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In an earlier post "Fed program to support corporate bonds" you talked about how the Fed adding reserves is bearish for risk assets because banks are having to either mark down the prices of risk assets or selling risk assets to bring leverage ratios back within regulatory limits. That makes sense by the equation, but what specifically are risk assets in this case? Stocks and bonds?
You said "It appears what they have been doing lately is marking down the price of risk assets. equity Indexes taking another big hit last week".
Can you explain how banks marking down the price of assets would cause the stock indexes to decline? I'm not seeing the mechanics of it. Do they sell stocks/index ETFs as part of mark down process?
MMT states it via their Platonist methodology via this Thesis: “all prices are necessarily a FUNCTION of what govt pays for things or what they let their banks lend against things”
(A -L)/A= 0.095
A= Asubrisk + Asubnonrisk
Solve for Asubrisk then you get the MMT “function” for the general price level of risk assets
Stocks are just like any other risk asset class... petroleum too that is way down....
Fed came in two weeks ago and reduced the bond prices from their recent highs...
They (govt and banks) are the price setters....
You go in and try to borrow $1M against a mobile home and the bank gives it to you the price of all mobile homes goes immediately to $1M....
It’s also true that a stock market decline or housing market decline, any price decline in an asset a bank holds, causes a markdown. So if stocks and houses are falling in price, bonds have to rise in price ( fall in interest rate)in an attempt to balance the balance sheet. Cuz rulz
They are setting A price for ventilators. Many hospital systems are still not getting the Feds best price. Trump is treating the Fed gov like his personal business........ based on how he’s run numerous casinos into the ground and only has hotels and golf courses that billionaires can afford we are fucked.
Matt your response logically and mathematically makes sense. But, for a laymen like me I'm still not seeing how banks on paper having to reprice their stock portfolio down would cause a bunch of people in the stock market to sell. So, a big Bank gets a bunch of new reserves and has to write down stock asset prices as a result how then does that translate to some stock trader dumping a bunch of stocks and just because on paper the bank says they are worth less. It's like if a bank says house prices are less I don't necessarily go out and sell my home.
I think the proper sequence of events (often times, many described the 2007/8 issue this way) is better understood as the banks reacting to the stock price fall not being the leading cause. They see stock price collapse and are then forced (by banking rules on ratios of outstanding loans to capital) to make adjustments. Because monetarists setup/regulate our system the Feds prescription works to actually make things worse often times. If banks start to look shaky because the Fed is making panic moves, many stock holders start to get antsy and sell. Not necessarily rational.
A lot of people do think they should sell their house when it falls in price, especially if they are paying a 300k mortgage and the house is now worth 200k. I agree it’s not the most rational move but many do it
Other thing is IOR policy if Fed lowers the risk free rate that has effect of increasing Asubnonrisk without a corresponding increase in L so bank leverage ratio is seen to increase which is else equal bullish...
You have to look at EVERYTHING the policy people do in total and see what it does to (A-L)/A...
If they increase ratio bullish if they decrease then bearish...
Fed just dropped risk free IOR to all time low of 0.1% which is bullish risk assets else equal..
NOT A RECOMMENDATION HERE IN ANY WAY SHAPE OR FORM...
"Collateral Valuation The pledged eligible collateral will be valued and assigned a haircut according to a schedule based on its sector, the weighted average life, and historical volatility of the ABS. This haircut schedule will be published in the detailed terms and conditions and will be roughly in line with the haircut schedule used for the TALF Facility established in 2008. (1)"
Regarding ventilators (I actually overheard a hosp dept head discussing this in hallway Fri eve), I don’t think the govt is demanding a large enough share of the orders. So they aren’t affecting price enough and states or hospitals are still dealing with companies directly (cuz kapitalism). This might change or the Feds might berate the companies that make ventilators for a living the way they are companies trying to convert from cars to ventilators. It doesn’t happen overnight to change an assembly line from cars to ventilators. Why aren’t hotels becoming hospitals within a week?
I think I follow. If Fed was adding reserves to banks balance sheet in exchange for Treasuries which are also a non-risk asset it would have no effect on (A-L)\A because non-risk assets would stay the same, and there would be no increase in liabilities.
