FDIC May Need $150 Billion Bailout

This news is from yesterday, but it bears mentioning.

[quote]From 2002 to 2007, U.S. lenders made a total of $2.5 trillion in subprime mortgages, according to the newsletter Inside Mortgage Finance. "Given the magnitude of the bad loans still on bank balance sheets, it would be miraculous for the FDIC to squeak by with losses of less than $200 billion,'' Whalen says. [/quote]


The pace at which these monster cost estimates are piling up tells us that there's a very high probability that the Federal Reserve is going to be directly monetizing debt, if they haven't started already.

This little chart from the Fed raises the prospect that direct monetization has already begun.

This chart reveals that the Fed has been expanding the monetary reserve base of the banking system at a fabulous clip lately. Consider that it took from 1913 until August to get to $875 billion. Consider that it only took two more weeks to expand that number by nearly 10%.

I am watching this because this is the fuel of inflation. It is also the very reason Zimbabwe is where it is, and also the #1 reason that any fiat currency finally dies. Overprinting (meaning too much being created electronically for the US - physical cash and coin is not what we're mainly talking about here).

Another interesting chart from this little publication is this one. It makes me wonder how many people have been taking cash out of the bank besides me....

The race right now is about whether the Fed can create enough new cash fast enough to stave off deflation. If they are successful, then great, I guess. If they fail, it is deflation on one side (probably leading to another Even Greater Depression), and hyperinflation on the other.

Either way, everyone should be heading into this weekend with both cash and gold in their physical possession.

This is a companion discussion topic for the original entry at https://peakprosperity.com/fdic-may-need-150-billion-bailout-2/


Not sure I am following you on this whole thing. The first chart seems to imply we are gearing up to increase M1 drastically because of the current mini-run on the bank. If they are successful, wouldn’t the velocity of money then increase and result in inflation? I guess I am not understanding what will happen if they can pump enough money into M1 fast enough to hold deflation in check. Seems to my inflation would result, or in this case is it just bringing more liquidity to the market?

Nate Lowrie

Chris, like Natelowrie, I’m not quite sure what your’re saying here. (One of the things I love about you is how you pull this info. up and make it sensical, so it would be great if you could shed some light.) You say:

"The race right now is whether the Fed can create enough new cash fast enough to stave off deflation. If they are successful, great, I guess. If they fail, it is deflation (leading to another Even Greater Depression probably) on one side, and hyper inflation on the other." (emphasis mine).

I had been under the impression that the risks are: 1. The Fed creates too much cash, thereby causing inflation; or 2. the Fed creates insufficient cash, thereby permitting deflation. You seem to be suggesting they could hit a sweet spot where everything would be OK. Is that what you are saying?


In Milton Friedman’s Monetary History of the United States, he presented a chart showing that the ratio of currency to deposits rose dramatically, as people redeemed bank accounts during Depression I.

According to the Fed’s H.6 release, there’s $777.7 billion of currency outstanding, versus $628.2 billion in demand deposits (checking accounts) and other checkable deposits. In a heavily-banked developed economy, this ratio is surprising in itself. Why so much currency? Apparently, half the U.S. currency is offshore, used as a parallel currency in Russia, LatAm, and plenty of other places.

Anyhow, so far, the currency/deposit ratio hasn’t exploded in the pathological manner that it did in the 1930s. After all, there was no FDIC in the early 1930s. So deposits in failed banks were simply extinguished. So far (as we saw last night with WaMu), the failed banks reopen and the deposits don’t disappear. But … I DO wonder about the $16 billion pulled from WaMu before it was seized. Somebody really should investigate how much of the $16 billion made its way back into the banking system. Because it’s the conversion of deposits to currency which drives deleveraging, via the money multiplier in reverse.

But converting deposits to currency may be a case of jumping from the fire into a sizzling frying pan. The most efficacious way to prevent a deleveraging from morphing into a killer deflation is to throw the US dollar up against the wall, blindfold it, and shoot it dead. (That’s what Frank Roosevelt did in 1933, when he devalued the dollar 41% against gold. And it did stop the 10% annual deflation which prevailed during 1930-1932.) Devaluation (which may forced upon the US rather than elected as a policy choice) will jolt nominal prices higher with a vengeance. Ten dollars for a gallon of gasoline, or milk.

