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Forex Blog - Banks “Arb” Fed/TARP Funds

Banks “Arb” Fed/TARP Funds

When Dallas Fed President Fisher today said he was pleased with US bank Q1 earnings (record for some), it reminded me of root canal surgery…zinging pain.

When the Fed opens its vaults for zero cost money and takes illiquid, questionably valued collateral in exchange for near infinite cash in a cash starved world, a monkey could make enormous amounts of money too…and risk free with buying government debt.  To attribute Q1 returns to any unique business acumen at the banks is like admiring Barry Bonds home run record.  It is juiced, unnatural and fake.  These are indirect wealth transfers from the tax payer to the banking system (zero cost money has huge long-term cost if US bonds and the dollar become worth a lot less).  The Fed on our behalf takes rates to zero, throws money at the banks with both hands for nothing and takes anything with a pulse for collateral to buy US government bonds is not capitalism at work.  And what allows banks to put on this “risk”?  TARP money.  Filling (partially) gaping holes in the capital structure from risk run amuck.  It is all too much to take.  And then to hear the bloviators whine about government overreaching into how banks operate makes me want to hurl.  This is like Barry Bonds getting annoyed at Major League Baseball, the institution that tolerated if not promoted steroid and human growth hormone abuse…Roger Clemens too…A-Rod…

Indeed the financial sector, which should be in permanent rehab, will likely be the driver for any positive GDP this year if it emerges.  Bank profits contribute to GDP.  Indeed the financial system was making up nearly 30% of GDP through 2007 until profits turned into losses in 2008.  But even with banks losing money, salaries and inputs (technology, real estate, equipment…) remain a major positive contribution to growth.  How ironic that the real fiscal stimulus taking place is happening in banking, the same sector that brought us the great recession, and not infrastructure as our politicians proclaim.

Don’t get me wrong.  I am not an advocate of a Darwinian approach to the banking system…more Lehmans are not in anyone’s interest, not even those short equities or even short bank stocks – what is the end of the world as we know worth?  What I am saying is that we need to keep things real…stop pretending we have a functioning banking system.  We have a functioning banking system propped up by the Fed and US Treasury, and not one based on anything the banks have done.

We got to where we got in asset prices in early March largely because of toxic waste on the balance sheets of banks and a hackneyed attempt by the Obama administration and Treasury Secretary Geithner to address the banking crisis initially.  Well the banks still have all the toxic waste on their balance sheets and marked at who knows what (PPIP awaited).  Trillions of dollars have been pushed into the financial system at highly subsidized rates.  Is it any wonder that banks looked profitable in Q1 and can now sell stock and non-FDIC-guaranteed debt?  In a world of imperfect information and highly distorted asset markets (big footprint of government) anything is possible.  This is a P.T. Barnum market.  Put on a show and they will come.  Issue anything and they will buy.

In March we really learned that the government would not let large institutions fail (because it has not authority and structure to unwind large financial institutions…never heard this from UK authorities and is such a load of malarkey).  But how well would the banking system work if the government withdrew its support?  We are told by authorities that they hope to exit the banking system (direct support) as soon as it is feasible.  Sorry but I think the current arrangement (the alternative to nationalization) means this support is more permanent than temporary.  Saying it is a success because it worked is not the right answer.  If the government throws endless cash at the banking system it will keep on ticking.  The right answer is it worked but at a huge cost (to taxpayers) and a lower cost solution was available.

Now that TARP is opening to the insurance business, one that is supposed to be the model of regulatory oversight, one wonders where it ends.  Will Vegas get a TARP line of credit?  How about UPS and Fed Ex?  The state of California?  New York City?

My point is the banking system and much of the real economy is doing better because of Uncle Sam’s largesse and not because of any wizardry from financial and industrial leaders.  And if government muscles in on how things are run on a micro level it is incredibly naïve to think this is overreaching.  It is a logical and unavoidable, if suboptimal, outcome.

I am also fearful of how this all gets unwound…eventually even banks will have to walk on their own, and in a new regulatory (constrained) environment.  It won’t be pretty.  And then there is the question of how the Fed exits its free money program without seeing US rates soar and the dollar collapse?  Not easily and timing and scale issues will be impossible to do smoothly.

But I also think it is too soon to trade the exit problem.  I think the economy has to be able to stand on its own first and we are at least a few years from that date.  I am not suggesting ever higher deficits (they are coming) and borrowing won’t see both yields higher and the dollar lower.  But the real debt/dollar crisis trade most my macro buddies want to own is not a serious near-term risk.  The world is still in awful shape, as trade and GDP figures continually remind me (PMI, ISM reports are crap indicators).   Unless the world becomes decoupled, a risk in the wake of the effects of a coupled world economy and financial system meltdown, there are not great alternatives to US Treasuries and the dollar – not even gold above $900.

David Gilmore   


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