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Radio Free Wall Street
Throwing a Bone To A Starving Dog
There sure has been a lot of nonsensical gibberish flying around the financial infomercial media, and in the world of blogs and message boards since Friday. So let’s try to separate fact from fantasy.
We’ll start with something I agree with. I do believe that the Fed’s action had everything to do with Countrywide’s bank arm, the well publicized run by their customers, and the fact that they were forced to borrow apparently all of their $11 billion bank credit facility. This is a dangerous and volatile mix in the arena of the public confidence game that fiat money systems depend on. The Fed had to do “something” to give the world the impression that they were actually “doing” something.
What did they actually do? Not much.
Countrywide Securities Corporation is one of the Fed’s 21 primary dealers. They are a direct participant in the Fed’s daily open market operation repo auctions. If the Fed was going to prop up anyone, this group would be first in line. And given that the vast majority of Countrywide’s assets are residential MBS, clearly they would stand to be the first of the first in this situation. The Fed’s actions on Friday were designed to soothe the fears of the biggest financial actors, the market, and the public in regard to the apparently sudden meltdown of this one particular bad actor.
But the Fed did not lower rates. It didn’t even increase the monetary base. It just put on a show designed to keep the public con going.
Any depositary institution can borrow at the discount window, but it is essentially only an emergency facility for banks that do not have access to the Fed Funds market for whatever reason. The rate at the discount window has been set at a premium of 1% above the Fed Funds rate since the Fed changed the policy on use of the discount window in January 2003. All Friday’s move effectively did was to lower the premium for these emergency loans to problem children by 1/2%. And right now Countrywide is the Fed’s seriously delinquent teenager in big trouble with the law.
So is the Fed’s action as a big deal as the market’s subsequent action and the punditic (yeah, I just made up that word) euphoria would have you believe?
No.
The Fed does not buy securities at the discount window. It makes emergency loans there, and since the rate is at a premium to the market, no one would use the Window if they weren’t in deep squat and were locked out of the Fed Funds market. How much lending is done at that Window? As of Wednesday of last week the total outstanding was $294 million. Not billion, million! Compare this with the total size of the Fed’s asset base of over $800 billion, and you get some idea of how truly insignificant the Fed’s symbolic ploy was.
But the market took the bait, hook, line, and sinker. The flipping and flopping will be something to see when the fish have their oxygen cut off.
I’ve seen a lot of misinformed discussion that the Fed is signaling that it is or will be buying the bad MBS securities. Not only does the Fed not buy bad securities, the Fed does not buy MBS securities. At least they haven’t yet. They hold no such securities in the System Open Market Account. In fact, as this accounting shows, they reduced the SOMA by over a billion in the week ended 8/15, and cut another $6 billion on Friday. In a move that I missed during the week, the Fed took the rare action of not rolling over about a billion of its maturing Treasury notes. They virtually always roll over 100% of the maturing paper they hold in the SOMA. The action of allowing paper to expire unannounced is a stealthy way of cutting the monetary base without anyone noticing. So, while the Fed Funds rate had traded well below the Fed’s target of 5.25% throughout the week, by Friday’s Open
Market Operations they had gotten the rate back to 5.35%.
This is not a sign of a Fed that has eased policy. Maybe that will change next week, but all we have so far is a few skillfully placed words designed to keep the con going. It’s a bit of a chess game. The Fed made its move, and now they will wait to see how the market reacts. If the boyz on Liberty Street and Wall Street are now patting themselves on the back at the moment, I suspect their self congratulations will be short lived, because there really is a liquidity crisis out there. There’s simply too much bad paper not paying the claims against it, and not being worth what the mark to model fairy tale said it was worth.
The market’s recovery was based in part on the expectation that the Fed may buy some of the bad MBS paper and magically transform bad to good. That expectation is likely to be one of those false assumptions that George Soros talked about. He said something to the effect that it is the speculator’s job to recognize the false trend, ride it, and exit before the crowd wakes up. I haven’t done the charts yet this weekend, but I suspect that the trend driven by this false premise may last all of a day and a half. We’ll see.
My guess is that the Fed will allow the worst of the crap credit and the crappy players to disappear from the firmament, but will save its firepower to save the biggest players in the banking system when the time comes. And that time is coming.
