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September 12, 2008

PLIF!! Just an Everyday Emergency
by Adrian Ash

"...Can you say Permanent Liquidity Insurance Facility without crying, yawning or laughing like a drain...?"

So U.S. Treasury Secretary HANK PAULSON - if the source gabbing to Reuters this week wasn't fibbing - remains "adamant" that he won't help fund the fire-sale of Lehman Bros.

Maybe he's just keeping tax-payers' safe cash in reserve, ready for the next meltdown on Wall Street. Perhaps the fourth-largest US bank is small enough to fail.

Or maybe he's genuinely trying to avoid an inflationary collapse in the Dollar, capping his big bail-out splurge with Fannie & Freddie and drawing a line in the sawdust. Last week's rescue should be enough for anyone, surely...not least on top of the $28 billion still outstanding on the Federal Reserve's balance-sheet from Bear Stearns' sale to J.P.Morgan in mid-March.

Oh, and the extra $25 billion of Treasury bonds the Fed auctioned off in exchange for "less liquid" assets on Monday. And the $25bn auctioned on Tuesday for more of the same.

Monday's auction was through the Federal Reserve's Term Securities Lending Facility (TSLF); Tuesday's was part of the Term Auction Facility (TAF). Or maybe it was the other way round. Whatever the official name, the New York Fed lent another $25bn on Wednesday in its Term Options Program (TOP).

Maybe this auction was the TSLF...or perhaps the TAF...or maybe it was just the same $25bn lent out three times. (That's how Fractional Reserve Banking works, after all.) Either way, we're getting a headache here at BullionVault just trying to count the zeroes, let alone keep track of the total.

So at the end of a miserable week for anyone hoping to call the bottom in Gold, Euros, crude oil, stocks, investment-bank bonds, housing and pretty much everything - and just before we fire up the Friday-night cocktail shaker - we'll opt to change the subject instead. A little.

"Borrowing from the Fed's discount window hit record levels in six of the past eight weeks, and reached $23.5 billion as of Sept. 10," reports Bloomberg, citing Fed data.

"By comparison, lending averaged just $779 million a week in the three months after New York Fed President Timothy Geithner urged banks to use the program [last summer]."

A few billion here, a couple-of-trillion there...who's counting? But "there comes a point where you take over the market," as European Central Bank (ECB) executive Nout Wellink said to Het Financieele Dagblad in Holland last week.

"If we see banks become very dependent on central banks [and their liquidity loans], then we need to stimulate them to tap into other financing sources."

The ECB should know. It has become pretty much the entire Spanish mortgage market since the start of this year. By the end of August it had lent €467 billion to commercial banks inside the Eurozone, "beating the €389bn it provided in mid-December to ease banks through the end of the year," reports Mark Gilbert at Bloomberg.

Across the Channel in London, the Bank of England's own "Special Liquidity Scheme" now holds £200bn of "less liquid assets" (around $350bn at face value) in return for lending out government bonds. Or so reckons UBS data-wonk Alastair Ryan. The Old Lady - just like the Fed - would rather keep the numbers all to herself.

But if the UBS guess-timate is correct, it now totals "four times more than the central bank envisaged in April" when it launched the program. And all this while, the deadline for shutting this scheme is now fast-approaching.

The Old Lady's "Special Liquidity" offering will close to new business on 21st October. Given the clear and growing demand, however, for these gilt-edged loans from commercial-bank borrowers, Mervyn King - the much-maligned if well-intentioned governor of the Bank of England - doesn't want to suddenly cut them off without a penny. That's why Dr.King - a chum of Ben Bernanke's from MIT in the '80s - told a parliamentary committee this week he'll replace his "special liquidity scheme" with a "permanent liquidity insurance facility".

You'll note the absurd acronym; surely "PLIF" can never be uttered without an exclamation mark.

You'll also spot the down-grading of crisis status, now "code orange" rather than "red". Post-October, the UK banking system will require common-or-garden everyday aid, rather than "special" emergency help. And two further points stand out, reckons Andrew Hill, writing the Lombard column in the Financial Times:

"First, as the governor said [to Parliament], the Plif is not a source of long-term funding. Second, like any claim on insurance, a proposal to use the Plif will not get automatic approval. Expect Mr King’s claims handlers and loss adjusters to take a close look at any requests for help.

"This approach looks tough, but also correct: if a householder wants to rebuild after a storm, he claims on his insurance; if he wants money to develop his property for the future, he should apply for a loan."

Tough-talking Mervyn, however, is still likely to play both insurer and lender, we guess...a little like the Japanese Post Office - the world's very largest banking & insurance group - but without the $3 trillion in assets. Oh, and with commercial banks playing the role of client, rather than servicing the hard-working Watanabe family in Japan - who this summer helped squirrel away a record excess of cash-savings over outstanding loans.

"As of July 31, ¥549 trillion sits in deposit accounts at Japanese banks," reports Ken Worsley at the invaluable Japan Economy News, "while ¥403.8 trillion is on the loan books. Back in 2000, the gap between deposits and loans stood at about ¥20 trillion."

Contrast that glut of cash-on-deposit over bank loans with the UK's position. Private banks here in Blighty have lent out £750 billion more than they've got on deposit from private business and savers - near enough equal to $1.3 trillion of missing money.

Even if you account for the £78 billion-worth of notes, coins and bank reserves sitting in purses, wallets and down the back of the sofa at the Bank of England, UK Plc still owes itself a lot more Sterling than now exists.

Our US readers will be very pleased to know that this situation doesn't apply in the United States. Well, not quite in the same Grand-Canyon-gaping-chasm kind of way - not when you consider that the US population outweighs the UK's five times over.

Commercial banks in the US hold an excess of only $1.2 trillion in "assets" compared to "liabilities" - meaning loans over deposits.

Even tough-lovin' Hank Paulson can help fill that gap - and make the banks whole - without sparking an inflationary dive in the value of dollars.

No...? But he's got Ben "Helicopter" Bernanke on hand to assist! That makes plugging the gap between bank "assets" and "liabilities" a cinch, don't you think?

Adrian Ash
BullionVault.com

Head of research at BullionVault.com, the fastest growing gold bullion service online, Adrian Ash is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.

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