Wednesday, March 19, 2008

There's No Stigma, Except When There's a Stigma...

GS, MS, and Leh admitted to borrowing from the Fed discount window. They did this because the Fed opened the discount window to brokers this week (formerly only open to banks) and insisted that no stigma would be associated with borrowing from the discount window. In the past, borrowing from the Fed's discount window was only done as a last resort. Drexel went to the discount window, only to be denied.

discount window

At any rate, given the bludgeoning of the brokerage stocks today, apparently, there is a stigma. Although a case can also be made that the negative action in brokerage stocks was related to the pummeling of the commodities market. Rumors were flying around again about massive liquidations, this time in commodities funds as opposed to fixed income hedge funds. If the bull market for commodities is over, brokers would suffer, given that this is one of the few remaining money makers for them. It will be interesting to see the release of the fed discount window data on thursday after the close of the market, particularly since this thursday is an options expiration...

1 comment:

Stephen said...

Leave it to K10 to come up with this blog...I will state beforehand that I too love mockery and the fact that most people don't have the simplest idea of how the market actually functions on a day to day basis. Repo traders are the lowest on the totem pole in regards to a fixed income floor. They are either getting accused of "ripping off other desks" or thought of as nothing more as the lowest rung on the food chain. That is until an actual financial crisis happens. Just ask the CEO of Bear Stearns. Its amazing how fast things can go wrong and mostly because supposedly real smart people don't ever want to believe the repo guy. The things I have witnessed the last 2 weeks within the repo and bill markets is one for the history books. Essentially, every position in the firm is financed thru the repo desks as well as customer positions. Bear was in a very unique position b/c of all the hedge funds that primed with them and essentially had leverage thru them...or let's just make it easy and call it repo. Well, given the fact that money accounts that come in everyday to help finance this collateral have decided they want nothing besides good ole fashion U.S. Treasuries has not helped the situation. Combine that with rumors that Bear Stearns is going down and then those accounts that are there for you everyday with the cash decide overnight that you are not a good counterparty...There you have it...A run on a bank in 24 hours. Poof...liquidity is gone and you are insolvent, the Fed taps a law that hasn't been used since 1930 which allows them to force a sale of a broker dealer in order to keep financial markets a float and all of the suddent Bear Stearns trades less than the value of A Rod's contract with the Yankee's. Now while most people are in disbelief, imagine being a Bear Stearns employee and sitting at home Sunday night. Its 8 pm and you are getting ready to watch Desparate Housewives with the honey bunny and your net worth has just gone to zero b/c you listened to guys like Jimmy Cayne, Warren Spector and Ace Greenberg tell you to believe in the company and never sell any of your stock that you are awarded as compenstion. Now mind you, Warren and Ace dumped most of their shares thereby "monetizing" their long years of service. The irony of the entire situation is that Jimmy was out playing bridge in Chicago at a fairly big tournament. He did go head to head with his former employee Warren and I'm sure had a smirk that was long and very enduring when he beat him. He also was the one to point the finger to Warren for the collapse of 2 funds over the summer and fired him because of it. Who knows if Bear actually moved all of that great paper off thier own books and into the fund b/c it was such a great opportunity...that I'm sure will be debated for years to come or when the SEC starts to investigate what actually went wrong.

This brings me to the next point. February has 3 major firms with offdated quarter ends. Goldman, Lehman and Morgan Stanley. The spread between fed funds and general treasury collateral was about 100 basis points. This spread in normal times used to trade at 25 to 50 on those days. Most of the time a 15 spread was a gift for the repo guys. Since the demise of the mortgage market that spread for normal days is out to about 40 or so given certain collateral supply. Now you have March quarter end for the rest of the street and also Japanese year end. That's where things got interesting. The Japanese who are owners of a lot of Treasuries (we seem to buy a lot of things from them so they are naturally long dollars and have nothing else to do with them besides buy UST but that's a discussion for another day---oh btw, the money they made on their treasury position is essentially getting wiped out b/c the entire globe is selling dollars...again another conversation for another day). You have a very real problem that the Fed actually got in front of. Its your Econ 101 class at 8am Friday morning and you've had 12 long island ice teas from the night before and you are wondering what the hell you are sitting there with a 4 color pen (this way you can actually follow the shifting curves) trying understand just what this person is saying. Japanese take all their UST's home for the month so they can print their year end books (reduce supply) and have customers who used to take all sorts of collateral but know only want 100% AAA rated UST's (increase demand) and there you go....Not enough UST's to go around. The Fed having realized this ahead time said you know what....Let's create new programs on the fly so we can actually help the street out b/c if we don't they will not have enough UST's around and subsequently will be left with too many mortgages and then they will not be financed which will be very bad for people. The cost of money could have gone thru the roof. Could you imagine the scenario where you as a dealer having to go and borrow cash and the collateral you have to post for that cash has 3 different prices at which it trades at (1. Price that the market hopes it trades at. 2. The actual price it trades at or you can sell it somone...that is generally about a 10 to 30 point difference depending on how much someone wants to help you out of your problem 3. The "oh my god, I want my mommy" price where all you want to do is get out of the finance business and get one of those silver carts so you can go head to head with the hotdog guy on 52nd and Park--down the street from the Bear offices.) Who knows what the rate would be...5%, 10% 20%....when you are talking about billions of dollars of positions it can add up very quickly. (some quick bond math. Value of 1bps overnight on a bln dollars is .2778 cents. So let's say you have 10bln that you need money for and you own it a 2% or 200 bps and you borrow money at 10% or 1000 bps. That's a loss of 800 bps on a 10 bln or 2.22 mln dollars for a day.) That will be an immediate call for a GA (ginger ale) and a bottle of pepto because the heartburn you are going to get from that situation is going to just about floor you. (It also allows for many drinks and a free pass for the evening so you don't lose your fcking mind.) So, as a result of all of this you have the current situation. The Fed is going to lend their portfolio of UST's to the street and the street will swap back mtge collateral for it. That should solve the problem (they actually only own about 700bln UST's and I come from the camp that Hope is not a strategy so I am still skeptical that this will work but Ben had no other choice and his weed guy is on vacation so he did the best he could). However, there is a hiccup here. Those programs don't actually start until 3/27th. So, right now the supply isn't in the street. This has led to the repo market doing something I've never seen. Essentially trading at 0. Its a 4 day weekend and the average level in the market for repo is trading at 15 bps. The current fed funds rate is 2.25 % but again...people only want treasuries so that's that. This has also caused a run on the tbill market. Every single bill inside 3 months of maturity is currently trading without a handle. That is there is no 1 in front of it. 3month bills this morning are trading at 0.50 bps. Bill traders are having a field day b/c they can name their price. All that matters to accounts is that they get their money back. Well, I'm tired of typing and I have to field an investor call explaining all of this yet again. Everyone have a nice weekend.