Bandaid on a Ruptured Jugular

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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
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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Lee Adler

I’ve been publishing The Wall Street Examiner and its predecessor since October 2000. I also provide analysis and charts for David Stockman's Contra Corner which I developed for Mr. Stockman. I’ve had a wide variety of finance related jobs in the past 44 years, including a stint on Wall Street in both analytical and sales capacities. Prior to starting the Wall Street Examiner I worked as a commercial real estate appraiser in Florida for 15 years. I also worked in the residential mortgage and real estate businesses in parts of the 1970s and 80s. I have been charting stocks and markets and doing analytical work since I was a teenager. My perspective is not of the Ivory Tower. It is from having my boots on the ground and in the trenches of the industries that I analyze and write about today. 

  68 comments for “Bandaid on a Ruptured Jugular

  1. OOUA
    March 11, 2008 at 9:48 am

    I noticed the NOB spread had a peculiar twist to it recently, it appears that the 10/yr/note short hedges against mortgage portfolios weren’t working as intended and in fact caused more damage as the mortgage portfolios found lower or no bids and the flight to quality caused the treasuries to move higher … a double whammy, getting caught wrong doing what is supposed to be the right thing … sooner or later this fiat interest rate enviornment will align itself with the real world, either as a result of the dollar sliding even further or foreign investment out and out drying up, or both

  2. bear cave
    March 11, 2008 at 10:22 am

    I’ll tell you what, even though at this point I have transitioned over from breakout/breakdowns to a “Short & Hold” attitude–at least, it feels like that what with the risk tolerance you have to have–this risk is ridiculous, what with these short squeezes… “Road Warrior Market” indeed.

    Here’s to the Little Sctick Save That Couldn’t.

  3. March 11, 2008 at 10:36 am

    If the Fed has broken the back of the panic flight to safety into Treasuries with this action of providing unlimited inventory to the dealers with which to meet the demand, they are going to rue the day. The panic could easily go in reverse to reach levels that would have been unimaginable. Yields are already up 17 basis points. If they get above 3.70 in the next couple of days, it would only take a couple more days to get to 4.70 as the market collapses.

    This really sets off all kinds of interesting possibilities. We have to wait for the end of the day to see where things stand. I’d hate to see all our shorts get stopped out, but if it happens, so be it. The Fed has declared itself the seller of last resort for Treasuries here, and the market has responded by saying, “Here, take mine, take mine!”

    So let’s see how this little gambit works.

  4. Jason Seese
    March 11, 2008 at 10:38 am

    Great article. Thank you for giving us insight into the Fed’s action today. I did not really understand what the Fed was doing; but you explained it very nicely.

  5. Stuart
    March 11, 2008 at 10:58 am

    What an orchestrated dog and pony show this is turning into. Unbelievable. Yen gets pummeled, Euro turns around on a dime… unbelievable pulling of the levers

  6. Jesse
    March 11, 2008 at 11:15 am

    Lee, that was a very poor analysis of today’s action. Here’s a more complete description:

    1. The Fed is lending treasuries and taking back mortgage securities that currently have a very poor market value. Think about it. Let’s say you’re Bear Stearns and are sitting on billions of crap mortgage securities. You’ll now be able to trade those at FACE VALUE for treasury securities. Instant liquidity. The Fed just bought those crap mortgages at full face. Sure, it’s considered at 28 day loan, but it will be extended indefinitely. This is true helicopter money to the tune of $700 for every person in the United States except that only banks and Wall Street are getting the money.

    2. What does this do? It frees up $200 billion for lending and speculating. You think that makes no difference? You’re wrong. It makes a big difference.

    3. The write-downs will now stop on mortgage paper. The Fed has now backstopped market values on mortgage paper. No more write-downs means more capital available to lend and speculate.

    This is a very big deal. That $200 billion will have a multiplier of at least 10 and account for $2 trillion of buying power just unleashed into the markets.

    This won’t begin until March 27. Add in another 50 basis point rate cut on March 18 and we are off the races.

    Cover your shorts now or get burned badly.

