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Radio Free Wall Street
Bandaid on a Ruptured Jugular
Let’s talk about the Fed’s expansion of its securities lending program that the market is so excited about this morning. It seems to me that the market does not understand the implications of this action.
We’ll take this one step at a time.
What is the purpose of borrowing securities from your broker? It’s the same for Primary Dealers borrowing Treasuries from the Fed. Why do PDs borrow securities from the Fed? To sell them short.
The Primary Dealers are heavily short Treasuries at all times. They are heavily long all other debt securities simultaneously.The level of securities lending in recent months is unprecedented in all of human history, by an order of magnitude of 10.
Securities lent by Fed to Primary Dealers
Why is that? Because they were heavily short Treasuries and are being subject to the greatest Treasury short squeeze in history. Their only out was to borrow more securities from the Fed and short more into the market as the public clamor and panic for “safe” Treasury securities rose to a mad crescendo.
The Fed is now responding to the pressure of the imminent collapse of the Primary Dealers and major banks worldwide, because not only are the PDs heavily short the stuff that is going up, Treasuries, they are heavily long the stuff that is going down, which is all other debt securities.
This is the worst of all possible worlds and the Fed’s action is like putting a bandaid on a ruptured jugular vein.
Accordingly, I predict that this morning’s massive short squeeze will be reversed in due course, perhaps no more than a few hours.
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68 Responses to Bandaid on a Ruptured Jugular
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“My guess is that the rise in the indices yesterday was worth more than $200 billion in market cap.”
You can’t artificially prop up real asset values indefinetely. Concerning the wealth effect: the real material effect is in housing because:
-it’s the biggest investment most people will ever make;
-it’s highly leveraged;
-emotional attachment to “shelter” is bigger than to a stock portfolio.
-it’s not a “long-term” investment per se (as a retirement fund)if you value “mobility” (e.g. the freedom to move for job or other reasons, without taking a loss)
The macroeconomic impact from housing is far larger than from the stockmarket, becasue housing is more equally distributed than stock holdings (the rich suffer the most).
There’s a natural migration to sites that add value. This is one such site.
Slightly unrelated, it’s going to be interesting what the Treasury budget deficit is when it’s released @ 2:00 est today…thinking back to an earlier post on “crowding out”.
“I agree they’re the dumping ground. FHLB debt carries an EXPLICIT USG guarantee.”
FHLB debt does NOT carry an explicit USG guarantee.
http://www.fhlbboston.com/aboutus/thebank/08_01_04_fhlb_system.jsp
Interesting (new info/insight for me, that is):
“Insured depositors are the wards of FDIC. Before August, FDIC would have had significant priority on the assets of a failed bank, selling off that bank’s assets to pay insured depositors. Unsecured commercial paper holders, bond investors, stockholders, and other creditors could only take what was left. The exodus of debt investors from the funding of mortgage originators like Countrywide and their replacement by FHL Banks at the head of the queue fundamentally changes this order. FDIC now only gets its pickings after the FHL Banks and the additional $200 billion in financing they have provided. This makes it more likely that, in the case of multiple bank failures, FDIC will not get a large enough slice of the pie to pay off insured depositors.”
http://www.mises.org/story/2772
Anybody short treasuries got a punch in the nose today.
But anybody short the buck is smiling
What is still unclear to me is the accounting treatment and the impact to financial statements that will occur as a result of swapping lower valued MBS for treasuries that can be sold for cash. For the BDs who must mark to market (unlike the commercial banks),I guess they avoid writing down whatever amount they are able to exchange in the auction. This serves to enhance earnings (avoid the writedown of the deterioration value or losses) and preserve book values. While this may be pushing out the inevitable, many investors rely & invest on quarterly numbers–this will help the BD participants print better numbers and higher book values than if they did nothing but take further write-downs as far as I can figure. Am I off the mark?
Great job Lou. Thx