Is The Federal Reserve Actually Destroying The Banking System And Other Remarks On The Banks
Einstein's remarks of war, "I know not with what weapons World War III will be fought, but World War IV will be fought with sticks and stones." could also be applied to economics on some level. In fact, both war and economics are conducted by the state and many have noted that principles required of both are very similar if not the same. Has there ever been a great economic power that was also not a great nation of war? The necessary yin and yang of man's great ability to create and yet destroy? Humanity will never achieve lasting greatness until we truly understand and consciously embrace our equally great ability to destroy what we have created. Embracing our limitations means they need to be written into our laws and our regulations. Laws that can never be changed. Ever. Most specifically, to protect ourselves from the actions of the state. In fact, this is exactly what the Constitution does. Do we need an economic constitution? Guiding principals of honesty, decency and economic truth to protect us from the timeless lies of people who would become kings at society's expense? That being the leaders of business and the state that created this mess for their own personal gain at the expense of society.
Sometimes I think people spend more time seeking their certification or degree than actually trying to determine what truth lies behind the regurgitated data of textbooks, lectures or assignments. This is most definitely the situation with many aspects of modern finance. Many of the mistakes today are greater than at any time in history. To a certain extent, we have destroyed ourselves with a combination of our knowledge and our beliefs. Technology (knowledge) has allowed many of the outcomes associated with economic miscalculations (beliefs) to be magnified to levels that threaten our future in ways that were not historically possible.
There are certain experiences in life that we never forget for whatever reason. One was a conversation with a good friend while still in school. I asked her about how she had come to a particular conclusion on a project we were working on. She said that she didn't really know but indeed her work was accurate. When I asked if that bothered her, she responded that the only thing she cared about was getting her degree and finding a good job.
My point is we can put a lot of rigor into ignorant arguments or conclusions and even have minimal intellectual depth to thoughts that formulate our conclusions. In other words, humanity often becomes enamored with our own baloney. If it is well written or well argued or is backed up by some supporting evidence and someone with a degree or certification or some social status is behind it, it surely must have validity. While we are talking about banks, let's look at an example written by a certified financial professional near the peak of this cycle. You'll understand why I shared that college experience when you read the linked text below.
At Morningstar, we've long recognized the moats of banks, and it's nearly impossible to understate their importance. Without a robust analysis of a company's competitive advantage and the sustainability of that advantage over time, investors run the risk of buying one-hit wonders that burn out fast…along with shareholders' money.
At Morningstar, we begin each new analysis with the idea that a company has no economic moat until one is proven. But our financial services team believes that the banking industry offers an exception to the rule. We would argue that every bank has, at a minimum, a narrow economic moat.
Regulation played a more important role historically, and we believe that the industry will continue its long-term trend of deregulation.
Over the decades, of course, things have changed. Banks can apply for a charter to operate in any state and can engage in many nonbanking businesses, such as investment banking, asset management, and insurance brokerage. But the foundation upon which the industry was formed is still present. The banks that dominated certain cities 75 years ago remain (in various forms) today. Think of Wells Fargo (WFC) in San Francisco, Fifth Third (FITB) in Cincinnati, and Washington Mutual (WM) in Seattle. We believe that this stems from banks' integral roles within their respective communities: In assessing risk, they must know a borrower well, and in making loans, a bank is essentially financing the growth of a community over time.
Banks have moats? And, what would that moat be? Government bailouts? I just have to giggle when I read some of the generally available perspectives out there. Given what you know today, how unbelievable is this? Yet, as unbelievable as it is today, it was equally believable by most when it was written. This was obviously someone who was enamored by baloney. A well presented and supposedly intellectually defended position. How much of what we absorb on a daily basis is undeniable truth?
I've remarked before that I model bank liquidity. This has allowed me to confidently remark time and again that the bank bottom callers relying on their gut-feel, seances and Ouija boards were wrong. I won't share the models by which I perform any analysis because frankly, it involves a lot of hard work and learning that has developed over countless years of effort. Work that isn't even generally understood by finance industry professionals. Additionally, some of my posts are well off the beaten path in topic and content as I try to keep this blog's scope relatively unique. Yet I see very similar perspectives, including remarks I can't find anywhere else but here, that often show up elsewhere. That's fine but it tempers any desire to share specific details. Were this simply average folk wanting a better explanation, I might oblige but beyond that I don't plan to enrich finance professionals with intellectual property that has value.
