Dr. John Hussman :
The Fed – “Hocus Pocus – it’s the same money!”
Here’s last week’s play-by-play
Monday (12/17): the Fed holds a $20 billion auction through its “term auction facility.” Unlike typical open market operations, which settle the same day, these would settle on Thursday 12/20 (which happened to be when the bulk of the expiring repos would come due). The Fed does, however, initiate a $9.5 billion 1-day repo, which pushes the amount of outstanding repos to $62.5 billion.
Tuesday (12/18): A $5 billion 4-day repo from 12/14 comes due, along with the $9.5 billion from Monday. The Fed replaces these with a $10.25 billion 1-day repo, for a net withdrawal of $4.25 billion in repos, bringing the total outstanding repos down to $58.25 billion.
Wednesday (12/19): The $10.25 billion from Tuesday’s action comes due, and the Fed initiates a $9.75 billion 1-day repo to replace it, for a net drain of $0.50 billion in “liquidity.” Even though the $20 billion from Monday’s auction hasn’t settled yet, you’ll notice from the Fed Funds chart ( http://www.ny.frb.org/markets/openmarket.html ) that the actual rate briefly slipped to 4%, below the Fed’s 4.25% target. Total outstanding repos: $57.75 billion.
Thursday (12/20): And now the acid test. The $9.75 billion 1-day from Wednesday comes due, along with a $10 billion 7-day (from 12/13), a $20 billion 8-day (from 12/12), and a $4 billion 14-day (from 12/6). Total expiring repos: $43.75 billion. Now remember, this is the day that the $20 billion from Monday’s auction settles. If the Fed initiates less than $23.75 billion in new repos, the “term auction facility” fails to “inject” any new liquidity at all.
On Thursday 12/20, the Fed initiated just $20 billion in new repos: A $10 billion 14-day, an $8 billion 7-day, and a $2 billion 1-day. So given $43.75 billion in expiring repos, the Fed replaced $20 billion through standard means, and $20 billion through the term auction facility. Overall, the Fed drained $3.75 billion of “liquidity” on the very day its first “term auction” transaction settled.
Also on Thursday 12/20 – the Fed auctioned off another $20 billion through its “term auction facility.” Those will settle on 12/27. So let’s continue.
Friday (12/21): the $2 billion 1-day repo from Thursday expires, which the Fed replaces with a $6.75 billion 3-day repo. Total outstanding repos as of last week: $38.75 billion in standard repos, plus $20 billion in term repos that expire in late January.
This week, $6.75 billion in repos expire on Monday 12/24, which we can guess will most likely be replaced with a 3-day or shorter repo. Why? Because on Thursday 12/27, two other repos also come due: the $8 billion 7-day from 12/20, and a $6 billion 14-day from 12/13. Assuming that the Fed rolls something close to Monday’s $6.75 billion out until Thursday, there will be a total of $20.75 billion in “standard” repos expiring on Thursday 12/27, which is precisely when the next $20 billion batch of “term auction” repos will start. Very convenient.
As a side note, we can already predict that at least one of the “term auction” repos that will be announced in January will have a settlement date of January 17. Why? That’s when the first term repo expires.
At present, the Fed has injected less than $20 billion in total “liquidity” since March – nearly all of which has been withdrawn from the banking system as currency in circulation. Normally, the Fed would have done a “permanent” open market operation by now, to finance this increase in currency demand (which predictably grows by $30-50 billion annually). But by constantly rolling over temporary repos every week or two instead, the Fed can act as if it is “doing more.”
As an additional remark, as I noted in mid-October, “we’re likely to observe a growing amount of what will wrongly be viewed as ‘cash on the sidelines’ and ‘money creation’ in the banking system. The problem is that the commercial paper market has dried up. If savers are not buying those securities as the proceeds come due, and a good portion of the borrowing is still somehow being rolled over, then it must be the case that the savers who used to own commercial paper are now saving in another form, and the borrowers who used to issue commercial paper are now borrowing in a different form. Most probably, banks will be the chosen intermediary, because savers view bank deposits as insured and somewhat safer than unsecured commercial debt.” This is a very predictable outcome, so be careful not to interpret, say, increases in M3 as being the result of “Fed liquidity.”
In short, the Fed is doing nothing more than predictably rolling over its repos, but with great flourish as if something more is going on. The fact is that current economic risks are not the result of a shortage in liquidity or confidence, but reflect a fundamental solvency problem among homeowners who borrowed more than they could afford, on the expectation that rising home prices would provide that affordability through “cash out” refinancing.
It may make people feel good that the Fed looks like it’s doing something, but these actions are being misrepresented to investors as being far more than they actually are. Misinformation simply creates false hope, and directs attention away from real problems. This is a disservice to investors.
Over the years, the misperceptions of investors have tended to be a source of periodic frustration for us (the 1999-2000 tech bubble being a good example), but avoiding those misperceptions has also generally been a great source of long-term returns. I don’t have any reason to believe that this instance will be much different.
ECB Liquidity – “Now you see it, now you don’t!”
Last week, the market shot higher on reports that the European Central Bank was injecting 348.6 billion euro (the equivalent of US$500 billion) of liquidity into the European banking system. The truth is that the ECB actually drained liquidity last week.
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