What do we really know?

Some of you may have read the recent story from Bloomberg, which has revealed the massive loans that were made by the federal reserve to some of the world's major banks, or rather the 'too big to fail' banks:

The Federal Reserve and the big banks fought for more than two years to keep details of the largest bailout in U.S. history a secret. Now, the rest of the world can see what it was missing.
The Fed didn’t tell anyone which banks were in trouble so deep they required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day. Bankers didn’t mention that they took tens of billions of dollars in emergency loans at the same time they were assuring investors their firms were healthy. And no one calculated until now that banks reaped an estimated $13 billion of income by taking advantage of the Fed’s below-market rates, Bloomberg Markets magazine reports in its January issue.
Saved by the bailout, bankers lobbied against government regulations, a job made easier by the Fed, which never disclosed the details of the rescue to lawmakers even as Congress doled out more money and debated new rules aimed at preventing the next collapse.
A fresh narrative of the financial crisis of 2007 to 2009 emerges from 29,000 pages of Fed documents obtained under the Freedom of Information Act and central bank records of more than 21,000 transactions. While Fed officials say that almost all of the loans were repaid and there have been no losses, details suggest taxpayers paid a price beyond dollars as the secret funding helped preserve a broken status quo and enabled the biggest banks to grow even bigger.

Interestingly, in a letter to a US senator, the Federal Reserve is claiming that the Bloomberg story is filled with errors.  The reason why I am posting on this story is that there was a fascinating snippet that came from the C-Span service, which shone a little light on what was taking place in 2008, as the economic crisis became apparent:

Now the interesting thing is that it is not clear where this information comes from. A senate hearing has the senator discussing the issue with Bernanke and Paulson (go to 1 hour and 50 minutes). In the discussion, Kanjorski suggests a similar scenario to the clip above, and asks for comment from Bernanke and and Paulson. They do not directly agree that the event took place, but they also do not refute it. When presenting the discussion of the bank run in the hearing, Kanjorski starts by saying that he had heard about a money market run from a friend in Wall Street, and that some newspapers were anonymously reporting this. He then goes on to say that 'he has evidence of this in some of our conversations' (presumably with Bernanke and/or Paulson), before saying 'with you and other experts'. He dates the event to 11-11:30 last Thursday, which is generally given as September 18, 2008.

I conducted a Google news search for the terms 'money market' and bank run for the 17th through to the date of the hearing, and could not find these 'anonymous stories' that Kanjorski discusses. This may be because I simply did not pick them up from the results, but I thought I would at least check to see if I could find them. However, I do find it distinctly odd that this is such a huge, if not momentous story, but all of the details are vague, and the sources are undefined. Why is it that we get no confirmation or denial from Bernanke and/or Paulson? Was it to avoid a fall in confidence? This might be seen as a justifiable reason, but I cannot help but think that this kind of information should be available (I have never supported the bailouts in the first place, so disagree with these arguments).

The other interesting point is that the date given by Blooomberg for 'neediest' day is December the 5th, a Friday. A good summary of the position of the world at the time of this stress can be found in this piece, dated 10 December:

Nations in Europe’s single-currency zone agreed Sunday to temporarily guarantee bank refinancing and pledged to prevent banks failing as part of a raft of emergency measures designed to get credit flowing again.
It was Europe’s most unified response so far to the global financial crisis and addresses a key part of the problem: banks’ reluctance to lend to each other. That has helped fuel the crisis that has pulled down some of Wall Street’s most storied names and is threatening the core of the U.S. and European economies.
After the Dow Jones industrial average ended its worst week in history, plummeting more than 18 percent last week, world leaders scrambled all weekend for a way to unblock money markets before they open Monday.

The ripples of the crisis were spreading with, for example, December 12th seeing the merger of Halifax and Lloyds TSB in the UK:

Halifax Bank of Scotland's bad debts and other charges have risen by two-thirds in two months as corporate and consumer loans buckle under economic pressure.