But, if Fed is buying from the public/non-banks then reserves and liabilities in the form of deposits to the people Treasuries were purchased from would increase which would be decreasing the ratio which all else equal is "bearish" for risk assets.
Does that part sound right?
I don't quite follow this though:
"Other thing is IOR policy if Fed lowers the risk free rate that has effect of increasing Asubnonrisk without a corresponding increase in L so bank leverage ratio is seen to increase which is else equal bullish"
How does lowering IOR rate increase non-risk asset price? I understand with bonds price and yield move opposite directions, but didn't think this was applicable to IOR because they stay at Par value??
Ok I see that on line 42 from March 11 to the 18th net unrealized gain dropped from 52 billion to 26 billion.
But, how did Fed buying bonds lower their price? Wouldn't that raise the price/unrealized gain?
Sorry don't follow this: (A-L) is increased by over $50B so banks can accomodate 10x that ($500B ) in either new risk assets or existing risk asset prices...
"Specifically, the Desk plans to conduct operations totaling approximately $75 billion of Treasury securities and approximately $50 billion of agency MBS each business day this week, subject to reasonable prices."
They get to dictate what (to them) is "reasonable"...
But, what forces market participants to sell Treasury and MBS securities to them at the price they want. Why would someone sell to Fed if someone else is paying a higher price?
My understanding is with Treasury auctions primary dealers are compelled to bid at competitive prices, but I'm not aware of anything that forces some market participants to sell to the Fed at what the Fed deems reasonable prices.
Thanks. I'm with you in theory, but just because you specify a price you'll buy at doesn't mean you can force the seller to sell at the price you offer to buy at.
You can force them when you make the rules for levels of capital requirements, make the rules about the timing of assessing capital, and the rules about what counts as capital. If they don’t sell now they risk the price falling more ( likely even the result of further Fed action)
“ In the United States, a primary dealer is a bank or securities broker-dealer that is permitted to trade directly with the Federal Reserve System ("the Fed").[3] Such firms are required to make bids or offers when the Fed conducts open market operations, ”
Thanks guys. Makes sense, I just didn't want to draw a conclusion I wasn't sure about. Needed someone with a better understanding to explain it. Appreciate your explanations.
One other clarification to Matt's earlier point:
"Other thing is IOR policy if Fed lowers the risk free rate that has effect of increasing Asubnonrisk without a corresponding increase in L so bank leverage ratio is seen to increase which is else equal bullish..."
Does this essentially mean that QE (Fed bringing down interest rates) is bullish for asset prices? It would seem QE is basically the same as lowering IOR just further out on the yield curve. But, I've seen on here that QE is actually bearish for stocks because it subtracts income from the economy. Both seem to have merit, but only one can be correct?? Can't quite square it.
Why toilet paper?
ReplyDeleteThe way Matt tells it, they should be stocking up on art supplies...
Hi Matt,
ReplyDeleteIn an earlier post "Fed program to support corporate bonds" you talked about how the Fed adding reserves is bearish for risk assets because banks are having to either mark down the prices of risk assets or selling risk assets to bring leverage ratios back within regulatory limits. That makes sense by the equation, but what specifically are risk assets in this case? Stocks and bonds?
You said "It appears what they have been doing lately is marking down the price of risk assets. equity Indexes taking another big hit last week".
Can you explain how banks marking down the price of assets would cause the stock indexes to decline? I'm not seeing the mechanics of it. Do they sell stocks/index ETFs as part of mark down process?
Thanks. Your info/explanations are top notch!
MMT states it via their Platonist methodology via this Thesis: “all prices are necessarily a FUNCTION of what govt pays for things or what they let their banks lend against things”
ReplyDelete(A -L)/A= 0.095
A= Asubrisk + Asubnonrisk
Solve for Asubrisk then you get the MMT “function” for the general price level of risk assets
Stocks are just like any other risk asset class... petroleum too that is way down....
Fed came in two weeks ago and reduced the bond prices from their recent highs...
They (govt and banks) are the price setters....
You go in and try to borrow $1M against a mobile home and the bank gives it to you the price of all mobile homes goes immediately to $1M....
eg right now govt is setting price for ventilators....
