This page has been archived and commenting is disabled.

"A Printer And A Prayer" - The Three Problems With The Fed "Liquidity Coverage Ratio" Plan

Tyler Durden's picture




 

A little over a week ago we wrote that in order to mitigate problems arising from record debt and soaring NPLs, the G-20 had a modest proposal for global banks: more debt. Specifically "in November said leaders will agree "that the world's top banks must issue special bonds to increase the amount of capital which can be tapped in a crisis instead of calling on taxpayers to come to the rescue, industry and G20 officials said." In other words, suddenly the $2.8 trillion in Fed injected excess reserves, split roughly equally between US and European banks, are no longer sufficient, and while regulators are on one hand delaying the implementation of Basel III and its tougher capital rules, on the other they are tactically admitting that whatever "generous" capital buffer banks have on their books right now will not be sufficient when the next crisis strikes."

The proposal for the first time introduced GLACs, or bonds known as "gone concern loss absorption capacity", seen by regulators as essential to stopping the world's 29 biggest lenders from being "too big to fail."

Some of our thoughts at the time: "according to the G-20, instead of having to collapse liabilities to offset that scourge of the New abnormal, namely Non-Performing Loans, banks are hoping to lever up, pun intended, the current scramble for yield and instead beef if up their cash asset, even if it means increasing the liability side of the balance sheet by issuing more debt. Because really all the GLAC do is limit how the banks may use the proceeds from such bond issuance. Then again, these being banks, one can be certain that the moment the GLAC cash is wired in, the funds will be used to ramp risk instead of sitting in a drawer somewhere, awaiting rainy days. Because nobody in a bank is paid for avoiding a crisis, and everyone is paid to generate a return even if it means making the systemic bubble even bigger."

And our summary:

in lieu of being able to actually generate and retain funds from operations, banks will once again scramble to raise epic amounts of debt, only this time, the proceeds will be retained "pinky swear" as a capital buffer, i.e., cash on the books. Cash which nobody makes a single dime in bonus on anywhere in the bank's org chart. Would anyone wish to wager how long before the trillions in GLACs are "mysteriously" found to have funded shanty town developments in Shanghai, to buy the S&P500 at the all time high, and naturally, the purchase of a golden commode or two in various US banks? How could this possibly fail...

 

And the absolutely brilliant punchline: who do these regulators and "leaders" think will be the purchasers of said debt? Why other systemically important, TBTF banks of course! Which means that, in the by now quite familiar "daisy-chaining" of counterparties and collateral, once one bank fails, its exposure via collateral, repo and certainly, funding of other bank balance sheets, everything will promptly freeze as risk reprices, a la Lehman bonds.

Fast forward to today when, focusing solely on the US, we learned that as part of the domestic "macroprudential" effort to ensure firms don't run out of cash in a crisis, the so-called Liquidity Coverage Ratio, US regulators said banks likely will have to raise an additional $100 billion to satisfy the new requirement, the WSJ reported.

The disclosure is part of the final draft of the so-called Liquidity Coverage Ratio, released by the Fed earlier today, and which was promptly passed on a 5-0 vote Wednesday that will subject big U.S. banks for the first time to so-called "liquidity" requirements. The Federal Deposit Insurance Corp. and the Treasury Department's Office of the Comptroller of the Currency adopted the rules later in the day.

According to the WSJ, the thrust of the proposal remains unchanged: Banks must now maintain enough safe assets to equal their net cash outflows over about a month.

Some of the details: "The 15 largest banks - those with more than $250 billion in assets - will have to hold enough cash, government bonds and other high-quality assets to fund operations for 30 days during a time of market stress. Smaller banks - those with more than $50 billion but less than $250 billion in assets - will have to keep enough to cover 21 days. Banks with less than $50 billion in assets and nonbank financial firms deemed by regulators as posing a potential threat to the system will not be subject to the requirements."

And some more:

Under the final version of the rule, U.S. banks with between $50 billion and $250 billion in assets will be able to calculate their liquidity positions on a monthly basis, rather than every day as proposed in the rule's first draft last fall. Those banks also won't have to start meeting the rule until January 1, 2016, giving them an extra year to comply.

 

Banks with more than $250 billion in assets will have to comply starting this coming January but will have until July 2015 before they must calculate the liquidity ratio on a daily basis.

 

...

 

Staff at the Fed estimated that the rule under consideration Wednesday would require big U.S. banks to raise an additional $100 billion of high-quality liquid assets, for a total of about $2.5 trillion.

