The Fed's Exit Plan

[ViC78]

The Fed's "Exit Plan" Is Just Another Secret Gift To Wall Street

Posted Feb 08, 2010 09:50am EST by Henry Blodget in Investing, Recession, Banking Related: spy, dia, XLF, qqqq, tlt, uup, ^gspc

The Fed is planning to detail its "exit plan" this week, the WSJ says. This exit plan is the means by which the Fed will gradually reverse the tremendous stimulus it is still pumping into the economy and financial system.
As we've noted often over the past year, the Fed is in a bind. During the financial crisis, it bought hundreds of billions of dollars of real-estate and other assets from banks to reduce mortgage rates and ease the pressure on bank balance sheets. This, in turn, pumped hundreds of billions of new dollars into the economy, which has enabled the banks--and bankers--to make a killing over the past year. The question is how the Fed can reverse this stimulus without killing the economy.
The idea behind giving the banks cheap money was that the banks would lend it to consumers and businesses. Unfortunately, that hasn't happened: Since the start of the crisis, bank lending has fallen off a cliff. The banks are, however, lending to the Federal government, which needs to fund record deficits by borrowing more than $1 trillion a year. The combination of the Fed's desire to stimulate lending via cheap money and the government's desire to stimulate the economy by running a huge deficit has made it a great time to be a bank: Banks can borrow from the government at artificially cheap rates and then lend the money back to the Federal government at higher rates, pocketing the difference.
And now it's going to get even better to be a bank.
Why?
Because the first part of the Fed's exit plan will reportedly be to increase the amount of interest the Fed pays on "excess reserves."
Banks are required to keep a certain percentage of their assets in cash at the Federal Reserve. Any cash above this required amount is "excess reserves," and the Fed is currently paying 0.25% interest on these reserves. The Fed's exit plan will call for increasing this interest rate, to encourage the banks to keep more money in excess reserves instead of lending it into to the economy and thus expanding the money supply.
The idea here is that, by increasing the amount of money on account at the Fed, the Fed will reduce the amount of money that gets loaned out to businesses and consumers, thus forestalling inflation. Increasing interest paid on excess reserves will also put off the day that the Fed has to start selling its real-estate assets back to banks, a process that might create taxpayer losses and raise mortgage rates, which the Fed is loathe to do.
Of course, in the process of increasing interest paid on reserves, the Fed will be paying banks even more not to lend. In the process, it will be giving banks yet another way to take nearly free money from the taxpayer and give it back to the government at a higher rate--and then pocket the difference.
It's a great time to be a banker.

[skidder]

Re: The Fed's Exit Plan

Kind of a stupid question here but how does the FED, by creating yet more money to keep already created money from being put into circulation by the banks, WITHDRAW money from the banking system? I can see how it dampens enthusiasm to lend by the banks but eventually the sums created by the FED to pay this increased interest have to start having an impact somewhere, don't they?
Doesn't this whole plan kind of reveal how impotent the FED is with regard to being able to drain reserves from the system???

[D-Mack]

Re: The Fed's Exit Plan

[ViC78]

Re: The Fed's Exit Plan

I can see how it dampens enthusiasm to lend by the banks but eventually the sums created by the FED to pay this increased interest have to start having an impact somewhere, don't they?

I would think that the maximum impact would be on the banker's bonuses via higher earnings for the banks, if this scheme is put in place as Blodget suggests. If that is the case, the only place where inflation would rear its head would be in higher priced assets like desirable real estate, paintings, boats etc. and a little will trickle down to the peasants (hotels, nannies, etc.)

[icm63]

Re: The Fed's Exit Plan

This is a joke..

The FED created heaps of money..

THAT WENT KNOW WHERE ! Unless you were buying stocks via GS, JPM, BAC, CIT.

It made no difference to Average Joe, the velocity of money still decreased.

So they pull it back in, so what ! Cant see how money that did very little, if pulled will make a difference.

Also I can see Obama ringing BEN saying I want a asset rally between Jun and Sept thanks !

[skidder]

Re: The Fed's Exit Plan

This is a joke..

