The Federal Reserve refuses transparency as lending surpasses 2 trillion according to a lawsuit recently filed November 7, 2008 by Bloomberg while their Freedom of Information Act request remains unanswered.
For those of us unaware of the who, what, where, when, why & how of all of this I will attempt to shed a little light and understanding in my common man stab at communicating the recent news regarding all of this.
The Federal Reserve is the institution charged by congress, (congress is charged under the constitution with the authority to mint the national currency) with minting money, developing and executing monetary policy to ensure maximum employment and to control inflation. Their efforts are aimed to mitigate the effects of the continuing disaster to our financial system which has been generally acknowledged as the biggest financial crisis since the great depression. The Federal reserve or "the Fed" has made a variety of "loans" under terms of 11 programs, eight of them created in the past 15 months.
Mostly, prior to September 2008 whenever the Fed made a loan to a bank there were very stringent standards for the collateral that could be accepted. When the Fed makes a loan the bank provides investment grade bonds as collateral for either cash or US Treasury bonds. Or, as Bloomberg notes:
Before Sept. 14, the Fed accepted mostly top-rated government and asset-backed securities as collateral. After that date, the central bank widened standards to accept other kinds of securities, some with lower ratings.
One of the issues now before us is what exactly constitutes an investment grade security. An investment grade security can be any financial instrument rated by the three major rating firms as being credit worthy. The firms are known as Standard & Poor's, Fitch & Moody's. In today's context a primary reason we are in such dire straights is because the rating agencies have been giving investment grade ratings to just about anything submitted for a rating since they get paid for providing this service by the folks seeking a rating for an investment product they produced. Most of us have by now have heard abut fancy sounding products that were based upon home mortgages, auto loans, student loans, credit card receivables and all sorts of other stuff. Well, since all regions nationally have been experiencing a decline in real estate values the investment grade products created from these mortgages have been failing. So, when we hear the MSM talk about the implosion in sub-prime or Alt-A mortgages what they are really alluding to is the likelihood that more and more of the securities created from these mortgages will also fail creating major problems for the folks that hold these products which are mostly banks, foreign governments, hedge funds, insurance companies and state retirement funds.
Since august 2007 these rating firms have had to reduce the ratings on hundreds of billions of these securities. As this quote reveals, when a security that has been used a collateral with the Fed for a loan and the collateral's rating gets reduced below investment grade the bank must post new collateral. Here is just a taste of the recent action on this front. emphasis mine.
Moody's Investors Service alone has cut its ratings on 926 mortgage-backed securities worth $42 billion to junk from investment grade since Sept. 14, making them ineligible for collateral on some Fed loans.
In a nut shell these products are the so called "toxic waste' on bank balance sheets the Treasury initially wanted the 700 billion dollar 'bail out" for so they could purchase them at auction so the banks would be able to loan money again. The bail out is now called the T.A.R.P. or the Troubled Asset Relief Program.
Another aspect of the great implosion of the credit markets was realized when the government determined it had to take over the two giant companies that purchase mortgages from banks and create securities. These companies are known as Fannie Mae and Freddie Mac. Prior to august 2007 about 45% of all mortgages written in the US ended up being purchased by these two companies, mostly the best mortgages as they has standards of quality that had escaped many mortgage originators. As this crisis has unfolded most investors stopped buying anything that was not government backed. To prevent a complete collapse in the US mortgage market Fannie & Freddie must now purchase about 85%-90% of the mortgages written in the US. Essentially, they are now the only game in town keeping the American mortgage market afloat and able to keep the banks in the business of making home loans. Now then you may be asking; "Why is this citizen talking about this?" and the answer is simple. When the Fed began to flood the banks with "liquidity" or money one of the primary ways they did this was to accept the banks Fannie & Freddie securities as collateral.
Total Fed lending topped $2 trillion for the first time last week and has risen by 140 percent, or $1.172 trillion, in the seven weeks since Fed governors relaxed the collateral standards on Sept. 14. The difference includes a $788 billion increase in loans to banks through the Fed and $474 billion in other lending, mostly through the central bank's purchase of Fannie Mae and Freddie Mac bonds.
So, what we are now learning is that on top of the Fed's lending to banks using Fannie & Freddie securities, which are now fully backed by the US Treasury since they have been nationalized, they have also loaned 788 billion since September 14 using collateral other than Fannie & Freddie securities.
In the article from Bloomberg they remind us of the following.
Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system.
The kicker here is that the Fed can loan money in several programs in amounts that far surpass the 700 billion TARP program with little or no public disclosure or transparency.