 

Fed officials didn't make changes in response to the industry's concerns about the rule's treatment of municipal debt securities, which weren't classified as safe "high-quality liquid assets" that could count toward a bank's compliance. But Fed Gov. Dan Tarullo said staff would reconsider that point in the future and "develop some criteria for determining which such bonds fall into this category and thus might be considered for inclusion" as a high-quality liquid asset.

The shortfall as illustrated visually by the WSJ:

On the surface, this is all great macroprudential news: forcing banks to hold even more "high quality collateral" is a great idea, to minimize the amount of money taxpayers will have to fork over when the system crashes once again as it certainly will thanks to the unprecedented Fed micromanaging interventions over the past6 years.

There are just three problems.

  • First, when it comes to high quality collateral, there just isn't enough, a complaint the TBAC made loud and clear in early 2013 and which served as the basis for our assessment that Tapering will have to take place at least until such time as the US once again is forced to plug massive deficit funding holes, and thus the Fed can monetize copious amounts of debt once more.
  • Second, when one considers that the last time the financial system imploded it took not the paltry $700 billion TARP widely trumpeted as the "total" bailout cost, but closer to $14.4 trillion to keep the system from collapsing. As such, $100 billion - if and when the banks' funding mechanisms lock up again in the absence of a perpetual Fed backstop - is nothing but pocket change, even if added to an existing pool of some $2.5 trillion in "high-quality liquid" assets. Furthermore, when the system is locked up in a funding spasm, the last thing any counterparty will bother with is purchasing liquid securities from insolvent competitors at par or even 50 cents on the dollar. In fact, due to the systemic interconnectedness, the only possible buyer of these liquid assets will once again be... you guessed it... the Fed.
  • Third, and this is where this whole "macroprudential" scheme crashes under the weight of its own illogic, is when one considers that the source of the funding of any one bank's debt issuance proceeds, are other banks and financial intermediaries, all part of the same group of chain-linked counterparties, which hold on their shoulders over $200 trillion in notional derivatives, and where even one collateral chain breach means net becomes gross and the derivative exposure collapes into the singularity of the next bailout. Basically stated, banks X will be selling debt to bank Y in exchange for cash, thus boosting bank X' capital line item, while depleting bank Y's. And when the moment comes to rescue the liquidity depleted bank Y, what then?

In other words, not only is this latest window dressing too little to make a dent, or that there simply isn't enough of the high quality, liquid collateral needed to prefund a disaster fund, but at the end of the day, all that is happening is a circular pickpocketing where liquidity is simply rotated in a circle without any exogenous funds entering or leaving the banking sector. And as everyone knows, it isn't any one banks that is insolvent: it is the entire banking sector in total, confirmed quickly when one recalls that Hank Paulson "forced" all the banks to accept TARP funding to restore confidence in the US banking system: not a piecemeal bailout.

Which is why we appreciate both the attempt to pull the wool in front of everyone's eyes, and the humor behind it - the sad truth is that all of the above is not only meaningless, but it will likely further concentrate collateral and liquidity shortfalls away into the weakest banks whose failure will just make the TBTFs even bigger and even more systematically important.

What is worst of all, is that this example clearly indicates that when it comes to macroprudential policy, all the Fed really has, is an attempt to reallocate liabilities among the banking sector, in the process further obfuscation each bank's total exposure. As to the most important issue, collateral chains and counterparty exposure should the "weakest link" in said chain fall, the Fed's weapons are the same two it had during the last crisis: a printer and a prayer.

Everything else is still nothing but smoke and mirrors.

 

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Wed, 09/03/2014 - 19:41 | 5177701 Seasmoke
Seasmoke's picture

Sure looks like the top 6 will roll over the rest ......the ultimate circle jerk. 

Wed, 09/03/2014 - 19:57 | 5177734 zorba THE GREEK
zorba THE GREEK's picture

THE WHOLE FINANCIAL SYSTEM IS A GIANT PONZI SCHEME.

Madoff would be humbled by it.

Wed, 09/03/2014 - 20:26 | 5177825 max2205
max2205's picture

Rinse.  Repeat

Wed, 09/03/2014 - 20:39 | 5177856 philipat
philipat's picture

Maybe they can acquire some of that "Quality Collateral" from Belgium, Luxembourg, Ireland, Cayman Islands  etc.............

Thu, 09/04/2014 - 00:01 | 5178496 knukles
knukles's picture

Oh and by the way, there was within the last day or two another gem passed by the federalies (We don't need no steeenkin' badges) that pretty much blows municipal obligations of any sort out of the "high quality" (or some such shit) asset/collateral category.  That might have been the SEC for mutual funds (money market) but "fer sur dude", the pool of "quality" collateral ain't there, folks.