I was away from the trading screens Friday afternoon, and I was listening to Gloomboomberg in the car. (I like Gloomboomberg Radio by the way. They tend to do real reportage and be pretty even handed.) One of the pundits (I think McCulley of Pimco) made the point that the real reason for the rally was the Fed’s statement in the morning, because the Fed suddenly woke up and found that the downside risk to the economy had ”increased appreciably,” which was a big change from their more muted statement regarding downside risks at the Fed meeting last week.
Well, Surprise, surprise surprise! Can you imagine that?
Here’s what they said.
Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward. In these circumstances, although recent data suggest that the economy has continued to expand at a moderate pace, the Federal Open Market Committee judges that the downside risks to growth have increased appreciably. The Committee is monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets.”
The players took this as a signal that the Fed will cut the Fed Funds rate imminently and that that is wildly bullish.
It sounds to me that the Fed was saying that the Wall Street Journal’s ”Best Economy in World History” may just be on the verge of collapse. The market’s knee jerk reaction was to judge that as bullish.
We’ll just have to see about that. As to the market’s apparent judgment that this was a policy loosening, the Fed stopped using the discount rate to set policy in 400 BC. Friday’s move was not a policy move. The Fed just cut the premium at Benny’s Pawn and Discount Drive Up Window for Problem Children — a mean, futile, and stupid gesture.
So far in this crisis, the Fed has NOT injected one cent of liquidity into the system except for that two day bulge on Thursday and Friday August 9-10, which they completely removed by Monday and Tuesday 8/13-14. The Fed remains tight in terms of the SOMA, and making matters worse, foreign central banks are dumping Treasuries to raise cash for injection into their own system in order to try and fix the extreme dollar squeeze in European credit markets. Last week they reduced their custodial holdings at the Fed by a record $17 billion. They actually sold $22 billion of Treasuries, but apparently the Asian central banks are still propping the GSE market as they bought $5 billion in Agencies.
We’ll just have to see if the world’s central banks have the firepower to stop a worldwide credit crunch and liquidity squeeze when some major players are essentially insolvent because dey ain’t no assets backing those ASSet backed securities. Rather than taking decisive action, it looks to me like the Fed is frozen in place like a deer staring into the headlights of an 80 mile per hour downhill runaway tractor trailer, while the ECB is fighting its crisis the only way it can, by selling Treasuries and injecting the cash into their system.
The fact is that the Fed remains shockingly tight in terms of the monetary base, which they have maintained at ZERO growth for the past 8 months, and LESS THAN ZERO in the past week when the sheet was hitting the fan. Sure that can all change next week, but you wouldn’t know it from the actions they took on Friday.
At this point, the cut at the discount window looks like nothing more than throwing a bone to a starving dog. Big freaking deal. Watch what they do, not what they say. It seems to me that they either don’t yet have a handle on the magnitude of the crisis, or they think that smoke and mirrors will fool everyone into thinking that happy days are here again and that the credit markets will “unfreeze” as a result. But so far, they haven’t “done” anything.
Finally, put this in your pipe and smoke it. This hasn’t been reported in the media but last week a $9 billion fund of hedge funds made a cash request of $500 million from the institutional money market fund where they hold their idle cash. For the first time ever, this fund of funds didn’t receive the cash immediately. As of Friday they had been waiting two days. They are still waiting, and there has been no word on how long it will take until they get their money. This is a fund that earlier took a $600 million hit on the Amaranth fiasco. And they are still waiting for the $165 million or so that they were supposed to receive from the liquidation.
This is just one fund folks. There are others in similar situations, perhaps hundreds, perhaps thousands of funds.
The run on the bank is only just beginning. Is the Fed’s Friday smoke and mirrors act going to change that?
I doubt it.
Lee Adler is the Editor and Publisher of the Wall Street Examiner and Wall Street Examiner Professional Edition. For daily updates on this ongoing saga get a risk free trial to the Wall Street Examiner Professional Edition Money, Liquidity and Real Estate service.
49 Responses to Throwing a Bone To A Starving Dog
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To accentuate the insolvency point (the real systemic lurking issue here), the issue pops up in this MSM article:
For Joe Mason, an economist and professor of finance at Drexel, the 30-day window is not long enough.