Soon we’ll all live in million-dollar homes – the same ones we occupy now! Cool

Im assuming the Adjusted Monetary Base is M1 money supply. Since M3 has been unreported for months now we really don’t know how bad the inflation situation really is.

The currency component of M1 indicates the amount of M1 in circulation not in banks. For example my wife and I decided to pull a large sum of money out of savings an pay off our 2008 prius car (now we are completely out of debt). Money was lent into existence by creation of the loan but when we paid it off that money "ceased" to be - deflation.

My guess is that, as the rational person pays off debt, there will be less money in circulation chasing more goods. In other words if I understand fractional reserve currency correctly - my spouse and I just wiped out money by paying off debt and slightly increased the Fed’s and FDIC’s problem (Chris correct me if I’m wrong) but in paying off debt, we just made the "crack addicted" meth monster (US economy) face the music by the erased amount of the car loan?

And by extension, as money is removed from banks, they can no longer maintain the fractional money creation in the market - so the either the money on hand needs to be replaced, or money ceases to be again?

These maybe poor examples but I hope people get the gest of what I’m saying.


Let’s put it in perspective… no matter what the bailout plan, put yourself in the position of the manager of the fund. Now imagine yourself managing the fund, buying toxic assets… now scroll ahead a few months. You’re down to your last billion … how would that make you feel? When people realize that the passing of this bill also means the passing of the last safety net and there’s nothing else underneath… won’t that spook the markets?

Based on history the Fed will inflate as we see above. Bernake is a scholar of the Great Depression and as such will put as much money into the system as possible to avoid deflation. Am posting this to make sure I get the "whole" picture as best I can…
Potential bailout and preexisting bailouts (and Fed policy) -> inflation -> hyperinflation
Commodities up | dollar down | interest rates eventually up
The economy is entering a severe recession -> increase in unemployment -> less spending -> -> downward pressure on prices –> depression
Fed on one side inflation :: Economy deflating –> Which side will win? If history is proof the banks tried to bailout the market during the crash of 1929 and we all know how that turned out.
If there is a loss of confidence people will head towards hard currency, and credit will tighten, Fed’s inflation will lead to people hoarding cash, which means the Fed’s efforts are futile. However, during a depression all prices fall including gold and silver.
Where I’m stuck is that if the dollar becomes worthless won’t gold and silver be the only thing worth something even though prices are falling?
Bernake is going to try to stave off deflation because the fiat system of currency only survives with inflation. As Chris stated earlier when debt is payed off that is a deflationary pressure on the system. When someone defaults on a loan and it has to be written off that is deflationary. Also, where there isn’t a willingness to lend that also leads to deflation.
Can we make the leap that prior to a deflationary collapse there will be inflation, which leads to hyperinflation? Once we hit hyperinflation prices of commodities will go through the roof and hard currencies will become precious as there is a limited supply unlike fiat currency.
Once we hit hyperinflation and the dollar is destroyed inflating won’t do anything after a point and we can use our greenbacks for heat. This is when deflation kicks in, and we experience Great Depression #2.
Or can we just jump to devaluation of the dollar, falling prices, and depression? – YIKES
There are many factors at play here and a push or pull on one or another may or may not trigger a collapse. What do I mean? Okay so the Fed inflates, which devalues the dollar and then the international community will want out of their dollars. Loss of confidence in the dollar.
However, what happens if we have deflation, but with our present debt burden is there any possibility of the dollar actually gaining strength?
FINALLY :slight_smile:
Am I making sense or completely off? I’m attempting to understand potential outcomes given the Fed inflating, a recession, potential depression, prices falling during a recession, but rising during inflation.
Are we headed toward an inflationary depression?
Off to read Mises…

Could you explain what it means to ‘monetize debt’?

It means when the Fed buys debt directly from the Treasury. It amounts to money printing. Think of it like a snake eating its tail.

Someone flame me if I’m wrong.

[quote]Based on history the Fed will inflate as we see above. Bernake is a
scholar of the Great Depression and as such will put as much money into
the system as possible to avoid deflation. [/quote]

Which, ironically, also makes him an idiot. Printing money is always inflationary, even if it magically manages to exactly match the deflation going down the inflationary effect will be quite obvious in historical charts when after fully unwinding debt builds again.

