Post by jeffolie on Aug 10, 2007 11:10:44 GMT -6
...no capital created in these operations...
...huge emergency repos but those are temporary loans...
...the money (credit really) the hedgies lost is in money (credit) heaven...
Q: "Ok, I have a question. The hedgies use leverage, make a wrong bet, and owe people money they do not have. The ECB loans out 130 billion spanking brand new dollars (Euros) to pay these people. How exactly is this brand new money deflationary?"
A: For starters there was no brand new money created by these central bank actions. There were, however, huge emergency repos but those are temporary loans. What happened is that banks fearing a need for capital would not lend money to each other like they normally would. This caused overnight rates to shoot sky high.
In the US, the Fed foolishly defends an interest rate target as does the ECB. To defend that interest rate target, repos or reverse repos (draining money) are used to keep the rates where the Fed / ECB wants them. Of course neither the Fed or the ECB has any real idea where interest rates should be and that is one of the reasons we are in the mess we are in.
At any rate, the money (credit really) the hedgies lost is in money (credit) heaven. It wasn't magically brought back by the ECB's or the Fed's open market operations. Those open market operations can help keep the interbank payment system afloat (at least for a while), but it can't persuade any new borrowers to borrow and it can't fix anyone's losses.
The ECB's Weber stated things incorrectly back on February 8 as I noted in Sudden Demand For Cash :
Weber: European Central Bank council member Axel Weber said investors shouldn't expect central banks to bail them out in the event of an "abrupt" drop in financial markets. "If you misprice risk, don't come looking to us for liquidity assistance."
The market came looking for "liquidity assistance" and got it in a flash. The Fed's Poole stated matters correctly.
Poole: "The Fed can provide liquidity support but not capital".
And that is what has transpired so far. There was no capital created in these operations, and even had the Fed done a coupon pass (created money), it would have been lent out not handed out.
It is the destruction of credit that is the deflationary phenomenon and that is happening at an increasing pace. It would happen at a far quicker pace if things were marked to market.
But all this misses the problem. The theory is flawed. Central banks promising new credit to strapped banks only helps them with their current problems. It will not get new credit into a system that can't take anymore. Banks, given their situation, are reducing drastically their new commitments, as they should. Borrowers can't afford to borrow more.
Sooner or later the market will realize that this is a credit crunch.
This is a process that is likely to take years to correct. It will not be a pretty process as debt gets destroyed (foreclosures) until enough of these excesses get wiped away to start anew.
One last thing: By providing emergency liquidity all the Fed is really doing is defending an interest rate target. It was the Fed defending interest rate targets way back when (say all the way down to 1%) that helped create this mess. If defending interest rate targets is the problem (and it indeed is) then defending interest rate targets cannot be the solution. It's time to abolish the Fed.
globaleconomicanalysis.blogspot.com/2007/08/globally-contained-liquidity-crunch.html
...huge emergency repos but those are temporary loans...
...the money (credit really) the hedgies lost is in money (credit) heaven...
Q: "Ok, I have a question. The hedgies use leverage, make a wrong bet, and owe people money they do not have. The ECB loans out 130 billion spanking brand new dollars (Euros) to pay these people. How exactly is this brand new money deflationary?"
A: For starters there was no brand new money created by these central bank actions. There were, however, huge emergency repos but those are temporary loans. What happened is that banks fearing a need for capital would not lend money to each other like they normally would. This caused overnight rates to shoot sky high.
In the US, the Fed foolishly defends an interest rate target as does the ECB. To defend that interest rate target, repos or reverse repos (draining money) are used to keep the rates where the Fed / ECB wants them. Of course neither the Fed or the ECB has any real idea where interest rates should be and that is one of the reasons we are in the mess we are in.
At any rate, the money (credit really) the hedgies lost is in money (credit) heaven. It wasn't magically brought back by the ECB's or the Fed's open market operations. Those open market operations can help keep the interbank payment system afloat (at least for a while), but it can't persuade any new borrowers to borrow and it can't fix anyone's losses.
The ECB's Weber stated things incorrectly back on February 8 as I noted in Sudden Demand For Cash :
Weber: European Central Bank council member Axel Weber said investors shouldn't expect central banks to bail them out in the event of an "abrupt" drop in financial markets. "If you misprice risk, don't come looking to us for liquidity assistance."
The market came looking for "liquidity assistance" and got it in a flash. The Fed's Poole stated matters correctly.
Poole: "The Fed can provide liquidity support but not capital".
And that is what has transpired so far. There was no capital created in these operations, and even had the Fed done a coupon pass (created money), it would have been lent out not handed out.
It is the destruction of credit that is the deflationary phenomenon and that is happening at an increasing pace. It would happen at a far quicker pace if things were marked to market.
But all this misses the problem. The theory is flawed. Central banks promising new credit to strapped banks only helps them with their current problems. It will not get new credit into a system that can't take anymore. Banks, given their situation, are reducing drastically their new commitments, as they should. Borrowers can't afford to borrow more.
Sooner or later the market will realize that this is a credit crunch.
This is a process that is likely to take years to correct. It will not be a pretty process as debt gets destroyed (foreclosures) until enough of these excesses get wiped away to start anew.
One last thing: By providing emergency liquidity all the Fed is really doing is defending an interest rate target. It was the Fed defending interest rate targets way back when (say all the way down to 1%) that helped create this mess. If defending interest rate targets is the problem (and it indeed is) then defending interest rate targets cannot be the solution. It's time to abolish the Fed.
globaleconomicanalysis.blogspot.com/2007/08/globally-contained-liquidity-crunch.html