Bank Arbitrage (JPM, C)
At yesterday’s presser, Fed chief Ben Bernanke indicated an easy policy stance for the foreseeable future.
While the basis of this is the ostensibly high unemployment, I believe it is really to buy time to rehabilitate the bank’s balance sheets. They remain poorly capitalized.
Rather than put insolvent institutions into reorg, we have allowed the hang on slowly getting better through a massive back door bailout: Borrowing from the Fed at near 0%, and lending it right back to Treasury at 2-3%. This is more politically acceptable than just writing them checks for $100s of billions of dollars.
Consider:
• Q1 2008: JPMorgan Chase had an average of $1.2 billion in outstanding Fed loans with a 2.1% interest rate while it held $2.2 billion in U.S. government securities with an average yield of 4.6%.
• Q4 2008, JPMorgan Chase had an average of $10.1 billion in outstanding Fed loans with a 0.6 % interest rate while it held $10.3 billion in U.S. government securities with an average yield of 1.7%.
• Q1 2009, JPMorgan Chase had an average of $29.2 billion in outstanding Fed loans with a 0.3% interest rate and held $34.6 billion in U.S. government securities with an average yield of 2.1%.
• Q2 2009, JPMorgan Chase had an average of $7.6 billion in outstanding Fed loans with an interest rate of 0.25% interest. Meanwhile, it held $34.6 billion in U.S. government securities with an average yield of 2.3%.
• Q1 2008, Citigroup received over $5.2 billion in Fed loans with a 3.3% interest rate and held $7.9 billion in U.S. Treasury Securities with an average yield of 4.4%.
• Q4 2008, Citigroup received $15.8 billion in Fed loans through the Fed’s Primary Dealer Credit Facility with a 1.2% interest rate; $11.6 billion in Term Auction Facility loans with a 1.1% interest rate; and $4.9 billion in Commercial Paper Funding Facility loans with a 2.7% interest rate. It simultaneously held $24 billion in U.S. government securities with an average yield of 3.1%.
• Q1 2009, Citigroup received over $12.1 billion in Fed loans with an interest rate of 0.5% while holding $14.3 billion in U.S. government securities with an average yield of 3.9%.
• Q2 2009, Citigroup received over $23 billion in Fed loans with an interest rate of 0.5% while holding $24.3 billion in U.S. government securities with an average yield of 2.3%.
• Q3 2009, Bank of America had an average of $2.9 billion in outstanding Fed loans with an interest rate of 0.25% while purchasing $23.5 billion in Treasury Securities with an average yield of 3.2%.
Sources: Federal Reserve, US Senate
Similar arbitrage has existed for the top 20 banks since the Fed took rates down to zero.
The bailout has always been about rescuing the banks, their management, shareholders, and most especially, their creditors and bond holders.
Tweet
Facebook
Reddit
Digg this!
April 28th, 2011 at 7:32 am
Keeping policy constant at 8.8% is hardly an easy policy stance, especially with inflation well below target.
April 28th, 2011 at 7:36 am
8.8%?
WTF are you talking about ?
April 28th, 2011 at 7:41 am
You forgot to include the depositors in that list. The FDIC was going to be on the hook for them and there’s no way they could cover C let alone JPM without getting a huge cash infusion from we the people.
April 28th, 2011 at 7:56 am
Barry,
When I calculated the advantage gained by banks, it’s not that large.
I just took the oustanding Fed loans to a bank, and multiplied it by the interest rate differential between what the Fed charged the bank, and what the bank gained from the treasuries. (Divided by 4 to get absolute gain per quarter).
The numbers are as follows (for JPMC)
Q1’08: $7.5m, Q4’08: $27m, Q1’09: $131m, Q2’09: $39m
Similar for other banks.
So the numbers are substantial, but not in billions.
Let me know if I missed something…
April 28th, 2011 at 7:56 am
Hang on, what does it matter whether the FED lending rate is zero whether this arbitrage can take place?
If the lending rates was 3% then in theory the same spread exists and the banks can borrow at 3% and buy treasuries yielding 5% or 6%?
This arbitrage has always existed and is why, IMO, the natural rate of interest on fiat money is 0% at the short end, and why eventually there won’t be any long bonds at all (the FED is already someway to making the latter come true).
The issue here is the amount of FED loans outstanding, not the lending rate.
