Friday, August 19, 2011

Are Savings Pools really looking to dis-intermediate themselves from investment?

Here's a paper by Zoltan Poszar I found of interest because it puts the recent financial crisis in a new light. Specifically, it explains why institutional cash pools are not invested directly in deposits of traditional banks but in deposit alternatives. By implication, many cash pools seek to dis-intermediate themselves from the savings to investment transformation process by opting out of the banking system. The reason is to ensure principal safety beyond what the FDIC deposit guarantee covers. The paper argues that not all savings are actually looking for a real investment outlet, but are only looking for placements that could function both as source of quick liquidity and as collateral.

Of course, these pools still ended up funding some risky investments, as they ended up with the shadow banking system. The paper argues it was because there weren't enough safe government securities. Zoltan focuses on the US financial system, which by virtue of its having the global reserve currency, suffers from the Trifflin Dilemma.

Zoltan suggests issuing more government securities so that 'AAA' structured bonds securitized by shadow banks do not have to fill the deficit supply of 'safe' assets demanded by asset pools. My take on their conclusion is either the US government must borrow more, people must save less, AAA companies must issue more commercial paper.... or people have to consider the possibility of losing some principal when they save, because if none of the first 3 musts happen, shadow banks will come back to fill the void left by the market.

With the government in austerity mode, a large demographic saving up for retirement, big companies awash in cash while small businesses are losing their customers, the chances of structured products making a comeback looks high.


Mario said...


Why not take off the cap on FDIC first of all?

Then join the Fed and Treasury balance sheets so no more PD's are needed.

Then set rates to zero.

And then the Treasury can literally just issue bonds at various maturities as demanded. There wouldn't be any more auctions just like there's no auctions for a savings account at your bank. You could literally go onto the Treasury website and buy yourself a bond at the going rate.

You could still have a bond market too on the exchanges, etc. Nothing would change except rates would be lower likely as they would be set by the zero ffr rate and there wouldn't be anymore PD's.

What do you think?

Rogue Economist said...

Mario, I'm not there yet on taking off the cap on FDIC. I think this will increase moral hazard among banks. At the very least, people would put their deposits on just any bank that promises the highest rates, just because they know all their money is guaranteed by the government. Although I'm not sure how the dynamics would change if rates are permanently at zero.

Mario said...

interesting point Rogue. You might be right there. I never thought of that. Interesting.