Leen’s Lodge, FDIC, The Fed
David Kotok
June 29, 2011
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“Bank reserves are slightly below $1.6trn despite the Treasury’s high cash balance at the central bank. The Treasury’s cash balance has averaged $130bn in the past two weeks compared with about $70bn over the same period in 2010. A higher Treasury cash balance at the Fed drains more bank reserves. We suspect the Treasury is keeping a thick liquidity cushion at the central bank in preparation for any potential volatility associated with the debt ceiling. Nevertheless, we expect bank reserves to reach $1.7trn by time QE ends later this month. The distribution of bank reserves has attracted a great deal of attention recently. Most analysts focus on the level of cash assets held by the largest domestic institutions compared with the US branches of foreign organizations. The cash assets of the non-US banks currently exceed $1trn compared with roughly half that amount at the 25 largest domestic banks. Moreover, these cash balances started rising sharply once QE began last November. Accordingly, there has been some speculation that the Fed’s liquidity expansion has mainly ended up on the balance sheets of the largest non-US institutions.” Source: Barclays Capital Weekly Federal Reserve Balance Sheet Update (24 June 2011).
We visited Leen’s Lodge on the weekend after Father’s Day. As part of a small group, we convened to prepare and strategize for the larger consortium of economic and financial-market experts who will gather during the first weekend in August.
We were: two lawyers, all investors, one Washington expert on energy and a political analyst, one retired ophthalmologist, one automobile marketer, and two bond managers (my colleague Peter Demirali and me).
We reviewed the uncertainty we see in the world. We fretted about the circumstances that have led us to worry – worry for our children and our grandchildren. Four of us are over 70. We had to monitor the amount of fried fish we ate over the campfire and limit the wine we took with dinner.
Never did we think we would be seeing a central bank policy that gives a $1 trillion edge to foreign banks over US banks. The quote above tells enough for the casual reader to understand the issue. We dug into some detail. The banking institutions abroad have double the money on deposit with the Federal Reserve than the largest twenty-five banks in the United States. Why? This occurs because of an action of the Federal Deposit Insurance Company. The FDIC changed the formulation of its assessments to expand to assets, not just deposits. The assets that are assessed include those that are excess reserve deposits of American banks placed at the Federal Reserve. Those deposits earn twenty-five basis points. American subsidiaries of foreign institutions are not subject to that assessment. That is the outcome since the FDIC introduced this fee assessment mechanism on April 1st.
The spread between the interest on excess reserves and Federal Funds has widened, because the Fed Funds rate is falling. Why?
Simply put, banks will not act at the margin in a way that loses money. Who can blame them? And so banks that were arbitraging monies they could obtain from various funding sources, including Fannie Mae and Freddie Mac, found the imposed assessment sufficiently large to cease this behavior. We are beginning to see enough change to estimate how much impact this FDIC fee assessment precipitated. The revelations above that are cited in Barclays’ research speak for themselves.
We have had an intervention that countered the Federal Reserve’s stimulus program. The intervention persists through today. The QE2 Federal Reserve program is ending momentarily. There is turmoil in the sovereign debt arena that we read about in the headlines. We have a slowing economy, exacerbated by weakness in the labor force and the housing sector, that has not healed.
What more uncertainty could one ask for?
An additional uncertainty came in the form of a political intervention in the oil price, where an agency decided with other agencies and political bodies to release reserves of oil in an attempt to drive the price down. It caused an immediate response in the marketplace, as one would expect. Examination of this suggests that the weakness in oil attributable to a reserve release that is a nonrecurring event can only be temporary. It will perhaps slightly improve the economic situation in the United States, because the oil price acts like a tax. Every penny a gallon in the gasoline price is roughly $1.25 billion in annual spending power, which is either inserted into the consumer’s pocketbook if the price goes down or extracted if the price goes up. It is only policy changes concerning drilling, substitution, alternative fuels, or natural gas that will make the real difference.
Our group sat at Leen’s Lodge. We observed the natural beauty of our surroundings: clear, pristine water teeming with bass and pickerel; wildlife, including moose and bald eagles. We contemplated the future and worried.
Maybe it is the nature of elders to worry. Maybe this is true of all generations, past and present; maybe concern grows with age. I have no way to know; I have only been sixty-eight years old once. I look at my three children and their spouses, my two grandchildren, and the world to come, and I worry for them.
Leen’s Lodge is a comfortable place. The food is delicious; the owner and manager, Charles Driza, is a hospitable innkeeper. Summer visitor business is 30% off from last year, suffering the results of the recession. There is no recovery in Washington County, Maine. Anyone who wants to take a trip to a delightful, quiet place might want to look into Grand Lake Stream, Maine, Leen’s Lodge, and these environs. Visit www.leenslodge.com for more information.
I’m back at my desk, working to sort through the knowns, the known unknowns, and the unknown unknowns.