One of these days, I’ll meet an economist that grasps that when two very different metrics work in tandem in a manner that disguises their effect, it won’t make it disappear. But, I fear that day will be 50+ into the future when Economics sheds its pseudo science origins, and its sophistry laced theories intended to support the status quo.

[quote] Potential bailout and preexisting bailouts (and Fed policy) -> inflation -> hyperinflation

Commodities up | dollar down | interest rates eventually up [/quote]

Basically. Though it is doubtful we’ll enter a full hyper inflationary spiral. The US government debt load (which, in this case, is the one that matters) isn’t high enough. Nor, will the government likely continue inflationary policies once the ‘power elite’ (read the rich) start squealing about inflation eating away their wealth.

However, even once the government stops such actions, expect inflation to take years to battle down completely.

[quote]The economy is entering a severe recession -> increase in
unemployment -> less spending -> -> downward pressure on
prices –> depression [/quote]

Don’t forget all those debts people owe eating into their spending as well! Especially now that they can’t just borrow faster to offset the loss.

[quote]Fed on one side inflation :: Economy deflating –> Which side
will win? If history is proof the banks tried to bailout the market
during the crash of 1929 and we all know how that turned out.

Banks don’t print money. Only the Fed can do that. As for which side will win. Both, simultaneously. The debt deflation and printing inflation will create both opposing and orthogonal pressures. For instance, you might see spiking commodity costs and interest rates while wages stay stagnant (or even drop) and unemployment climbs.

Error! Error! History has repeatedly proven that economists know jack shit about recession and depression events. Any claim of ‘X’ always happens during ‘Y’ is likely flawed. Indeed, the fact the economists fail so badly in predicting/comprehending such events is pretty much proof that economists know very little about, well, economics.

And, one begins to see how we so easily paint ourselves into economic corners.

[quote]However, what happens if we have deflation, but with our present debt
burden is there any possibility of the dollar actually gaining
strength? [/quote]

Depends on how the two factors (printing vs debt destruction) meshed.

I went to my bank yesterday and asked them for a somewhat substantial amount of money, perhaps enough to buy a nice used car. They were quite surprised, why did I want that amount of money, what could I possibly use it for. I let them know that I just wanted to have some cash on hand "just in case." (The question annoyed me a little - it was my money, and if I wanted to withdraw it and light it on fire, it was my business, right?) They said they would have to order that amount of cash, that I could have a few thousand now, and that I should return four days later to get the complete amount then.
I mean, you kind of expect the bank to have money, right? Well turns out, they don’t. At least not very much of it. And certainly not there ready to give you.
Chris is right. Society is full of a bunch of very small doors, built to handle a slow trickle of people through them. That’s all just great until everyone tries to pile through the doors at once. And we don’t know this until we really need to get through that door and, alas, its just too small for everyone to fit through at once. And of course by then it’s far too late.
If you happen to have it lying around, or if you feel like establishing a reserve of actual cash "just in case", go try and withdraw $10k from your local bank. See how they react.

Depending on the daily activity at a local branch bank, they usually keep a relatively small amount on hand. A couple hundred thousand is about the most, and that includes all denominations and coins. This would be typical at moderate level of customers in a suburban/urban area.

I’m betting they had it, but you would have wiped out their supply of $100’s and then instead of 1 unhappy customer, they’d have a bunch of unhappy customers.

that would also require approval from higher up for most any teller. If you were attempting fraud (not in anyway insinuating you were), the poor tellers job could be on the line. Banks are also required to report large cash withdrawls to the Feds (Anti-money-laundering, patriot act fun stuff)

A four day wait seems a little extreme. If they’re either a single-stand alone community kind of bank or the only nearby branch of a larger institution, they probably do have to order it. But if they have other banks nearby, they should be able to transfer it.

chris etal i heard on npr tonite a clip which will air on this american life with ira glass this weekend about the credit markets freezing up. i do not understand how the labyrinthine world of credit markets work. but is this economic terrorism in that they are not going to lend any money unless we fork over the dough? they make money lending money and they are not going to make any if they dont lend any. at some point i assume the markets resume functioning. help me get this please

Little is being said about the hight cost of fuel and it’s impact on our economy.