The banking giant, whose shareholders yesterday approved its takeover by Lloyds TSB, said its charges for bad debts and asset devaluations were £8bn for the year to 30 November, up from £4.8bn at the end of September. It also warned that more pain lay ahead, sending its shares down 23 per cent and hurting those of other British lenders. Shares in Lloyds fell by 18 per cent, RBS was down 15 per cent and Barclays lost 8 per cent.

My question here is as follows; was the December 5th bailout due to another bank run, or was it preventative? Again, this needs to be made public. What were the drivers of this huge bailout, and how were the bailouts decided upon, such as the reason why bank x got amount y?  Bloomberg have done us all a great service in providing some of the information surrounding the bailouts, but I cannot help but be concerned that there still remains so much opacity. The questions are endless....

The point in this post is really to say that there seems to be two worlds. One world is that of the politicians, the central bankers, the too big to fail banks - and the other world is the rest of us. I think of Kanjorski's comments about his hearing the news of the bank run from a friend in Wall Street, and the conversations that he has had with Bernanke and Paulson, and the opacity of explanations, and wonder at what is now taking place in this 'other world'.

At the moment, we have the European crisis in full swing but the official statements, the press releases and so forth, are not really telling us the story. We are, as when the economic crisis first broke, almost certainly being kept out of the full picture. Those holding the levers of power are having their private discussions, and the impact of those discussions, and the decisions that flow from them will impact upon all of us. I am not sure that this can, under any circumstances, be justified. The excuses that the underlying story is kept under wraps to 'maintain confidence' simply does not excuse this opacity.

The point here is that there are not really two worlds, as they are directly connected. However, it seems that the decisions taken and information being held in one world are being undertaken without any real reference to the second world. The disconnect is artificial, and it is wrong. Those in that first world perceive themselves as 'the wise', but do not reconise their ongoing failure. They pull policy levers here, they pull policy levers there, and they keep the levers, and the drivers of their actions, hidden from the second world.

If they had succeeded in stemming the economic crisis, I might be content. However, they promised resolution, but have only succeeded in making the scale of the crisis ever larger. They are not wise; their record tells us that they are fools. They have forfeited any excuse for being privileged insiders who exclude the second world from information, and proper scrutiny of their decisions. I guess my real question, the burning question is this; what are these fools now up to behind closed doors?

Smoke on the Horizon?

A very quick post as I have had a rather odd email from a reader of the blog. I have taken out the identifying elements, but the email is as follows:

Just thought I would tell you about a letter I received on Friday from my bank,

I run a small business and bank with Santander in the UK.
The letter was to find out how big our business is.
They are creating a data base containing all small businesses eligible for the deposit protection scheme.

Smoke on the horizon?

This is some of the recent news on Santander, starting with:

Chief Executive Officer Alfredo Saenz told investors last month it may take three years for profit to “return to normal” in the face of mounting Spanish defaults and weakening earnings in the U.K. and Brazil. Santander expects to “approximately” match 2010 profit this year, he said today. The bank said it could reach a core capital ratio of 10 percent by June 2012, exceeding European requirements, without selling new shares and while maintaining its dividend policy.

“In Spain, I’m still a bit scared about the real-estate market because I still have the impression that there are more losses to come out there,” said Peter Braendle, who helps manage about $60 billion, including Santander shares, at Swisscanto Asset Management in Zurich. “Fortunately, Spain is only one side of the Santander story because they have a diversified business.”

And from the FT:

Retail and corporate customers withdrew £2.5bn of deposits from the UK arm of Santander in the third quarter of this year after the bank changed its funding strategy. Santander said it had moved to shift its funding mix away from expensive deposits by cutting interest rates on some accounts as it had been able to access cheaper financing elsewhere.

