I woke up this morning to this report at Investment Research Dynamics:
On December 23, 2015 the Federal Reserve’s Capital Account plunged by 65% – $19 billion – when the Surplus Capital Account dropped by that amount …
The 65% plunge in the Fed’s Total Capital Account, accounted for by the $19.4 billion drop in Surplus Capital, took the Surplus Capital account down to only 25% of Paid-In Capital (Total Capital minus Surplus Capital = Paid-In Capital). This points to a large scale financial crisis that had to be addressed by allowing some of the Fed member banks to withdraw an amount of Surplus Capital well in excess of the amount required by the Fed’s Board of Governors. Perhaps that might explain the Fed’s unscheduled “expedited, closed meeting” that took place on November 23.
Per the Financial Accounting Manual for the Federal Reserve Banks, the primary purpose of Surplus Capital is to provide a buffer against Paid-In Capital in the event of losses. And there’s the rub. Without having the benefit of even a modicum of Fed transparency, I would suggest that the $19 billion removed from the Surplus Capital account at the Fed was used to address collapsing energy-related loans (assets) sitting on the balance sheet of some of the big regional banks. On the assumption that these assets fall within the 10% reserve ratio requirement, it would suggest that some or several regional banks – and possibly one or two of the Too Big To Fail banks – have sustained at least $190 billion in losses in their energy-related loans. Or they are getting ready to take write-downs of that magnitude …
Given that there has never been a drop in the Fed’s Surplus Capital even remotely close to the 65% plunge that occurred the week of December 23, that sudden plunge in Surplus Capital at the Fed is somewhat shocking. But, given the probability that it is being used as an attempt to douse the lit fuse of a massive energy-related financial nuclear bomb in the form of defaulted energy loans and related derivatives, that drop in Fed capital is horrifying.
The BKX bank stock index has dropped 18% since December 23 vs. 7.5% for the S&P 500 in the same time period. While all eyes seem to be fixated on Deutsche Bank’s stock, it would seem to me that we should be focused on the financial meltdown occurring behind the Fed’s “curtain” that is clearly going on in the U.S. banking system based on the sudden plunge both in the credit quality of the Fed’s balance sheet and the recent cliff-dive in bank stocks.
The U.S. financial system is collapsing. This is evidenced by the extreme recent volatility in the S&P 500, as the Fed fights the inevitable stock market collapse, and in the recent run-up in the price of gold and silver. As a final thought to this analysis, I would suggest the possibility that the fraudulent silver price fix on the LBMA last week was a last gasp attempt by the big bullion banks to grab as much physical silver as they can, as cheaply as possible, before the price of gold and silver are reset by the market. How else can you explain the 40% move higher in the HUI gold mining stock index since January 19?
So, in short, the author’s hypothesis for explaining the crunch in the Federal Reserve’s reserves was that the money was needed by contributing banks in order to cover massive losses on their balance sheets – indicating that the US banking system is in dire trouble, recession is coming, time to panic, etc.
Not so fast! A few hours later, the post was updated:
[Note: A reader alerted me to this – LINK – which explains the $19 billion drop in Capital Surplus. Congress passed a law requiring all surplus capital at the Fed in excess of $10 billion to be transferred to the Treasury as part of the Highway Bill passed in early December.
So, this data point, while being consistent with a troubled financial system, was actually caused by something else entirely. Nevertheless, its consistency with the author’s general mind-set – Dave Kranzler has been writing about an impending meltdown in the US financial system for years now – meant that, without additional context, it could be drafted into supporting the hypothesis.
This is a natural human tendency. As Heuer tells us:
New information is assimilated to existing images.
Kranzler saw the data point, it fit with his existing (and, I must say, highly plausible) hypothesis, and he constructed a story around it which was later found to be incorrect.
It happens a lot – so often that it would be unfair to hold out Kranzler’s hypothesising as anything other than an example of a natural phenomenon. For example, I remember once, about five years ago, a data point came out concerning some aspect of China’s financial system. It was sufficiently abnormal to draw comment from across the spectrum of economic and financial talking heads about what might have caused it and what its implications might be. The next day, the ministry responsible for publishing the data point revised it away as an error. All of the earnest hypothesising had been sparked by some numpty making a mistake on her spreadsheet.
Possibly the most famous, and humorous, example of hypothesising from an ambiguous early datapoint is Kent Brockman’s performance in this clip from The Simpsons.
Having noted his mistake in attributing the $19 billion drawdown to problems in the financial system, Kranzler goes on to say:
But does not change the thesis for the banking system underlying the analysis below: the banking system is starting to collapse again from billions in defaulting loans – loans that banks refuse to write down in value, just like they refused to mark down the value of the collapsing mortgage derivatives trusts in 2008 per “The Big Short.” It also calls into question the credibility of a Federal Reserve that is allowed and enabled to operate with just .8% of book capital – $39 billion of total capital against $4.442 trillion in liabilities covered by just $4.482 trillion in “assets.” Finally, it calls into question the legitimacy of a Federal Government that continues to pass legislation for spending programs for which it has an increasingly diminishedability to fund. The analysis below is a snapshot of the collapsing U.S. and financial, economic and political system.]
Here, he is precisely correct. While the datapoint doesn’t support his hypothesis, neither does it disprove it, or any of the other datapoints which support that hypothesis, in any way.