Our economy is going down the tubes. The high cost of fuel has driven up the production and shipping cost of everything. Consumers have nothing left over after filling the tank and paying more for the necessities of life to spend on extras, save or invest. We need to get ourselves out from under our dependency on foreign oil. Our economy is in a sorry state of affairs directly related to the high cost of fuel. We have become so dependant on foreign oil that we have neglected to fully utilize such natural sources of energy such wind power & solar power. Along with modern technology such as plug in cars, hybrid cars, v2g technology ,and regenerative braking, technology we still seem to be floundering as a nation as to devising the best plan utilize all that is available to us and lift ourselves out of this mess we are in. We need to take our closest look at which candidates put our economy and energy crisis at the forefront of their agenda. There is a new book coming out soon called…The Manhattan Project of 2009 by Jeff Wilson . It looks like it’s going to be an eye opener and further the cause of all those who are worried about our environment and dependence on foreign oil. www.themanhattanprojectof2009.com

energy the 800 pound gorilla in the corner no one seems to want to address. i have been disagreed with here but we are at peak oil probably as of 05 chris has a very good take on our situation. i have a friend who is a geologist and he says the idea we have 250 years of coal is ludicrous and is based on the last mineral survey in 1976. that it is the best guess total of all coal reserves much of which is never that is in never going to be mined. as chris pointed out is it useless to speak about tons of coal it is about btus. which at present has flattened but will soon go down. with 150 new coal permits applied for in the last 2 years we actually have somewhere between 50 and 100 years according to my friend.personally i would like to see it stay right where it is. if we would spend all the money we are spending on war and bailouts we would be much further along than where we are. we will never be independent of foreign oil as long as we have any kind of dependence on it. amory lovins has quite rightly pointed out we have plenty of energy …we just have to use less by using itmore efficiently. those of you in theburbs are living is what is the worst failure of the human experiment …behinf the failure to understand the exponentiial function. my own vote would be for tax credits to individuals to put up solar water heaters, windmills and solar panels and also mine the great potential of energy efficiency. we would save much fossil fuel help the environment, put all those plumbers, electricians and carpenters who are currently not doing very much back to work thereby lowering unemployment. create jobs and get the economy moving in the right direction. we need to decentralize the grid get our electricity out of the hands of big corporations, limit the risk of terrorist attacks on our electric supply etc. i could go on all nite but the debate is starting and i am just breahtless at the prospect of hearing an intelligent dialogue. micropower is one of the fastest growing sectors of new energy development google wave for more info. as for candidates probaly obama on astate level bernie sanders in vermont has already introduced a bill in the senate. live green

I’ve had a crazy couple of days. My wife and I decided to convert most of our cash into gold & silver. I had an incredible time trying to find 90% silver - every single Internet dealer was out of stock. They were promising delivery in "2-3 weeks", but a friend who works in the business told me delivery times looked more like 10 weeks. I started calling local coin shops. I’d find someone who had it, but by the time I got down there three other people had come in and bought it. I finally found a place with a supply and a decent price, and I jumped on it.
Gold has also been disappearing. Apmex.com and several other prominent sellers are very short on supply. I suspect "smart money" is moving into precious metals very quickly.
Interesting times…

"Banks don’t print money. Only the Fed can do that." – sr barbour

Depends on what you mean by "print." For sure, only our beloved Federal Reserve can emit those lovely peachback FRNs with the sloppy off-center printing.

But if you borrow $1,000 from your local bank, they book the loan as an asset, and create a $1,000 deposit in your name as a corresponding liability. This $1,000 deposit is literally created from thin air. The only constraint is that the local bank had to have at least $100 of reserves on hand.

Unfortunately, this cool fractional reserve money machine works in reverse, too. If your local bank finds itself $100 short of reserves, they need to extinguish $1,000 worth of loans, pronto. Thus the phone call: "Sorry, dude. We’re pulling your $1,000 credit line. Goodbye and good luck!"

On an economy-wide basis, when the shortfalls are in the hundreds of billions, the credit extinguishment implied by the reverse money multiplier could be in the trillions. Not to worry – it’s only paper money.

that should read google WADE not wave. sorry

[quote] But if you borrow $1,000 from your local bank, they book the loan as an
asset, and create a $1,000 deposit in your name as a corresponding
liability. This $1,000 deposit is literally created from thin air. The
only constraint is that the local bank had to have at least $100 of
reserves on hand. [/quote]

Not in so much. Saying that the banks create money out of thin air is a deep mischaracterization that leads to even deeper misunderstandings. If they truly created the money out of thin air, then they’d have no concern about recollecting the money at a future point.