The FED created heaps of money..

THAT WENT KNOW WHERE ! Unless you were buying stocks via GS, JPM, BAC, CIT.

It made no difference to Average Joe, the velocity of money still decreased.

So they pull it back in, so what ! Cant see how money that did very little, if pulled will make a difference.

Also I can see Obama ringing BEN saying I want a asset rally between Jun and Sept thanks !

That's kind of the point of my question ( I think), the aren't pulling anything "back in". The FED prints a trillion bucks, buys a trillion worth of junk mortgage for 100% of face and then bribes the bankers to not lend it by offering them interest to park said trillion with the FED. The whole point it now appears was to keep the banks solvent (or at least operating) AND to make sure they did NOT lend out the money.
Now it seems they have no effective way to drain those funds because all they have to trade for them is junk mortgages, which no one is going to buy for anywhere close to 100% of face. So, they are upping the interest paid on these "reserves" in an attempt to re-enforce the money dam that keeps this money out of circulation. That means they are creating yet more money to pay bankers as a bribe to stop loaning money.
It shows me that they have no good plan for draining this trillion or so they shoved into the banks. I don't know what that means but it appears problematic for the FED, so that can't bode well.

[grapejelly]

Re: The Fed's Exit Plan

Dan Amerman has a great piece on this exact topic and why the Fed "exit plan" is doomed

Now let's step back from the cleverness of the Federal Reserve chairman and consider what's really happening here. A huge sum of money, over a trillion dollars (total Fed balance sheet growth) was created quite literally out of the nothingness with no assets or taxes. It's just pure monetary creation, and it was distributed in such a way as to yield the maximum benefit for some very well connected political insiders, the executives of the banking industry. But we don't have to worry about the inflationary consequences, as the money can theoretically be contained indefinitely by the Fed paying the banks a higher rate of interest than anyone else. This high interest rate can be either directly on the excess balances or through the reverse repos and other methods the Fed can use to pull money out of circulation.



What is the source of the Federal Reserve's perfect credit and its ability to pay higher interest rates than anyone else in the market which, in the Fed’s opinion, makes it certain that this cash will be contained? The source is the direct creation of money. Because the Fed can directly create money, it can pay however much interest as it takes.



When it comes to “reverse repurchase agreements” and similar arrangements, which are Bernanke’s ultimate source of confidence that he can put the monetary creation genie back in the bottle at will, what do they really come down to? The Federal Reserve drains money from banks by making the banks deals that are too attractive to refuse, through giving them back even more money at the end of the short term contract. Each round of reverse repos that is used to contain excess money, ends up leading to still more money out there in a matter of days, that then needs to be contained in the next slightly larger round. Repeat, repeat and repeat as needed – for there are no limits.
The theory is that a potentially infinite sum of money can be created and passed to politically connected insiders, but the damage can be contained through the creation of infinite money to pay them off, to keep them from actually spending the money that was given to them. In my opinion, this is a crazy strategy for preserving the value of our money — but it is our current reality.


The Fatal Flaw
There is good news and bad news about how this strategy has performed in practice. The good news is that the first round from the fall of 2008 actually worked. The original investments were commercial paper and emergency loans to banking institutions, each of which are quite short term in nature. The commercial paper has paid off. The great majority of the bank loans have already been repaid.


But there is troubling news as well. According to the theory behind the original plan – as each loan payment came in, the money should have been extinguished, and a proportionate amount of excess reserve balances forced back into general circulation where the need to invest could potentially stimulate the economy. By the end of 2009, the excess reserve balances should have been gone and the Federal Reserve balance sheet should be back down to about $800 to $900 billion, with the “liabilities” consisting almost entirely of physical currency. The desperate measures successfully taken in the fall of 2008 should already be a historical footnote, being discussed only in graduate student seminars over the coming decades.


However, in the real world – the excess reserves are still there, and the new Federal Reserve is still almost triple the size of the old Federal Reserve. Because the fatal flaw in the plan is that the real world isn’t about economic equations, but rather people. The Federal Reserve is run by people with quite human motivations, who are subject to the temptations of power and hubris.