 And the UKPA:

Santander UK said it had also overhauled its customer complaints process, recruited 1,100 customer facing staff and relocated its call centres back in the UK to improve its service.
The bank admitted it still had more to do to improve customer service to levels of satisfaction in other areas of the bank. The group was the UK's third most complained about bank behind Barclays and Lloyds in the first half of the year.
The group is in discussions to buy more than 300 branches from RBS, which will add 30,000 small and medium-sized enterprise (SME) customers, which would take its share of the market to 9% from 4%. The deal is expected to complete towards the end of 2012.

 And the BBC;

The bank said it would increase its Tier 1 capital level to 9.2% by June 2012, which would bring it in line with criteria set by the European Banking Authority.

Smoke on the horizon? The most interesting part is that Santander has been losing customer deposits, and the bank's version of this is that the use of wholesale funding is a choice. This from the Financial Post:

Spain’s banks face a massive spike in their funding needs next year at a time when a credit crunch on wholesale markets and calls to increase provisioning against toxic property assets has made the sector’s liquidity a crucial concern.
Around 130 billion euros ($174 billion) of Spanish bank debt will come to maturity next year, according to Thomson Reuters figures. Many banks took on three-year, government-guaranteed debt in 2008, making up a large chunk of the borrowing.

but later in the same article:

Banco Santander SA, Spain’s biggest bank and one of the best-capitalised in Europe, issued up to 7.5 billion euros of three-month to 18-month commercial paper in September, paying between 3 percent and 3.75 percent depending on maturity.
On the covered bond side, bankers expect markets to stay closed for the foreseeable future unless a European-wide solution is introduced to deal with the sovereign debt issue.
In June, Santander struggled to place a 1 billion euro five-year covered bond, backed by a pool of loans the bank had made to regional governments across Spain.

Smoke on the horizon? You could read these articles many ways (if you read the complete articles, the picture is even less clear), but one thing that is certain is that any Spanish bank going to the wholesale funding markets is going to be treated with, at the very least, some caution. It seems odd that they might choose to opt out of the retail and corporate deposit markets in the current environment, regardless of how competitive they might claim those markets to be. It is also notable that in the environment that they are being squeezed two ways, with requirements for larger capital buffers, and facing a difficult market for raising capital. On the other hand, the letter in the email just seems odd, and might therefore be a badly timed administrative requirement, and the bank on a spending spree buying up RBS branches (but with access to deposits)?

I don't have time to go into more depth on this, as it is just an off-the-cuff article in response to the email, but I would certainly be concerned if my bank was in the Santander stable, regardless of the issue of the letter described in the email. I'll leave you to make up your own minds.

The UK and the Silent Bank Run

There is nothing so dramatic as a line of people lined up outside a bank, hopeful of retrieving their money whilst there is still money left. It makes a good picture for the papers. What of the silent bank run? This is where there are no lines of people, but just a long line of electronic transactions as institutional investors remove their funds. No pictures. No drama. No headlines.

Some of the regular readers will know that I have been discussing such a bank run for a long time. I have suggested that the current financial crisis is all about overseas depositors steadily withdrawing their funds from the UK economy (it is not the underlying crisis). The pouring of money into the banking system by the government is an attempt to save the banking system, not only from catastrophic losses, but also from this steady bank run that is resultant from these withdrawals. As that money pulls out of the economy, it is no surprise that the economy comes ever closer to full collapse. It was, after all, the foundation on which the economy was built.

I have recently had a commentator point to an article in the Independent newspaper (many thanks to the anonymous poster). Whilst an occasional browser of the paper, I missed this very important article which, as the commentator points out, was tucked away in the dark corners of the finance section. However, this article should be the stuff of headlines and, in light of the importance, I will quote at some length:

A silent $1 trillion "Run on Britain" by foreign investors was revealed yesterday in the latest statistical releases from the Bank of England. The external liabilities of banks operating in the UK – that is monies held in the UK on behalf of foreign investors – fell by $1 trillion (£700bn) between the spring and the end of 2008, representing a huge loss of funds and of confidence in the City of London.

