Wednesday, September 17, 2008

Money Markets in Complete Panic

The Fed conducted two auctions under its TSLF program today which attracted significant demand from primary dealers.  Under the TSLF, dealers offer hard-to-finance securities in return for Treasuries.  Investors are hoarding Treasuries because they are unwilling to hold any other collateral for fear that a counterparty will default leaving them with securities that they can't sell.  This hoarding has caused Treasury bills to trade close to zero, a highly unusual situation that last occurred around the time that Bear Stearns was on the brink and then not since World War II.  The TSLF is meant to alleviate this problem by helping dealers to finance their less desirable securities and giving them treasuries in return.  The results of the TSLF, which generated record demand at record spreads was an indication of how desperate dealers are to secure funding  The 28-day auction drew $71.25 billion in bids versus the $35 billion offered by the Fed with a stop-out was 3.00% (quoted as a spread).  The 14-day auction drew $64.35 billion versus the $35 billion offered with a stop-out of 2.50%.    
If you are looking for an explanation as to why Morgan Stanley and Goldman Sachs' stocks were getting pummeled the last few days despite their relatively decent earnings results, this is it.  Although the SEC and some pension fund managers believe this is an attack on the US financial system by opportunistic hedge funds, I believe it is investors reacting to the potentially catastrophic consequences of a complete seizure in the money markets that is bigger than the Fed's capability to resolve.  Morgan and Goldman rely on the money markets for financing, which are still digesting the consequences of the rash of bailouts, takeovers, and  bankruptcies.  Two money market funds just reported that they broke the buck due to investments in Lehman commercial paper.  How willing will money market funds be to invest in any more broker dealer investments? 
Calculated Risk highlights a quote from Morgan CEO John Mack in a NY Times article that is terrifying.  According to two people briefed on talks between John Mack and Citi CEO Vikram Pandit, Mr. Mack said "We need a merger partner or we're not going to make it."  It has been confirmed in the mainstream press that Mr. Mack is seeking a buyer for Morgan Stanley, however, that quote has a sense of urgency that is very unsettling.  If Morgan strikes a deal, can Goldman survive as an independent dealer or will it too be forced to find a partner?  I honestly don't know, and I suspect that the market's trajectory will continue downward until these issues are resolved.  

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