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.
“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?”
Also, the past few years have been the first time the discount rate has been kept above the fed funds rate. Even during Volcker’s supposed tightening campaign, he “left the back door open,” as Rob Landis put it.
Lee-do you consider CFC “too big” to fail by the Feds definition?
Idoc-
I don’t know. But I look at it this way. I suspect that CFC has a lot of bad sheet on its books that may have gotten there because of, shall we say, a “slight bending of the rules.” Would the Fed want to bail out a player that is infused with that smell?
And what would a bailout entail? Certainly not a rescue of the stockholders. Normally a bailout means that the depositors are made whole, the bondholders are left to fight over the carcass, and the stockholders can go pound sand.
Oh, and by the way, I doubt that the Fed has a definition of too big to fail.
The Fed will respond on an ad hoc basis, cobbling together a strategy as events dictate. I think that they are already way behind the curve, and that the curve may be such that the Fed is blind to what may lie ahead and what to do about it.
My main concern right now is just exactly how far this market rally will go. I’ve closed all but 3 of the shorts I had on our Chart Pick list over the past few days, and I want to see which way the wind blows before adding any longs or getting short again. I suspect the process will take a couple of weeks.
Lee:
What are your thoughts about the founder’s $348m?
Actually, I think it was something like $546 million.
I’m looking forward to seeing the perpwalk.
If they can find him. He’s probably already on the beach with his sun reflector in a South Pacific island nation without an extradition treaty.
LOL
I forgot to add – a magnificent analysis as always Lee. Thank you for putting this out for everyone.
You’re welcome CCG. When I can write articles that don’t impinge too much on the rights of subscribers to the exclusive proprietary material that they are paying for, I will do so. They’re paying the bills that enable me to be here, so naturally I will reserve the more detailed analysis, conclusions, and forecasts for them, but I’m looking forward to doing a few more generalized postings here on the free side of the site. It’s a lot of fun doing it, and a lot of fun seeing and responding to the feedback!
Regarding the derivative volume of $415 trillion!!!!(according to Joe) isn’t it a ‘zero sum’ game? How would it impact the market as a whole? (I am no economist)
I guess that’s the $64 trillion question, but definitely not a zero sum game. Somebody is holding the risk, and that’s the grist for a systemic meltdown.
Derivatives (the over the counter kind which is the subject at hand) will be proven to be a zero sum game for many. Those who get zero back from their so called investments in so called hedge funds, and myriad little mountains of assets across all classes.
I suppose there is some academic theory which might prove derivatives in total are a zero sum game, if fraud didn’t permeate the system. Then too it is impossible to actually match up the pluses with the minuses in an orderly manner.
Nobody knows who has what. The record keeping is abysmal. The Fed and the big boys had a few meetings on this over the last year or so. There are not enough accountants in the world to actually figure it out. Look at Fannie and Freddie. Thousand of green eye shade guys have been toiling away there for three years and they still don’t know what the hell the score is.
In a certain way derivatives are the market as a whole or at least such a big part of it that separation is impossible.
From what I can tell, the Fed’s SOMA account (http://www.newyorkfed.org/mark.....dings.html) shows only government securities in it. However, in the trading detail the provide, they seem to show the fed buying mortgage backed securities (see: http://www.newyorkfed.org/mark.....WMORE=TRUE
What exactly is happening?
Paul
Those are repurchase agreements aka repos. They are little more than very short term loans.
I have read that the MBS securities in question are typically backed by either Ginnie Mae or one of the GSEs, although I suppose the Fed can take anything as collateral.
These items show up on the Fed’s balance sheet under “Repurchase Agreements”.
Here’s what the Fed says about Repos:
http://www.newyorkfed.org/abou.....fed04.html
The balance sheet notes that the value of Repurchase Agreements represents:
Cash value of agreements, which are collateralized by U.S. Treasury and federal agency securities
So again, I would assume that the only MBS collateral they are taken are those issued by Fannie, Freddie, and Ginnie. Not that that’s a good thing, just that they don’t “appear” to have lent against any of the crappier subprime and alt A except to the extent that a small portion of Fannie and Freddie MBS are backed by that stuff.
I regret that I will be unable to respond to any more questions or comments this evening. Hopefully others with some knowledge can contribute to the discussion.
Thanks to all for your comments. Have a great evening!
How can fed bail out any bank. They owe 8 trillion to lenders. All they can do is print money and really do a serious damage to the green back.
May be my comment is stupid, can you expalin Lee?
CDs safe? I was shocked when I went to the FDIC website and found that they only had funds amounting to ~1.2% of the nations insured deposits in reserve to come to the rescue with. So if this thing really goes south isn’t it going to take a vote of congress to bail out the FDIC? I suppose that vote might not be too hard to get given it will put Grandma on the streets if they don’t give it. Or am I missing something?
Gbow,
I just went to the FDIC.gov website and could not find the page that shows the funds on hand for insurance. Could you post the appropriate link?
http://www.fdic.gov/about/fina.....stake.html
Letter to Stakeholders. First spreadsheet towards the bottom.
to you dumb ass you who you you think people who want to buy a house want to be in bad position i dont think so. as of myself i wast mislead my this loan agent or loan officer to get a loan that i cannot afford i have limitid english only . i keep singning things that i dont have idea what i’m singing for if its for the benefits for me or not.they dont tell you what’s the pros or cons if you get those exotic loans like interest only,hybrid arms,alt-A jumbo loan or what ever they call it evendo people cannot afford they will find away so you will get that loan but they will not tell you the down side they just want fast commision money. you think alot of minorites who have limited english and they work to the bone they know what they been signing for? so in my situation right now i dont know nothing about real estate market and i’m just learning thing alittle bit if i could get back from the beggining if i iknow i was given aloan that i cannot afford i would should get it. but those con loan or broker agent will find away and do the smooth talking so you would make to beliieve that the loan that they give you is in your best interest. bullshit! if is not crime to kill those pigs loan agent or brokers i would not hesitate to kill them for fooling us now i’m shoot i keep paying ontime to my interest only loan for 2 years and it will reset to the point i cannot afford it. sometimes i ask myself what the point paying my monthly morgage on time when it it gona fail it anyways.
hans, one thing to remember is nobody is holding a gun to anybody’s head.
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Consider if you will commentators, the following:
The more short term rates are cut, the more gold comes into competition with short term treasuries.
It requires leverage to build up a portfolio of currency bets, so those may be restrained in a credit crunch. Some of these currency trading accounts are offering 200x leverage. One wrong bet, and the money is gone.
If you place cash in a currency account, then you are expecting a monthly return of very limited percentages. And if you were to place your money into a medium term bond with the least risk of decline in terms of yield and price fluctuation, then the money is put away for a long time.
So what do you do if you have cash and want to place it in a liquid investment and have to weigh the risks?