Money is power, and a trillion dollars is a great deal of raw power for the small group of un-elected economists who run the Federal Reserve. Each board member knows that the trillion dollars shouldn’t be there, because of the threat to the value of the currency they are supposed to maintain. But they got the money and they got it scot-free. More money than an entire year’s individual income taxes for a nation (as recently as 2004), and they don’t have to answer to Congress on how they spend it. The Federal courts are uninterested, the press has no idea what’s going on, and neither does 99% of the public. In other words, the members of the Federal Reserve board find themselves with an awesome amount of power that is essentially extraconstitutional, without the usual checks, balances or semblance of accountability.


So naturally, the members of the Federal Reserve Board are exercising that power, and the bad news is that they entirely spent the newly created money as it came back to them. (Who does hand power on that scale back?) This second round is however far more ambitious – and far more dangerous – than the original very temporary intervention into short term and relatively high quality investments.

[bcassill]

Re: The Fed's Exit Plan

The Fed has a plan? Ha, ha...ha, ha, ha...hahahahahahahahahahahahaha!

[bobola]

Re: The Fed's Exit Plan

This big bank / FED money shoveling scheme sounds like a gigantic Monoply game, with multiple banks for the select (too large to fail) few, who keep raking it in, while everyone else (Joe taxpayer) keeps on paying rent.

The old adage of the golden rule is so true - he who has the gold makes the rules.

[ThePythonicCow]

Re: The Fed's Exit Plan

Dan Amerman has a great piece on this exact topic and why the Fed "exit plan" is doomed

Argh! We're being as blind as bat dung.

It's right in front of eyes and we cannot see. This is not a battle royale between the forces of inflation and deflation. This is not about corralling the excess liquidity pumped in by the Fed.

This is (one of) the next bubble(s) to collapse!

Coming off the NASDAQ and other stocks crash of the 1990's, several bubbles were intensified:

• A bubble in mortgages on residential real estate in the U.S. and other countries provided ready (over) consumers.
• A bubble in industrial capacity in China provided ample (excessive) production capacity.
• The boyant tax revenues and business activity bloated pension funds and local, state and federal balance sheets with unfunded liabilities based on the promise of continuing prosperity.
• Money center banks bloated on derivatives and swaps built on the residential mortgage bubble.
• Regional and local banks bloated on commercial real estate loans to retail chain expansion serving the "needs" of these increasingly "wealthy" consumers.

The residential mortgage bubble has burst (or is half way through bursting, I'm unsure which.)

The present story to which I am responding is one piece of this. In the last decade, banks went from a nutritious diet of good hay (well vetted loans held to maturity for well known customers) to be fattened up on a diet of corn silage (MBS fees and bubble prosperity loans and derivatives and swaps thereof.)

Now that corn silage is being replaced with intravenous high fructose corn syrup. The Fed has taken some of the worst of the toxic fat off the failing carcasses of our banks and replaced it with the pure fructose of zero risk earnings (well, zero risk so long as you trust the Fed.)

What happened to the dot com companies and investors therein back in the 1990's? They were fattened up and then smashed into oblivion.

What is happening to the home "owner"? They've been fattened up on the promises of "always rising" real estate prices and are now being smashed into oblivion.

What happened to the banks and funds feasting on this residential real estate paper and securitized swapped derivatives thereof? They were fattened up and are now in the ICU, getting that intravenous fructose drip, further exposing their sorry balance sheets to the whims of the Fed. They will be smashed into oblivion in due time. As I wrote in one of my first posts here on iTulip over a year ago (if my memory serves), JPMorgan hates competition. They periodically go through a phase of destroying and/or consuming most of their competition.

What is happening now to the production engine in China? It's cruising for a bruising. It was fattened up as part of undermining and displacing the legendary productive capacity of the U.S. and now is teetering on a long and dramatic crash.

The faces of Blankfein and Hank Paulson which we all love to hate are side shows distracting us from what's happening here.

