CBO Issues Fed-Flattering Propaganda

[amborin]

http://www.nakedcapitalism.com/2010/06/cbo-issues-fed-flattering-propaganda.html

CBO Issues Fed-Flattering Propaganda

"I’ve seen some eye-poppin’, credulity-stretchin’ accounts in my time. The report “The Budgetary Impact and Subsidy Costs of the Federal Reserve’s Actions During the Financial Crisis,” just released by the Congressional Budget Office, ranks with the most extreme. It claims that the budgetary cost (which corresponds roughly to expected losses) of the Fed rescue facilities launched during the financial crisis is approximately $21 billion. Moreover, its peculiar formulation (”fair value subsidies”) conveys the misleading impression that this was the extent of the central bank’s support to the financial services industry.

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Yves here....... not only were the Fed’s numerous bailout vehicles a clear violation of Constitutionally-stipulated budget processes, but they expose taxpayers to the risk of eventual costs, since if the Fed takes big enough losses, the Treasury will have to recapitalize the monetary authority (the Fed can simply “print” its way out of a certain level of losses, but if that activity were to stoke inflation, the Fed would need instead to seek funds from the Treasury).
.......However, note the framing of the report. It conflates the discussion of budgetary costs and financial services industry subsidies, when explicit costs to taxpayers are only the tip of the iceberg of the bennies that banks received from Fed. While the other forms of support are arguably outside the CBO’s purview, the failure to state those omissions means that defenders of the Fed and the banksters can use this report to obscure the true extent of welfare for financiers.

A partial list of the subsidies the report chose to ignore:

1. Far and away the biggest, near zero short-term interest rates. As we pointed out recently, this is the biggest source of real cash earnings at financial firms these days, since banks can earn easy, risk-free profits simply by borrowing from the Fed and parking the proceeds in longer-dated Treasuries (even though the biggest financial firms are also reporting embarrassing trading profits, those are due in part to low interest rates, both their impact on funding costs and by boosting asset values). These low interest rates are a large tax on savers. Not only do they make investing in comparatively safe and liquid investments unattractive, but they compress risk spreads by enticing investors to go into riskier assets to chase yield, which props up prices of investments generally.

2. Gross underpricing of the rescue facilities. Bagehot’s rule for a distressed financial firm is to lend freely against good collateral at a penalty rate. But the Fed instead lent against virtually any and all collateral and at attractive, often artificially low rates.
.....The CBO’s “fair market” value seeks to argue that the facilities were priced correctly using an NPV analysis, but that’s bogus. First, as we will see in due course, a mere eyeballing of the results strains credulity. But second, the idea of the Bagehot rule is both to provide for good incentives (you don’t want to make it attractive to use emergency facilities) and to allow for an ample margin for error. A characteristic of panics is they follow bubbles, and what looked to be a decent valuation for collateral might prove to be more than a tad exaggerated. For instance, AAA CDOs were acceptable collateral at the Fed pre-crisis, and if memory serves me correctly, the haircut was 30%. That seemed hugely generous, but the record shows that real-estate related CDOs would have needed a haircut of 80% to 100%.

Although my favorite example comes from the TARP, which is also discussed in the CBO report, it illustrates the general principle. This discussion comes from former derivatives trader Roger Ehrenberg:

The US taxpayer has been systematically looted out of hundreds of billions of dollars… Whether anyone will admit it or not, without the AIG (read: Wall Street and European bank) bail-out and the FDIC issuance guarantees, neither Goldman nor any other bulge bracket firm lacking stable base of core deposit would be alive and breathing today…
.....It stood with the rest of Wall Street as a firm with longer-dated, less liquid assets funded with extremely short-dated liabilities….In exchange for giving the firm life (TARP, FDIC guarantees, synthetic bail-out via AIG, etc.), the US Treasury (and the US taxpayer by extension) got some warrants on $10 billion of TARP capital injected into the firm. While JP Morgan Chase CEO Jamie Dimon prefers to poke a stick in the eye of the Treasury, seeking to negotiate down the payment to buy back the TARP warrants, Lloyd Blankfein smartly paid the full $1.1 billion requested. He looked like a hero for doing so, a true US patriot repaying the US Government in full for its lifeline, thanking the US taxpayer in the process. $1.1 billion… $1.1 billion…Hmm…something doesn’t seem right. You know why it doesn’t seem right? BECAUSE THE US TREASURY MIS-PRICED THE FREAKING OPTION.

