonds, so now instead of an interest flow going from one private sector market participant to another (all within the currency user sector) we now have interest flows going from the private sector to the fed.. Do I have this anywhere near correct? Sounds even worse than QE where you're eliminating interest payments from govt to private sector, now interest payment are extracted from the private sector. Reverse fiscal policy... If this is "not even wrong" anyone have any links that'd help?

Matt Franko said...

Sure that is where Fed gets all of its income they get the coupon payments from the bonds then have to pay IOR to the banks that receive the reserves..,

IOR right now is 0.1% and they have about 2T of Reserves at depositories ( this is in process of being increased) so their whole nut is down to 2B for IOR ....

If they have 4T of assets and can get 1% on that then total revenue is 40b so they have plenty to run the Fed (about 7B annual) and pay the IOR...

The leftovers they have to transfer to the Treasury account and by law have to maintain like 6.8b min/max retained earnings...

So when MMT says “they can run negative equity” I think by LAW they can’t do that law says steady 6.8b with periodic transfers to Treasury...

Matt Franko said...

sths,

I’ll rewrite the equation like this:

(Asubrisk + Asubnonrisk - L) / (Asubrisk + Asubnonrisk) =. 0.095

At all times....

So you can see when they (for whatever reason) do a very large increase in the Asubnonrisk (Reserves are non risk assets at banks) which they are currently in process it appears of increasing them by 700b in just two weeks so Asubrisk has to be reduced...

in order to maintain the constant 0.095 regulatory ratio the govt puts on them...

They can do this by either selling risk assets or marking down the price of existing risk assets...

It appears what they have been doing lately is marking down the price of risk assets. equity Indexes taking another big hit last week ...

If the Fed just buys the USTs from the banks (USTs are non risk) then there is no change the two entities just swap one non risk asset for another non risk asset ... but that is not what is happening bank ownership of USTs is at all time highs...

Fed is buying USTs and MBS mostly from non banks....

Matt Franko said...

“ Corporate bonds, bond-tracking ETFs, and MBS that were owned by banks (just banks?) ”

No , bank ownership of those are also at all time highs... Fed buying from public.... banks have to shed risk assets... bearish...

Matt Franko said...

"(well "loss", since when you have the magical money computer, a loss doesn't really mean anything)."

Joe no that is MMT bs... they all mailed it in 10 years ago...

Fed is required BY LAW to maintain a 6.8B residual value... they cannot take a loss... it is against the law...

Fed wont be buying any junk... too risky...

This is all a usual monetary policy nothing burger being tried by libertarians ...

Were going to need fiscal.... eventually...

Matt Franko said...

sths,

If they buy the bonds from banks then it is MMT "asset swap!" no change in the ratio..

However, if they buy them from the public then no.... if I own a Treasury and it is redeemed thrn i want to roll into new bond and Fed steps in front of me then I can’t buy one and am left with a bank deposit ... That transaction results in both a new asset and a new liability at the bank , the asset is the new reserve the Fed created and the liability (to the bank ) is my deposit...

So (A-L)/A is decreased... numerator unchanged and denominator is increased... so risk asset levels have to be reduced to compensate for the additional non-risk the Fed added...

Joe said...

Thanks Matt, much appreciated.

Looks like we're gonna get some fiscal policy soon. The proposed package is better than I had expected. Except for a lot of it is loan.

But when they say "which would include $425 billion for the Federal Reserve to leverage for loans to help broad groups"

Why does the Fed need money from the treasury to lend? If it just lends, it gets the loan as an asset and the loan as a liability. Is just in anticipation of defaults to prevent the negative equity situation you said is illegal?

Joe said...

Sounds to me like the $425B is loanable funds model..

Matt Franko said...

It looks like the 425 is a guarantee against loss.... the Fed cannot take a loss.. law requires Fed to keep 6.8B minimum equity/residual/retained earnings...

So if Fed buys some auto loan paper that is out there for 50B then half of it goes bad then treasury will reimburse Fed for the 25B loss out of the 425 set aside by Treasury... would have 400b left then...







sths said...

