Thursday, June 19, 2008

Criticizing the central banks balance sheet is easy

but what else is there as lender of last resort.

Grant wrote a brilliant piece, Walter Bagehot Was Wrong, if it only would not be spiked with flaws and political resentment. By reading between the lines I would say he was right with one (not mentioned) observation: It was Trichet who saved the world from financial Armageddon, by early recognizing not to apply the sledge hammer and slash IRs but rather complying with the ECB's role as the lender of last resort. Bernanke only recognized this in the last minute after he had already done damage with interest rates.

To Grant's point:
"A measure of the difficulty of that work is the huge volume of lending that the Bank of England and the ECB, especially, have chosen to undertake; over the past 12 months, the balance sheets of the ECB and the Bank of England have grown by 21% and 19.4%, respectively. (In comparison, the Fed is a model of restraint.)"

This is simply a misleading statement because what matters is not the size of the balance sheet but the quality of assets and liabilities. By comparing the different balance sheets I am assuming that the 21% and 19.4% reflect the amount of ABS paper, for the ECB and the BoE respectively. In its latest Flow of Funds statement (release Z1 from June 2008) the Fed lists under assets $156 billion in bank loans n.e.c (not elsewhere classified, which is another way of saying that these are illiquid assets possibly MBS), for the first time ever on its balance sheet. The size of the Fed's balance sheet is about $900 billion. The $156 billion mark is 17% of the total. This is somewhat lower but don't forget the Fed came late to the action as lender of last resort. In the meantime they have loaned out plenty of government paper in exchange for ABS paper.

We all would prefer Hankey on the helm of all central banks but then we also would need Mellon and Hoover to purge the rottenness out of the system, and we know too well how this game ended.

source: Walter Bagehot Was Wrong
By JAMES GRANT, Grant's Financial Publishing Inc.

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