Some $597.5bn was lost to the banks in the last quarter of last year alone, after a modest positive inflow in the summer, but a massive $682.5bn haemorrhaged in the second quarter of 2008 – a record. About 15 per cent of the monies held by foreigners in the UK were withdrawn over the period, leaving about $6 trillion. This is by far the largest withdrawal of foreign funds from the UK in recent decades – about 10 times what might flow out during a "normal" quarter.

If we think of the numbers that we are looking at, it becomes self-evident why the endless bailouts by the government are falling into a black hole. The government is having to bail out the banks to repay these overseas investors such that, as fast as the money is pumped in, it is pumped straight back out to meet the demands of overseas depositors. With the banks sitting on mountains of toxic debt, with no market left for the sales of these toxic assets, there is nowhere to turn except to the government.

It is as I have long suspected. I have always been of the view that this is not really just about bailing out little old ladies with their savings held by RBS, but also about bailing out all of the overseas investors who stand to lose so much money.

The reason for the bailouts is the can be found in a comparison with the banking crisis in Chile many years ago. I read a paper some time ago on the subject, where an attempt was made by Chile to allow banks to fail, but international pressure forced a reversal of the policy (apologies, I hunted for the paper on the subject, but it is now lost in the 1000+ papers I have lying around). Added to this pressure is the internal pressure caused by politics, and the fact that many advisors to government come from the system that is being bailed out. This has driven governments to think that the banks must be saved, even at the risk of their own downfall.

This ongoing outflow of money from the UK banking system, and also from the UK economy more widely, is at the heart of the financial crisis. Whilst there are no headlines, there is no question that the nature of the problem is as severe as the Northern Rock fiasco. However, the UK government is in the position of guaranteeing this huge outflow and, one way or another, they will somehow need to find ever more money to support the outflow.

Quite simply, the government has made a commitment that it will never be able to keep. The only method will finally be to default through the printing press. As the demands from overseas deposits continues, more money will pour in to the banks from the government, and much of it will just transfer out of the country. The government was never going to have access to such an astonishing amount of resource.

It was a very long time ago that I first realised that the UK was bankrupt. As each day goes by, there are ever more stories that confirm this. It really is very simple. The UK collectively borrowed money that it could never pay back, as it simply does not have the wealth to make the repayments.

Note 1: It may be with relief that you note that this is a short post. I have several real life commitments that are pulling me away from time on the blog. I am hoping to be back to more regular and more deeply considered posts in a while.

Note 2: I have also been distracted by a book which is heavily promoted by the Austrian Economists. It is called 'Economics in One Lesson', by Henry Hazlitt. The book was published a long while ago, so there is a free online version here. It is relatively short ( I read it in about 3 hours approx.) and is one of the most outstanding works on economics that I have read (The Wealth of Nations by Adam Smith still tops my list). As such I strongly urge you to read it (in particular for a regular commentator Lord Keynes, as it covers many of the points that he has made in recent posts).

Note 3: Some replies to the comments on my last post on Quantitative Easing (QE - printing money):

Tiberius mentions that buying gilts directly through QE by the Bank of England (BoE) might 'be in direct violation of the Maastricht Treaty'. I think this is another reason for the circumspection....

Ketley highlights some of the BoE's statements to point out that much of what is going on is about confidence. My feeling is that 'playing' with confidence is a very dangerous game. As soon as the truth 'outs' then the confidence game comes to a messy end. Ketley also notes that there is a possibility of much of the media simply regurgitating press releases on QE, and this does seem to be the case. If only the press would take the time to look around, they might actually find some different perspectives.

An anonymous poster points out the damage of this policy to savings, and asks how much inflation will follow. My simple answer at this stage - I simply do not know. Once this process of money printing starts, it can create self-reinforcing feedback - and this makes it beyond prediction. Equally, there is no firm timescales for when it will kick in.

