All this may seem obvious Henry. Rest assured I for one don't think don't think you are at all a hysterical doomster. Seems to me you have a lot of fun...
Best,
Clark
To paraphrase the Prudent Bear. For Private Use Only. A bit long but worth the read.
My "..." indicates abreviation
"Importantly, money markets are a vital mechanism for the banking system, as the purchasers of bank loan securitizations, as a direct lender, and, on the other hand, as a holder of institutional deposits. Some seem to be hung up on the issue of money market fund deposits as a “medium of exchange,” which they differentiate from bank deposits. But this is not an issue as money market funds are at the epicenter of the contemporary book entry financial system with a Credit-based settlement process.... I will add, however, that such a system should not be expected to function as swimmingly (appearance of endless liquidity) with any serious contraction of lending. The expansion of money market deposits certainly creates inflationary purchasing power, although much of this fuel is contained within the sectors where lending is most prevalent – financial assets and real estate.
....Additionally, the demand for loans and securities from non-banks such as finance companies, aggressive mortgage lenders, hedge funds and the “special purpose vehicles” have in real life led to a competitive bidding up of prices throughout the debt securities market and a resulting explosion in money and Credit. Importantly, lending dynamics were forever altered once boring old bank loans were transformed into the precious hot commodity for fabricating securities that, marked- to- market on a daily basis, generate coveted trading and speculative profits. And as trading, “structured products,” and leveraged speculation turned endemic, the availability of the enormous financial Credit to sustain such endeavors became a critical systemic issue. There is then no mystery why the money market, enjoying the unencumbered ability to “multiply” deposit money, now commands its place at the epicenter of the U.S. securities-based Credit mechanism.
Nonetheless, many steadfastly hold to the erroneous notion that only banks create money and Credit. Contemporary money and Credit is created largely through the expansion of myriad financial sector liabilities, something that many non-banks have been engaged in aggressively and conspicuously. I also continue to read analysis that money market fund deposits are different in kind from bank deposits, with the inference that these deposits are in some way deficient to bank deposits and, hence, generally impotent in influencing economic and financial market performance. I could not disagree more, and I only wish there was appreciation as to how money market fund claims are created.
They are “multiplied” through the process of financial sector lending and liability expansion, albeit through banks, the GSE, “special purpose vehicles,” securitization trusts, Wall Street securities firms, finance companies, captive finance units, Credit card lenders, etc. I would even go so far as to argue that money market funds, as the chief mechanism for financing the holdings of Credit market instruments, become only more critical and vulnerable by the day.
Economists have a long history of clinging to traditional and outdated notions of what functions as money, too often blindly ignoring financial system “evolution.” Consensus opinion held for decades (best illustrated during the heated 19th Century Currency School vs. Banking School debates in Britain) that bank notes, and not deposits, impacted prices and the economy. Not viewed as money and thus with little concern for the consequences of rapid deposit expansion, this error led to a dangerous inflation of these claims and resulting financial fragility. We have witnessed a replay of history.
I hope the above analysis helps to illustrate how money market fund deposits are, like bank deposits, the residual of the lending process. The issue is not what constitutes a bank (or bank deposit), but the nature of liabilities of the institutions, instruments, vehicles, and mechanisms of contemporary lending. I also hope the above examples illuminate how the explosion of non-bank entities easily explains the relatively slow growth of bank assets (loans) in the midst of historic Credit excess – non-banks are doing much of the lending, while many bank loans are securitized and sold into the marketplace where related liabilities become the assets (intermediated) held by money market funds.
With the ballooning of GSE assets, special purpose vehicles, and securitizations, it is today not very useful to focus exclusively on bank assets as a measure of lending or liquidity.
I have referred to money market funds as a parallel financial system that has evolved as the key financing mechanisms for the securities markets. The similarities of these respective booms are no coincidence. Many have convinced themselves that money market funds do not have intrinsic liquidity for transactions, say as checking accounts enjoy. But this view completely misses the essence of money market funds and the explanation for the explosive growth of industry assets. Money market accounts are THE transaction accounts for financial markets. Whether it is the millions of online traders, millions that hold IRA or defined contribution retirement accounts, the millions that have brokerage accounts, the thousands of hedge funds, the Wall Street firms or the banks themselves, securities transactions are settled with transfers in and out (debits and credits!) of money market fund accounts.
