Friday, March 02, 2012

Fed Vs. Banks On Hard Assets Foreshadows Inflation Preparation

There's more than meets the eye in news of banks fighting the Fed to retain their ownership of commodity storage facilities.  Forget the debate over how far the Volcker Rule should go in requiring banks to maintain capital.  That's for the equity side of the balance sheet.  This commodity stuff is about the asset side of the ledger.

Banks know as well as anyone - well, probably better than the average person - that the Fed's dollar debasement policy will eventually push serious inflation into the economy.  Inflation destroys the value of fixed income instruments.  Banks have every reason to be concerned about how badly inflation will hurt the book value of loans they've issued.  Holding hard assets on their balance sheets can ameliorate the effect of inflation on their loan portfolios.  How much it will help will of course vary by institution, but those TBTFs that went hog-wild with home mortgages have the most to lose from inflation.  They know who they are.  BofA's rush to buy Merrill Lynch may be a saving grace if the bank can hold onto whatever hard asset store Mother Merrill is allowed to retain..

The Fed may not have much choice but to accommodate banks' desires to continue holding commodities, even if they are restricted in trading them.  Think of a hard asset hoard as a balance sheet backstop that gives the Fed time to delay further QE.  Keeping this grandfather exemption for bank holding companies will give the Fed room to focus liquidity backstops on banks that didn't do much trading with commodities.  Helicopter Ben needs to think about how he can make the Fed's job less difficult as we approach the next round of the financial crisis.  Think hard, Ben.  Think hard assets.

Full disclosure:  No positions in any company mentioned.