One reason that it’s silly to get worked up about banks gambling with your deposits is that they’re mostly not. Your deposits have a tendency to be structurally senior, insured, at regulated subs, etc.; nothing all that bad will happen to them. Banks are gambling with your money market funds, and with the securities-lending proceeds from your mutual funds. Which are not insured, or particularly regulated, but which fund something like $1.9 trillion of securities dealers’ inventory through tri-party repo, as well as providing some $6 trillionish in other collateralized funding for dealer and hedge fund inventories. And this is really much worse, crisis-wise. Since deposits are insured, runs on them are rare. Runs on repo probably caused the financial crisis. Maybe.
NY Fed President William Dudley gave a pretty good speech about this stuff today; you should read it, or read some summaries here or here. The most fun parts for me had to do with the tri-party repo market.
First of all, if you’re following that market you may be aware that the Fed is moving to get rid of “the unwind,” in which
- by day, cash investors deposit their cash at JPMorgan and BoNY and JPM/BoNY lend cash to securities dealers, but
- by night, those cash investors lend the cash directly to the dealers in the freaky unregulated shadow banking market.
Those two activities sort of live on a continuum – traditional(ish) banking by day, shadow banking by night, but still the same provision of credit to the same people based on the same collateral. It’s just that during the day the cash investors’ risk is wrapped in the gentle embrace of the clearing bank; at night the cash investor snuggles up directly with the collateral. Dudley argues that this combined the risks of shadow banking with the complacency of regular banking: Read more »
Today the Federal Reserve released transcripts of its 2007 FOMC meetings. The Fed has a policy of releasing these transcripts with a five-year lag. This has various advantages in terms of encouraging candor and allowing the FOMC members to discuss material nonpublic information, etc., but it has the singular disadvantage of making them look like idiots, because everyone else is five years smarter than they are. “Hahaha William Dudley thinks that Bear Stearns is fine! Bear disappeared like four years ago! Has he been living under a rock? What a moron!”
Still I think the advantages of delay outweigh the disadvantages, for the Fed. Here is Dudley in August 2007 on Bear, etc.:
As far as the issue of material nonpublic information that shows worse problems than are in the newspapers, I’m not sure exactly how to characterize that because I guess I wouldn’t know how to characterize how bad the newspapers think these problems are. [Laughter] We’ve done quite a bit of work trying to identify some of the funding questions surrounding Bear Stearns, Countrywide, and some of the commercial paper programs. There is some strain, but so far it looks as though nothing is really imminent in those areas. Now, could that change quickly? Absolutely. For example, one question that we’re following with Bear Stearns is what their clients do in terms of continuing to want to do business with them. Obviously, if people start to pull back in their willingness to do business with Bear Stearns, the franchise value of the company goes down, and that exacerbates the problem. One thing that we have heard about Bear Stearns is that they have approached a number of major commercial banks about a secured line of credit. We don’t know what the outcome will be, but they are clearly trying to get even better liquidity backstops than those they have in place today. But as far as we know, they have enough liquidity—and Countrywide as well at this moment.
Laugh if you want, but that’s sort of the thing about banks and liquidity: it’s there one day, and gone the next, and its disappearance is never predictable because as soon as it becomes predictable that your liquidity will disappear, it has already disappeared. However good may be your arguments. Bear, at the time, really was drowning in liquidity.1 Dudley just looks a little wrong in hindsight; the guys at Bear who were working to bail their sinking ship had no choice but to make contemporaneous public statements about their liquidity that were true until they weren’t. And that looked, by virtue of the quick flip between “drowning in liquidity” and just “drowning,” like they weren’t true – in a liability-incurring way – even when they were.
The transcripts don’t seem particularly laughable to me2; the FOMC members seem serious and sensible and earnest and informed and reasonably on top of current events without being all that on top of the future.3 This is called the efficient markets hypothesis. Here is Ryan Avent: Read more »
You may remember that, earlier this week, Bloomberg reported that in June 2008, with the world’s financial system in the balance, then-Treasury Secretary (and Goldman Sachs alum) Hank Paulson (1) rode in an elevator and (2) upon disembarking from said elevator told a bunch of his friends who had WORKED AT GOLDMAN WITH HIM about how he was going to nationalize Fannie and Freddie (which he did about two months later) so his friends should short the hell out of the GSEs, which they then proceeded to do, or not do, since “The managers attending the meeting were thus given a choice opportunity to trade on that information. There’s no evidence that they did so after the meeting; tracking firm-specific short stock sales isn’t possible using public documents.”
So that happened. Fast forward to September 2011, when, with the world’s financial system in the balance, New York Fed president (and COINCIDENTALLY ALSO a Goldman Sachs alum) William Dudley met with some other hedge fund friends to ask them about what to do about Europe. And again about two months later, the Fed did some stuff about Europe. Very suspicious.
The Wall Street Journal reported on this meeting today and, while the article loses some points for not describing whether Dudley stepped off an elevator, jogged up a flight of stairs, or clambered in a window to arrive at the meeting, it’s actually remarkably fair in explaining how much you should freak out about this (not that much), as well as in foreshadowing how much people will freak out about it (quite a bit):
Read more »