  7. March 11, 2008 at 11:39 am

    Jesse- Russ and I are currently having the same conversation of the points you raised. You’ll have to forgive me for the “poor analysis” which I wrote in the first few moments after the release.

    At this point I would agree in part with what you’re saying, however, based on what I read on the Fed’s discussions of what collateral they accept, they never accept face value of a security as collateral for anything, so I would assume that this applies to the securities swap. The Fed performs an analysis of some kind to establish the value of the collateral, and they lend on some portion of that. There was no information in the documentation of this announcement that the Fed will accept collateral at face value rather than market value.  So is this a means of swapping bad collateral for good? I highly doubt it, but we’ll see.
    If information becomes available that says the Fed will accept the securities at face value I would have to change my current thinking accordingly.

    I don’t think that this frees up $200 billion for lending and speculating. The PDs are currently short about $95 billion in Treasuries. Last August, they were short about $180 billion. They have gotten absolutely killed. At the same time their long positions in the stuff that has been going down in value have ballooned from around $400 billion to around $590 billion. So they have been on the wrong side of both trades to the tune of hundreds of billions and their positions have been constantly deteriorating and getting bigger at the same time, for 6 months.

    The $200 billion in securities lending is like giving a transfusion to a corpse.
    I don’t see the connection between this action and stopping the deterioration of mortgage paper. If you can provide some evidence of how you think that would work, I will certainly consider it.

    Until then I will stick with my poor analysis. I think it’s the correct poor analysis, but it was hasty, and I may have to think it through some more.

    Of course, the proof is in the pudding.I suspect that the outcome of this clearly desperate action will be the same as to the other Fed actions.

  8. CE
    March 11, 2008 at 11:45 am

    Jesse,

    I think the Fed is not really buying the crap mortgage securities. It’s more of a loan with MBS as collateral. If the value of these collateral drops, then I would believe that Fed will ask for top up.

    What I think today’s Fed action does is to allow PD that are short on cash to get some liquidity without selling their MBS into a very weak market. This prevents further collapse of MBS market.

    What you describe is more of Fed BUYING over the MBS, which I don’t think is the case, yet.

  9. March 11, 2008 at 11:49 am

    CE. That sounds right to me.

    It’s fascinating. Lots more questions than answers right now.

  10. March 11, 2008 at 12:04 pm

    The gambit does not appear to be working. The 10 year Government Agency spread has widened out to 95 on Fannie-103 on Freddie. New record for this crisis.

    The first Primary Dealer to go bk should be BSC. But there may be others less well known who beat it to the punch.

    Our short covering triggers become effective at 3PM. I’m anxious to see how things stand at that time.

  11. Rogue Poster
    March 11, 2008 at 12:06 pm

    Looks more like three fingers of Jack in the morning coffee than a vote of confidence. Got the market out of bed, yes, but now the flu and cold symptoms are returning.

  12. Lemur
    March 11, 2008 at 12:23 pm

    Who knows whats going to happen short term or indeed how high they can goose things today. But faced with days like this when I am giving back lots on my shorts I remind myself that just like Enron (whose financial gimmicks were no substitute for a sustainable business) that sooner or later ‘the king with no clothes’ will be exposed.

    The fed is just stalling.

  13. LawyerL
    March 11, 2008 at 12:25 pm

    The fed has published a list of haircuts (percentage of par or mktvaule)they would lend against. MBS with a maturity of 5 years or less is about a 2% haircut. Or put another way, they will lend 98% of the value of the MBS or agency paper.

    Ofcourse the qustion is– what is the value of the MBS. It will be assigned by the FRBNY. If they use the ABX from markit,they will only be able to lend based on 55% of par for AAA subprime mortgage backed securities. BUT if they mark to model like the Investment banks do, the Fed can get the value up quite high I suspect.

    The fed wants to do this–i.e get value up high, I suspect.

    For other reasons, this program saves (or at least postpones the pain)for companies like Thornberg and other hedge funds
    because this should slow down the margin calls by the investment banks on those types of Levered entities.

