First off, here’s a good summary of where the Economy is going by Caroline Baum:
U.S. Recession Indicators Are All Pointing South
However, her next article, personally, was rather disappointing. She dismisses those calling attention to the “Aggregate Reserves of Depository Institutions and the Monetary Base” statistic that has recently flown out of its historical level. She says their emails remind her of those sent by the, “Black Helicopter/Tin-Foil Hat” crowd. In other words, conspiracy theorists. Besides this, her article is very informative to those who don’t know about reserve requirements, basic accounting, and the TAF loans recently instated.
She saved me a lot of work: I was going to write a blog post clarifying all those things so people can understand what all this really meant.
However, a lot of assumptions have been made about what those pointing out the statistics are claiming.
The most notable one, is that people who talk about non-borrowed reserves are implying that banks are insolvent. If anyone believes that, well then, they are crazy. If you are one of them, you can actually go here and theorize about where the Fed has taken all of the United State’s gold. God speed to you, you’re doing us all a big favor.
Lets make this clear: The TAF auction along with common things like REPOs that provide liquidity to banks who have sufficient collateral. For a thorough discussion and critique of Baum’s dismissive article you can read this great post (Subscribe to the blog if you can also, his posts are must reads): Tin Foil Hats.
If your too busy to read that here’s a summary: In trying to point out the illogicalness of those with “tin foil” hats on, unfortunately the critics have put on some of their own. They claim that the Fed can simply “print out” money, as if money grew on magical trees in the Treasury’s backyard or as if the market wouldn’t reject the dollar, devalue it, if that were to happen. Unfortunately, as some have put it, the Fed is playing a complicated game. Printing money is not the solution and people are ignoring the fact that the monetary base is actually decreasing.
Now: What am I claiming? Simple: this is one of many indicators that should be looked at in tandem, not in isolation. To say that this stat is insignificant, is absurd. Any statistic that moves outside of its normal operating parameters deserves attention, especially one that indicates the financial industries level of borrowing during a time of financial stress.
Although I agree with everything Mish had to say, I liked the statistic because it shows the financial industries need for capital. If banks need cash, they will start to liquidate their assets. Depending on the urgency, different assets will be liquidated. For a discussion on that front head over to Mish’s page and learn about balance sheets.
Now, for some basic accounting: What is the most liquid asset in any company’s balance besides cash? Marketable Securities.
If banks need money desperately, chances are they will start liquidating their marketable securities. Their best performing and highly overpriced, in PE terms, marketable securities will be the first to go. What brought me into analyzing this phenomenon is the huge drop off in tech stocks, a sector which performed superbly during the whole subprime crisis, but has taken a beating since Jan 2nd (the start of the new tax year for traders). For a recap of the madness, take a look at Bloomberg’s summary. If you like pictures, here’s a nice one. In one sentence: Tech stocks are at below internet bubble crash valuations in terms of PE.
Furthermore, banks have now for the first time turned an idle liability into an expense. Sure the Fed is saving the banks money by giving them low interest rates, but banks have typically never paid interest for such large sums of reserves. The Fed is just saving the banks from borrowing at ridiculous rates as risk gets repriced on Wall Street. This is just another sign of banks raising their cost of capital. Not lowering it despite the decreasing fed funds rate. The H.3 data was just an early indicator of what is now becoming apparent in the industry. For example, here’s an article from today of Bloomberg announcing just that: Bernanke Stymied as Rate Cuts Fail to Lower Borrowing Costs.
Why does this matter to investors? Because banks are probably more worried about fixing their balance sheets right now then investing. Right now, banks are struggling to survive, not getting rich. Banks are tightening lending on every front and raising capital from where ever they can. If you don’t understand that the demand for stocks in general is as important as the fundamentals of an individual stock then you are missing half the picture. At the heart of the mater is that the stock market is a capital market. If there is a lack of capital to invest it simply won’t flourish. For evidence of this go look up Japan, a perfect example of a modern economy entering a deflationary spiral, where some stocks, not all, were trading below their companies cash reserves per share. For all the naysayers thinking, “Pssh, this isn’t Japan in 1991,” understand that what are thinking was exactly what Wall Street bet on when they came up with CDOs. Everyone cumulatively bet that existing housing prices would never decrease since it hadn’t happened since The Great Depression. For a discussion on that head over to Mish again and read, “Things that Can’t Happen.”
