A classic tsunami of political events and financial wizardry has converged, threatening to suck in the world and spit out the pieces. With elections looming in the US, the pressure to do something – anything – can easily be dismissed as political expediency. However, there is a more proximate cause to the urgency displayed by Washington D.C. over the last two weeks, one that will etch September 2008 in the history books.
On September 10, 2008, total borrowings of depository institutions from the Federal Reserve sat just under $20 billion, a level held since the beginning of the summer. By September 10, borrowings had more than doubled to $48 billion. One week later, borrowings ballooned to $188 billion and, by October 1, 2008, bank borrowings from the Federal Reserve had topped $367 billion.
In less than one month, borrowings from the Federal Reserve have increased by 1700%.
Two new programs are all but wholly responsible for this jump in borrowings, the Primary Dealer Credit Facility and the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility.
On September 21, the Federal Reserve extended special credit to the US and London-based subsidiaries of Goldman Sachs, Morgan Stanley, and Merrill Lynch. That week, loans to Primary Dealers jumped $68 billion and another $60 billion in the week ending October 1.
Meanwhile, on September 19, due to extraordinary demand for investor redemptions, the money market mutual fund liquidity facility was opened. Under this program, depository institutions (domestic and foreign) are advanced cash to buy asset-backed commercial paper from money market funds on a non-recourse basis; this means that as long as the commercial paper conforms to the Letter of Agreement, the participating banks carry no risk. $122 billion has been loaned since the start of this program.
Now, ask yourself, if you own a bank and can purchase commercial paper from money market funds risk-free or lend to another bank with risk, which will you do? If you run a money-market fund and can buy paper knowing that banks will compete to buy it from you at a profit, will you loan cash at risk or buy conforming paper? The answers are obvious and backed by the Fed's own data.
Since September 10, bank deposits at the Federal Reserve have increased by $147 billion, an astounding 459% increase in less than one month. What we've got here is a good old fashioned Fed-manufactured disincentive to loan reserves.
All the recent ballyhoo about small businesses and homeowners having their lines of credit revoked? If it is more than anecdotal, this is why. Wailing about the LIBOR increasing? Of course it went up; it's a risk premium!
Last month, redemptions may have been pressing on money market funds to the point where they may have gone into receivership. In that case, their assets would be held by a court and the proceeds used to pay off liabilities and the remainder to investors. This month, through the magic of Fed and Treasury high-finance, commercial lines of credit may be drying up and the taxpayers are on the hook for the cost of keeping the funds afloat with interest.
Enter the Billionaire Bailout
Keep in mind, when the Special Financing Program and the Money Market Liquidity Facility were starting, Henry Paulson and Ben Bernanke were busy in the background trying to generate support for the Billionaire Bailout. "I believe if the credit markets are not functioning that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way," Bernanke told the Senate on September 23.
How on earth did this guy have the testicular girth to make a statement like that when his organization had colluded with the Treasury to freeze short-term credit markets just that week?
"You ask about the taxpayers getting on the hook? Guess what, they're already on the hook. They're on the hook with the system we had,” Paulson told congress. Yes, yes we were as of that week.
Some legislators were also adamant about inserting provisions in any measure to tighten oversight, better protect homeowners, issue government stock warrants in exchange for relief and bar Wall Street executives from receiving "golden parachute" compensation packages as they exit struggling firms.
However, Bernanke and Paulson suggested such measures would delay passage of the legislation. The consequences of stalling could be dire, they said, inflicting further damage to an already fragile U.S. economy, as well as the global financial markets.
Really? After opening up the Money Market Liquidity Facility to foreign banks with US offices, they were worried that the contagion may spread?
I don't think that I am cynical enough to suggest that a credit crunch could be manufactured to provide incentive for fat bailout checks for your friends. However, if one were to do so, the timing (congress heading out for elections) and the method could not be more effective. Remember, though, that Lehman, AIG, Merill Lynch, and Washington Mutual were cascading off the cliff casting doubt on any choice in the timing.
No, I could only be that cynical if Paulson and Bernanke had exhibited strong resistance to golden parachutes or oversight of the bailout.