Getchur treasuries while you can, because there's not toughen to go around.
Just wait till a major collateral call.

And for some o' you fuckers reading this, I toldja so.  No, not anybody posting here.... some assholes with whom I worked long ago.  You know who you are.  No 3 handles on long bonds, no negative bill yields, no Liquidity Traps, no shortage of collateral....

Thu, 09/04/2014 - 06:36 | 5178890 Bangalore Equit...
Bangalore Equity Trader's picture

"Quality Collateral" from Belgium.....

Sure, maybe I can lease some magic Indian cows to your core USA banks to use as Quality Collateral. They can mark them to market as their value in India is infinitely uncalculable. They are the reincarnation of the greatest living soles to grace the planet. Surely this is the answer and CONfidence will be assured.

Wed, 09/03/2014 - 19:53 | 5177721 SAT 800
SAT 800's picture

Hmmm. Verrry interesting post.

Wed, 09/03/2014 - 19:55 | 5177727 Cognitive Dissonance
Cognitive Dissonance's picture

Faith and belief is all that is holding this house of cards up. And that faith and belief is generated by confidence everyone will act sanely and prudently when the next crisis hits and that regulators will be able to contain the problem.

"That's my story and I'm sticking to it." - Yellen

Wed, 09/03/2014 - 20:13 | 5177773 DeadFred
DeadFred's picture

So the plan is to meet in November and pass a plan to make banks have more capital at some unknown date in the future? Even if this plan was sound we aren't goiong to make it until NOVEMBER before everything starts to melt down. 

Wed, 09/03/2014 - 21:11 | 5177956 OC Sure
OC Sure's picture

And they'll be "strategizing" at their Annual Research Conference in Philadelphia, Sept 26-27,

http://www.ijcb.org/authors/cfp.htm , with plenty of incantations for their latest magic; Dynamic Stochastic General Equilibrium models:

"This paper introduces banks into a dynamic stochastic general equilibrium model by featuring asymmetric information as the underlying friction for banking. Asymmetric information about asset qualities causes a lemons problem in the asset market. In this environment, banks can issue liquid liabilities by pooling illiquid assets contaminated by asymmetric information. The liquidity transformation by banks results in a minimum value of common equity that banks must issue to avoid a run. This value increases with downside risk to the asset price and the expected degree of asset illiquidity. It rises during a boom if productivity shocks cause the business cycle."

 http://www.ijcb.org/journal/ijcb14q3a8.htm

...uh, huh.

 

.

Wed, 09/03/2014 - 21:43 | 5178101 IANAE
IANAE's picture

[soapbox]

All the ivory tower models and assumptions in the universe are at best useless and at worst dangerous when used to prognosticate the future and future human behavior and thus markets to such hypothetical future state, and the more complex the model and its assumptions the more spectacular its failure is likely to be.

[/soapbox]

Emanuel Derman says it well:

"Whenever we make a model of something involving human beings, we are trying to force the ugly stepsister's foot into Cinderella's pretty glass slipper. It doesn't fit without cutting off some essential parts. Financial models, because of their incompleteness, inevitably mask risk. You must start with models but then overlay them with common sense and experience."

Wed, 09/03/2014 - 19:57 | 5177735 alfred b.
alfred b.'s picture

 

   Whether it's the Fakeral Reserve or the scheming illusionists, their bag is getting real low on 'tricks'!

 

Wed, 09/03/2014 - 20:04 | 5177751 F0ster
F0ster's picture

So Gold isn't a "high quality asset" in the twighlight zone banking system?

/facepalm

Wed, 09/03/2014 - 20:04 | 5177755 q99x2
q99x2's picture

Nice article.

Wed, 09/03/2014 - 20:08 | 5177763 holdbuysell
holdbuysell's picture

Yup. The Big Print is yet to come.

Wed, 09/03/2014 - 20:38 | 5177829 Everybodys All ...
Everybodys All American's picture

The whole derivatives market if we truly have a stock market meltdown will simply go away. None of those securities will function as intended. If you print again you will only make the cost of living so terrible a revoltion will be inevitable.

Wed, 09/03/2014 - 20:38 | 5177858 Dragon HAwk
Dragon HAwk's picture

so all the money is fake and it's in the wrong peoples hands ?

   there is a simple solution there folks... :)

where's that guy selling tickets to Barter town :)

Wed, 09/03/2014 - 20:47 | 5177893 techstrategy
techstrategy's picture

Gold going parabolic is the only thing that can reliquify the system and make it solvent again.