In fact any Joe swapping cash for 25y treasury bond and then selling it 3 months later is getting paid a 25 year rate for what amounts to a 3 month “investment” . Highly liquid nominal bonds don’t provide any social benefit whatsoever and represent a gift to the holder whoever they are.
April 28th, 2011 at 7:57 am
ByteMe,
no Error made, he covered them, here: “…their creditors and bond holders…”
actually, thanks to the (long-time) existence of the FDIC, “Depositors”, on average, don’t, even, view themselves as “Creditors” to their ‘Depository Institutions’..
April 28th, 2011 at 8:21 am
At least the bank with which I was familiar invested in Treasuries because: 1. they had large sums which could not be lent because of lack of demand (not to mention lack of qualified borrowers under the economic circumstances), 2. there were few other regulatorily permitted investments, 3. the banking industry was understandably very concerned about liquidity at the time because the extent of loan losses and how long that would go on, and other liabilities, was very unclear. Correspondent banks and entities such as the Federal Home Loan Bank (counterproductive to recovery) were reducing, eliminating or requiring more collateral for their liquidity lines. They accepted US instruments at 100% margin but downgraded as collateral commercial and mortgage loan portfolios pledged. This tended to move funds from portfolios of loans, which degraded liquidity, to US securities which did not.
All I am suggesting here is that there were other considerations at work than pure arbitrage, at least from the banking side.
April 28th, 2011 at 8:33 am
(Inadvertently erased comment and had to rewrite) On the second writing forgot to mention that bank regulators were also VERY concerned about liquidity and a bunch of Treasuries soothed the savage beast.
April 28th, 2011 at 8:49 am
“Let me issue and control a nation’s money and I care not who writes the laws.” Mayer Amschel Rothschild, 1790.
JPM, C, BAC simply follow this 200+ year old “wisdom.” Regardless who’s the government – Dems, GOP, T-parts….
April 28th, 2011 at 8:56 am
“The bailout has always been about rescuing the banks..”
Of course it was. That is the Fed’s true mandate, all cover about the “dual mandate” notwithstanding. We have an institutional structure today that does not address our problems very well. They are descended from earlier days, from other times, and I suppose we are therefore stuck with them, the days of innovation for America being over.
April 28th, 2011 at 9:05 am
It’s a good think the banks aren’t allowed to charge consumers usurious interest rates. We’d have some real trouble then.
April 28th, 2011 at 9:05 am
. . . a good THING . . .
Oy.
April 28th, 2011 at 9:09 am
The Big Banksters own the Fed, they are the only ones with access to free money. If the Fed backs away from the US trough and maintains free funding for the big banksters their spread increases.
The safest bet in the house is that QEIII won’t be called QEIII.
The Fed needs to shift it’s focus to solving the Big banksters foreclosure problems, they need to create a US entity to take foreclosed proerties off the banksters hands at a “fair” value to the banksters and then let the US hold the bag.
April 28th, 2011 at 9:10 am
wally,
to your Point..
“The Federal Reserve System does more than conjure up money from thin air. (That would be enough!) The Fed is also regulator/protector of the American banking industry. Indeed, as recent events amply demonstrate, we may think of the industry as a government-organized protectionist cartel, with the Fed as the hub. One need look no further for evidence than the relationship between the New York Federal Reserve Bank under now-Treasury Secretary Timothy Geithner, whom the New York Times calls “the leading architect of [bank] bailouts.” (See last week’s TGIF, “Of, By, and For the Elite,” for details.)
No one familiar with the origins of the Fed, or the other Progressive Era reforms, should be surprised. Those who have not studied the Progressive Era in any depth, however, are likely to believe those reforms were imposed by enlightened politicians to end abuses by big business. That is one of many fairy tales we learn in school. It’s not so, but it serves its purpose, which is to protect the left and right wings of the ruling party from the radical laissez-faire alternative. Those reforms, though of course cheered on by European-educated American intellectuals attracted to power and ambitious Progressive politicians, were in fact the brainchildren of the corporate elite. Its members disliked the vigorous market competition of the late nineteenth century because it cost them market share, and their efforts to stifle competition through mergers had failed miserably. So the elite turned to the state for protection. (See Roy Childs’s classic “Big Business and the Rise of American Statism” here.)
