Archive for December, 2011

$29 Trillion Bailout: Response to Critics

L. Randall Wray | December 10, 2011

OK, anytime one criticizes the Fed or Wall Street there will be some push-back by the professionals who serve their masters. (By contrast, Barry Ritholtz understood the argument, see here.)  My original piece on Friday got picked up by a number of blogs and generated a lot of hostile responses. I expect that. It is obvious from their comments that many of them did not bother to read the post very carefully, or, if they did, that they stuck to talking points. And it looks like many of them deal in obfuscations that would make Chairman Bernanke proud.

But let us presume they were not hired by the Fed and Goldman and instead assume good intentions. I will have a longish post over at New Economic Perspectives tomorrow that addresses several issues that were not adequately covered in my post on Friday. But here I will deal with the main topic of a number of the comments—which centered around the proper way to measure the Fed’s intervention: stocks or flows.

Several commentators presume I cannot tell the difference between stocks and flows. No long-time reader of this blog or of NEP would be confused about this. I know the difference, and indeed have been using Wynne Godley’s stock-flow consistent approach for a very long time.

As I said on Friday, we can choose any of three different measures to ascertain the size of the Fed’s response. First, we can look at peak lending at an instant; more practically, we could choose end-of-day lending by the Fed. We can measure this by looking at the Fed’s balance sheet, adding across the assets associated with the emergency lending facilities (a Fed loan to a bank shows up on the Fed’s balance sheet as an asset; a Fed purchase of an asset from a bank moves that asset to the Fed’s balance sheet.) This is the measure the Fed chooses, and it comes to a peak of $1.2 trillion on a day in December 2008.

(It will miss any off-balance sheet commitments. For example, if the Fed extends a guarantee that does not get triggered, it will never show up on the Fed’s balance sheet, meaning that a measure that includes only assets on the Fed’s balance sheet will miss some of the ex ante exposure to risk. We’ll ignore that here. Much like Bernanke’s claim that the lending turned out OK—because most loans got paid back—that is 20-20 hindsight and does not count when it comes to ex ante risk.)

OK, the peak instantaneous lending is a useful measure. I have never denied that. The analogy is to the six shot glasses poured by the bartender. If we want to tally up the Fed’s exposure to losses, that is a relevant measure. But note that my piece was not focused on risk to the Fed. To be sure, $1.2 trillion is a big exposure. It merits some concern. To my mind, this is a second order issue, although it is highly probable that Congress will be very concerned with Fed exposure to losses. continue reading…


The Shadow Banking System Is Slowly Imploding

Thorvald Grung Moe | December 9, 2011

Lessons from the bankruptcy of MF Global — the 8th largest in US history

Yesterday, CEO Jon Corzine of MF Global appeared before the House Agricultural Committee. The hearing was a reminder that despite well intended legislation, including the Dodd-Frank Act, the speculative behaviors that brought down AIG and Lehman are still considered fair business deals in the financial sector.

Recent reports on the financial crisis in Europe confirm that MF Global was not an isolated case. The extent of speculative positions among banks have reached mind-boggling proportions, with OTC derivatives now standing at over $700 trillion (!) and increasing rapidly.  Banks in Europe are currently scrambling for funds as their regular sources of funds are rapidly drying up. Several analysts point to the fragility of the shadow banking system as a key determinant of the ongoing liquidity crisis, where virtually unlimited leverage seems to be the norm rather than the exception.

According to a Reuter’s report yesterday, the bankruptcy of MF Global shows how the London OTC market has been used by AIG, Lehman, and now MF Global to accumulate layers and layers of leverage on only a tiny bit of capital. The process of re-hypothecation is behind all of this, with especially lax rules in London permitting, for example, the finance arm of AIG—AIG Financial Products—to run up a CDS position of $2.7 trillion just before the firm collapsed in 2008.

Re-hypothecation occurs when a bank or broker re-uses collateral posted by clients, such as hedge funds, to back the broker’s own trades and borrowings. The practice of re-hypothecation runs into the trillions of dollars and is perfectly legal. It is justified by brokers on the basis that it is a capital efficient way of financing their operations, much to the chagrin of hedge funds. 

