trying to understand 2008 bailout ??

Discussion in 'Economy' started by Widdekind, Apr 21, 2012.

  1. Widdekind
    Offline

    Widdekind Member

    Joined:
    Mar 26, 2012
    Messages:
    813
    Thanks Received:
    35
    Trophy Points:
    16
    Ratings:
    +35
    In 2008, banks "borrowed" $0.7T from the Federal Reserve (FR)
    [​IMG]
    To fund the "loans", the FR initially liquidated $0.5T of "traditional securities" from its "balance sheet" portfolio, on the open market. With the Money, the FR purchased toxic assets from banks, adding the assets, to the FR "balance sheet". But as the bailout continued, additional "loans" were still required. So, the FR subsequently printed $2T of new Money, with which the FR purchased over $1T of additional toxic assets from banks, again adding the assets, to the FR portfolio.
    [​IMG]
    In 2009, the FR began liquidating toxic assets from its "balance sheet", selling them back to banks. With the Money, the FR purchased US Government debt assets, from those same banks. By 2010, most toxic assets had been, thusly, exchanged for US Government bonds. Banks were "bailed out", and now retain their toxic assets, plus the $2T they received from the FR, for the sale of US Government bonds. Banks are keeping the $2T in the FR, as "excess Reserves", on which they are now earning 0.25% interest:
    [​IMG]
    [​IMG]
    Banks have dis-invested from $1T of real-estate (property), business & industry (plant & equipment), and other securities; and re-invested into $0.5T of Government bonds, seemingly "shying away" from the private sector:
    [​IMG]
     
    Last edited: Apr 21, 2012
  2. DSGE
    Offline

    DSGE VIP Member

    Joined:
    Dec 24, 2011
    Messages:
    1,062
    Thanks Received:
    30
    Trophy Points:
    71
    Ratings:
    +30
    That isn't really "the bailouts". The bailouts were TARP. This is the Fed functioning in its Lender of Last Resort role. Half of the reason the Fed was created in the first place was because of bank runs. During banking crises, credit collapses. Since what banks do is "Maturity Transformation", they take short term liabilities and turn them into long term assets, during a credit freeze their ability to meet short term obligations can result in illiquidity, and illiquidity can quickly turn into insolvency.

    The problem is that if people are concerned about the liquidity or solvency of an institution (say because they hold deposits there or the institution owes them money soon), then this can lead to a run on that institutions liabilities. This fear of illiquidity/insolvency can end up being self-fulfilling, as the run on the bank makes it illiquid. It also means other institutions won't lend to the institution or rollever its loans, making it incapable of gaining liquidity to repay people. So with otherwise healthy banks becoming illiquid/insolvent in times of financial panic, the Federal Reserve's job is to act as a Lender of Last Resort, giving short term collateralised loans of created money.

    So that's the theory behind the $700 billion in loans. The problem being, of course, that the solvency of the banks was in serious doubt (TARP was arranged to make sure they stay solvent). The Fed should only be lending to solvent banks. And just in case the bank does go under, the Fed needs good collateral, usually Treasury securities, so that if the loan isn't repayed they sell the collateral. But the Fed took risky assets as collateral. If the banks they gave loans to went under, leaving them with shitty collateral, the Fed would have taken a huge loss on its balance sheet.


    The $2 trillion expansion of their balance sheet was QE 1 and 2. The Fed usually conducts monetary policy through the Fed Funds rate, but that went to 0. So QE is an "unconventional" monetary policy tool. In reality, QE does nothing. The Fed have started paying interest on reserves to make sure it doesn't get out there and they've made clear that they're going to quickly tighten if inflation picks up. They've set an explicit 2% PCE inflation target. So it's just gonna sit there as excess reserves, earning something like $1 billion of interest per year for doing nothing.

    The Fed has handled this whole mess very poorly. Not catastrophically, like the Depression, but poorly.
     
  3. Widdekind
    Offline

    Widdekind Member

    Joined:
    Mar 26, 2012
    Messages:
    813
    Thanks Received:
    35
    Trophy Points:
    16
    Ratings:
    +35
    first, the Fed always purchases "collateral" assets, when it "loans" Money ?

    second, if the Fed was created in 1913 "because of bank runs"; then what happened in 1929 ?
     