That said, I will show you the chart below which adds validation to the perspective that I shared on here some time ago - that I believe the Federal Reserve and Treasury's scatter-brained plans to save the mega banks are actually killing the healthy banks and by conclusion the American economy. There are a half a dozen reasons why I make this statement and there are many contributing explanations for the chart below but I'm going to share a potentially unique perspective on one in the next paragraph. Before I do, again, I support the Federal Reserve's macro attempts to stabilize the banking system. I just disagree with the lack of planning and lack of well-thought policy that has developed. But, I do have hope they are learning through the process.
So, let's continue by looking at short term Treasuries and a potential explanation, or partial explanation, for their bizarre actions. Short term Treasuries are hovering right at zero percent interest. The only explanation I have seen for this involves people being so panicked they are willing to irrationally forgo any return for safety. I find this position very dubious on many levels. At least as a full explanation. A more plausible explanation may be that financial firms are willing to buy Treasuries at zero percent or, if possible, even marginally negative rates because the Federal Reserve is now paying interest on required and excess bank reserves. Were this the case, the explanation for zero percent rates on notes would have nothing to do with panic or fear. It would be a calculated action of insolvent banks attempting to rebuild their balance sheets. Banks that would be willing to add Treasuries to their reserves at zero percent return rather than lend for profit. In other words, the Fed (via the Treasury) would be issuing Treasuries to the market to prop up the bank balance sheets and the banks would be adding the Treasuries the Fed is issuing to prop up the very banks that are then acquiring the Treasuries issued to prop them up. Huh? It's a mouthful. I do have limited data confirming this perspective but it is a more plausible than any other explanation I have seen as banks hoard cash and seek safe short term liquidity with the benefit of earning a return.
This is the ultimate implementation of circular logic. The Fed is bailing out the banks and the banks in return are bailing out the Fed (Treasury). Not specifically but on some level there is truth to this statement. That's a little like using one credit card to pay off a second credit card. Then using the second credit card to pay for the first. Then concluding the world has become a better place.
All the while, the insolvent banksters getting handouts from the Fed are unwilling to extend credit because comparatively they get a guaranteed return on Treasuries, even if minuscule. Regardless of whether this scenario is happening exactly as I have outlined it, refusal to extend credit creates a recursive impact of taking more and more money out of the economy that eventually makes it economically impossible for more and more debtors to repay their obligations to the heretofore healthy banks. Thus, tighter credit, fueled by insolvent banks the Federal Reserve is attempting to save, starts destroying the balance sheet of healthy banks and their customers. This could lead to a self-fulfilling prophecy of an ever larger banking calamity. And, if there is any legitimacy to this scenario, and I believe there is some evidence therefore, it is likely happening, in a great irony one of the Fed's primary tools to save the banking system would actually be destroying the healthy banks and the economy. So, the Fed could lower short term rates in an attempt to deter this banking behavior but this would limit an unhealthy bank's ability to take advantage of the Fed's paid reserves program. I expect the Fed will lower rates in an attempt to force unhealthy banks to lend their way to health. Will it work?
As I've said before, the Fed should remove the sick banks or risk destroying healthy banks and possibly even contributing to a depression the Fed's policies are ironically meant to avoid.
Remember, we have talked about this concept in literal terms but let's make this simple point again. The Fed and Treasury cannot remove risk. There is no way to remove risk. All one can do is transfer risk and potentially relieve some of the time value of its impact. The crisis before us still remains and nothing has been done to resolve anything that caused it. All the government's plans have done is transfer some of the risk in the banking system to the U.S. government and the buyers of its debt. That's it. Nothing more, nothing less. If the economy does not stabilize, and it won't without first experiencing substantially greater pain, and/or plans are not instituted to stimulate market-based and private sector growth, the government's monetary policies will eventually fail on some level.
Capitalism is a bad word right now due to the behavior of the elitists who created this mess, but capitalism is the only way out. Government can play an important role in our recovery but nothing being discussed right now will move to recovery. Assisting those who are on the verge of losing a place to live or providing some type of unemployment benefit is a role government can play but a government works project is not a plan for recovery. I'm not saying rebuilding or building infrastructure is not important. But, were recovery so simple as embracing the Soviet planning model, we'd all be Bolsheviks. Or Europeans. Instead, we must repudiate the European style of colonial capitalism that has recently come to define our society and the European style of government involved capitalism that is now encroaching into our society. Government involvement in capitalism may be necessary short term because, paradoxically, government has not been constructively involved in capitalism for some time. But long term, we must return to the American style of capitalism that created the most dynamic and wealthy society the world has ever seen. And, the only people that will make that happen reside outside of the bureaucracy. That would be you.
