Friday, October 18, 2013

This Week in Bank Failures

The federal government shutdown started with great fanfare on October 1 with huge promises, house parties, and so many lights you could have thought it was Christmas time. It ended much more quietly, the lights long gone, the promises vague and muted, the final hour of debate in the House shortened by almost half because no one really wanted to be in the limelight taking credit for a political stunt turned disaster. There were no celebrations that I know of because the people most affected had to get up and go to work in the morning. (I am sure some people who got their jobs back are out celebrating tonight.) The economic damage had been done, and political damage too. Unlikely players, from Starbucks to the U.S. Chamber of Commerce, drew lines and made new enemies along the way. One lasting consequence, though, is that many people came to realize how much they liked the federal government in some way, whether it was the panda cam or the economic statistics.

The Fed and federal banking regulators operated normally during the shutdown, and though seemingly not much happened, the Fed’s balance sheet continued to grow with new asset purchases. The Fed now owns about $2 trillion in federal government debt and nearly as much in mortgage-backed securities, an astonishing amount in total. There was some hand-wringing this week about what happens when the Fed starts selling off its assets, as if it might just dump $4 trillion in securities on the market some day. Realistically, though, the Fed will never sell most of those assets — nor does it need to. Most of the worry seems to originate on Wall Street, where if they had a $4 trillion portfolio, they would immediately start day trading. Wall Street traders and analysts probably have some difficulty believing that the Fed is not planning on any London Whale-style financial maneuvers. But the Fed is a different kind of bank, and it can easily just keep bonds until they mature. That is what I imagine will happen with most of the assets the Fed is currently holding. In theory, the Fed could sell a block of assets to reduce the money supply, slow growth, and fight inflation, but I am not sure that opportunity will come up between now and 2025.

I saw the suggestion that the Fed could forgive the $2 trillion in U.S. government debt it holds. In theory, that would be a transaction with no financial impact, but there are legal and policy complications, so it won’t happen — at least, I hope the suggestion was merely rhetorical.

Bank failures are likely to resume in the coming weeks as banks post quarterly results. There are always a few unhappy surprises among banks’ income statements, and when those happen to a bank that is already on the edge, regulators can decide it is time to take action.