VoxEU wrote an article regarding elevating the FHLB, refining and adjusting its purpose, and discussed a little bit about its importance.  I am so happy to see it getting some light shed on it.  The FHLB is a silent but powerful support system to our banks.

Mark Thoma, an econ professor of The University of Oregon, picked up on the article.  He had no comment or much knowledge on the FHLB system, which proves the lack of understanding even in the academic, “in-the-loop” circles.

Here was my comment to his post, for education purposes:

I’m happy to see that this article is starting to get around. It had been surprising that there hasn’t been any publicity in regards to the FHLB’s importance to the banking system.

The way that the FHLB is set up is, in the best of terms, “all-encompassing.” In order for a bank to borrow term advances/loans from the FHLB, it has to pledge it’s mortgage portfolio. The amount you can borrow depends on the type of loan (conforming, jumbo, “subprime”, 2nd home, etc) that is pledged, and there are separate haircuts for each.

The FHLB can impose adjustments to haircuts to different loans. During the height of the crisis, this became a concern because the majority of many banks’ wholesale funding is from the FHLB. An increase in haircuts equal a decrease in borrowing capacity. Also, an increase in defaults or slips in status of loans equal decreases in borrowing capacity.

It’s troubling when borrowing is limited further because the FHLB is the cheapest wholesale funding out there compared to brokered deposits, term repo agreements and other wholesale options. Banks can borrow overnight often below the fed funds effective rate, as well as cheap longer term funding up to 20 years. Constricting this sources forces banks to use brokered deposits to fund loans or investments, which is expensive both in terms of rates paid as well as FDIC assessments.

On top of this, the FHLB requires banks to buy stock in order to be a member. How much stock a bank has also limits the amount it can borrow. If banks want to borrow more against the loans you pledged, they will have to buy a % in stock. I know some (maybe all) banks have stopped paying dividends on stock.

The FHLB also issues debt, which is very common for a bank’s investment portfolio to hold, and is viewed the same way as other GSEs.

Essentially, banks are often shareholders, borrowers and lenders to the FHLB. When regional home loan banks have issues, i.e. Seattle or Atlanta, it’s a cause for great concern to the longevity of the banks which are supported by the HLBs.

I am enjoying these post-it note doodles.  I wish I could say the idea of doodles on post-its was original.

“Definition: A linear transformation T: U → V is invertible if there exists a linear transformation L: V→ U such that LT(u) = u, for all u in U, and TL(v) = v, for all v in V.”

Plain english, please.  I assume this means that a matrix for a linear transformation is invertible if you are able to reverse the transformation and get to the same starting point…  seriously, someone correct me before I get too far along.

Theorem (The roguelynn inequality) – Mathematics is masculine if, and only if, there exists explanatory language that is not simple english, such that your ego does not exist in the state of mind spanned by the confused basis L.

Proof: Let T be the text book at hand, such that T is written by mathematician(s).  Also, let basis L be the language in which T is written, given that it is written in obfuscating english.

Suppose there exists a student S, such that S needs to learn textbook T.  In order for the product of TS = grade of A, there must be the learning of L from T, such that the product of TS is an isomorphism to L. Recall that TS ≠ ST.  Therefore, TS = [A]L.

Editor’s note: I’m even confusing myself.

My point is that I find abstract mathematics pretty masculine.  And the reason is such that I read something, and I question “is this what it really means?”  While the frustration increases, it leaves me with a bruised ego from the sense of “I should probably know this, but this obfuscatory language is questioning my sense of the subject…”  It’s the same kind of testosterone induced sense of ego where one doesn’t want to ask for directions.  You’ve been there before, you should know how to get there now…

I get the sense that mathematicians don’t want “the common folk” to learn this stuff (which pushes me more…) from the difficult language in which they write.  I’m left to struggle through this, impatiently but rewardingly so.  It seems like a perpetual loop – once I understand this, I will continue to write such logic based arguments only to confuse others.  And I know my response will be “what, you don’t understand?”  Understanding abstract math almost divides and creates “classes” within intelligence.

