Putting the shadow banking system back in vogue

Marshall Auerback here.

Let’s talk a little about the economic data released on Friday. On the plus (contrarian) side, everybody is talking about the unemployment number and NOBODY happened to mention that consumer credit was UP on Friday, even before TALF. I think we are very close to the bottom. I think that New York Fed President Dudley is screaming to the investment funds, hedge funds, private equity to do these deals with TALF.

Think of it this way.

A well funded PE fund takes $100M out of a fund of say $1B and does TALF at 10-times leverage and makes, say, a conservative 600 bp (maybe much more — I just don’t know where these ABS credit card and auto spreads are trading right now).

That’s $60M profit on the $100M investment or 60% per year. Put another way, that’s an incremental 6% on their overall fund returns on the entire $1B sized fund. If they get more aggressive as a percent of total fund invested in TALF the numbers are much bigger.

The Shadow Banking System will be back in vogue.

If this money then gets re-loaned to consumers as the asset is cleared off the banks’ balance sheets, the consumer starts spending and because the Fed has provided the tinder in the form of the Monetary Base, the Velocity of Money picks up — and then money supply and bank deposits and then the economy starts to turn up. And then the demand for commodities and equities participate until the Fed has to take away the “punchbowl” but they will not follow William McChesney Martin as to his prompt responses and that’s when commodities and gold shine.

The issue, short term, is that equities can really blossom if Velocity picks up because the monetary tinder has been just sitting there waiting for the gasoline to be added to the fire.

Am I oversimplying this or leaving something material out?

Related articles
Consumer credit: Surprise $1.8 billion jump – CNN Money

  1. Vangel says

    “Am I oversimplying this or leaving something material out?”

    You are leaving the potential of getting wiped out because the purchase is not profitable and the leverage forces liquidation or bankruptcy of the PE fund. Unless the government is going to guarantee a profit the scheme will be far too risky for many and has the potential of making a bad situation worse. Of course, if the government guarantees a profit the PE fund can make a profit and do well but that does not guarantee economic salvation because of the potential of massive price inflation in the commodity sector that would accompany any real recovery. The recent price collapse has taken a lot of supply off line and has delayed or cancelled many projects. Both trends would take some time to reverse and that would mean massive price inflation that will threaten any recovery.

  2. fred says

    There’s one problem with any recovery scenario I can think of; interest rates. Once the velocity of money spikes, the global bond markets are not going to dither. They will sell off hard and fast. What then; monetize the federal debt? Buy every mortgage? Buy all the commercial paper?

    The problem of too much debt hasn’t gone anywhere. It’s just sitting out there, waiting for all this new money to gain traction. But when that happens, at some point lending becomes very dangerous at anything approaching current interest rates. Default risk may recede, but inflation risk can be equally damaging to lenders. So now, those mountains of debt are still present, just with rapidly rising interest rates. How does that get resolved?

  3. Vangel says

    “How does that get resolved?”

    It gets resolved by a loss of purchasing power of the fiat money. The answer is the devaluation or replacement of the currency.

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