The Liquidity Trap Part Deux

It looks like the banks are going to have a tight leash, courtesy of the Fed. A new rule says that instead of banks being required to be “capitalized”, that they will be forced to be liquid enough to survive a full, open-bore bank run for 30 days. Sounds great, but remember, it’s a liquidity rule; not a capital rule.

Here’s the difference: Capitalization is not cash. Liquidity is cash, or the cash equivalent, such as with Treasury Securities. There’s two things that catches my eye. First is that banks have been hoarding cash since 2008, which the Fed has been happy to print. Second is that there could be a loophole in the form of MBS (Mortgage Backed Securities). First thing’s first.

How much liquid will the banks be required to have? About $2 Trillion according to the Fed – almost the same amount that they were bailed out with.

As I’ve pointed out many times, we’re already in a liquidity trap. Since 2008, the Fed has pumped $10.8 Trillion into the banks. The last time there was this much “liquid”, Noah built himself a boat.


As of right now, so much money has been pumped into the banks, that every man, woman and child in America could get a check for $3 Million.

The whole reason no one has a job is because of the liquidity trap – and the Fed wants to pour gasoline on to that fire. Now, I’m all for liquidity regulations. It’s just the wrong time to do it.

The second part is this: Banks want MBS to count toward liquidity. In other words, every time the bank approves a mortgage, that mortgage would count toward their cash assets. There’s a problem with this picture:


All of those new Mortgage Backed Securities, if there are any, because there hasn’t been movement on mortgages since 2008, will be bought by the Fed if the go bad (again). The Fed is already sitting on $1.4 Trillion of bad MBS. If the banks are required to have $2 Trillion in cash, and include their MBSs, then 80% of their “liquid” could be wiped out on another housing crisis.

Remember – the reason the U.S. Unemployment is sticky, is because of IS-LM; there’s too much cash hoarding.

And none of the rules on MBS have changed. Nor has the accounting rules.

So while the rules are good, and the theory of liquid versus capitalization makes sense, adding more “liquid” in a Liquidity Trap now just means that we’re going to need a bigger boat. Add to that the bank’s desire to tie MBS to the liquid, and we’re all going to need life jackets.

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One Response to The Liquidity Trap Part Deux

  1. Pingback: Pour On The Liquid | The Conscience of a Progressive

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