  14. March 11, 2008 at 12:28 pm

    One thing I feel sure of is that this confirms just how badly the broker-dealer community has been wounded in this mess. I have repeatedly stated in my reports to subscribers and in posts over on the Stool Pigeons Wire at Capitalstool.com that they are the ones on the floor bleeding out. This is just more evidence of that. The pigmen no longer have the capacity to support the market. They are the walking dead.

  15. Stuart
    March 11, 2008 at 12:28 pm

    “it will be extended indefinitely.” That reference to the 28 day loan period is the key assumption supporting any conclusion the fed is buying MBS.

  16. March 11, 2008 at 12:36 pm

    $110B TAF
    $100B 28-day repos
    $200B Securities Lending
    $80B TOMO

    If fully deployed, the Fed will be pushing $500B secured by $700B in their own account(SOMA).

    Folks, this is dangerous…

  17. Jim S.
    March 11, 2008 at 12:44 pm

    OK, let’s say the Fed takes some MBS in exchange for a loan and lets say the PD goes BK.

    So the Fed has to eat that loss. But what does that mean? Does it just mean that the Fed pumped money out of thin air into the system and (assuming the MBS isn’t worth much) now that money is gone?

    Is it purely an inflationary event?

    Thanks,

    -jim

  18. March 11, 2008 at 12:47 pm

    According to an official at the Fed, the mode of determining the value of the securities will be decided in the coming days before the first auction. This official, who was speaking off the record, also indicated that the collateral has to be of the highest quality, rated AAA, and here’s the more important factor in my view, not on credit watch for downgrade. If it is, it will not be accepted, and if it the collateral is downgraded during the term of the operation it would be put back to the borrower who would be required to replace the collateral.

  19. LawyerL
    March 11, 2008 at 12:49 pm

    Oh another thing. There are other questions that arise.

    In working papers of the Federal Reserve, the authors have questioned whether the Fed has the authoity to lend against MBS. Those authors concluded NO. The Fed is not authorised by congress to do this type of lending.

    Another question. When you lend 98% are you really a lender or an equity investor.

    an observation– if the Fed values the MBS high–the taxpayers can take a big hit. The collateral is still bad and not worth the loan amount no matter what the the rating agencies say.

  20. March 11, 2008 at 12:52 pm

    He said that the purpose of the operation was to provide liquidity to good quality securities which cannot be moved due to market conditions. He also said that it was important that the effect of the operations were reserve neutral, that they would not affect the level of reserves in the system because they involved the swap of securities of equivalent value. This would enable the Fed to scale up the operation as necessary to accommodate the need.

  21. March 11, 2008 at 12:58 pm

    I see this as having the potential to reverse the rally in the Treasury market, but not reverse the deterioration of the corporate, GSE, and MBS markets. Keep an eye on the spreads in the days ahead. If they continue to widen, it spells disaster.

  22. Rogue Poster
    March 11, 2008 at 1:01 pm

    Does AAA include securites that only achieve that status because they are insured? What is “highest quality?”

  23. March 11, 2008 at 1:06 pm

    They are still relying on the ratings agencies. With so many AAA issues that really aren’t AAA, I think that the issue is whether they are on watch or not. If they are on credit watch, they are automatically disqualified. They don’t say anything about taking CDOs. Just AAA rated private label MBS.

  24. karen
    March 11, 2008 at 1:08 pm

    From Miller Tabak’s Tony Crescenzi:

    As of Feb 27, primary dealers held $139.7 billion agency securities and $60.2 billion mortgage-backed securities. (Add those numbers up and you get $200 Billion! So the Fed’s facility is literally able to handle ALL the agency and mortgage-backed securities that dealers hold.

    I hope this adds to the discussion which I sincerely appreciate.