Oddly, I’m cultivating an interest in pure and applied mathematics…  It’s a moth to a flame thing.

This leads me to another theorem that I have.  More finance-y based.  For those of you that are familiar with the DOS-based program Bloomberg, equipped with it’s very own keyboard, you can relate when I say the first time I saw that, I thought “wtf…”  While the key word “TOP” is logical for Top News, and perhaps “FWCV” may be intuitive for Forward-looking Yield Curve analysis, how the hell are you supposed to know this right off the bat…   But the whole system is very foreign, especially in the age of “user-friendly programming.”  Granted, similar to my point above, I feel damn proud having figured out *some* of the system, and have a general comprehension of how it works and where to get information.  Might I say, that I am indeed certified in such a program, and still do not know all that Bloomberg can do?

I should also make the point that while this program is quite antiquated, it is vastly utilized in the field of finance since it was released (in the 80s?), and therefore will be quite difficult to change such a system.  When will computer programmers, bankers, financial engineers and economists start working together?

*cough* I think I just hit on a bit of the problem of how this crisis got started… but that’s for another time.

This is not an “I told you so” moment, since it was pretty expected, but needless to say, only last week did I write a post about this:

http://online.wsj.com/article/SB125668489932511683.html?mod=WSJ_hps_LEFTWhatsNews

“Anna Molly” – Incubus.
I need to start doing this again – title posts coincidentally with a good song.

Anyways – a better title would be “When there is smoke, there is fire.”  I should have written about this a while ago: rates.

Who out here in this blogosphere, or anywhere mind you, shop a little for interest rates for your savings/money market/CD accounts (maybe even checking if you dig deep)?  I know you can pretty easily with bankrate.com.  I even knew a [[smart]] guy that would shop for higher rates constantly, and would always find a rate higher than his student loans in order to pay for the interest.  I wonder how he’s doing now…

Anyways, I wanted to write about how published rate offerings for different banks may suggest how they are fairing this tumultuous economy going on here.  Please direct yourself here for a second - it’s HSBC’s published rates, frequently changing.  Scroll down to the various CDs they offer, from 3 month duration up to 2 years.  

Anything pop out at you that’s a bit off?  It seems logical for higher rates for the longer term, as it’s considered more risky the longer you lock in your money in a CD, and the bank should pay for that.  The shorter the term, the more liquid it is, the lower the theoretical risk.  HSBC’s rates pretty much follows that, except for their 2 year term CD at 1.60%.  It’s below the 1 year at 2.00%.

This is a micro banking definition of an inverted yield curve.  A normal yield curve would have interest rates increase as the duration of the CD increases.  This represents the risk for reward theory mentioned a second ago. 

When looking at irregularities like HSBC’s rates, it can give you some insight to how the bank currently managing itself.  Looking at these rates, I would have the initial thought that HSBC doesn’t really need immediate, short term funding (shown with the very low rates for 3 & 4 month CDs), nor do they need much longer term funding (shown with the lower rate in the 2 year term).  Where the bank is willing to pay for money is the intermediate terms that they offer, the 1 year, 13 months and 15 months.  Perhaps they are having some difficulty gauging themselves through that 12 -18 month cycle, or maybe they are quite weak in that ‘bucket’ of time.  Whatever it is, they are willing to pay up for these terms for some reason.

When I’ve rate surfed in the past, I’ve noticed huge differences in immediate short-term (less that 6 months) rates versus long term.  These banks were begging for short term funding, perhaps couldn’t get it anywhere else (might have no one willing to lend to them).  Anomalies, for sure (hey! back to the song of the post!).  But should be taken into consideration while rate shopping for your money.

Why?  Well, if there is a huge discrepancy within their short term versus long term funding (i.e. 2% for 3 month CD versus 1% for 3 year…I wouldn’t think that’d be out there though, at least for the major banks), this screams “we need money! now!”