Lord Sidcup asked for M0 and M4 figures. M0 is no longer reported (interestingly went in 2006, I think), and M4 can be found here (only reports to January 2009 at the moment). For those that do not know what these are, basic definitions can be found here on Wikipedia.

An anonymous poster offered this analogy for QE, which is very good:

It's like we're collectively trying to refuel a car with four flat tyres.

If I can take the liberty, I might suggest an alteration - that it is trying to pump air into 4 flat tyres, all of which have punctures.

Paulsc expresses interest in the reply from the BoE to my letter to them seeking clarification of the policy. I have had a reply that they are putting together an answer, and am therefore awaiting a response. (see below for update)

Paul offered an interesting point with regards to the press, identifying their lack of spine over QE. I note that some commentators are dusting off their critical points of view, so there is still 'hope' for the press.

Lord Keynes: You say in your example:

The banks are hoarding the £30 that they have been receiving as interest. Also, the banks refuse to lend any new money to people, so the economy just can’t get that extra £30 to get the economy on track.

You are talking about lending for consumption. Lending for consumption = a future contraction....Also, nobody is 'hoarding' money. They are lending it to governments....the banks do not sit with piles of cash in vaults, but buy 'safe' assets according to Basel II requirements. 'Hoarding' is an emotive word for saving and investing. When money is not being consumed (whether by governments or consumers) it is used to invest in new business ventures. This is not hoarding.

You also say:

The central bank removes the extra £30 it injected. We are back to the original situation of £100 in the economy.

But who is going to buy the Gilts, and when are they going to be sold again. In a year, in two years, in five......

You later say:

Of course, printing money can be put to productive purposes. If the money was lent directly to the government and they spent it on building new factories producing manufactured goods (e.g., in a high value added industry like high tech) and these goods were bought by domestic and foreign consumers, then of course printing money can generate real growth

In this case, why not print £1 trillion? This would provide massive amounts of money to do things...but the money money would cease to have any value. Money is not a 'magic' thing. It represents a unit of exchange and (if it is not printed in this way) a store of value, and in a good monetary system also represents a contract.

Overall, I do urge you to read Economics in One Lesson. I believe that you read widely on economics, and believe that this book may have a profound impact, as it will give a different perspective to that of the economic theory that led us to this disaster, and is leading us ever deeper into crisis.

Lemming: Regards to borrowing/lending. The key here is that borrowing for consumption is problematic, not that all borrowing/lending is bad. You later mention:

Similarly, is it equally possible that a 'make work' scheme, or a money printing operation *could* produce genuine wealth?

If this were the case, then we could hand everything over to government and dig ditches for £1 million a day. There is only one way to increase wealth - to produce goods and services for which there is demand, and increasing wealth can only be achieved in an economy by producing more goods and services. The issue distribution of wealth is another matter, but the root source of wealth is output, not money.

On the other hand, having someone do 'make work' contributes nothing.....what is their output worth? If it is make work, nobody wants the output enough to pay for it....

I hope that helps.

Red: Very interesting link about the China spending spree. The article is broadly supportive of my recent speculation on the Chinese exit from Treasuries, but we will see....

Note 4: I am still hoping to take a look at US QE, but will struggle against events, as I think they are moving fast. One point of note comes from an article here:

European banks face a US dollar “funding gap” of almost $2 trillion as a result of aggressive expansion around the world and may have difficulties rolling over debts, according to a report by the Bank for International Settlements.

It seems that more and more trouble comes out of the woodwork. If everyone goes down the QE route.....what happens then? Global hyper-inflation? How do you guess at the future value in currencies with ever more 'dirty laundry' appearing. I made a bold prediction of the collapse of the $US, and still believe this is about to happen....but....will this delay it? I am not sure....

Note 5: I have finally got hold of a copy of Niall Ferguson's 'The Ascent of Money' and should be able to let you know whether it meets expectations in a day or two. So far, it is excellent.

Note 6: I have just found a reply from the BoE in my inbox, and will post on their reply shortly.