Over the years regulators gradually relaxed the quality requirements for such re-hypothecation, from initially only treasuries, to eventually money market funds, and now foreign sovereigns. This was the legal basis for the legitimate trades MF Global was engaged in, buying AAA European sovereign paper, despite their hedge fund clients probably shorting the whole sector. Eventually MF Global lost trust in the market and couldn’t meet the liquidity run when clients wanted their money back all at the same time (“classic bank run”). This then led to a scramble for cash, in the process also compromising client accounts. But, as several commentators have pointed out, the basis for their implosion was speculative trades on the basis of this process of re-hypothecation, leading up to a leverage ratio of close to forty. continue reading…


The Fed’s $29 Trillion Bailout of Wall Street

L. Randall Wray |

UPDATE:  to read the Working Paper (“$29,000,000,000,000: A Detailed Look at the Fed’s Bailout by Funding Facility and Recipient”) click here

Since the global financial crisis began in 2007, Chairman Bernanke has striven to save Wall Street’s biggest banks while concealing his actions from Congress by a thick veil of secrecy. It literally took an act of Congress plus a Freedom of Information Act lawsuit by Bloomberg to get him to finally release much of the information surrounding the Fed’s actions. Since that release, there have been several reports that tallied up the Fed’s largess. Most recently, Bloomberg provided an in-depth analysis of Fed lending to the biggest banks, reporting a sum of $7.77 trillion. On December 8, Bernanke struck back with a highly misleading and factually incorrect memo countering Bloomberg’s report. Bloomberg has—to my mind—completely vindicated its analysis; see here.

Any fair-minded reader would conclude that Bernanke’s memo to Senators Johnson and Shelby and Representatives Bachus and Frank is misleading. One could even conclude that it is not just a veil of secrecy, but rather a fog of deceit that the Fed is trying to throw over Congress.

He argues that the sum total of the Fed’s lending was a mere $1.2 trillion, and that it was spread across financial and nonfinancial institutions of all sizes. Further, he asserts that the Fed never tried to hide the bail-outs from Congress. Both of these assertions fly in the face of the facts available (as the Bloomberg response makes clear).

As Bernanke notes, highly credible analyses of the bailout variously put the total at $7.77 trillion (Bloomberg) to $16 trillion (GAO) or even $24 trillion (I think this is Senator Bernie Sanders’ figure). He argues that these reports make “egregious errors,” in particular because they sum lending over time. He also claims that these high figures likely include Fed facilities that were never utilized. Finally, he asserts that the Fed’s bailout bears no relation to government spending, such as that undertaken by Treasury.

All of these assertions are at best misleading. If he really believes the last claim, then he apparently does not understand the true risks to which he exposed the Treasury as the Fed made the commitments.

There are a number of issues that must be understood. First, the Fed quibbles about the differences among lending, guarantees, and spending. For the purposes of this blog I will accept these differences and call the sum across the three “commitments.” In spite of what Bernanke claims, these do commit “Uncle Sam” since Fed losses will be absorbed by the Treasury. (The Fed pays profits to Treasury, so if its profits are hurt by losses, payments to Treasury are reduced. If the Fed should go insolvent, the Treasury will almost certainly be forced to recapitalize it.) I do, however, agree with the Chairman that a tally should not include facilities that were created but not utilized (there were several of them, and the tally I present below does not include any facilities that were not used).

Second, there are (at least) three different ways to measure the Fed’s bailout. One way would be to find the day on which the maximum outstanding Fed commitments was reached. According to the Fed, that appears to have been about $1.5 trillion sometime in December 2008. I’m willing to take Bernanke at his word. Another way would be to take the total of commitments made over a short period of time—say, a week or a month. That would be a measure of systemic distress and would help to identify the worst periods of the GFC (global financial crisis). Obviously, this will be a bigger number and will depend on the rate of turnover of Fed loans. For example, many of the loans were very short-term but were renewed. Bernanke argues that it is misleading to add up across revolving loans. Let us say that a bank borrows $1 million over night each day for a week. The total would be $7 million for the week. In a period of particular distress, the peak weekly or monthly lending would spike as many institutions would be forced to continually borrow from the Fed. Bernanke argues we should look only at the lending at a peak instant of time.