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3. The Fed has allowed Wall Street to skim more from its rescue operations, like its over $1 trillion purchase of mortgage backed securities. From the Financial Times in 2009:

Wall Street banks are reaping outsized profits by trading with the Federal Reserve, raising questions about whether the central bank is driving hard enough bargains in its dealings with private sector counterparties, officials and industry executives say…

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Now to the report itself. It is unabashedly Fed and financial services industry friendly. Start from the top: “The financial system plays a vital role in the U.S.
economy.” You can tell this is a preamble to “the Fed had to rescue the banks” which it predictably recites later:

In CBO’s judgment, if the Federal Reserve had not strategically provided credit and enhanced liquidity, the financial crisis probably would have been deeper and more protracted and the damages to the rest of the economy more severe.

Yves here. This anodyne statement is intellectually dishonest. The report discusses ONLY the Fed’s rescue programs. Thus, the CBO posits bi-modal choice (acting v. not acting) when the officialdom had a huge menu of possible actions. This “the Fed had to Do Something, ergo its programs were warranted” misses the massive moral hazard of what was put in place: the continuation of super-low interest rates and the Greenspan/Bernanke puts, the failure to remove the managements and boards of seriously troubled organizations.

Yves here. Regular readers of this blog know we have done extensive analysis on Maiden Lane III, one of the rescue facilities for AIG’s toxic exposures (see here and here for a few of the examples). The idea that it will show no losses is utter hokum. Similarly, the Fed’s massive purchase of MBS are also likely to result in red ink. The central bank entered into them explicitly to tighten risk spreads at a time when Treasury yields were at low levels, thanks both to heightened appetite for safe assets and active efforts by the Fed to lower interest rates.

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The quote suggesting reserve balances were $6 billion in July 2007 was quite wrong, but typical. That was the size of required reserve balances. But required clearing balances were about the same size, so that brings the total to double that, then you have to add another $2 billion for excess balances. So, it was about $14-16 billion total. People who don’t understand the Fed’s operations don’t know that they have to add a few things into the Fed’s balance sheet quote of reserve balances.
......This paper unwittingly suggests that any Audit the Fed initiatives that have the CBO as an important actor will be ineffective, perhaps even counterproductive. If the CBO is as easily led by the nose as this report indicates, it’s likely to be another garbage in, garbage out exercise in modeling that serves to tart up Fed propaganda. The government official who called this exercise to my attention labeled it a “disgrace”, and I agree fully with his assessment."


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Curious Trading by Federal Reserve Advisor May Result in JPMorgan Chase $1.264 Billion Windfall

"Since the Federal Reserve Bank of New York finished purchasing $1.25 trillion in mortgage backed securities in March 2010, it has continued to support those markets with billions in so-called dollar rolls. Even as this is not well known, what is less well known is that the advisor to the Fed's other MBS portfolio also continues to actively trade the account. The annual turnover appears to be 12%. One has to ask what the purpose of this turnover is, given it was sold to the public as a portfolio simply being wound down. Just what has BlackRock been selling off and who is buying the discards? (Could it be the Fed itself?) Is this a case of getting stronger paper into the portfolio for the benefit of JPMorgan Chase, run by President Obama’s "Favorite Banker", Jamie Dimon? Will an easily overlooked disclosure in the portfolio’s audit allow a $1.264 billion windfall payment to JP Morgan in the coming weeks? Nothing can be known for sure unless the Federal Reserve provides further data. But the trading in the portfolio and its valuation is very suspicious. Below is some background followed by a forensic analysis of what is known to date, with a discussion of what further data needs to be provided by the Fed to gain a full understanding of what BlackRock is attempting to accomplish with the unusually heavy trading in Maiden Lane......"

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"....The two important points thus far are: (1) the portfolio would be used to wind down certain Bear Stearns assets and (2), JPMC is lower on the repayment ladder than the American taxpayer, inasmuch as the NY Fed can be said to represent such.
"....

"........It appears to be a backhanded escape clause that would allow JPMC to be repaid ahead of the NY Fed. No mention is made of any qualifications to ensure that the NY Fed would have a chance at future recovery. Additionally, the use of the term “commence” means it was not contemplated for bothparties to be repaid in full ahead of time. Delving into the 2008 Maiden Lane audit for clarification, there are a few more details:

Repayment on the Senior Loan may only begin prior to the second anniversary of the closing date of the Loans if the Subordinated Loan has been paid in full. Repayment of the Loans will only occur after payment in full of closing costs for the LLC, operating expenses, and maintenance of a reserve account for loan ...."


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http://www.zerohedge.com/article/curious-trading-federal-reserve-advisor-may-result-jpmorgan-chase-1264-billion-windfall