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February 05, 2008

Fed Release: Banks Insolvent

Posted in: Monetary Policy, The Evidence

If you’ve listened to the darker ruminations on the cable news channels recently, you’ve probably heard someone say something to the effect that “the current crisis is the biggest systemic risk since the Great Depression”. I’m a high volume viewer of cable news, and I know I’ve heard just such language more than a dozen times in the last week. Given the idiosyncrasy of cable news, you might be wondering if this isn’t just today’s prevailing hyperbole to make sure you wait through the next commercial break to see what it’s all about. In this particular case, you might want to hold off on that grain of salt.

According to the recently released Aggregate Reserves of Depository Institutions and the Monetary Base, there is trouble brewing in the financial system. More specifically, it appears that our banking system, taken in the aggregate, is in fact insolvent. Get the PDF version of the report on our server here.

While I am by no means an expert at reading the Fed’s various releases, I am also not a neophyte. I’m pretty good with all things financial – good enough to know that the information contained within the report belies the conventional wisdom that the ‘nimbleness’ of the Fed has helped us avert the worst case scenario. From my reading, nothing could be further from the truth.


For purposes of this discussion, I’ll be focusing on a very narrow part of the release, specifically the first page of the report, and on that page, the first four data columns. This is the part of the data that details the reserve requirements of the banks and the actual reserves on hand. It is here that the problem becomes apparent, and amazingly, the first indications of a problem (in the data set in question) really only surfaced in December.

We’ll look at January of 2007 as an illustration of how to understand the numbers:

Jan 2007

Total Reserves – 42.171
Required Reserves – 40.665
Non-Borrowed – 41.960

(all totals in $ Billion)

So in the January 2007 period, the aggregate member banks were required to have 40.665 billion in reserve, but actually had 42.171 billion in cash reserves, an excess of 1.506 billion over the requirement. Of the cash reserves on hand, 211 million was borrowed funds, an insignificant total as the reserves were covered without the borrowed funds.

The story is similar throughout most of 2007, with borrowed funds creeping toward 2 billion in a few months; without exception, the non-borrowed funds were enough to cover the reserve requirements. Without exception, that is, until we reach December.

In December the picture changed radically:

Dec 2007

Total Reserves – 42.585
Required Reserves – 40.837
Non-Borrowed – 27.154

(all totals in $ Billion)

For the first time in the period covered by the report (and likely in many, many moons), the non-borrowed funds were insufficient to cover the reserve requirements, falling short by more than 12 billion. Also significantly, the Fed extended term auction credit of more than 11 billion in the period – and banks having to borrow to meet the minimal reserve requirements is anything but a picture of health.

sick dollar

Of course, the December numbers came before the Fed loosened it’s policies in earnest, so the more optimistic among us might expect to see an improvement in bank performance in January, as the Fed’s ‘nimble’ response to the burgeoning economic crisis work their way into the broader credit markets.

Such optimism would not be warranted. In the bi-weekly summary released for the two-week period ending January 2, the amount of non-borrowed funds fell to 8.7 billion, and two weeks later (Jan 16) to just 198 million. In the most recent summary ending January, the non-borrowed portion is a negative number, meaning that all of the reserve requirements are borrowed, with an additional 8.7 billion borrowed to cover continuing operational needs. In other words, they are – in the aggregate – insolvent.


In spite of my profound disdain for the concept of central banking, I’ll hold off on an ideological diatribe for the moment. The situation is incredibly tenuous, and I have every reason to believe that the situation will continue to deteriorate. This is not a philosophical exercise; it is tragically real. And those guys on the cable news shows suggesting that this is the biggest financial crisis since the Great Depression? They just might be wrong – this one has the breadth and depth to dwarf the Great Depression.

pray for ben

If you’re inclined to pray, maybe you’ll want to remember Ben Bernanke in your prayers tonight. In spite of my objections to the fundamental premise for a central bank, they’ll have to navigate us through this crisis in the short run. The only question I’d ask is this – when this thing finally comes to a head, will we just sweep the mess under the rug and repeat the process, or will we start to ask ourselves if a system based on sound money wouldn’t be a better solution? We need a better solution.

Governments are not equipped to rationally control a fiat currency, and bankers will always manipulate it for the purposes of the financial sector of the economy. I don’t suspect we’ll see an end to the Fed or a return to non-fiat currency anytime soon. Sound money is only good for the average working (and saving) man, and we all know how easy it is to get people to vote against their interests. We have a central bank, don’t we?

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