“[Lenders] are going to have to roll that over in 30 days, max,” he said. “The problems will take a lot more than 30 days to work out.”
Mason also cited Bagehot’s rule, a basic banking principle which he explained as the need to distinguish between illiquid and insolvent organizations. “You want to lend to illiquid but not insolvent institutions,” he said. Lending to insolvent institutions just enables them to dig themselves an even deeper hole.
To him, that’s what seems to be happening.
“I would argue that Countrywide is insolvent. Their only asset is their pricing platform, their business algorithm, and that’s not working. The next biggest asset they have is the toner for their copiers.”
so with all of this regarding hedge funds, direvatives, too little fed money, etc. where does all of this leave all of us little people who have some cash and equity in our homes? No one has addressed what the total impact and ramifications will be if the credit markets and the stock markets here and around the world crash.
A wilderness of evangelism before the reality sets in, more like. The beauty of it all is that there isn’t any maudlin reporting in the press, aside from the goldilocks theme.
Nothing less than a keen awareness on the part of central bankers everywhere, that their particular currency may risk collapse. Only give out what’s necessary.
http://tinyurl.com/279err
Its not JUST mortgages, but massive long/short currency bets.
I suspect that everyone will have a lot less equity in their homes, if any, and a lot less cash.
But if you still have family and friends, what difference does that make? Everything is relative, and when times are bad relatives are everything. Stay close to your loved ones. That’s where I find my solace in all this. I just hope that things don’t get as bad as I suspect they might.
As for the excess cash that people have, I hope they have it in a safe place, like T-bills, for now. If under $100,000, FDIC insured accounts in the largest national banking institutions are ok for now.
Lee, why would anyone ever use the discount window at 5.75 when they could just keep turning over Fed repos at 5.25 or less? is it the increased hassle of turning it over every 1-3 days? also, if the banks do use the discount window and are using cdo’s, subprime mbs as collateral that is decreasing in value daily, isn’t the Fed in effect bailing them out?
Why indeed?
In fact, it is hardly ever used as the current balance of a couple hundred million shows.
It’s strictly an emergency facility for bad actors who find the regular fed funds market closed to them.
My point was exactly that, that the Fed isn’t bailing anybody out. Whether they will or not remains to be seen. As I said in the article, my hunch (strictly a hunch) is that they will save their firepower for rescuing only the ones that are too big to fail, the biggest of the big.
I’m a mortgage consultant and have recently begun advising my clients with large equity reserves to consider harvesting that equity while it still exists. Assuming all other variables are in line (cash flow to support higher debt liability, etc.)is this sound advice?
I’m the wrong guy to ask what to recommend to homeowners. I sold my home in Florida in June 2005 and built a home in central Quebec for all cash. We just rent in Florida now.
Harvesting equity? Sounds like “increasing debt.” How is that a good thing if the value of the collateral is declining? The poor bastard still has to pay it back. Where’s he going to invest the cash to make the kind of return he’d need to cover the increased debt service? He’s better off if he does nothing. Get the mortgage paid off as fast as he can, and start saving money. That’s my view.
In your current position, you have a conflict of interest. You’re still trying to make a living, but the best advice is either to sell now if you are willing, or if you love your home, to stay put and keep making the payments. While your house is getting cheaper, so are all the others. So you’re not really losing anything. If I could sell, invest the proceeds for income, and rent something nice, that’s what I would do.
If I were an honest mortgage broker, I’d probably quit my job and get trained as an appraiser. There’s going to be a mountain of foreclosure related appraisal work for years.
Hey, come to think of it, that’s EXACTLY what I DID in the late 80s.
Well not quite. As the mortgage market was collapsing in the fall of 87, they canned my ass. I was in the 3rd or 4th round of layoffs that began in May 87.
Best thing that ever happened to me. It was a relief to get out and go in a completely different direction. Some of the guys I worked with at GMAC Mortgage either went to jail or ended up in a very bad place because of problems with cocaine and alcohol. Definitely not my style.
I think Ben wants the market to fall and rid of the excesses too.
But he wants orderly selling.
Hence his move to slaughter the shorts on option expiries Friday to make a move. He wants selling to be done by long unwinding and not shorts add to position.
A number of the guys on the message boards at Capitalstool.com had a similar opinion. They have a very good thread going there this weekend by the way.
