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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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I’m seeing double bottoms in all of the charts. I predict fresh all-time highs in equity prices by July 4th. I see a relentless grind higher and the vix dropping to 14 or so.
Shorts will not be able to ride out this move higher. It’s cover now or be crushed.
The Fed is engaged in the Japan syndrome. Keep moving a large block of toxic waste forward in time. Best case, think Japan circa 1988.
The Fed has poured hundreds of billions into the markets over the past few months. There are trillions sitting in short term cash equivalents earning a negative yield.
The pendulum has swung way too far towards fear. I now see the Sheeple chasing the market much higher and getting out of safety. This will last much longer than most think.
The lows are in for at least the next 6 months. I see a massive move higher in equity prices and a big drop in volatility.
Bears who have overstayed their welcome will be smoked.
Peter- Good point. I had pointed out in some past discussions over on Capitalstool.com that I thought the US was engaging in exactly the same policies it had told the Japanese were bad! bad! bad! 20 years ago.
What hypocrisy. Now that the shoe is on the other foot…. The whole thing is sickening.
The Fed definitely reads the stock charts. They have made major policy changes before when the market was at major support levels. There is no way that is by accident.
From the interfluidity link:
“From a cash-strapped firm’s perspective, borrowing a treasury, then borrowing cash against that Treasury in ordinary repo markets, is equivalent to borrowing cash directly from the Fed, except that there’ll be an extra middleman to pay.”
That statement makes sense to me,
except I think Lee is correct to point out the difference from a coupon pass, in that the cash is pulled away from a less-troubled bank when the repo is completed between the troubled and less-troubled bank.
Contrast this with a coupon pass, where no such cash is pulled out of the system. Thus this action is not multiplicative to money supply like a coupon pass is multiplicative.
Am I on the right track here?
Jesse looks incorrect to me because of this difference.
Jesse, please address this pull of cash, as I described.
I think Lee is correct. It shifts risk between banks as the Fed is the middleman, without adding to money supply.
When you exchange a pile of garbage mortgage paper for treasury securities, it’s like trading a turd for a gold coin.
Jesse should just ‘show his work’-in detail.
If we could answer this question it would help, I think.
#47 I think says,
yes, it is different than a coupon pass. It is not multiplicative. But it does let the turd holder carry on new, less incumberred, business and thus it is less money deflationary than being incumberred by a turd.
“There is no way that is by accident.”
Agree, not a chance. They have excellent market technicians on hand for ALL markets and know precisely when to apply the goose.
It’s remarkable any MBS holds a AAA rating. According to a paper by Greenlaw, Hatzius, Kashyap, and Shin, 80% of subprime mortgages initiated between 2004-2006 went into AAA pools. And of all mortgages written in these years, about 28% were subprime. Where’s the AAA?
Lee,
great post. I agree.
This MBS/Treasuries swap is only a delaying action until the banks can be re-liquefied from the difference between the fed rate and their offered loan rate. There is no chance that the Fed will eat these bad MBS
#52
To make FED’s life easier, from now on there will be no more downgrades and any credit watch will be cancelled.
Who is going to rate triple A? These guys?
http://www.bloomberg.com/apps/news?pid=20601109&sid=areM7a9s02ko&refer=home
“The fact that they’ve kept those ratings where they are is laughable,” said Kyle Bass, chief executive officer of Hayman Capital Partners, a Dallas-based hedge fund that made $500 million last year betting lower-rated subprime-mortgage bonds would decline in value. “Downgrades of AAA and AA bonds are imminent, and they’re going to be significant.”
I am a stock investor, not an expert like the rest of you, so take these comments with that in mind.
I think the Fed was concerned about a financial meltdown, that, if it got out of hand, would have been perhaps unstoppable, even by the Fed. When major margin calls began last week, they set off a negative feedback loop–forced sales, lower collateral value, more margin calls, etc. Great quality paper–such as TMA’s based on borrowers with avg FICO scores of 744, avg loan size of about a million, and average LTV of 67%, and loss ratio of under 0.1%–were being quoted at 75-85% of par (with Bill Gross apparently a very happy buyer at those levels).
However, it was obvious that forced sales at that level would bankrupt most of the companies in this space that were leveraged 5-fold or more–which was (and is) a lot of them.
So the Fed basically said, we’ll make a “normal” market in these securities–agency paper as well as AAA-rated non-agency paper. In essence, the Fed was saying, “we’ll step in so that these securities can be sold at the same reasonable “market” levels that this paper was selling for before the margin calls began.”