Wed, 09/03/2014 - 20:52 | 5177911 oudinot
oudinot's picture

We're fucked......

Wed, 09/03/2014 - 21:00 | 5177932 Toxicosis
Toxicosis's picture

I'm telling Bon Jovi you stole their song.

Wed, 09/03/2014 - 21:23 | 5178007 bluskyes
bluskyes's picture

Isn't liquidity a function of price? If everyone all of a sudden thinks that "asset xyz" is overpriced, doesn't that lower liquidity?

Does liquidity mean something that is always easily sold to those who have wealth during periods of crisis - such as the Chinese? In this case, shouldn't the banks be increasing yuan/internationally denominated assets?

edit. Perhaps the banks can just lower their maximum daily withdrawl limit to something around $20

Wed, 09/03/2014 - 21:25 | 5178030 cart00ner
cart00ner's picture

More cash our kids, grandkids, great grandkids etc. will have to pay back.

Wed, 09/03/2014 - 22:20 | 5178208 IANAE
IANAE's picture

In the states insurers are required to report their financial position on a statutory (i.e. liquidation) basis of accounting, are subject to restrictions on the types of assets they hold, have various 'non-admitted' asset haircuts imposed, and must meet minimum regulatory capital standards. 

In particular, while they are generally able to reinsure their insurance exposure, the reinsurers are themselves tracked by regulators and, in certain circumstances, the insurer's balance sheet credit for such reinsurance is disallowed in part or in whole unless it is fully collateralized.

Which is to say, statutory accounting effectively unwinds the off-balance sheet reinsurance and requires risk-based haircuts and collateral....the financial game of musical chairs (i.e. collateral chains) is controlled by way of simple, robust, microprudential statutory accounting rules. 

The chain is only as strong as its weakest link.

Thu, 09/04/2014 - 01:15 | 5178635 Notsobadwlad
Notsobadwlad's picture

Which only goes to absolutely prove that the 2008 financial crisis and the takedown of Bear and Lehman were events planned by the conspiratorial banks and their government puppets.

They had to sacrifice some of their members to make it seem real ... which it absolutely was not, completely contrived. What did it gain them? Greated control of all real assets and fearful peoples and governments who would roll over to their demands.

Incidous!

Thu, 09/04/2014 - 07:17 | 5178937 radical
radical's picture

I think the gem hidden in this proposal/effort indicates the true motivations.  "Quality assets" mean US Treasuries for US banks.  This seems to be another scheme to find a forced buyer of our deficit, and it cosmetically looks better than having the Fed print money.  Why US Treasuries? If a financial crisis hits, historically, there has been a flight to Treasuries, and the increase in price for Treasuries actually improves a bank's balance sheet.

Unfortunately, this is also a "tell" as to why the ZIRP will never end.  If interest rates ever increase, mark-to-market accounting requires loan principal to be written down.  Depending on a bank's loan portfolio, the write-down could put them in the regulatory danger area for capital requirements.  In other words, the capital shortfall mentioned in this article is too low, with the expectation that interest rates will ever increase.  With the distinct possibilty of interest rate increasing triggering another banking crisis, the Fed/G20/and our dear leaders have trapped us permanently.

Thu, 09/04/2014 - 09:32 | 5179442 numapepi
numapepi's picture

I wonder if this more of a scheme to limit the inflow of capital to the system if and when inflation starts? If inflation kicks in, the FED could force banks to meet the demand faster pulling capital from loans to reserves, or increase the reserve requirements, thus diminishing the capital available for loans and theoretically limiting the possibility of runaway inflation. Such "the hand is faster then the eye" tricks would(n't) allow them to print forever? What do you guys think?

Thu, 09/04/2014 - 19:58 | 5182526 RMolineaux
RMolineaux's picture

The only legitimate, long-term solution to bank capital inadequacy is organic growth in traditional activities.  To accomplish this, the following is suggested: 

Reduce executive compensation to ethical levels - an examination of such compensation in the 50's is recommended.

Close down market speculation with insured depositor funds, and its associated unearned bonuses for the speculators.

Regulator assistance to establish service charges at levels that will recover costs and yield a small profit.

Thu, 09/04/2014 - 19:48 | 5182482 RMolineaux
RMolineaux's picture

I do not see any alternatives being offered.

Do NOT follow this link or you will be banned from the site!