  25. LawyerL
    March 11, 2008 at 1:26 pm

    Here is the chart of Haircuts that the Fed is using for the TAF and likely the securities lending program

    http://www.frbdiscountwindow.org/discountmargins.pdf

    Here is the working paper that questions the authority

    http://www.federalreserve.gov/ Pubs/FEDS/2000/200051/200051abs.html

    Page 58
    There is No Express Authority for the Federal Reserve to Purchase:
    Corporate Bonds
    Commercial Paper
    Mortgages
    Equity
    Land (Other that Federal Reserve premises)

  26. Stuart
    March 11, 2008 at 1:27 pm

    So here’s the question then. What happens in 28 days after each respective auction? They can only do one of two actions. Extend the term or call in the loan. If they extend, it will be clear for all this a covert bailout. If they call in the loans, we have even a bigger implosion a month from now.

  27. MLK
    March 11, 2008 at 1:35 pm

    Lee, this was an impressive, rapid posting.

    The further postings here from others, along with your responses, again beg the continuing question (since last fall) of how far the Fed will go to save the PDs. Back and forth this discussion goes with much talk this weekend (and here this morning) that the Fed through TAF was, in effect, “nationalizing” the PDs’ losses.

    The fatal problem with this theory in my view is that the Fed is a separate entity. Its interests are not a mere mirror of either the “public interest” (whoever that is defined) or the PDs.

    I just simply don’t see serious evidence that the Fed has decided to sacrifice, or even place in serious jeopardy by its own immediate actions) — let alone risk — its institutional interest to save some PDs.

    The Fed may be accepting a broader range of securities but I throughly agree with your comment in #19. It is accepting high quality (such as it is) and over-collaterlizing.

    I don’t think it’s coincidental that dead-duck Countrywide had to get their ($50 billions from FHLB, NOT the Fed.

  28. LawyerL
    March 11, 2008 at 1:41 pm

    The FHLB is the mortgage dumping ground for the industry in my perception. The difference is that they only lend about 75% of value.

    Stuart: I believe they will absolutely roll over in 28 days unless the market clears in a really substantial way. Unlikely IMHO.

  29. MLK
    March 11, 2008 at 1:49 pm

    Re LawyerL in #27:

    I agree they’re the dumping ground. FHLB debt carries an EXPLICIT USG guarantee.

    I don’t know whether the Fed rolls some or all in 28 days. But my point is that the Fed is not going to bailout PDs (or anyone else) to its own detriment. Since this all started the Fed, over and over again, has made it clear it’ll provide liquidity but not capital. Any bailout will have to come from Congressal/Presidential/Administrative agency action (and check-writing).

  30. karen
    March 11, 2008 at 1:54 pm

    “28 Days Later”

    and excellent post at interfluidity

    http://www.interfluidity.com/posts/1205254205.shtml

  31. MLK
    March 11, 2008 at 2:00 pm

    Thanks for the heads up on that interfluidity post. The following from that post is a fundamental question to answer:

    “To the extent Fed loans (in cash or securities) are genuinely overcollateralized, they are more “debt-like”, as equity is “risk capital” and the Fed bears little risk of nonrepayment. To the extent that the true value of the collateral is less than the value of the loans, either initially or due to decay over time without new collateral being posted, the facilities appear more like equity.”

  32. LawyerL
    March 11, 2008 at 2:01 pm

    MLK: “to its own detriment” gets a little fuzzy at times. Here is an example.

    Investment bank has a 2 billion loan to Hedge fund. Haircut is 3%. So they lend 1.94 billion on Alt A “AAA” rated paper. Interest rate Libor+200 bp.

    Investment bank enters security lending agreement with Fed for 28 days on collateral for Libor+ 50bp.
    The spread earned by Investment bank goes to equity for as long as it is earned.

    The Collateral can still be bad–say default rate of 16%–This clearly eats into the AAA traunches but the rating agencies don’t downgrade.
    This program prostpones the pain BUT pain there shall be. Taxpayers may take the hit.

  33. March 11, 2008 at 2:03 pm

    Now that they have started this program, I have little doubt that it will be around for a very long time.

  34. Stuart
    March 11, 2008 at 2:06 pm

    If it becomes clear that they are intending on simply rolling these balances forward indefinitely, what happens to the dollar at that point? My guess, is a sharp right turn down.