In no industry was this more true than in banking…”
“…To make a long story short, Rothbard writes in The Mystery of Banking: “The growing consensus among the bankers was to transform the American banking system by establishing a central bank. That bank would have an absolute monopoly of note issue and reserve requirements and would then insure a multilayered pyramiding on top of its notes. The Central Bank could bail out banks in trouble and inflate the currency in a smooth, controlled, and uniform manner throughout the nation.”
Essentially it would be a cartel that would allow concerted action free from competition. A cartel unsupported by government is vulnerable to independent competitors. To succeeded in defiance of market forces, a cartel needs government help, either to force everyone into it or to hamper outsiders…”
http://www.fee.org/featured/bankers-bank/
April 28th, 2011 at 9:14 am
Ben’s snow job
… Ben S. Bernanke, addressed concerns about sluggish growth so far this year. Severe snowstorms, which shuttered many businesses, may also explain why output grew much less than economists had initially expected when the year began, he said.
I knew the gurus had it right when they said $4 gas wouldn’t affect the recovery.Now that the snow melted we can expect a big 2Q bounceback, right? Hmmm.maybe these unprecedented tornadoes in the south slowed down the recovery.
The American economy slowed to a crawl in the first quarter, but economists are hopeful that the setback will be temporary.
Total output grew at an annual pace of 1.8 percent last quarter, the Commerce Department said Thursday, after having expanded at an annualized rate of 3.1 percent at the end of 2010. Most economists had forecast growth of 2 percent in the first quarter.
April 28th, 2011 at 10:33 am
Jeez, when are we going to stop pissing and moaning about the FED? it has been around for just short of a 100 years and was adopted for exceptionally good reasons. It has gotten us thru two world wars, a host of other wars, a depression, and two grand recessions plus a host of mini-recessions not to mention a host of other blunderings caused by our inability to properly provide oversight. They have done a masterful job of keeping the ship off the rocks. I can’t imagine they won’t continue to be successful unless knot heads like Ron Paul and other FED bashers begin to prevail. Without the FED, we would be totally screwed.
April 28th, 2011 at 11:21 am
yeah… bailing out the banks is also the point of paying interest on reserves. It’s a free gift of money to the banks. But otherwise, if you tighten policy and squeeze interest margins, the banks are bust. So interest on reserves buys you the leeway to tighten.
April 28th, 2011 at 11:29 am
‘Without the FED, we would be totally screwed.’ — louiswi
Ha ha ha! Love your off-the-wall parody. But you do need to punch up the laugh lines a bit. It comes across so ‘straight man’ that some people won’t get the rich sarcasm.
‘Masterful job of keeping the ship off the rocks’ — hoo hah, almost split my sides on that one!
April 28th, 2011 at 12:24 pm
Isn’t that what any institution would do for its shareholders? We need to keep in mind who owns the beast from Jeckyl Island?
April 28th, 2011 at 12:43 pm
Also consider that its generally poor form to let your largest Primary Dealers go tits up (without whom, the Fed would have a slightly harder time of monetizing the debt in a less obvious fashion). It is in the interest of the host that the cancer not completely dissapear.
April 28th, 2011 at 1:26 pm
[...] The banks are the continued beneficiary of the Fed’s low-interest rate policies. (Big Picture) [...]
April 28th, 2011 at 1:57 pm
@fundaman: “When I calculated the advantage gained by banks, it’s not that large.”
i’ve been thinking the same thing. if this is how the fed intends to dig the banks out of the mega billion dollar hole they are in, its going to take a looooonnnnnngggg time!
April 28th, 2011 at 3:45 pm
I think it is important to look at the term of credit before you can call it arbitrage. I know there is this belief out there the fed lends at 0% and then banks lend the treasury back at higher rates. But you have to always look at the duration of the loan. The treasury still borrows at the lowest rate for the same duration. Borrowing at 0% for overnight rates and then lending to treasury at 3% for 10 years is not really arbitrage. It can be downright dangerous.
April 28th, 2011 at 4:13 pm
Pretty much redefines the notion of the “carry trade,” doesn’t it?
April 28th, 2011 at 6:58 pm
What a joke – the US spent the entire decade of the ’90s criticizing Japan for keeping phantom banks on life support…and I thought the US was about creative destruction. Wise men learn from others mistakes.