What we are coming to understand is that this 788 billion the Fed has loaned since mid September is being collateralized with the toxic waste the banks could not sell on the open market Toxic waste the 700 billion TARP was supposed to be for, but the Fed is loaning money against it with little or no disclosure while freeing up the 700 billion TARP money for the Treasury Department to do direct cash injections into banks.
Two months later, as the Fed lends far more than that in separate rescue programs that didn't require approval by Congress, Americans have no idea where their money is going or what securities the banks are pledging in return.
They have also done an admirable job at helping to clarify this with this insight.
The Fed's lending is significant because the central bank has stepped into a rescue role that was also the purpose of the $700 billion Troubled Asset Relief Program, or TARP, bailout plan -- without safeguards put into the TARP legislation by Congress.
Bloomberg quotes why this is important to the big money management folks with this bit of sunshine.
``The collateral is not being adequately disclosed, and that's a big problem,'' said Dan Fuss, vice chairman of Boston- based Loomis Sayles & Co., where he co-manages $17 billion in bonds. ``In a liquid market, this wouldn't matter, but we're not. The market is very nervous and very thin".
Federal Reserve spokeswoman Michelle Smith declined to comment on the loans or the Bloomberg lawsuit. Treasury spokeswoman Michele Davis didn't respond to a phone call and an e-mail seeking comment.
We are getting this response from administration and Fed officials after their leadership said the following in congressional testimony in September.
At a Sept. 23 Senate Banking Committee hearing in Washington, Paulson called for transparency in the purchase of distressed assets under the TARP program.
``We need oversight,'' Paulson told lawmakers. ``We need protection. We need transparency. I want it. We all want it.''
At a joint House-Senate hearing the next day, Bernanke also stressed the importance of openness in the program. ``Transparency is a big issue,'' he said.
As expected the banks are resisting transparency and full disclosure on a variation of the tried & true theme.
Banks oppose any release of information because it might signal weakness and spur short-selling or a run by depositors, said Scott Talbott, senior vice president of government affairs for the Financial Services Roundtable, a Washington trade group.
``You have to balance the need for transparency with protecting the public interest,'' Talbott said. ``Taxpayers have a right to know where their tax dollars are going, but one piece of information standing alone could undermine public confidence in the system.''
Here is the point when the rubber hits the road and we discover who is on which side of the fence. These quotes are courtesy of Barney Frank, House Financial Services Committee Chairman.
"The Fed's disclosure is sufficient and that the risk the central bank is taking on is appropriate in the current economic climate".
``I talk to Geithner and he was pretty sure that they're OK,'' said Frank, a Massachusetts Democrat.
``If the risk is that the Fed takes a little bit of a haircut, well that's regrettable.'' Such losses would be acceptable, he said, if the program helps revive the economy.
Frank said the Fed shouldn't reveal the assets it holds or how it values them because of ``delicacy with respect to pricing.'' He said such disclosure would ``give people clues to what your pricing is and what they might be able to sell us and what your estimates are.'' He wouldn't say why he thought that information would be problematic.
Note: New York Federal reserve Governor (and candidate for treasury secretary) Timothy F. Geithner.
And here is what sounds like music to my ears from a big money market participant that seems to be voicing the opinion of that part of society that wants transparency in the worst way.
Revealing how the Fed values collateral could help thaw frozen credit markets, said Ron D'Vari, chief executive officer of NewOak Capital LLC in New York and the former head of structured finance at BlackRock Inc.
``I'd love to hear the methodology, how the Fed priced the assets,'' D'Vari said. ``That would unclog the market very quickly.''
WOW!
What I hear being said is that the actions by the Treasury department and the Federal reserve with regard to this lack of disclosure is adding to market uncertainty and negatively effecting the thawing of the frozen credit markets which is what all of this is supposed to be about.
Bloomberg adds this as a reminder that many of us are demanding transparency in what exactly the Fed is doing and what toxic waste it is accepting from institutions in deep trouble a for very important reasons. Essentially, if these banks fail or run into bigger problems and cannot meet their repayment clauses then we, the taxpayers are on the hook for these loans.
The Bloomberg lawsuit argues that the collateral lists ``are central to understanding and assessing the government's response to the most cataclysmic financial crisis in America since the Great Depression.
What I hear Bloomberg and other smart folks saying is that we do not know if the Fed is holding non investment grade securities as collateral or if they are pressuring the rating firms to slow the pace of their process that reviews and downgrades securities they have rated. One thing is certain, there is one heck of a motive for the Fed & the treasury to apply pressure upon these folks to paper prop this toxic waste so that the financial system does not suffer any more shocks because of their complete and total lack of risk management.
A quick note on risk management. last week the former head of risk management at Bear Stearns, the investment bank that died in March because the huge risks they made in their investment securities were realized when they imploded has just been named to a leading role at the Fed to help manage all of these Fed programs.