Thanks for your reply. I guess my point was that with money still relatively cheap in the conforming market, and with people depending on home equity to fund stuff like college, etc., it might make sense to convert that equity to cash now rather than later when the equity may have dried up, or the cost of accessing it becomes to high. BTW, excellent blog.
I remember my father telling that after the bank holiday (I think it was in 1929) he was given $10 for his $100 he had in the bank. So if this happens now, then Lee is probably right in that everything will adjust in the same manner including debt.
Increasing debt to capture cash will put pressure on the homeowner. And putting the cash in t-bills can be risky as well. If international sellers come in, the market value of debt instruments will fall – it is an absolute indirect relationship. And that has already happened. What if China sells their debt investments, which is 1/3 of the US debt? Market value of the debt instruments will go down.
I believe that being in cash and maintaining or reducing home mortgage debt is the answer. I liken it to the pioneers going West. When adversity struck they “farm-a-circle” the wagons. They protected their backsides, stuck together, pooled their resources, if you will, and fought the adversity together.
I believe that most of this financial turmoil will most likely affect the big gamblers of the world and probably will have minor impact on most of us.
While longer term Treasuries will be adversely affected pricewise by rising yields, that doesn’t apply to T-bills. You buy the 13 or 6 month week bill at a discount commensurate to the interest rate, and receive par (face value) at maturity.
I see that as the least risky alternative at this time, although rates have been driven through the floor last week. I suspect that they will rise again in the not to distant future. If so, that would be a good thing for those with cash to invest. If not, well, at least your capital isn’t at risk.
It isn’t just the subprime or non-conventional mortgage market, which, by the way, isn’t totally investor and lender mistakes. Three other issues need to be recognized. 1) To what degree I do not know, but mortgage brokers and loan originators were submitting fraugilent documentation to the lenders. 2) Mortgage brokers and loan originators were stating income way over reasonable income and underwriters were either not catching it or overlooking it. 3) The borrowers themselves knew for the most part knew they were sticking their necks out on a limb. So they are responsible as well.
And the same thought process applies to the derivatives. $415 trillion!!!! You got to be kidding!! Who’s kidding who here? And in an unregulated market? Gambling has moved from Las Vegas to Wall Street and now to derivatives! And a lot of it has to be borrowed money. Talk about a tsunami.
Joe-
The bank holiday was in 1933. I sure hope things never ever get that bad. Right now, if I were drawing an analogy to the 1929-33 period, I’d say that we were in August 1929, after the initial selloff in the stock market but before the crash.
Can the Fed and the world’s central banks pull the right strings to avert another crash? I just don’t know. Perhaps they can at least cushion against the worst aspects of a violent credit contraction. We’ll just have to see.
Joe- With regard to your second comment, I had a couple of observations that I posted on the Capitalstool.com message boards in this post and the following one.
I do agree with the concept of short term debt instruments. Note that cd’s and money markets are safter and the yield really isn’t that much less given the risk we may be facing in the very immediate future.
One of the principles of investing that I learned a long time ago as a stockbroker was this: He who loses the least wins! So there may be opportunity loses being in cash. However, I sleep very well at night being in cash. I liquidated all equity investments 3 weeks ago when the market was 13,900 and went immediately to cash. There is too much uncertainty out there. I will be the first to tell anyone I don’t know the answers. I do know that protecting what I have is an action I know and can take.
By the way I did the same thing 4 weeks before the 1987 correction and the .com correction.
So how much time do you give Countrywide before it goes bankrupt?
Not to preach to the choir, but it will be a while before the dust settles just as you stated with regard to 1929 and 1933. Believe me, I am probably one of the most optimistic people there is. But this doesn’t feel good and doesn’t look good. There are too many variables for me to not be in cash for a while.
J P Morgan saved the banking world then. I hope that there are the “powers that be” who will respond to our financial issues to day as Mr. Morgan so unselfishly did then.
Pete:
Good question. Note that the 11.5 billion with 40 banks has tapped them out. Note that the real estate market is down. Note that builders are not selling new construction and that new permits are way down. Note that the founder of Countrywide systematically liquidated $348 million of Countrywide stock over the past 13 months. Hmmmm!
I suspect that if Countrywide goes into bankruptcy, he could buy it back for pennies on the dollar.