Discount Window

We have discussed forecasts for the second (and certainly not last ) February 29 3 Year LTRO in the past, with expectations for its size ranging from €1 trillion all the way up to a mindboggling €10 trillion. Today, Goldman has conducted a poll focusing on investors and banks, to gauge the sentiment for what has over the past 2 months been taken as the latest Deus Ex, which is really nothing than yet another bout of quantitative easing, only one in which the central bank pretend to be sterilizing 3 year loans by accepting any and virtually all collateral that banks can scrape off the bottom of their balance sheets (as a reminder, back in the financial crisis, Zero Hedge discovered that the Fed was accepting stocks of bankrupt companies as collateral - certainly the ECB is doing the same now). And once the banks get the cash instead of lending it out, or using it for carry trades, they simply use it to plug equity undercapitalization due to massive asset shortfalls on their balance sheets which are mark-to-unicorn^TM, yet which generate zero cash flow, even as banks have to pay out cash on their liabilities. In essence, the banks convert worthless crap into perfectly normal cash with the ECB as an intermediary: and that is all the LTRO is. Luckily, as we pointed out, even the idiot market is starting to grasp the circular scam nature of this arrangement, and the fact that it is nothing short of Discount Window usage, and because of that, the stigma associated with being seen as needing this last ditch liquidity injection is starting to grind on the banks. It is only a matter of time before hedge funds create portfolios in which they go long banks which openly refuse to use LTRO cash, and short all the other ones (read every single Italian and Spanish bank out there, and most French ones too) because at the end of the day one can only fool insolvency for so long. But once again we are getting ahead of the market by about 3-6 weeks. In the meantime, and looking forward to the next LTRO, whose cash will be used exclusively to build up "firewalls" ahead of the Greek default, here is what Goldman's clients expect to happen...

While Bernanke's prepared remarks to the Senate today will be identical to those given to Congress last week, the Q&A session will be different. One notable difference will be Bernanke's take on the "huge jobs number" which was not public last week. He will likely be put to task to answer if and why he still expects QE when the economy is supposedly improving (on the back of a collapsing labor force, yes it makes no sense, don't ask us). We wonder what his non-answer answer will be to that one. Also we wonder if like last week, when answering Congressman Flores, he admits that the ECB collateral certification process is much better than that of the Fed when it comes to issuing cash under the discount window.

In all the excitement over the December 21 LTRO, Europe forgot one small thing: since it is the functional equivalent of banks using the Discount Window (and at 3 years at that, not overnight), it implies that a recipient bank is in a near-death condition. As such, the incentive for good banks to dump on bad ones is huge, which means that everyone must agree to be stigmatized equally, or else a split occurs whereby the market praises the "good banks" and punishes the "bad ones" (think Lehman). As a reminder, this is what Hank Paulson did back in 2008 when he forced all recently converted Bank Holding Companies to accept bail outs, whether they needed them or not, something that Jamie Dimon takes every opportunity to remind us of nowadays saying he never needed the money but that it was shoved down his throat. Be that as it may, the reason why there has been no borrowings on the Fed's discount window in years, in addition to the $1.6 trillion in excess fungible reserves floating in the system, is that banks know that even the faintest hint they are resorting to Fed largesse is equivalent to signing one's death sentence, and in many ways is the reason why the Fed keeps pumping cash into the system via QE instead of overnight borrowings. Yet what happened in Europe, when a few hundred banks borrowed just shy of €500 billion is in no way different than a mass bailout via a discount window. Still, over the past month, Europe which was on the edge equally and ratably, and in which every bank was known to be insolvent, has managed to stage a modest recovery, and now we are back to that most precarious of states - where there is explicit stigma associated with bailout fund usage. And unfortunately, it could not have come at a worse time for the struggling continent: with a new "firewall" LTRO on deck in three weeks, one which may be trillions of euros in size, ostensibly merely to shore up bank capital ahead of a Greek default, suddenly the question of who is solvent and who is insolvent is back with a vengeance, as the precarious Nash equilibrium of the past month collapses, and suddenly a two-tier banking system forms - the banks which the market will not short, and those which it will go after with a vengeance.

Earlier today, the New York Fed was kind enough to voluntarily disclose the finacial holdings and assets of one former Goldman Sachs employee, and current FRBNY president Bill Dudley. Bill Dudley is also known as the gentleman to have received, when he was stil head of the PPT, aka the Fed's Open Markets Group, a waiver signed by one Tim Geithner on September 19, 2008, allowing him to keep not only his investment in AIG, which was "de minimis" at $1,200, but also in General Electric, which was not de minimis at $106,830. And while his modest holdings of AIG likely did not impact Dudley's protocol of bailing out the failed insurer, his interest in GE, and thus its then fully held subsidiary NBC Universal, parent of such comedy channels as CNBC, could potentially have been a source of conflict. Which is why the Fed has disclosed the full holdings of Dudley as of the 2008 year, in which we find that the bulk of Dudley's net worth was held by JPMorgan Chase Deferred Income Benefit Award (over $1MM) and JPM Chase Deferred Compensation ($500,001-$1,000,000). Was Mr. Dudley also completely conflict free vis-a-vis the bulk of his holdings, and their custodian, and did the New York's Fed largesse to bail out JPM among many others, have anything to do with this particular heretofore unknown detail? Of course not. After all, Jon Corzine is a free man. In other news, anyone who needs urgent access to the discount window or a $1 trillion overnight loan at 0.001% interest, should just call the Fed's 24/7 hotline: 877-52-FRBNY.