From Bloomberg notes with some snark:
-- Let’s say you were the chief risk officer of the former Bear Stearns Cos. in the two years preceding the bank’s collapse in March.
And let’s say, just for argument’s sake, that the postmortems revealed Bear to have had too much risk and too little management of it. The only way JPMorgan Chase & Co. would agree to acquire Bear was with a $29 billion sweetener from the Federal Reserve for some of the less-palatable assets.
Following the acquisition of Bear Stearns by JPMorgan, you would expect said chief risk officer to:
a) Retire quietly to his country home;
b) Open a "consulting" business, allowing him to deduct the costs of a home office at the country home;
c) Land a plum job offer from another Wall Street bank;
d) Land a job as a bank supervisor at the Federal Reserve.
If you picked a, b or c, you would be incorrect. The correct answer is d.
Michael Alix, chief risk officer at Bear Stearns from 2006 until its demise in March, was named senior vice president in the Bank Supervision Group of the New York Fed on Oct. 31.
It’s not unusual for Wall Street to reward its own, offering rogue traders -- the ones who escape criminal prosecution -- new jobs at different firms. But the Fed? At a time when its balance sheet is exploding with increasingly risky assets?
http://www.bloomberg.com/...
Here is the link to the Bloomberg article on their Federal reserve suit.
http://www.bloomberg.com/...
Here are some updates on loans the Fed has outstanding or have resolved themselves.
Some of your good folks may be wondering where are the rest of the Fed's loans to bring the total of outstanding to 2 trillion. One of the answers can be found in a program that predates these current troubles called the "discount window". Prior to August 2007 banks avoided this facility like the plague because to use it was interpreted by the market as a sign of weakness. The Fed has done an admirable job of eliminating that stigma. The way the discount window works is a bank can borrow from the fed at a rate of 1/2 of 1 percent, or 50 basis points above the prime lending rate which now stands at 1% or an effective rate of 1.5%. here is the kicker. The reason the Fed is doing this is in order to provide extra liquidity to the banks. What this really means to us is that a bank can borrow money from the Fed, our money so it can loan it back out and make money, which is what banks do. However, as the prime rate and discount window rates have gone down to almost 0 the rate banks are charging for a mortgage has gone from 5.82% for a thirty year mortgage last month to 6.03% this month. Essentially, the Fed is loaning our money to the banks so they can make more money by inflating the interest rates charged to us so they can make up for all the money they lost making mortgages they never should have causing 1 in 5 mortgage holders to owe more than their houses are currently worth.
Don't you feel better already?
In March, 2008 as part of helping JP Morgan/Chase Manhattan bank purchase Bear Stearns the weekend before it would have failed the fed assumed 30 billion dollars worth of Bear's toxic waste to help facilitate the deal. Well, those loans have now been settled and the Fed lost 26.8 billion of the 30. From Bloomberg:
The central bank is also responsible for losses on a $26.8 billion portfolio guaranteed after Bear Stearns Cos. was bought by JPMorgan.
There is news from the insurance company, AIG the Fed bailed out in September. (Emphasis mine)
In addition to the $85 billion loan on Sept. 16, AIG got two more government credit lines totaling $58.7 billion last month to make up for more losses, including $37.8 billion for a securities lending operation.
The U.S. will cut the original $85 billion loan that saved the New York-based insurer in September to $60 billion, buy $40 billion of preferred shares, and purchase $52.5 billion of mortgage securities owned or backed by AIG, according to a person familiar with the matter. The funds will help AIG retire part of its credit-default swap portfolio and bolster its securities lending operations, said the person, who declined to be identified because the plan hasn't been officially announced.
For those of you who are not in the know, the Credit default Swap or CDS market is a totally unregulated market whose current value worldwide is estimated at about 54 trillion dollars.
Here is the link to the AIG business.
http://www.bloomberg.com/...
And here is a link to an article that discusses the efforts the organization that represents the folks involved with the Credit Default Swap market at adding transparency to their totally opaque market. I would like to note that the efforts discussed as ground breaking amount to just one more fluff job designed to say hurrumph in true Blazing Saddles style. NOTE: I am not buying it for a nanosecond.
http://www.ft.com/...
As an add-on here is an article about how the Chairman of the Fed thinks we may have a "Too big to fail" problem. Ya think?
http://www.bloomberg.com/...
Another add-on is this gem from today's financial times discussing why the US should not "abandon" its plans to purchase toxic waste.
http://www.ft.com/...
Well there it is folks. There is so very much more happening right now in the world of finance, but I thought it worthwhile to concentrate on these areas as the Fed and Treasury work in the shadows and once more prove that the whatever the current administration has to say cannot be trusted simply because it will change before the ink is dry.