The Fed has not been about re-inflating the economy of us ordinary Americans and the risk is not that their fanciful balance sheet creations will escape the corral. Their primary interests in the main economy are to hold it hostage and to keep it alive long enough to carry out other deeds. They are about fattening up the banks another notch on even more empty calories, in preparation for the kill.

In the last 24 hours before sending an old cow off to the beef market, my Dad would feed the cow potatoes (which the government provided us dairy farmers below cost as a subsidy to the potatoe farmer). This made the cow thirsty and they'd drink much water. The cow would weigh more at the auction, and earn Dad a few more dollars.

The Fed is fattening up the banks with:

• swaps of toxic paper for Treasury paper
• repos of more toxic paper (repos are the pawn shop trades of banks), and
• increasing earnings on these "excess" reserves.

I see dead banks.

[Gnosis]

Re: The Fed's Exit Plan

For a thought provoking brain-tickle, go back to Martin Armstrong's thesis and think about the synthesis of this thread and his thoughts on the matter.

[ViC78]

Re: The Fed's Exit Plan

What is happening now to the production engine in China? It's cruising for a bruising. It was fattened up as part of undermining and displacing the legendary productive capacity of the U.S. and now is teetering on a long and dramatic crash.


The Fed has not been about re-inflating the economy of us ordinary Americans and the risk is not that their fanciful balance sheet creations will escape the corral. Their primary interests in the main economy are to hold it hostage and to keep it alive long enough to carry out other deeds. They are about fattening up the banks another notch on even more empty calories, in preparation for the kill.

TPC -

What deeds are you referring to? The narrative was always that the FED is a private cartel for the banks and is looking out for the interests of the banks. What you are suggesting is that the banks are as much of a roadkill as the rest of us (please correct me if I am wrong). So, what is the end game for the Fed according to you?

[ThePythonicCow]

Re: The Fed's Exit Plan

TPC -

What deeds are you referring to? The narrative was always that the FED is a private cartel for the banks and is looking out for the interests of the banks. What you are suggesting is that the banks are as much of a roadkill as the rest of us (please correct me if I am wrong). So, what is the end game for the Fed according to you?

The Fed (by my narrative) is not looking out for "the banks", but for the wealthiest few and the banks they choose to favor.

Yes, I am suggesting that most banks are as much of a roadkill as the rest of us.

I am predicting that we will have a second round of crunch time and financial panic this year or next, with many bank failures, including a few of the biggest banks, leading to acquiescence of the U.S. to imposed stiffer BIS formulated rules seeming to come from the IMF which will leave most banks destroyed, assimilated or enslaved. U.S. political, monetary and financial independence is at grave risk of being further compromised.

JPMorgan Chase will be a survivor. Citi, Goldman, BAC and WF are fighting for their lives.

Once most banks are dependent on their "excess" reserves held at the Fed for solvency, they can be herded to the execution chambers at will, perhaps due to the "regrettable" imposition of fiscal restraint imposed on the profligate U.S. by the IMF (an agent for monetary globalization.)

[mmr]

Re: The Fed's Exit Plan

The US is going to acquiesce to the pending European / BIS rules regardless of whether or not there's an economic collapse. The Fed is worried about the impact, but can't do much about it unless the administration is willing to breach some international treaties.

With capital and liquidity requirements going up, banks won't be able to make loans (even if there were unserved credit-worthy borrowers, which there basically aren't right now) and will have to load up on "safe" treasuries and Fannie / Freddie bonds. From a lending perspective, the banking industry is in run-off mode for the foreseeable future.

Even the "casino" part of the industry (GS, MS, JPM) won't be immune, since the Europeans / BIS are going after trading and derivatives businesses. For example, they're going to try to make all the banks including JPM hold capital against the notional value of their credit default swaps. Assuming minimum 8% capital, JPM will need $6 trillion notional CDS x 8% = $480 billion in equity. (That's about four times what they have now - good luck raising that, so goodbye derivatives businesses and inflated bonuses.)

Before it's all over, I wouldn't be surprised if the government ends up being the largest lender, competing against the banks directly. If no private company can satisfy the god-given American right to cheap credit, well, the Treasury and Fed will have to step in (even more than they already have).