I think the Fed will roll over the debt at 28 days in most cases, but may not in all. Will the Fed be left holding the bag on some of the collateral? Sure. But just like the RTC was initially stuck with $300 billion (in late 1980 dollars!) of supposedly bad debt, spread out over several years, the hickey was relatively easily absorbed by the financial system.
Is the hickey that the Fed/federal govt going to get as result of this move going to be as serious as the hickey could have been if the Fed had NOT stepped in? I highly doubt it.
Does the Fed know how it will handle all things going forward? Heck no. It’s never had to deal with this scenario, and it will work out the rules as it goes along.
Will the Fed rescue all the paper? No. Unlike many reports I have read, I do not believe the Fed will take “crap” and lend 100% on it. It may lend something, or nothing at all, on the “crap”–we’ll get more clarity as the rules evolve. For both political and economic reasons, the Fed will let fail those that should, as best as it can identify them (sure, mistakes will be made).
That’s my simple-minded two cents worth from a layperson investor.
Jack Yetiv
The Fed has turned itself into some sort of market maker of last resort, but only to a limited part of the market, I guess. The added liquidity will mute the marked-to market losses (less forced selling), but bad stuff in the end will be bad stuff. The Fed is limited in so far that it has no direct link to the highly leveraged, unregulated hedgefunds, who have no access to a lender-of last resort, no reserve requirements. Makes you wonder what’s going on below the radar.
Kris B, Jack and Jay-
All excellent, thoughtful posts. Jack, You may not think of yourself as an expert, but from reading your post, I certainly think that you are!
I want to thank everyone who visited and contributed their thoughts. This is a discussion I am proud to be associated with!
I also want to thank those of you who subscribed to the Professional Edition. Your support is greatly appreciated! I look forward to earning your continued support, trust, and confidence in the difficult days ahead that we all face.
Regards to all!
Lee
“What’s going on below the radar”…
1. Ben is making sure his future employer on Wall St. has big bonus bucks to pay.
2. The Fed under Ben is making Alan’s Fed look like a junior varsity team.
3. The U.S. is becoming a cross between the old Prussia war machine and a banana republic.
4. Social security payments to the baby boomers will buy a great deal less.
5. Eventually the USD will no longer be the reserve currency of the world just as the British pound suffered the same fate.
6. Ben wants to go down in history and he will do whatever it takes to make his mark, middle class be damned.
Boat- The only thing I would disagree with is point 2. Bernanke is only trying his pitiful best to clean up the mess that Greenspan made. I lay the blame for this situation entirely on Greenspan. Not that Bernanke has handled things all the brilliantly, but I do see him as trying to make the best of the irreconcilable mess that he was handed.
At the heart of things, this is about insolvency, and the only way to cure that is to let ‘em fail. The Fed’s problem is that it is charged with the ultimate responsibility of preventing the collapse of the banking system, and the idea of “letting ‘em fail” kind of runs counter to its charter. Ultimately they must let some fail and keep others alive. That’s what I think it will come down to, but they are not at that point yet. They still think they can save the system by buying time.
We all know that that is not going to work. There’s no question that US taxpayers are going to be told to bend over and take it.
Hell, we already are.
But Greenspan made the mess.
To Lee:
There is no question the taxpayers are “gonna take it.” I think the purpose of Bernanke’s gambit was to try to lower the eventual amount that we all “have to take.”
I, for one, think that this intervention WILL lower the amount we’re gonna have to take. Will it lower it from the trillion it would have been to the $100 billion it will be (I am making these numbers up!)? Who knows.
But as “inappropriate” as it may be, it’s good also to keep in mind that if stock indexes are kept more stable (eg, backstopped at 11,500 rather than the 10,500 they might have reached), THAT may “refund” us taxpapers, at least collectively, if not individually, some of what we’ll all have to pay. This was probably also taken into account (yes, I know the Fed is not supposed to take this into account) when the Fed was calculating its own “return” on its 200 billion “investment.”
And the reason the stock market is important from a macroeconomic perspective is that instead of being just the “result” of a recession, it can also “cause” one, or cause one to be deeper or longer if people stop spending because they feel poorer.
Whatever we say about the longterm effectiveness of the Fed’s intervention, I think we can all agree that if backstopping the recent slide was an objective for the macroeconomic reasons I stated, it succeeded (perhaps too much).
My guess is that the rise in the indices yesterday was worth more than $200 billion in market cap.
Jack Yetiv