The expansion of money market claims (deposits) should be recognized as the undisputed inflationary fuel for the financial markets, markets that today dominate the economy. And having become a leading source of finance for the GSEs, commercial mortgage, Credit card, auto and home equity lenders (through securitizations), this fact alone goes a good way in explaining the resiliency of retail and automobile sales, as well as the unrelenting mortgage finance Bubble. Would we have zero percent financing without a booming securitization market? Would “structured finance” be viable without the money markets? How about the housing Bubble? If it were only the banks, would we have seen more pull back in consumer lending by now?
I will take the other side of any argument as to the crucial role now played by money market funds in the U.S. economy.
.....throughout incredible economic growth and development, historic financial system evolution, the breakdown in monetary regimes, various booms and busts, and major alterations in the control over the financial apparatus, bank lending to finance commercial investment remained the heart and soul of the Credit system and the dominant transmission mechanisms to the real economy (with money a key residual). Nowadays, this simply no longer holds true.
Lending to the asset markets – largely securities and real estate – dominates the Credit system and provides the “backing” of money. Marketable securities have transplanted loans, with profound ramifications for such a radical departure in the financial transmission mechanism.
...importantly, it is today critical to recognize that non-bank liabilities - transformed through money market fund intermediation into deposits – are in some cases “superior” liabilities. The lack of reserve requirements and their “moneyness” (perceived liquidity and safety of nominal value, hence virtually insatiable demand) provide a most powerful mechanism for Credit excess, as we have witnessed. And in a time where the opportunities for bank lending (and deposit creation) to profitable enterprise is increasingly limited, money market fund intermediation of asset and consumption-based lending runs unabated. Not only does this Credit sustain spending, it also, importantly, creates the liquidity life blood for our New Age market-based Credit system.
The “moneyness” of non-bank liabilities has been evolving for decades, although it clearly came into full fruition during the past decade. Four related key developments come to mind: First, the rapid acceptance, growth, and integration of money market funds within the financial system. Second, the explosion of securities issuance – debt, equity and particularly asset and mortgage-backed securities – concomitant with Wall Street’s (as Master of the securities markets) rising prominence. Third, the ballooning of GSE balance sheet liabilities and off-balance sheet guaranteed securities. Fourth, the proliferation of Credit insurance, derivatives, liquidity arrangements, “special purpose vehicles,” CDOs, and such – the enormous growth in “structured finance.”
As we have discussed repeatedly, these profound Credit system developments created a paradigm shift in regard to risk intermediation and systemic Credit availability, especially in the securities markets. Such momentous developments absolutely beckoned for diligent analysis and careful consideration by the Greenspan Fed. The Fed’s erred by responding to this paradigm shift with full support and accommodation.
Recently Greenspan made the comment that it is the Fed’s role to react to the structure of the markets. I read this as confirmation of our view that of the Fed’s new priority of managing market “liquidity.” Admittedly, having over years fully accommodated the securities markets and Wall Street as they supplanted banking system predominance, the Fed has little alternative. But this concession to Wall Street goes much beyond just ultra-fine tuning.
No longer is Fed policy seeking to influence control through bank lending to commercial enterprise – adjusting interest rates and lending capacity in a transmission mechanism operating on real economic returns. Rather, policy acts on interest rates and spreads, largely impacting securities markets and aggressive financial players. Financial and speculative “profits” provide the key (dysfunctional) transmission mechanism to the real economy. Interestingly, in some of the earliest discussions of the role of central banking in Britain, it was recognized that one of the dangers of allowing central bank discretionary powers was that previously misguided policies would only create the opportunity for only greater discretion and the precarious compounding of errors.
Wow, we have witnessed precisely this risk play out in spades.
...the Fed missed its opportunity to preserve its limited control over a rapidly evolving market-based Credit system, while also failing to squelch insidious leveraged speculation and resulting asset Bubbles. Indeed, instead of squelching it nurtured, and the monetary disorder genie was let out of the bottle. Today, leveraged speculation has become “too big to fail.” This regrettably ensures that flawed policy is locked in nourishing dysfunctional processes, with reverberations throughout the financial system and economy. And as long as expanding mortgage and consumer debt provides the securities of choice for the leveraged speculators, apparently that’s what the system’s going to create in excess – the powerful financial infrastructure and indelible processes assure it.
That the nature of this Credit excess does anything but promote long-term economic growth or financial stability doesn’t even factor into the equation. The bottom line is the system is impaired and the transmission mechanism hopelessly perverted, with failed policy frozen in the headlights. But we’ll be the first to admit that the U.S. financial sector maintains its extraordinary capacity to create its own liquidity.
The outcome is, however, only further impairment to an already acutely fragile U.S. debt structure. |