ReplyDeletecm
ReplyDeleteIt’s also true that a stock market decline or housing market decline, any price decline in an asset a bank holds, causes a markdown.
So if stocks and houses are falling in price, bonds have to rise in price ( fall in interest rate)in an attempt to balance the balance sheet.
Cuz rulz
They are setting A price for ventilators. Many hospital systems are still not getting the Feds best price. Trump is treating the Fed gov like his personal business........ based on how he’s run numerous casinos into the ground and only has hotels and golf courses that billionaires can afford we are fucked.
ReplyDeleteThanks Matt and Greg.
ReplyDeleteMatt your response logically and mathematically makes sense. But, for a laymen like me I'm still not seeing how banks on paper having to reprice their stock portfolio down would cause a bunch of people in the stock market to sell. So, a big Bank gets a bunch of new reserves and has to write down stock asset prices as a result how then does that translate to some stock trader dumping a bunch of stocks and just because on paper the bank says they are worth less. It's like if a bank says house prices are less I don't necessarily go out and sell my home.
Not trying to argue, just trying to understand.
Thanks again!
Cm
ReplyDeleteI think the proper sequence of events (often times, many described the 2007/8 issue this way) is better understood as the banks reacting to the stock price fall not being the leading cause. They see stock price collapse and are then forced (by banking rules on ratios of outstanding loans to capital) to make adjustments. Because monetarists setup/regulate our system the Feds prescription works to actually make things worse often times. If banks start to look shaky because the Fed is making panic moves, many stock holders start to get antsy and sell. Not necessarily rational.
A lot of people do think they should sell their house when it falls in price, especially if they are paying a 300k mortgage and the house is now worth 200k. I agree it’s not the most rational move but many do it
I more or less agree with Greg...
ReplyDeleteOther thing is IOR policy if Fed lowers the risk free rate that has effect of increasing Asubnonrisk without a corresponding increase in L so bank leverage ratio is seen to increase which is else equal bullish...
You have to look at EVERYTHING the policy people do in total and see what it does to (A-L)/A...
If they increase ratio bullish if they decrease then bearish...
Fed just dropped risk free IOR to all time low of 0.1% which is bullish risk assets else equal..
NOT A RECOMMENDATION HERE IN ANY WAY SHAPE OR FORM...
We now just have to watch what happens if they really are going to buy $4T of assets under this new policy...
ReplyDeleteI cant see that helping to stabilize prices at all...
What prices are they going to pay???? They always pay less than listed prices..
Watch for guidance on "haircuts"... which is the discount they will agree to pay...
https://www.swfinstitute.org/news/78318/explainer-term-asset-backed-securities-loan-facility-from-march-2020
ReplyDelete"Collateral Valuation
ReplyDeleteThe pledged eligible collateral will be valued and assigned a haircut according to a schedule based on its sector, the weighted average life, and historical volatility of the ABS. This haircut schedule will be published in the detailed terms and conditions and will be roughly in line with the haircut schedule used for the TALF Facility established in 2008. (1)"
Regarding ventilators (I actually overheard a hosp dept head discussing this in hallway Fri eve), I don’t think the govt is demanding a large enough share of the orders. So they aren’t affecting price enough and states or hospitals are still dealing with companies directly (cuz kapitalism). This might change or the Feds might berate the companies that make ventilators for a living the way they are companies trying to convert from cars to ventilators. It doesn’t happen overnight to change an assembly line from cars to ventilators. Why aren’t hotels becoming hospitals within a week?
ReplyDeleteThanks guys. Appreciate your insight.
ReplyDeleteI think I follow. If Fed was adding reserves to banks balance sheet in exchange for Treasuries which are also a non-risk asset it would have no effect on (A-L)\A because non-risk assets would stay the same, and there would be no increase in liabilities.
But, if Fed is buying from the public/non-banks then reserves and liabilities in the form of deposits to the people Treasuries were purchased from would increase which would be decreasing the ratio which all else equal is "bearish" for risk assets.
Does that part sound right?
I don't quite follow this though:
"Other thing is IOR policy if Fed lowers the risk free rate that has effect of increasing Asubnonrisk without a corresponding increase in L so bank leverage ratio is seen to increase which is else equal bullish"
How does lowering IOR rate increase non-risk asset price? I understand with bonds price and yield move opposite directions, but didn't think this was applicable to IOR because they stay at Par value??