There was a time when depositor institutions (which nowadays paradoxically includes such entities as Goldman Sachs and its millions of ATMs crisscrossing the land), not flush with unprecedented amounts of bank reserves (which just hit an all time record high of $1.59 trillion), would go to the Fed's discount window for short-term funding needs: a stigmatized act which telegraphed to the street that the borrowing bank was undergoing some form of liquidity crunch. Not surprisingly, the Fed fought tooth and nail to prevent discount window disclosure from becoming public, especially since it was later discovered that the biggest recipients of Fed Discount Window generosity were foreign banks, and especially Dexia. We bring this up because going through the Fed's weekly balance sheet update (yes, it just hit a new all time record, and yes, we will provide a full breakdown soon) we find that weekly borrowings across the Fed's three discount window facilities, Primary, Secondary and Seasonal Credit, surged to a 2011 high of just over $100 million, and also saw the very first usage of the "reserved for really ugly bank" Secondary Credit Facility in the current year to the tune of $9 million. Yes, in the grand scheme of things this is a modest number, but when one considers that with all the liquidity sloshing around there should be no discount window borrowings at all, the fact that we have had such a dramatic spike is troubling to say the least. As for the culprit, we have one guess. If proven correct, this would mean that the emergency liquidity provisioning system of the ECB is starting to get a little "problematic" to put it mildly.

Tired of poring through thousands of PDF files from the Fed's Bloomberg FOIA release? Curious why Ron Paul said that he "was surprised and deeply disturbed ... to learn the
staggering amount of money that went to foreign banks" and is planning to hold a hearing over emergency loans to the branches of non-U.S.
banks? Then here is the excel file for you: the following publicly shared google docs spreadsheet contains the complete Discount Window loan origination data from March 14, 2008 through March 16, 2009. We offer it so that anyone who wishes to perform their own analysis on the primary data can do so (and needless to say banks noted as FORI in the markstat entity type are foreign borrowers). 

Discount Window spreadsheet link.

While Zero Hedge ploughs through 25,000 or so pages of just declassified information focusing on the Discount Window, but containing previously undisclosed information on the entire alphabet soup of systemic rescue facilities, and prepare to present our findings shortly, we would like to facilitate the crowdsourcing effort in perusing the data which the Fed has made prohibitively difficult to access (only distributed on physical CD), by uploading the entire data dump at the following link.

Our very preliminary question is whether the Fed really expects the US public to believe it does not keep track of the collateral it lends Discount Window money against, and if that rhetoric question is false, then why is collateral data not disclosed?

While we await the thousands of pages of discount window data to hit the public docket, below we present to our readers the historical borrowings on the Fed's Discount Window, which consists of the Primary Credit, Secondary Credit and Seasonal Facilities. Borrowings across all three peaked at $110,753 million according to the Fed. There is of course, no indication of what type of collateral is used against these borrowings although as Zero Hedge first disclosed over a year ago, many of the stocks pledged by failing companies were those of bankrupt companies. There will hardly be much if anything revolutionary in this incremental disclosure, but it will confirm just how many times Goldman and JPM may have accessed the discount window following repeated claims they did not need to do so. The reason banks no longer use the discount window as can be seen on the chart below, is that with $1.4 trillion in excess reserves there are no liquidity constraints any more as all the capital comes in the form of electronic money allocated as reserves by the banks, which money is fungible and thus banks no longer rely on actual lending by the Fed. Incidentally, combined borrowings across all three Discount Window facilities in the week ended March 23 was $13 million: the lowest since 2004.

In all the recent hoopla over Excess Reserves and spurious rumors over whether or not they should generate any form of interest (readers will recall a key catalyst for a surge in the market two weeks ago was the expectedly false rumor that Bernanke would announce the elimination of any IOR (Interest Paid On Reserves) rather than keeping the even current minimal 0.25% rate), everyone seems to have forgotten that old staple: the Discount Window. And probably logically so: while the Excess Reserve issue is one that deals with excess liquidity in the banking system (by definition: otherwise it would be lent out to consumers), Discount Window-related concerns deal with the opposite, or a liquidity deficiency. Logically, the two are mutually exclusive: near record excess reserves held with Federal Reserve Banks simply means that banks are not in any want for money (of any term, but most specifically ultra-short term).Looking at the Fed's H.4.1 statement confirms that for the week ended July 29, the Fed's Primary Credit facility (aka the current version of the Discount Window, together with the Secondary Credit and the Seasonal Credit Facility) usage has plummeted to just $11 million: a negligible number for a "rescue facility" that at the peak of the crisis saw more than $100 billion in overnight borrowings. The finding is not surprising, when considering that the rate on the Primary Credit Facility is 0.75%. As this is higher than the rate on the 2 Year Treasury, there is very little banks can do in reinvesting capital that is more expensive than even long-term funding sources. In other words, with well over a trillion in Excess Reserves, banks are becoming increasingly self-funding, at least in the medium term, and seek to disintermediate themselves from the Fed. In looking at the same problem, but from the perspective of the IOR, the Atlanta Fed concludes: "One broad justification for an IOR policy is precisely
that it induces banks to hold quantities of excess reserves that are
large enough to mitigate the need for central banks to extend the
credit necessary to keep the payments system running efficiently. And,
of course, mitigating those needs also means mitigating the attendant
risks." An environment in which banks are increasingly leery of relying on the Fed for funding, irrespective of whether IOR at 0.00% or 0.25%, is not one in which consumer should expect to see any incremental lending any time soon.

