I Found the Money

Early this year I was blessed with a minor miracle when a salesman from Ladenburg, Thalmann offered to give me free trial access to research by Dick Bove, a best-in-class banking sector analyst who has given me a fascinating perspective on the financial panic. Bove was right in sending warning signals to his clients early on, but too early to move to a buy rating on his companies. But his prolific commentary has been very useful in helping me understand how the crisis unfolded.

Yesterday, just after I’d hit “send” on my blog post, Bove’s latest research commentary provided a vivid demonstration of just how much liquidity has been injected into the economic system, and that it still sits on the sidelines, ready to finance a recovery if only the bankers would do their job.

Banks are required to keep a portion of their deposits on reserve at the Federal Reserve. Though they traditionally do not receive interest on these moneys, just recently the Fed started paying interest as a way to enhance the banks’ earnings power to help them get out of the current crisis. Since these reserve deposits have not traditionally earned interest, banks have historically kept these deposits at the minimum required level.

In the past few months, with investors fleeing the stock and bond market, Certificate of Deposit sales soaring, and the industry receiving billions from the government, the banks have received hundreds of billions of dollars which would normally flow back into the real economy through the banks’ lending and investment function. Instead, banks have been taking these billions and placing them back into the Federal Reserve where they sit as reserve deposits, earning interest. These deposits have stabilized the banking system, but leave the rest of the economy without sufficient capital to continue operating.

Bove noted that net “free reserves” had grown from roughly $40 billion in August of this year to well over $400 billion more in early November, and to more than $600 billion by the time of this blog post. It is an unprecedented build up in potential monetary stimulus.

Yesterday’s blog entry asked bankers to “show us the money!” and start lending again. Well, with Bove’s help yesterday, I found the money. It is sitting on the sidelines while bankers re-arrange deck chairs on the Titanic. If they would stop laying people off long enough to make a few loans to customers who desperately need liquidity, it would sure help their customers and the nation’s taxpayers who just voted to give them a $700 billion Christmas gift. Even if they just invested the money in corporate bonds, the capital markets would receive an enormous boost.

There is plenty of firepower to get this economic situation turned around. If I can see it, sitting in the middle of flyover country, you can be certain that Bernanke has noticed it as well. I’m hoping that the Fed stops paying interest on reserves. If the bankers still don’t start doing their job, then the Fed might as well expand its commercial paper program and start stealing the bank’s best customers right out from under them. Once the liquidity starts flowing, investors will start taking advantage of the enormous bargains that have developed amidst the panic.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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