Five Things You Need to Know: Permabears!; Why Traditional Bank Runs Do Not Occur; Why Traditional Bank Runs Do Occur; Money Market Infections; Department of Weirdly Accurate, Yet Strangely Unrelated, Headlines
What you need to know (and what it means)!
Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
What would you think of us if we outlined the following bearish scenario:
Skyrocketing consumer debt loads over the past decade, the result of a cocktail comprised of expanding risk appetites encouraged by rapidly rising home prices, have now reached a point where the average American household owes more money than it earns. By comparison, in the 1980s this debt-to-income ratio was below 60%. In the past decade, "financial innovations" have allowed consumers to borrow based on the expectations that their collateralized assets (their homes) would rise in value. Now, with home prices declining and mortgages more difficult to obtain, many consumers have no choice but to cut back on their consumption, and such a reduction in consumer expenditures exposes underlying macroeconomic vulnerabilities. Moreover, because consumers were essentially leveraging these anticipated asset price increases, and channeling their borrowed funds into non-productive consumables, any decrease in time preferences, or decrease in available credit, may have the effect of further amplifying the effects in the macroeconomy, allowing the relatively small number of households with weak balance sheets to have a larger, disproportionate negative impact on the macroeconomy.
- Wow, after reading something like that, you would probably shake your head and say, "Man, you guys are bearrrrr-ish! Come in off the window ledge!"
- You might even cut and paste that paragraph in an email to a friend and write something like, "Check out the tune Gordon Grim and the Depressionists are singing over in Minyanville. Yikes!!!"
- Or, if you read further, you might note that we're actually not the ones making that bearish case.
- So who is?
- The second highest-ranking official in the Federal Reserve.
- In a paper being presented at a central bankers conference today in Sydney, Australia, "The Rise in U.S. Household Indebtedness: Causes and Consequences," the guy just behind Federal Reserve Chairman Ben Bernanke, Vice-Chairman Donald Kohn, with Fed economist Karen Dynan, is arguing that the excessive accumulation of debt can, in some circumstances, lead to financial distress.
- Moreover, Kohn and Dynan say, the reaction of financial markets to these developments raises the possibility that credit availability could be hampered for a larger group of households, which could, in turn, have effects on the broader economy!
- Why, why does the Fed hate America?
2. Why Traditional Bank Runs Do Not Occur
But wait, there's more. Check it out, another interesting research paper from the New York Fed on why traditional bank runs no longer occur:
Modern Banking without Bank Runs
David R. Skeie
Federal Reserve Bank of New York Staff Reports, no. 242
JEL classification: G21, G28, E42
- "In the literature, bank runs take the form of withdrawals of real demand deposits that deplete a fixed reserve of goods in the banking system," Skeie writes in the abstract.
- In the modern world, however, large withdrawals take the form of electronic payments, so there's no corresponding "depletion of a scarce reserve."
- "I show that interbank lending and monetary prices imply that traditional bank runs do not occur," Skeie wrote.
- The conclusion: "This finding suggests that deposit insurance may not be needed
to prevent bank runs in a modern economy."
- But let's back up a second. Skeie notes early in the paper that, "This paper does not claim that bank runs do not occur in a modern economy, but rather that pure liquidity-driven depositor runs solved by deposit insurance are not the issue of concern."
- "Systematic real asset losses do not lead to bank runs; but a coordination failure in the interbank market does cause not only bank runs but also contagion, which requires a lender of last resort rather than deposit insurance to resolve."
- Unfortunately, that's exactly where we were last Thursday and Friday.
- And that's why the Fed lowered the discount rate, essentially sending a message to large banks that they are willing to be that lender of last resort if necessary.
3. Why Traditional Bank Runs Do Occur
Meanwhile, back in the real world, anxious customers jammed the phone lines and Web site of Countrywide Bank (a division of Countrywide Financial (CFC)) and crowded its branch offices to pull out their savings because of concerns about the financial problems of the mortgage lender that owns the bank, the LA Times reported late last week.
- At Countrywide Bank offices, so many people showed up to take out some or all of their money that in some cases they had to leave their names, the LA Times said.
- "Bill Ashmore drove his Porsche Cayenne to Countrywide's Laguna Niguel office and waited half an hour to cash out $500,000, which he then wired to an account at Bank of America."
- Speaking of traditional "runs on the bank," this leads us to today's Number Four item...
4. Money Market Infections
Unbeknownst to most investors, Bloomberg this morning warns, some of the largest money market funds today are putting part of their cash into one of the riskiest debt investments in the world: collateralized debt obligations backed by subprime mortgage loans.
- U.S. money market funds run by Bank of America (BAC), Credit Suisse Group (CS), Fidelity Investments and Morgan Stanley (MS) held more than $6 billion of CDOs with subprime debt in June, according to fund managers and filings with the U.S. Securities and Exchange Commission, Bloomberg said.
- There are 38.4 million money market fund accounts in the U.S., according to the Investment Company Institute.
- Bruce Bent, who in 1970 created the first money market fund, The Reserve Fund, told Bloomberg that no money market fund should invest in subprime debt.
- "It's inappropriate,'' Bent, 70, said.
- Nevertheless, despite Bloomberg's ominous warnings, as we noted last week money market funds at reputable institutions are extraordinarily unlikely to "break a buck," as the saying goes.
- Only once before has a money market fund failed.
- According to Bloomberg, a fund run by Community Bankers Mutual Fund of Denver failed in 1994 after it invested in securities that defaulted.
- Investors were paid 96 cents a share and the fund was liquidated, the article said.
5. Department of Weirdly Accurate, Yet Strangely Unrelated, Headlines
Minyan Eric out in Aspen made sure we saw this headline topping the Aspen Times.
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