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April 1, 2020 | Fed “Temporarily” Blesses More Leverage: What’s Really Going On?

Mike 'Mish' Shedlock

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.
With reserve requirements down to zero, the Fed has now reduced capital requirements on banks.
Another Bazooka to NowhereIn yet another act of Fed desperation, Big Banks Get Blessing to Extend Leverage.

To ease strains in the Treasury market resulting from the coronavirus and increase banking organizations’ ability to provide credit to households and businesses, the Federal Reserve Board on Wednesday announced a temporary change to its supplementary leverage ratio rule. The change would exclude U.S. Treasury securities and deposits at Federal Reserve Banks from the calculation of the rule for holding companies, and will be in effect until March 31, 2021.

Liquidity conditions in Treasury markets have deteriorated rapidly, and financial institutions are receiving significant inflows of customer deposits along with increased reserve levels. The regulatory restrictions that accompany this balance sheet growth may constrain the firms’ ability to continue to serve as financial intermediaries and to provide credit to households and businesses. The change to the supplementary leverage ratio will mitigate the effects of those restrictions and better enable firms to support the economy.

As the Board has previously stated, financial institutions have more than doubled their capital and liquidity levels over the past decade and are encouraged to use that strength to support households and businesses. The Board is providing the temporary exclusion in the interim final rule to allow banking organizations to expand their balance sheets as appropriate to continue to serve as financial intermediaries, rather than to allow banking organizations to increase capital distributions, and will administer the interim final rule accordingly.

The supplementary leverage ratio generally applies to financial institutions with more than $250 billion in total consolidated assets. It requires them to hold a minimum ratio of 3 percent, measured against their total leverage exposure, with more stringent requirements for the largest and most systemic financial institutions. The change would temporarily decrease tier 1 capital requirements of holding companies by approximately 2 percent in aggregate.

The change will be effective immediately and the public comment period will be 45 days.

Effective Immediate With 45-Day Comment Period

Why bother with comments?

Oh wait, I get it.

Banks will ask to make this permanent . They will also seek even greater leverage.

The Problems are Debt and Leverage

Excuse me for pointing out that the problems are debt and leverage.

So, how does encouraging banks to take on more debt with more leverage help?

Temporary?

And what about this “temporary” thing?

Will banks reduce capital ratios now if they believe they will have to go out and raise capital later?

Explaining the 3% Capital Requirement

If banks increase leverage then suffer a 3% loss, they will be wiped out.

Will they?

My best guess is banks have already taken huge capital losses but are hiding them under mark-to-fantasy options.

Recall that regulators suspended mark-to-market rules in March of 2009 and never restored them.

Estimating Bank Losses

The Fed increased the amount of leverage banks can have because banks have likely already taken a 1-2 percentage point hit to capital, if not far more.

If so, the Fed is not really encouraging more leverage. Rather the Fed just blessed the increased leverage that has already taken place.

Why?

So that banks will not be forced to raise more capital at this time.

What Can Possibly Go Wrong?

For starters, the Covid-19 Recession Will Be Deeper Than the Great Financial Crisis.

Also, please see Nothing is Working Now: What’s Next for America?

Mike “Mish” Shedlock

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April 1st, 2020

Posted In: Mish Talk

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