Across The Curve, in an attempt to disagree with my analysis appears to have unintentionally validated it.
Let me explain.
John Jansen links to a posting talking about the "need" (or lack thereof) for reverse repos.
What he misses (perhaps because he fails to understand the mendacity of people who have been caught with their pants around their ankles) is the reason for the waiver from Tier Capital demand from the primary dealers.
The linked analysis is correct presuming that the "excess reserves" created still exist.
But the demand for "relief" from Tier Capital requirements is apparently real.
Occam's Razor applies to the obvious discrepancy: The simplest explanation is likely to be correct.
In this case the question is:
Why would the primary dealers demand relief from Tier Capital requirements in order to engage in reverse repos with The Fed, when they were recipients of the original "excess reserves" that occurred when the money was printed in the first place?
The answer is simple: those "excess reserves" no longer exist, having been sucked into the vortex of debt deflation.
Let's recount what we know to be facts:
- Lending has not increased since "QE" began, despite the alleged purpose for "QE" being to increase lending. In fact total bank credit is decreasing at a rate never before seen in the history of modern data collection. This is being reflected in consumer credit, business credit, all forms of credit - except for Federal Government debt.
- The Primary Dealers are asserting that they require Tier Capital Relief to be able to participate in the reverse repo operation.
- Yet in theory at least, the "new reserves" that were created, since they financed Treasury issue, which the primary dealers intermediate, should be sitting on their "credit balance" with The Fed. That is, either The Primary Dealers are lying (they require nothing) or they don't have the reserves any more.
2 (original reserves) + 2 (QE'd reserves) = 4, and as a consequence The Fed should be able to execute 4 (total reserves) - 2 (QE'd reserves) = 2 (original PD reserves) without doing any damage at all to the market or to the primary dealers.
BUT THIS IS TRUE IF AND ONLY IF THE "PRINTED" PD RESERVES ARE STILL THERE!
It is therefore rather obvious that the truth is that the "4" may in fact be a "3" (or worse, a "2"!) and thus The Fed would execute 3 - 2 = 1, where "1" is less than the required Tier Capital leading to an instant
Let me put the structure of this alleged "reverse repo" in bold for those who have a problem with reading comprehension:
The Fed's Balance Sheet shows a HUGE growth in "excess reserves" - there is ALLEGEDLY over $1 trillion in such "excess reserves" at The Fed as of the last balance sheet release last week. These reserves are allegedly (according to The Fed's balance sheet) ON DEPOSIT with The Federal Reserve. They were created by The Fed when The Fed purchased open market securities (MBS and Treasuries) and each of those transactions were completed through a primary dealer. As each of those transactions was made with a Primary Dealer that PD is the putative "owner" of those "excess reserves" that are held on deposit.
As such a "reverse repo" to the PD community is a BOOK ENTRY for the cash in that NO CASH EITHER PHYSICALLY OR ELECTRONICALLY MOVES. It is already on deposit and if it is really there unavailable to the Primary Dealer for their business purposes.
The PD thus "gains" the securities that are "PUT" in the Reverse Repo but what they "give" is the deduction from their on-deposit AND UNTOUCHABLE FOR OTHER PURPOSES "excess reserves."
This, of course, assumes that these "excess reserves" which are allegedly present really are, and that they really are "excess" - that is, not otherwise encumbered - and they're not SUPPOSED to be encumbered.
Jansen was one of the bloggers recently "invited" to Treasury. Nonetheless, it is rather galling to watch a clearly-intelligent individual entirely ignore what amounts to kindergarten math when it comes to what is the obvious and indeed only rational explanation for the Primary Dealers' demand.
Simply put, the system is (still) insolvent as it was last fall and that insolvency has been papered over with The Fed's "money hose."
The system has NOT "stabilized" - quite to the contrary. As with the FDIC that has refused to close banks until they are 30, 40, or even 50% underwater on their assets The Fed has effectively papered over the insolvency of the primary dealers to the point that they are now demanding the ability to ignore the primary safety and soundness metric for a bank - Tier Capital - as "compensation" for participating in The Fed's attempt to drain the excess reserves it pumped in. This says that they're not only still broke they're more broke than they were last fall!
The bottom line is that The Fed is screwed; Bernanke was gamed and instead of "QE"d funds being used to increase lending the "printed money" was used to both cover defaulted debt and speculate in the markets.
In order to reverse the QE'd money hose and suck those excess reserves out of the system The Fed will have to accept the truth relating to where that new Fed Credit went coming to light - either in the form of bankruptcies or forced selling of assets.
Neither is acceptable to The Fed (or the politicians) but that doesn't change the fact that this is the only rational explanation for the Primary Dealers' demand, nor does it change what the final outcome will be. The politicians would be wise to stomp on this now to stem the damage but they won't just as the Japanese Government didn't.
We have learned nothing from history even when the lesson was taught just one year ago.
The underlying mathematical truth - that this was nothing more than "extend and pretend" writ large, and failed to result in actual asset quality improvement - has not been lost on the FX market, nor on commodities such as gold. The Dollar has tanked as currency traders have come to recognize that creating synthetic shorts on dollars through carry trades are essentially risk-free, since forcing The PDs to cover the reverse repos means either crashing the stock and commodity markets, the PDs themselves, or both.
This, by the way, is exactly what Japan had happen to them. The unwind of the Yen Carry featured prominently in the 2008 market collapse, especially in the credit markets where the loss of the "free money hose" caused risk premia to blow wide and created a feedback loop that was arguably one of the primary triggers for the global meltdown.
Notwithstanding The Japanese Government's desire to prevent it the unwind happened anyway and The Japanese Government found itself on the hook for the balance it had printed, which it has now tried to absorb. This made the damage from the carry permanent, just as it will in our case.
Those who refuse to learn from history are consigned to repeat it, and with our tax receipts crashing we will not be able to cover the damage when it becomes apparent, especially if we continue to allow that damage to accumulate.