Think about it this way. A half dozen drunken sailors are at the bar, and the bartender refills their shot glasses with whiskey each time a drink is taken. At any instant, the bar-keep has committed only six ounces of booze. That is a useful measure of whiskey outstanding. But it is not useful for telling us how much the drunks drank. Bernanke would like us to believe that if the Fed newly lent a trillion bucks every day for 3 years to all our drunken bankers that we should total that as only a trillion greenbacks committed. Yes, that provides some useful information but it does not really measure the necessary intervention by the Fed into financial markets to save Wall Street.

And that leads to the final way to measure the Fed’s commitments to propping up our drunks on Wall Street: add up every single damned loan, guarantee and asset purchase the Fed made to benefit banks, banksters, real Housewives on Wall Street, fraudsters, and their cousins, aunts and uncles. This gives us the cumulative Fed commitments.

The final important consideration is to separate “normal” Fed actions from the “extraordinary” or “emergency” interventions undertaken because of the crisis. That is easier than it sounds. After the crisis began, the Fed created a large alphabet soup of special facilities designed to deal with the crisis. We can thus take each facility and calculate the three measures of the Fed’s commitments for each, then sum up for all the special facilities.

And that is precisely what Nicola Matthews and James Felkerson have done. They are PhD students at the University of Missouri-Kansas City, working on a Ford Foundation grant under my direction, titled “A Research And Policy Dialogue Project On Improving Governance Of The Government Safety Net In Financial Crisis.” To my knowledge it is the most complete and accurate accounting of the Fed’s bailout. Their results will be reported in a series of Working Papers at the Levy Economics Institute. The first one is titled $29,000,000,000,000: A Detailed Look at the Fed’s Bailout by Funding Facility and Recipient. Read it here.

Here’s the shocker. The Fed’s bailout was not $1.2 trillion, $7.77 trillion, $16 trillion, or even $24 trillion. It was $29 trillion. continue reading…


The Crisis Behind the Crisis

Michael Stephens | December 8, 2011

In his latest installment, C. J. Polychroniou surveys the slow motion collapse of the eurozone and the ongoing fragility of the US economy, and insists that underneath it all lies a deeper crisis.  What we are witnessing, he suggests, is not just the fallout from the latest banking panic or financial crisis, but a set of symptoms linked to a broader economic malaise:  a crisis of advanced global capitalism.

Advanced capitalism had been facing severe structural stresses, strains, and deformations for many years prior to the eruption of the financial crisis in 2007, including overproduction, growing trade deficits, lack of job growth, and elevated debt levels.

Private debt accumulation in the West, which has spiraled out of control, is largely the outcome of wage stagnation. In the United States, wages have remained stagnant since the mid to late 1970s, leading to a new Gilded Age, with renewed claims about the superiority of Darwinian capitalism. At the same time, the poor and working-class populations have come to be seen as a sort of nuisance in the galaxy the rich occupy, with attacks being launched by the rich on their wages and working conditions and the media often carrying out derogatory campaigns against working-class identity.

Read the one-pager here.


Levy Institute Launches Greek Website

Michael Stephens |

Policy coordination and information exchange are critical to resolving the eurozone crisis. With this in mind, the Levy Institute is making selected publications that address aspects of the crisis—including policy briefs, one-pagers, and working papers—available online in Greek translation. A list of our current titles is available at, and more will be added weekly.


ECB Inaction: Dogma and Rationality

Michael Stephens | December 7, 2011

As Dimitri Papadimitriou has said, the European Central Bank is one of the only institutions that can save the euro project.  The commitment alone to making unlimited purchases of member-state debt might do the trick.  But as we have seen, there is a lot of opposition to the ECB acting as lender of last resort.  Why?

Here are a couple more links on this question:

Paul De Grauwe (“Why the ECB refuses to be a Lender of Last Resort“):  it may not (just) be dogma holding the ECB back, but a rational (though, to De Grauwe’s mind, unfortunate) calculation.  His analysis suggests the ECB won’t act until the sovereign debt crisis turns into a banking crisis.