  35. MLK
    March 11, 2008 at 2:10 pm

    LawyerL: Don’t be shy. It doesn’t just get “a little fuzzy at times.” Often the taxpayer and (by any reasonable definition) the national interest gets screwed.

    I guess I should have been more clear. I fully expect the Fed to favor the interests of the PDs over “the public.” But much of the commentary I’ve read on this broad subject fails to take into account that the Fed is not the same as the treasury or the USG generally. It is sui generis — a separate entity with its own institutional interests.

  36. LawyerL
    March 11, 2008 at 2:21 pm

    MLK: Yes, I think you are right.

  37. Jesse
    March 11, 2008 at 2:42 pm

    This is the same exact impact as a $200 billion coupon pass. Absolutely no difference at all.

  38. MLK
    March 11, 2008 at 2:56 pm

    Re Jesse #37:

    I do think these actions are different. Lee got to the core of it. PDs are short treasuries and long other sinking debt — given markets currently, a prescription for a death spiral if there ever was one.

    I don’t believe the Fed can reverse long-term trends. But it can deliver pain and uncertainty to those holding positions contrary to its goal. Thus the short-covering surprise today.

    It seems to me that with this action the Fed is delivering a message to those who (late in the game) moved into treasuries as a flight to safety.

  39. March 11, 2008 at 2:57 pm

    A coupon pass, i.e. a direct purchase of Treasury securities by the Fed injects cash into the system and expands the overall level of reserves. This operation does not inject any cash into the system, and does not impact reserve levels. They are the same before and after the operation. The level of cash reserves in the banking system will not change at all. It just moves the money around somewhat. The Fed’s aim is to take some of the stress off the primary dealers without increasing the size of the monetary base. This follows their policy of recent months.

  40. Jesse
    March 11, 2008 at 3:50 pm

    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.

  41. March 11, 2008 at 4:09 pm

    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.

  42. Jesse
    March 11, 2008 at 4:28 pm

    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.

  43. March 11, 2008 at 4:36 pm

    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.

  44. March 11, 2008 at 5:25 pm

    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.

  45. March 11, 2008 at 5:46 pm

    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.

  46. Jesse
    March 11, 2008 at 6:04 pm

    When you exchange a pile of garbage mortgage paper for treasury securities, it’s like trading a turd for a gold coin.

  47. Frothy Conundrum
    March 11, 2008 at 6:05 pm

    Jesse should just ‘show his work’-in detail.

  48. March 11, 2008 at 6:47 pm

    #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.

  49. Stuart
    March 11, 2008 at 6:57 pm

    “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.

  50. Winston Munn
    March 11, 2008 at 8:28 pm

    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?

  51. garyalan
    March 11, 2008 at 10:31 pm

    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. kris b
    March 12, 2008 at 12:01 am

    #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.”

  53. Jack Yetiv
    March 12, 2008 at 1:36 am

    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

  54. Jay
    March 12, 2008 at 5:52 am

    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.

  55. March 12, 2008 at 7:32 am

    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

  56. Boat 52
    March 12, 2008 at 7:33 am

    “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.

  57. March 12, 2008 at 7:54 am

    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.

  58. Jack Yetiv
    March 12, 2008 at 8:54 am

    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

  59. Jay
    March 12, 2008 at 10:43 am

    “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).

  60. Stuart
    March 12, 2008 at 12:01 pm

    There’s a natural migration to sites that add value. This is one such site.

  61. Stuart
    March 12, 2008 at 12:05 pm

    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”.

  62. Alex
    March 12, 2008 at 1:35 pm

    “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

  63. Jay
    March 12, 2008 at 3:13 pm

    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

  64. Crimson Ghost
    March 12, 2008 at 5:16 pm

    Anybody short treasuries got a punch in the nose today.

    But anybody short the buck is smiling

  65. n2alpha
    March 12, 2008 at 10:16 pm

    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?

  66. NBKid
    March 13, 2008 at 12:21 am

    Great job Lou. Thx

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