There is no free lunch. That is, unless it's a holiday lunch with friends and family.
Sometimes I think people spend more time seeking their certification or degree than actually trying to determine what truth lies behind the regurgitated data of textbooks, lectures or assignments. This is most definitely the situation with many aspects of modern finance. Many of the mistakes today are greater than at any time in history. To a certain extent, we have destroyed ourselves with a combination of our knowledge and our beliefs. Technology (knowledge) has allowed many of the outcomes associated with economic miscalculations (beliefs) to be magnified to levels that threaten our future in ways that were not historically possible.
There are certain experiences in life that we never forget for whatever reason. One was a conversation with a good friend while still in school. I asked her about how she had come to a particular conclusion on a project we were working on. She said that she didn't really know but indeed her work was accurate. When I asked if that bothered her, she responded that the only thing she cared about was getting her degree and finding a good job.
My point is we can put a lot of rigor into ignorant arguments or conclusions and even have minimal intellectual depth to thoughts that formulate our conclusions. In other words, humanity often becomes enamored with our own baloney. If it is well written or well argued or is backed up by some supporting evidence and someone with a degree or certification or some social status is behind it, it surely must have validity. While we are talking about banks, let's look at an example written by a certified financial professional near the peak of this cycle. You'll understand why I shared that college experience when you read the linked text below.
At Morningstar, we've long recognized the moats of banks, and it's nearly impossible to understate their importance. Without a robust analysis of a company's competitive advantage and the sustainability of that advantage over time, investors run the risk of buying one-hit wonders that burn out fast…along with shareholders' money.
At Morningstar, we begin each new analysis with the idea that a company has no economic moat until one is proven. But our financial services team believes that the banking industry offers an exception to the rule. We would argue that every bank has, at a minimum, a narrow economic moat.
Regulation played a more important role historically, and we believe that the industry will continue its long-term trend of deregulation.
Over the decades, of course, things have changed. Banks can apply for a charter to operate in any state and can engage in many nonbanking businesses, such as investment banking, asset management, and insurance brokerage. But the foundation upon which the industry was formed is still present. The banks that dominated certain cities 75 years ago remain (in various forms) today. Think of Wells Fargo (WFC) in San Francisco, Fifth Third (FITB) in Cincinnati, and Washington Mutual (WM) in Seattle. We believe that this stems from banks' integral roles within their respective communities: In assessing risk, they must know a borrower well, and in making loans, a bank is essentially financing the growth of a community over time.
Banks have moats? And, what would that moat be? Government bailouts? I just have to giggle when I read some of the generally available perspectives out there. Given what you know today, how unbelievable is this? Yet, as unbelievable as it is today, it was equally believable by most when it was written. This was obviously someone who was enamored by baloney. A well presented and supposedly intellectually defended position. How much of what we absorb on a daily basis is undeniable truth?
I've remarked before that I model bank liquidity. This has allowed me to confidently remark time and again that the bank bottom callers relying on their gut-feel, seances and Ouija boards were wrong. I won't share the models by which I perform any analysis because frankly, it involves a lot of hard work and learning that has developed over countless years of effort. Work that isn't even generally understood by finance industry professionals. Additionally, some of my posts are well off the beaten path in topic and content as I try to keep this blog's scope relatively unique. Yet I see very similar perspectives, including remarks I can't find anywhere else but here, that often show up elsewhere. That's fine but it tempers any desire to share specific details. Were this simply average folk wanting a better explanation, I might oblige but beyond that I don't plan to enrich finance professionals with intellectual property that has value.
That said, I will show you the chart below which adds validation to the perspective that I shared on here some time ago - that I believe the Federal Reserve and Treasury's scatter-brained plans to save the mega banks are actually killing the healthy banks and by conclusion the American economy. There are a half a dozen reasons why I make this statement and there are many contributing explanations for the chart below but I'm going to share a potentially unique perspective on one in the next paragraph. Before I do, again, I support the Federal Reserve's macro attempts to stabilize the banking system. I just disagree with the lack of planning and lack of well-thought policy that has developed. But, I do have hope they are learning through the process.