I want to drive home that if a bank overall is paying significantly higher rates compared to those around them during a time like this, it should be highly questioned.   I’d currently be wary of smaller, community banks doing this.  Their troubles are less publicized, and therefore issues may not be immediately apparent other than published rates to the general public (although you can pull up public FDIC call report filings -10Qs for banks- and dig in yourself if you’re so inclined).   It’s a decent gauge on how a bank is doing – to see what they are willing to pay for.

Granted, this may not apply in a better rate/economic environment.

One of the reasons Secretary of State Hillary Clinton is visiting China is to persuade leaders that US debt is still good.  *chuckle*  Sorry, I couldn’t hold that one back.  Here’s a good overview article in the WSJ.

An article of inspiration came across my way, Why China Needs US Debt, thanks to curious friends.  Yet I’m not sure if this article does a good job of tying together its own answer to the title question.  Why does China need US debt?

Let’s break it down to the simple GDP equation found in any econ 101 text: GDP = Consumption + Investment + Government Spending + Net Exports.  We also must think in the context of Chinese habits and culture.  Generally, it’s understood that the US depends on the majority of its imports from China, and China depends on us for the majority of their exports.  Of course the question rises of how much each country is exposed to another, but that’s a different discussion.

China is an overall net exporter, where the country exports more than it imports (US – vise versa).  Most countries are typically one way or the other, few are equally balanced.  Investment and consumption is not exactly the focus here, where those variables focus on the aggregate of the individuals.  Government spending more so – on top of reinvestment into a country’s infrastructure, welfare programs etc, a government typically invests in other governments with its excess money (in China’s case – excess from exporting).

A question came to me – why doesn’t China reinvest in itself (rather than investing in US and elsewhere)?  With the fact that the country’s GDP is disproportionate to it’s population when comparing to other country, my answer is this:  China has had outrageous growth rates, in the double digits.  That’s why it’s considered alarming that its current growth rate is 6.8% q/q.  But one can not think of GDPs growth rate as a ‘return on investment’ kind of deal.  6.8% just means that from the last quarter, China grew its consumption, investment, gov’t spending and exports.  Unless you were able to make an index betting on the GDP of China, you can’t theoretically invest in it’s GDP, take the proceeds and reinvest.  

China’s government is reinvesting in itself, a lot.  The reason why it’s behind other countries is that the government is playing catch up since the mid-1900s after realizing protectionism is not the way to go.  Also, the country is still very agrarian – not comparable to that of Western Europe, US, etc.  

US lops up all of China’s exports, and as more of a convenience, China lops up all the US debt.  Investing in US treasuries, at least in the past, has proven to be very liquid.  And with China already earning US dollars with its massive exports, it does not have to exchange its currency to buy debt from the US (avoiding huge exchange risk).  While it may not yield the greatest rate, governments investing in US treasuries are looking for safety, security, and liquidity.  The reason why one invests is they do not need the money now but they want a return on their money.  Governments often have future obligations, like social security payments.  The government will put the tax money away, and being prudent, will look for security rather than return.  As I said, liquidity is another requirement – as the government may need to liquidate for immediate needs (*cough cough* leading to another topic of US’s lack of social security).

Of course now, you can see why Clinton must convince China to stick around…The US needs money, it needs someone to buy the debt.  That alone gives it the air of illiquidity.  And if anyone has even looked at the yields, they are pitiful.  Mind you, our image of security is being badly tarnished with what’s happening within our borders.  You can almost picture Uncle Sam holding a gun to China’s head saying “We’re bankrupt – buy our bad debt.”

Something I’ve been curious about – and I think deserves more attention – are the Basel accords.  

From what I know up front, there are two and provide guidelines for capital requirements for banks.  And that Basel is in Switzerland.

The second Basel agreement is more pertinent, yet still only recommendations.  It provides recommendations for capital adequacy…sound relevant?  

-side note – banks in Europe have more of a liberal accounting system, with the ability to write off non-performing assets to look like they’re profitable (e.g. Deutsche Bank in 4Q07 I believe, maybe 1Q08).  

Sparing myself from reading 350 pages, there are three pillars of the agreement: capital allocation is more risk sensitive, separating operational risk from credit risk, and align economic and regulatory capital to reduce the possibility of regulatory arbitrage.