Thank you Matt, appreciate the explanation. One more question if you don't mind. Can you walk through how a fiscal spend by the federal government help increase risk asset prices by increasing bank capital?

Matt Franko said...

https://www.thebalancesmb.com/what-are-retained-earnings-393324

Matt Franko said...

Well that wouldnt necessarily increase bank capital...

its (A-L) or 'retained earnings'... so if due to robust fiscal the banks make munnie, and dont use it to pay dividends and 'retain' the earnings, then it increases capital...

or if Fed reduces the risk free rate then the NPV of existing bank assets probably increases without any liability so that could increase (A-L) too...

https://www.thebalancesmb.com/what-are-retained-earnings-393324

Matt Franko said...

This good too on Accounting

https://youtu.be/Lq4zu6F9aEs

Joe said...

Where did they pull $6.8B from? Seems arbitrary.
What do I even have to google to find this stuff?

Matt Franko said...

https://www.federalreserve.gov/newsevents/pressreleases/other20190322a.htm


"The Federal Reserve Banks' 2018 earnings were approximately $63.1 billion, representing a decrease of $17.6 billion from 2017. The Reserve Banks provided for remittances to the U.S. Treasury of $65.3 billion in 2018, including two lump-sum payments totaling approximately $3.2 billion that were necessary to reduce the aggregate Reserve Bank capital surplus to $6.8 billion as required by the Bipartisan Budget Act of 2018 and the Economic Growth, Regulatory Relief, and Consumer Protection Act. Interest income on securities acquired through open market operations totaled $112.3 billion, a decrease of $1.3 billion from the previous year. Interest expense on depository institutions' reserve balances during the year was $38.5 billion, an increase of $12.6 billion from the previous year. Interest expense on securities sold under agreements to repurchase was $4.6 billion, an increase of $1.2 billion from the previous year. Reserve Bank operating expenses were $7.0 billion"

Matt Franko said...

6.8B probably = 1 year of Fed operating expenses back then...

Joe said...

Thanks Matt. Again, much appreciated.

Joe said...

I'm not trying to argue, just trying to understand, but I opened up the Economic Growth, Regulatory Relief, and Consumer Protection Act. Page 45 says

"Federal Reserve Surplus. The Fed’s capital comprises paid-in capital issued to
member banks and retained earnings deposited in its surplus account. Section 217
reduces the statutory cap on the Fed’s surplus account from $7.5 billion to $6.825
billion and requires funds in excess of that amount to be remitted to Treasury as
general revenues. CBO estimated that this provision would increase revenues by
$478 million on net over 10 years. 156 CBO assumed that the Fed would finance
the transfer by selling Treasury securities, which otherwise would have earned
$177 million in income that would have been remitted to the Treasury in the next
10 years. Thus, the provision can be thought of as shifting Fed remittances from
the future to the present, as opposed to representing new economic resources
available to the federal government."

The way that sounds to me is the $6.8 billion is a maximum, not a minimum.

Matt Franko said...

Right so if it gets much higher than that they have to transfer the balances into the Treasury Account...

The law charges them to maintain it at 6.8B by continuously transferring excess of that into the Treasury Account...

Otherwise they could buy every asset on planet earth...

This is how govt regulates their fiscal agents...

the MMT people thing Fed can run what they call "negative equity" they are in cloud cuckoo land on this...

they need training in Finance and Accounting... they are all Art Degree economists and are creating an alternative universe that doesnt exist...

If govt wanted them to run "negative equity" then the law would say "statutory cap of -50B" or whatever...

then they would have to figure out how to transfer a negative balance in excess of that into the treasury account... which now were getting rediculous...

Matt Franko said...

If you take Finance and Accounting (which the MMT people dont...) then you know the balances are all POSITIVE numbers...



Matt Franko said...

Here:

https://en.wikipedia.org/wiki/Factoring_(finance)

This is what the Fed does....