So, let's continue by looking at short term Treasuries and a potential explanation, or partial explanation, for their bizarre actions. Short term Treasuries are hovering right at zero percent interest. The only explanation I have seen for this involves people being so panicked they are willing to irrationally forgo any return for safety. I find this position very dubious on many levels. At least as a full explanation. A more plausible explanation may be that financial firms are willing to buy Treasuries at zero percent or, if possible, even marginally negative rates because the Federal Reserve is now paying interest on required and excess bank reserves. Were this the case, the explanation for zero percent rates on notes would have nothing to do with panic or fear. It would be a calculated action of insolvent banks attempting to rebuild their balance sheets. Banks that would be willing to add Treasuries to their reserves at zero percent return rather than lend for profit. In other words, the Fed (via the Treasury) would be issuing Treasuries to the market to prop up the bank balance sheets and the banks would be adding the Treasuries the Fed is issuing to prop up the very banks that are then acquiring the Treasuries issued to prop them up. Huh? It's a mouthful. I do have limited data confirming this perspective but it is a more plausible than any other explanation I have seen as banks hoard cash and seek safe short term liquidity with the benefit of earning a return.
This is the ultimate implementation of circular logic. The Fed is bailing out the banks and the banks in return are bailing out the Fed (Treasury). Not specifically but on some level there is truth to this statement. That's a little like using one credit card to pay off a second credit card. Then using the second credit card to pay for the first. Then concluding the world has become a better place.
All the while, the insolvent banksters getting handouts from the Fed are unwilling to extend credit because comparatively they get a guaranteed return on Treasuries, even if minuscule. Regardless of whether this scenario is happening exactly as I have outlined it, refusal to extend credit creates a recursive impact of taking more and more money out of the economy that eventually makes it economically impossible for more and more debtors to repay their obligations to the heretofore healthy banks. Thus, tighter credit, fueled by insolvent banks the Federal Reserve is attempting to save, starts destroying the balance sheet of healthy banks and their customers. This could lead to a self-fulfilling prophecy of an ever larger banking calamity. And, if there is any legitimacy to this scenario, and I believe there is some evidence therefore, it is likely happening, in a great irony one of the Fed's primary tools to save the banking system would actually be destroying the healthy banks and the economy. So, the Fed could lower short term rates in an attempt to deter this banking behavior but this would limit an unhealthy bank's ability to take advantage of the Fed's paid reserves program. I expect the Fed will lower rates in an attempt to force unhealthy banks to lend their way to health. Will it work?
As I've said before, the Fed should remove the sick banks or risk destroying healthy banks and possibly even contributing to a depression the Fed's policies are ironically meant to avoid.
Remember, we have talked about this concept in literal terms but let's make this simple point again. The Fed and Treasury cannot remove risk. There is no way to remove risk. All one can do is transfer risk and potentially relieve some of the time value of its impact. The crisis before us still remains and nothing has been done to resolve anything that caused it. All the government's plans have done is transfer some of the risk in the banking system to the U.S. government and the buyers of its debt. That's it. Nothing more, nothing less. If the economy does not stabilize, and it won't without first experiencing substantially greater pain, and/or plans are not instituted to stimulate market-based and private sector growth, the government's monetary policies will eventually fail on some level.
Capitalism is a bad word right now due to the behavior of the elitists who created this mess, but capitalism is the only way out. Government can play an important role in our recovery but nothing being discussed right now will move to recovery. Assisting those who are on the verge of losing a place to live or providing some type of unemployment benefit is a role government can play but a government works project is not a plan for recovery. I'm not saying rebuilding or building infrastructure is not important. But, were recovery so simple as embracing the Soviet planning model, we'd all be Bolsheviks. Or Europeans. Instead, we must repudiate the European style of colonial capitalism that has recently come to define our society and the European style of government involved capitalism that is now encroaching into our society. Government involvement in capitalism may be necessary short term because, paradoxically, government has not been constructively involved in capitalism for some time. But long term, we must return to the American style of capitalism that created the most dynamic and wealthy society the world has ever seen. And, the only people that will make that happen reside outside of the bureaucracy. That would be you.
There is no free lunch. That is, unless it's a holiday lunch with friends and family.
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