Let’s look at the first pillar for now (as I don’t have the focus after work for all three at once!) – capital allocation being more risk sensitive – it outlines capital adequacy for credit, operational and market risk.  It also aligns itself with a minimum capital requirement.  When banks take deposits and turn it around for investments, they can choose investments or loans, and the Basel accord rates this on a scale from least to most risky, starting with government bonds at 0%, OECD countries at 20%, mortgages at 50%, commercial loans at 100% and now something new – subprime borrowers at 150%.  The minimum capital requirement that the Basel accord lays out is 8% with the risk weighted assets.  I believe this is to encourage banks to even out their risk – but I wonder why there isn’t a maximum.  Perhaps I’m not understanding this fully.  Lastly – the first pillar says that banks basically can evaluate credit risk by their own means: the “Standard Approach”, or the foundation/advance “Internal Ratings Based Approach.” 

So returning to that side note – the IRB approach? huh? so you have the power to rate your own credit risk, even right it down so much that you create the illusion to have a profit?  I hope this approach is moderated…or at least looked after.

next to come: pillar 2 of the 2nd Basel accord.

This past week I’ve had a slough of inspiration from women that I didn’t realize I admired so much.  While it’s not much about economics, I feel like sharing

” It’s four o’clock, do you know where your money is?”
-Maria Bartiromo (she’s on my desktop right now!)

You can’t help but be mesmerized by her presence on CNBC, where she’s worked since 1993.

Erin Burnett, the other “money honey”

Graduated Williams College, worked at Goldman Sachs, then made her path through different media outlets to finally being a rather newbie to CNBC.

Anna Schwartz, somewhat lost under the shadow of Milton Friedman

Received her master’s in economics at the age of 19 from Columbia University, it wasn’t long before she joined the National Bureau of Economc Research;  she joined Milton Friedman in writing ”A Monetary History of the United States,” which I’ll soon be getting to reading (it’s making for nice decoration on my desk!).

I swear I had more women I looked up to.  I think I’m just forcing it too much.  There are people in my life daily that I admire, but I’ll keep that to myself

Who gives you inspiration?

~house of cards ~ radiohead ~

I spend a lot of time watching the news, both at work and at home.  We all know what’s going on with our economy, how the fed and treasury are trying to help the financial system out, trying to help consumers out.  And then we see retailers increasing discounts during this time of looming depression to lure customers into relaxing their white knuckles on their cash.

But how has this economy really affected consumers?

Here’s how I see it so far – the banking system has crashed and is evolving into something never seen before.  The financial system is wiping out.  No longer do 150 year old companies exist.  More and more the sector is becoming an oligarchy.

And the news is reporting that it’s all about the credit markets.  Yes – well, it’s what caused it.  But it’s the banks’ problem.  I don’t really see it affecting consumers.  Their reaction to save more may be because of a perceived personal credit crunch.  But how many have you actually experienced a bank withdrawing your credit line on your card? 

I realize two separate points that go against this argument: 1) people are being denied new credit and loans, which cultivate growth in our economy and 2) people are losing jobs.

But for those not employed by the financial sector (about 94% I believe) – there’s still income.  Propensity to save is due to the fact that we see 6% of the job force is losing their jobs.  That we see foreclosures increasing.  That we hear banks not lending anymore.

Maybe I’m not making my point clear – consumers have money.  They have income.  They may not be able to move into a home – but they can still spend.  We still have credit, just not new credit.

Am I insane? I just saw someone on CNN saying they are choosing to use cash over their credit card.  But that means they have the ability to use credit.  I just think that the propensity to save and to spend shouldn’t be affected if you have a job.  You just can’t buy a house right now.

This point is not very refined – I just had to get it out there.

I can’t resist trading free money  

Current positions:
shorting the GBP against USD
long on both USD & GBP against JPY
^up $1500 for the day ^

Soon to-be-settled holdings (stupid program is slow!):
AAPL
CSCO
AEO
GS
TIVO
BEBE

Also looking into health care and pharma companies for this time in the economy.