In reality, the action of a bank lending varies quite profoundly, depending on the type, the length, and the manner of the lending. A simple loan has an interesting characteristic of 'drawing money from the future. To fully explain this examples are really necessary:



Lets say you have Bob and Joe. Bob has one $10 bill, and both are on a raft in the middle of an ocean. Joe has an apple, and Bob buy that apple for $20 so we have:

Bob Joe

-10d $10

So in other words, Bob promises to pay Joe more money in the future. Joe gets to hold the $10 bill. Notice, there are no ‘new’ bills. This is because money hasn’t been printed.

Now, latter Bob catches a fish, and Joe buys the fish from Bob for $30. To complete this exchange, Joe gives Bob $10 then calls Bob on his debt, getting the $10 back. He then pays Bob $10 again, and then promises $10 more in the future. Notice how the bill changed hands 3 times in this described interaction. This is the monetary effect of huge debts, in effect, extreme monetary velocity.

Now create an even bolder senario. Its five days later and the distribution is:

Bob Joe

$10 -100d

Now Joe has somehow gotten his hands on fresh water. Bob, very thirsty, buys that water for $300. So Bob gives $10 calls on the debt, to get $10 and repeats for an insane 21 exchanges of that $10 dollar bill. Bob then takes a debt of -190d. Notice that debts are getting very very large compared to the number of bills. This is one example of leverage. That is, as long as Joe and Bob feel comfortable allowing the other to sink really deep into debt and refrain from ‘calling’ each other on it when the other can’t pay. Everything is fine and dandy.

Unfortunately, real life doesn’t work this way. Sooner or later one party takes on more debt than he can ever repay (even if all commodities are inflating insanely as in the raft example.), or one party ceases to concern himself with the intent of ever repaying back (Hey, thinks Joe, why bother paying back? I’ll just keep taking and then and when Bob finally gets angry, refuse to give him anything back!).

That is, all loans are based on trust. Trust that the other party will pay and trust that the other party can pay. The rational that debts can be larger is also quite sensible. More goods are always being produced in the future (even if the economy is smaller). As such, even if there is no build up of wealth a person can ‘consume’ enough ‘consumable goods’ over a period to add up to the value of a larger debt. As such, debt does not automatically presume that future will be larger than the present, but rather, that the future will be large enough. (And if debt is really high, like in the USA, it does become a larger than the present issue).

However, nothing in this raft constitutes the effect of printed money. Indeed, debt creation is far and distant from money creation. Let us consider the same situation as before Bob and Joe on the boat, but this time they are using a ‘seashell’ to stand in for the $10 bill. Lets call them $s. So we have:

Bob Joe

$s1 -10d

Now, Joe and Bob reach an abandoned island beach. Joe being a cunning man refrains from paying Bob back and instead, quickly grabs up 10 seashells and gives them to Bob. Joe, has in effect ‘printed’ $s10.

So we have

Bob Joe

$s11 0

Which is exactly the same (inflationary effect accounted for) as:

Bob Joe

$1 0

That is, this exchange is no different than Joe simply outright saying he has no intention of ever repaying Bob back. Indeed, the only difference is that when the economy starts back up again (because Joe and Bob forgive each other and work out a reasonable arrangement – Bob swallowing his losses, Joe finally agreeing to pay the original debt (now 11x as big!) in full, or some variation there of). there are $s11 instead of $1s. That is, an inflation of 1000%.


To put it another way. Printing money, and debt creation are as different as night and day.


Steve, your example does not employ double-entry bookkeeping for both actors, making it difficult to follow. Nor does it provide for a central bank which can discount Joe’s debt and issue more ten-dollar bills (whether in deposit form or as printed currency is irrelevant, as they are interchangeable).

Murray Rothbard ("The Mystery of Banking") believed that bank lending creates fiat money from thin air. And so do I. More pertinently, so does Ben Bernanke, or he wouldn’t be trying so desperately to expand the monetary base.