Gary,

What do you think of the OFF BALANCE SHEET GAME being played? Do you think it will work better for the FED then it did for the banks WE are bailing out?

PR

From an post earlier of mine:

It's become a bit of a hobby to marvel about how, in order to respond to the credit crisis, the Fed as well FHLB, Fannie, and Freddie, are doing precisely what got private actors into their messes in the first place.

Sceptics say the devil is in the detail or that the growth of banks’ balance sheets is not a good measure of their riskiness, even though most systemic bank failures have been preceded by excessive growth of bank asset values....Off-balance-sheet liabilities are a logical next step!

If your wondering HOW... the Fed using so called "reverse MBS swaps", could refill their stock of Treasuries by swapping back iffy securities wrapped with a Fed guarantee, would have no direct balance-sheet impact whatsoever, and if repeated would provide the Fed with a potentially infinite supply of Treasury securities to swap. That would however, like we saw with the banks create off-balance-sheet liabilities in order to evade what might be on-balance-sheet limits.

Check out the reading below from the Chicago Fed in 1996, and see what you make of the possiblity that the "Swaps":

Asset Swap Fundamentals
An asset swap relates to the recomposition of a security’s cash flows. Typical structuring may include repackaging an issue paying fixed rates into floating rates (or vice versa) or converting cash flows stated in one currency to another. Asset swaps are undertaken for a number of reasons and can fulfill various goals but, in the final analysis, swaps are undertaken to transform and improve the character of an investor’s assets.

Asset swap transactions are primarily driven by an investor’s need for cash flow profiles not directly attainable in the current marketplace. That lack of availability may stem from a dearth of specific instruments whose characteristics address one’s intended investment objective, or a prohibition from investing in a specific instrument based on preexisting guidelines or mandates. In order to create the desired cash flows, an existing market instrument is combined with an accompanying swap or series of swaps. The resulting synthetic asset portrays the unique characteristics sought by the investor.

Between the potential for more off balance sheet write offs, AND the change in the rules out of the blue this week allowing Banks to be Permitted to Count Goodwill As Capital, a sound case can be made for pro-cyclical capital requirements, that is, lowering the amount of capital that banks must hold relative to assets in bad times and increasing it in good ones. Indeed, well designed pro-cyclical rules lean against the banks' propensity to overdo on lending to the point where they blow themselves up. And the fact is that regulators relax capital requirements (aka regulatory forebearance) when the banking system looks wobbly, so make a virtue out of necessity by making equity requirements more stringent in upturns.

So this regulators cutting banks plenty of latitude at times like this is predictable, and the measure described in the New York Times is no surprise:

With little notice, regulators at four agencies that oversee the nation’s banks and savings associations on Monday and Tuesday proposed a significant change in accounting rules to bolster banks and encourage widespread industry consolidation by making them more attractive to prospective purchasers. The regulators and the Bush administration have decided to resort to further loosening of the accounting rules to try to get the industry through problems that some experts have attributed in large part to years of deregulation.......

The action by the four banking agencies provides more favorable accounting treatment of so-called goodwill, an intangible asset that reflects the difference between the market value and selling price of a bank. The move is similar to a step taken in the midst of the savings-and-loan crisis that helped many institutions in the short run. Over the longer term, that decision increased the overall costs of the bailout after the government took away the goodwill benefits. Under the proposal issued this week, the regulators would permit buyers of banks and thrifts to count some of the goodwill toward meeting their regulatory capital requirements.