Noah Millman (“In the Long Run, We’re All German“):  the ECB is engaged in a game of chicken, attempting to secure as much of a commitment to fiscal rectitude and reform as it can before it steps in to stave off a eurozone collapse.  (Recent suggestions of a kind of quid pro quo in which a stronger fiscal pact would lay the groundwork for the ECB stepping up as lender of last resort lends some credence to this theory.  They should also plant doubts for those who think the ECB’s inaction on this front stems merely from good faith concerns about Article 123-type Treaty obstacles).

Update, Dec. 8:  Paraphrasing ECB chief Mario Draghi, today:  “Quid pro what?  Never heard of it.”  (Or more accurately, according to the FT “Mr Draghi made clear that the option of capping government bond yields had not been raised at the governing council meeting.”)


Would an ECB Rescue Be Inflationary?

Michael Stephens |

This is one of the questions Marshall Auerback tackles in a piece at Counterpunch.  His answer, as you might expect, is “no.”  He also addresses the concern that the ECB risks an impaired balance sheet if it steps up and plays a larger role in buying member-state debt:

… if the ECB bought the bonds then, by definition, the “profligates” do not default. In fact, as the monopoly provider of the euro, the ECB could easily set the rate at which it buys the bonds (say, 4% for Italy) and eventually it would replenish its capital via the profits it would receive from buying the distressed debt (not that the ECB requires capital in an operational sense; as usual with the euro zone, this is a political issue). At some point, Professor Paul de Grauwe is right :  convinced that the ECB was serious about resolving the solvency issue, the markets would begin to buy the bonds again and effectively do the ECB’s heavy lifting for them. The bonds would not be trading at these distressed levels if not for the solvency issue, which the ECB can easily address if it chooses to do so.  But this is a question of political will, not operational “sustainability.”

So the grand irony of the day remains this: while there is nothing the ECB can do to cause monetary inflation, even if it wanted to, the ECB, fearing inflation, holds back on the bond buying that would eliminate the national [government] solvency risk but not halt the deflationary monetary forces currently in place.


A More Dovish Fed?

Michael Stephens | December 6, 2011

While the latest figures show the unemployment rate dipping below 9 percent, a lot of this decrease has to do with individuals giving up and leaving the labor force.  As for additional stimulus, Congress is currently negotiating an extension, and possible expansion, of the payroll tax cut.  But Republicans are insisting that it be “paid for,” so it’s not yet clear what effect this would have if passed.  That leaves the Federal Reserve as the only US institution to turn to.  Zero Hedge tries to provide some (small) reason for optimism on this front, suggesting that the composition of the FOMC may become more “dovish” in 2012 when the next group of voting members is rotated in (Fisher, Kocherlakota, Evans, and Prosser out; Pianalto, Lacker, Lockhart, and Williams in).


Hudson on Debt and Democracy

Michael Stephens | December 5, 2011

Michael Hudson has an article appearing in the Frankfurter Allgemeine Zeitung on the history of debt and democracyFor those who can’t read German, Hudson has produced an abbreviated English version.  An excerpt:

The idea of an independent central bank being “the hallmark of democracy” is a euphemism for relinquishing the most important policy decision – the ability to create money and credit – to the financial sector. Rather than leaving the policy choice to popular referendums, the rescue of banks organized by the EU and ECB now represents the largest category of rising national debt. The private bank debts taken onto government balance sheets in Ireland and Greece have been turned into taxpayer obligations.

Read the English version here.


“An ideologically useful but unrealistic vision of capitalism”

Michael Stephens | December 2, 2011

A great series of videos at INET collecting clips from Robert Johnson’s interview of Steve Keen, who is among those (few) credited with seeing the financial crisis coming.  Hyman Minsky’s work has played a large role in Keen’s own thinking on this.  In this particular clip, Keen talks about the ways in which economists have been taught to assume an unhelpful story about the way in which banks operate and touches on the basic idea of endogenous money.

Along similar lines:  this working paper by Randall Wray looks at what banks actually do (and what role the financial sector should ideally play in an economy) in the context of examining Minsky’s later work at the Levy Institute on restructuring the American financial system.  (Policy brief version here).

Also, take a look at the last video in which Keen talks about developing a monetary model of capitalism.  For non-economists, this has to be among the more confusing claims to theoretical advancement.  (“Wait … you mean there are economic models that don’t include money?  Wh…”)