The biggest surprise in Goldman's Q2 8-K was the firm's disclosure that Trading and Principal Investment revenue plunged by 43.2% sequentially, and 42.4% quarter over quarter. The firm's once unbeatable trading operation is finally showing cracks. If a firm backed by the full faith and credit of the risk free discount window is not showing record trading revenue growth quarter over quarter, what can the rest of us do? One wonders if the firm may have finally started following guidelines on prop from flow information segregation. While the 8-K does not disclose profitable trading day information, we are confident that when released, the 10-Q will demonstrate that this quarter Goldman had at least 10 trading days in which it lost money in the current quarter: a stunner compared to the recent near flawless performance in the past several quarters. Either Goldman's Achilles heel has been exposed or the firm is blowing money on purpose.

The ECB's equivalent of the Discount Window, the Marginal Lending Facility, has seen a spike in borrowings over the past two weeks. As of May 12, total borrowings were €4 billion, after hitting €4.4 billion the night before, the second highest amount borrowed by European banks since an errant print of €5.2 billion in January 19, which was more of a liquidity rebalancing instead of an actual indication of short-term liquidity demand. We are keeping a close eye on this indicator as it is the best determination of the funding and liquidity problems gripping Europe. And as the chart shows, beginning in May, more and more banks are now relying on the ECB for overnight liquidity.

In the past two weeks, borrowings under the ECB's "discount window" equivalent, the Marginal Lending Facility, have jumped substantially. Where on April 25th just E2 million was outstanding, it has subsequently jumped all the way to 2.6 billion on May 3 (yes, for Americans these sums are paltry, but for European, and especially Greek banks, half a billion could mean the difference between life and death). And with the O/N-3M repo spread blowing out, the ECB could be once again becoming the lender of first and last resort. One of the rumors for the jump in borrowings has been that Greek Piraeus bank was on the verge in the last days of April after a full blown bank run, and only a last-minute MLF borrowing helped it stave off bankruptcy. The MLF dropped to E1.3 billion yesterday, although this could be merely a liquidity shift from one source to another. Keep a close eye on the ECB's daily MLF report to determine if there is a backdoor bailout occurring of one of the more troubled European banks. We will also provide details later on today, when the data becomes available, on whether the Fed has disclosed any FX swaps having taken place in the prior week.

As expected, Goldman did approach AIG about contract tear downs of its CDS contracts, and "Goldman would likely accept a small concession." This makes sense due to the draconian collateral margin demands that Goldman had previously extracted from AIG (12% positive haircut), and also due to spurious collateral demands made by Goldman ($1.3 billion more than BlackRock's estimated fair value). This is all as Zero Hedge reported yesterday. Yet another smoking gun emerges, this time not from Goldman, but from French bank Societe Generale...

Even with lots of worthless chatter coming out of the White House in the past 24 hours, one solitary fighter for "the common man" emerges in the form of Barney Frank. Whether this is due to the Congressman not getting a thick enough envelope endorsed and signed by the Big 5 banks, or not, we don't know yet. However, courtesy of our sources on the Hill, the latest development our of Washington is that Frank is trying to generate support for a Congressional bill that would allow only retail banks with a lending function to have Fed discount window access. While this is a brilliantly simple solution to see hedge funds, and for some reason Bank and Financial Holding Companies, like Goldman Sachs finally open up some retail depository branches, the response from Wall Street would be furious. Many banks still exist only courtesy of the last recourse short-term funding option that the discount window affords them. If the Big 18 are forced to lend, which is the prima facie reason for this bill, only to be able to fund their speculative gambling courtesy of zero percent cost of capital, then all bets will surely be off. Goldman without discount window access is the most ludicrous thing imaginable.

The two lessons we take away as standouts from the credit crisis are probably somewhat unconventional, but we think they are of great import. First of all, "big" has a way of changing to "trivial" overnight when one is talking about government spending. Second, the "biggest of the big" isn't summed up by large, complex models. Instead, it gets added up on scratch paper. Or via the calculator feature of a Blackberry. Or scrawled on a cocktail napkin with a leaky pen. Today, drawing from these lessons, we think that five simple lines portend something, well, big.