Only the "not available for sale" securities are held at par...
ReplyDeleteThe "available for sale" securities are subject to "mark to market"....
See Line Item 42 Page 5 here:
https://www.federalreserve.gov/releases/h8/current/
UNtil Fed jumped on the bond prices last week, banks had in excess of a $50B unrealized gain on available for sale securities...
(A-L) is increased by over $50B so banks can accomodate 10x that ($500B ) in either new risk assets or existing risk asset prices...
works opposite when they raise the IOR...
ReplyDeletecauses unrealized losses like in 4Q 2108 and they crashed it 20% by the time they finally stopped raising...
Ok I see that on line 42 from March 11 to the 18th net unrealized gain dropped from 52 billion to 26 billion.
ReplyDeleteBut, how did Fed buying bonds lower their price? Wouldn't that raise the price/unrealized gain?
Sorry don't follow this:
(A-L) is increased by over $50B so banks can accomodate 10x that ($500B ) in either new risk assets or existing risk asset prices...
"But, how did Fed buying bonds lower their price?"
ReplyDeleteBecause that was all they would pay... this is what I'm trying to tell you they are the price setters...
The price is what they pay....
Here:
ReplyDeletehttps://www.newyorkfed.org/markets/opolicy/operating_policy_200323
"Specifically, the Desk plans to conduct operations totaling approximately $75 billion of Treasury securities and approximately $50 billion of agency MBS each business day this week, subject to reasonable prices."
They get to dictate what (to them) is "reasonable"...
But, what forces market participants to sell Treasury and MBS securities to them at the price they want. Why would someone sell to Fed if someone else is paying a higher price?
ReplyDeleteMy understanding is with Treasury auctions primary dealers are compelled to bid at competitive prices, but I'm not aware of anything that forces some market participants to sell to the Fed at what the Fed deems reasonable prices.
Thanks again
Im going to take a stab and say its because the Fed is the largest buyer and when you are the largest buyer you get to dictate price you buy at.
ReplyDeleteThanks. I'm with you in theory, but just because you specify a price you'll buy at doesn't mean you can force the seller to sell at the price you offer to buy at.
ReplyDeletecm
ReplyDeleteYou can force them when you make the rules for levels of capital requirements, make the rules about the timing of assessing capital, and the rules about what counts as capital. If they don’t sell now they risk the price falling more ( likely even the result of further Fed action)
They’re Primary Dealers they HAVE TO sell to the Fed when Fed demands it...
ReplyDeletehttps://en.wikipedia.org/wiki/Primary_dealer
ReplyDelete“ In the United States, a primary dealer is a bank or securities broker-dealer that is permitted to trade directly with the Federal Reserve System ("the Fed").[3] Such firms are required to make bids or offers when the Fed conducts open market operations, ”
Here they just bought 60b more today
ReplyDeletehttps://www.newyorkfed.org/markets/pomo/operations
Whatever they paid today is the price today....
Thanks guys. Makes sense, I just didn't want to draw a conclusion I wasn't sure about. Needed someone with a better understanding to explain it. Appreciate your explanations.
ReplyDeleteOne other clarification to Matt's earlier point:
"Other thing is IOR policy if Fed lowers the risk free rate that has effect of increasing Asubnonrisk without a corresponding increase in L so bank leverage ratio is seen to increase which is else equal bullish..."
Does this essentially mean that QE (Fed bringing down interest rates) is bullish for asset prices? It would seem QE is basically the same as lowering IOR just further out on the yield curve. But, I've seen on here that QE is actually bearish for stocks because it subtracts income from the economy. Both seem to have merit, but only one can be correct?? Can't quite square it.
Thanks
QE raises interest rates if Fed refuses to pay the list price for govt bonds...
ReplyDeleteRates were LOWER 2 weeks ago before the Fed came in heavy....
10 yr was 0.3% thrn Fed came in and ran it up above 1%... have let it come down a bit since then
MMT via Platonist liberal art methodology: “it’s about price not quantity...”
ReplyDeleteThanks again for explanations.
ReplyDelete