A new report from the Federal Reserve has confirmed the non-borrowed reserves of U.S. banks plummeted to a negative $18 billion at a recent accounting, reflecting an apparently worsening situation from the negative $8.8 billion reported at the end of January.

The numbers appeared particularly alarming in that the Fed, going back to1959, never before had reported that the non-borrowed reserves of depository institutions had been in the red.

But experts said the assumption bank assets had deteriorated so badly that financial institutions would be bankrupt if the Fed did not provide billions in liquidity to prop up bank balance sheets is alarmist.

Econometrician John Williams, in his subscription newsletter ShadowStats.com, said the negative numbers are a result of how the Fed has chosen to account for lending at a new Federal Reserve discount window, identified as the term auction facility, or TAF.

Technically, a close examination of the Fed data reveals TAF borrowing hit $60 billion in the two-week period ending Feb 13, while required bank reserves were $40 billon, a large part of the explanation why non-borrowed bank reserves were recorded as a negative $18 billion.

In other words, banks still have $40 billion in required reserves, an amount that has remained stable since the beginning of 2007.

Still, Williams reports the appearance of the negative numbers in this report, while not a cause of alarm, should be a cause of concern.

“That lending dwarfs total reserves suggests the banking system remains unstable in its still-unfolding solvency/liquidity crisis,” Williams wrote.

If the crisis in bank assets and reserves was over, Williams argues, TAF lending would be at zero, not exploding at the current rate of some $20 billion per month, and banks again would be willing to lend to each other in the overnight markets, the normal method banks used to adjust reserve requirement shortfalls.

As long as the Fed remains willing to provide an almost unlimited amount of liquidity to its TAF auction facility, banks should be able to continue meeting reserve requirements, even if the amount of borrowing from the Fed is at levels previously not experienced.

In a technical note, reported by the Wall Street Journal, the Fed attempted to dispel concern as a “false alarm” by arguing, “The negative level of non-borrowed reserves is an arithmetic result of the fact that TAF borrowings are larger than total reserves.”

Put simply, the concern among financial experts is the continuing crisis in mortgage assets, reflected in banks having to discount the value of Collateralized Mortgage Obligations in their asset portfolios.

Collateralized Mortgage Obligations, or CMOs, are securities put together when Wall Street firms package mortgage loans sold by originating financial institutions, features which then are sold back to the financial institutions.

As defaults and foreclosures have grown in the mortgage market, these losses have to be reflected in the CMOs which bundled the mortgage loans together.

Then, as financial institutions bring the CMOs to market and find their value has decreased, these losses must be reflected in the banks writing off the CMO losses, in turn reducing the estimated market value of their assets by the amount of CMO losses written-off.

Testifying before the Senate Committee on Banking, Housing, and Urban Affairs on Feb. 14, Federal Reserve Chairman Ben S. Bernanke acknowledged his continuing concern about the adequacy of bank assets.

He noted some banks have responded to recent losses in their asset portfolios by raising additional capital.

“Notwithstanding these positive factors,” Bernanke said, “the unexpected losses and the increased pressure on their balance sheets have prompted banks to become protective of their liquidity and balance sheet capacity and, thus, to become less willing to provide funding to other market participants, including other banks.”

Bernanke also noted banks were becoming more restrictive in lending to businesses and households, a factor Bernanke saw as contributing to a worsening outlook for the economy in recent months.

Media wishing to interview the author of this article, please e-mail Tim Bueler.


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