  4. DSGE
    Offline

    DSGE VIP Member

    Joined:
    Dec 24, 2011
    Messages:
    1,062
    Thanks Received:
    30
    Trophy Points:
    71
    Ratings:
    +30
    Well it doesn't purchase anything, it always takes collateral. So if the Fed loans a bank $1 at the discount window the bank has to give the Fed a Treasury bill in case they default. If they fail to repay the loan, the Fed sells the Treasury bill to get its money back. If they repay the loan, the Fed gives them back their T-bill.

    Hahaha. Yeah, the Fed has been... incompetent... for most of its existence. Most economists agree that the Depression was entirely the Fed's fault. They got their shit together around 1982, but then the GFC hit and they let nominal spending fall the largest amount since the Depression. The Fed has a terrible track record.
     
  5. Widdekind
    Offline

    Widdekind Member

    Joined:
    Mar 26, 2012
    Messages:
    813
    Thanks Received:
    35
    Trophy Points:
    16
    Ratings:
    +35
    which resembles "buying & selling" ? the Fed does not simply print cash, and give it away; the Fed always "buys & sells" ? do US Government bonds ever get "paid back", when the Fed "buys" them off the open-market; or do bonds immortally persist in the Fed's portfolio "balance sheet", perpetually attracting interest ?



    and a $3T portfolio ?
     
  6. DSGE
    Offline

    DSGE VIP Member

    Joined:
    Dec 24, 2011
    Messages:
    1,062
    Thanks Received:
    30
    Trophy Points:
    71
    Ratings:
    +30
    Not really. When buying & selling takes place normally that means that ownership of something swaps. What's happening here is that the Fed has created money and loaned it out, and in the event that that loan is not repaid, the Fed is allowed to take ownership of the collateral and sell it. Like taking a mortgage out on your house. In the event that you default on your mortgage the bank can seize and sell your house. But in the meantime, they can't walk in and take a swim in your pool.

    Yeah they get paid back. The bonds mature. Normally the Fed doesn't want to remove that money from circulation when the bond matures, so they take it and buy another bond in the open market.



    For now.
     
  7. Widdekind
    Offline

    Widdekind Member

    Joined:
    Mar 26, 2012
    Messages:
    813
    Thanks Received:
    35
    Trophy Points:
    16
    Ratings:
    +35
    banks take customers' money, from short-term demand-Deposits; and buy long-term bonds, having higher yields?

    if so, then over the long-term, in "steady state equilibrium", banks could have old long-term bonds, finally maturing "now", in order to meet short-term obligations "now"; meanwhile, they could keep investing "now", in more long-term bonds, for "far in the future". But, if old bonds "fail", then banks could wind up wanting for their expected returns "today", from old investments, made "long long ago" ?
     
  8. DSGE
    Offline

    DSGE VIP Member

    Joined:
    Dec 24, 2011
    Messages:
    1,062
    Thanks Received:
    30
    Trophy Points:
    71
    Ratings:
    +30
    Buying bonds or other assets or making loans.

    Not really. Say you have a $1M bond you bought 1 year ago maturing tomorrow. You didn't know at the time you bought it how much in reserves you need. Maybe tomorrow when you get the $1M it turns out that depositors want to withdraw a total of $2M dollars? So you can keep reserves against your deposits for that case, or you can borrow the reserves you need on the Fed Funds market.
     
    Last edited: Apr 22, 2012
  9. Widdekind
    Offline

    Widdekind Member

    Joined:
    Mar 26, 2012
    Messages:
    813
    Thanks Received:
    35
    Trophy Points:
    16
    Ratings:
    +35
    i'm only trying to say, is "Maturity Transformation (MT)" is not an intrinsic problem per se, as long as the bank has been "in the game for a while", so that old loans are coming due (bringing money back to the bank), as fast as new outlays are required ? For fluctuations in Demand for currency, the bank keeps "excess Reserves" & Vault-cash, which they would need whether or not they "transformed maturity". i found the following figure; i'm only trying to say, that as long as banks "planned well yesterday, for today", that present income streams from old-but-finally-maturing long-term loans could meet (expected) present demands:
    [​IMG]

    in the following figure, to whom are "financials" indebted ? banks themselves owe money... to whom ?
    [​IMG]
     
    Last edited: Apr 22, 2012
  10. hortysir
    Offline

    hortysir In Memorial of 47

    Joined:
    Apr 30, 2010
    Messages:
    20,459
    Thanks Received:
    4,027
    Trophy Points:
    270
    Location:
    Lakeland, FL
    Ratings:
    +6,296
    Too late.

    Obama won.

    :eusa_shhh:
     

Share This Page