Marshall Auerback here. I wanted to add a few thoughts to the discussion about recent events in U.S. banking. Below is the Federal Reserve press release on the Bank of America bailout. Here are the most important words from the release:
where the debt is supported by collateral and the issuance supports new consumer lending.
The carrot and stick in the paragraph in red above and below is something brand new and out of the box. It is surprising that it came on Bush’s watch but it has Obama’s fingers all over it. This is a big new push by the government and it has Barney Frank and Shelia Bair’s names all over it.
- We, the US government want to make consumer loans, you the bank want a nice interest spread, say 12% plus.
- The US will guarantee your loans that are presently going for only 200bp over governments 94.5% fro 10 years) and you can go and make credit card loans at 16% and make a 1200 bp profit margin.
- Then JPM just puts up the credit card loans as collateral as per the new government request.
Bottom line: The U.S. government is now making credit card loans and letting JPM make a 1200 bp profit margin, if not more.
Talk about restoring the banks’ balance sheets through a positive yield curve. They will backstop bond issuance from every firm that qualifies as a bank from GS to BAC, etc. for ten years if they agree to make consumer loans.
Do you realize that money is fungible and thus JPM for instance could go and get 10 year loans at FDIC rates, probably at several hundred basis points below prevailing market rates.
And all JPM has to do is to show the government that it made new consumer loans for the amount of the new government guarantees. That shouldn’t be too hard as the money is fungible so JPM says that every new consumer loan that it makes in the normal course of its business will be from those new loans.
GS sold 3 year bonds at 2% over US govt 5 year for 3.25% in December.
Can you imagine, here was a firm that was collapsing in market confidence just 3 months ago that is now able to sell 10 year paper at 200 bp over 2.5% treasuries?
Here is an idea.
Let’s start a bank, borrow for ten years at 4.5%, use part of the money to buy gold, use part of the funds to buy government guaranteed mortgage bonds of equal or lesser maturities and use the positive yield spread between the cost of funds and the yield on the mortgage bonds to pay the interest on the portion of the funds used to buy the gold.
So at the end of the day you have gold that is funded by government guaranteed debt, the carrying cost of which is paid for by buying US government guaranteed debt (mortgage backed bonds) and use the positive carry to fund your gold purchases.
All you need to do is start a bank, fund it with 8% tier 1 capital and you are off to the races.
And you want to know why gold will trade at 5-10X in 5-10 years, you are looking at the reason in the paragraphs below.
What are we waiting for?
Federal Reserve Board of Governors, Joint Press Release
Board of Governors of the Federal Reserve System
Federal Deposit Insurance Corporation
U.S. Department of the Treasury
For immediate release, January 16, 2009 (note the items in red)
Treasury, Federal Reserve, and the FDIC Provide Assistance to Bank of AmericaThe U.S. government entered into an agreement today with Bank of America to provide a package of guarantees, liquidity access, and capital as part of its commitment to support financial market stability.
Treasury and the Federal Deposit Insurance Corporation will provide protection against the possibility of unusually large losses on an asset pool of approximately $118 billion of loans, securities backed by residential and commercial real estate loans, and other such assets, all of which have been marked to current market value. The large majority of these assets were assumed by Bank of America as a result of its acquisition of Merrill Lynch. The assets will remain on Bank of America’s balance sheet. As a fee for this arrangement, Bank of America will issue preferred shares to the Treasury and FDIC. In addition and if necessary, the Federal Reserve stands ready to backstop residual risk in the asset pool through a non-recourse loan.
In addition, Treasury will invest $20 billion in Bank of America from the Troubled Asset Relief Program in exchange for preferred stock with an 8 percent dividend to the Treasury. Bank of America will comply with enhanced executive compensation restrictions and implement a mortgage loan modification program.
Treasury exercised this funding authority under the Emergency Economic Stabilization Act’s Troubled Asset Relief Program (TARP). The investment was made under the Targeted Investment Program. The objective of this program is to foster financial market stability and thereby to strengthen the economy and protect American jobs, savings, and retirement security.
Separately, the FDIC board announced that it will soon propose rule changes to its Temporary Liquidity Guarantee Program to extend the maturity of the guarantee from three to up to 10 years where the debt is supported by collateral and the issuance supports new consumer lending.
With these transactions, the U.S. government is taking the actions necessary to strengthen the financial system and protect U.S. taxpayers and the U.S. economy. As was stated in November when the first transaction under the cTargeted Investment Program was announced, the U.S. government will continue to use all of our resources to preserve the strength of our banking institutions and promote the process of repair and recovery and to manage risks.