Libor Dropping, Drastic Fed Actions Finally Working

Three-month Libor fell again to 3.03%, the 15th consecutive drop, indicating that the Fed's dramatic actions are making a difference.  Make no mistake, however, the Fed's actions are dramatic with a capital "D."  Yesterday's release of the Fed's balance sheet showed it ballooning to $2 trillion.  As of October 29th, the Fed had lent $145 billion out of its new commercial paper facility directly to companies which had been shut out from raising short-term financing due to the seizure in the credit markets.  For those unfamiliar with this new facility, it is the first time that the Fed has lent money directly to companies that are not banks (excluding AIG, of course) since the Great Depression.  Other than the new commercial paper funding facility, borrowings from the various other facilities remained relatively unchanged, give or take a couple billion here and there.  

AIG's borrowings declined a bit.  Well, sort of.  It paid back some of the expensive 8.5% money from the special loan it was granted by the Fed, by borrowing from the new commercial paper funding facility at rates of 2-3%.  You can't fault the insurer from trying to reduce its funding costs.  Sadly, there are many other things to fault the insurer for, which require a completely new post (coming soon.)  

In any event, less stress in the money markets is extremely positive news.  Although it doesn't mean the Dow will race right back to 14,000, it does significantly reduce the probability of solvent companies facing bankruptcy because they cannot access short-term financing to run their day-to-day operations.  It also means that every company with an unused revolving borrowing facility doesn't have to draw it down fully from its bank out of sheer panic, thus causing further stress on the banking system.  It is true that we have yet to return to normal business conditions, for without the Fed, we would be facing global banking failures and bankruptcies left and right.  But at least we have stepped back from the precipice.   

Just a Sprinkling of Government Bailouts

This weekend was light on the government bailouts, indicating that strained credit conditions around the world are easing. The Dutch government injected $13.4 billion into ING Groep, the largest Dutch financial services firm and South Korea agreed to guarantee $130 billion in bank debt.  Meanwhile, Iceland is set to announce a $6 billion IMF Fund-led rescue package to help stabilize its beleaguered economy after a spectacular failure of its highly leveraged banks.  It's nice to know that even though the IMF chief is busy having an affair with one of his subordinates, he can fit in a bailout loan or two into his very busy schedule.  As I noted Friday afternoon, significant signs of improvement were evident in the money markets as three-month Libor dropped 36 basis points to 4.06% and overnight Libor fell 16 basis points to 1.51%.

Crazy volatility in financial markets always unveils a few rogue traders.  Both the Chinese and the French (once again) have been taken to the cleaners by traders executing "unauthorized" trades.  Citic Pacific announced a $1.89 billion losing currency bet that was discovered after an executive violated procedures.  The Jerome Kerviel award, however, goes to Groupe Caisse d'Epargne, a large French mutual bank that uncovered  an $800 million loss resulting from derivatives trades that were supposed to profit from stock market gains.  The losses were attributed to a group of around six traders, so really, it's nowhere near as impressive as Jerome's attempt to bankrupt Soc Gen by himself.  Still, "unauthorized" trading seems to occur a bit too frequently.  I wonder how often the losses are just small enough to be buried into an earnings report.     

  

Money Markets Show Significant Improvement, Will Volatility Finally Subside?

I am hearing from my sources that money markets are showing significant signs of improvement today.  Three-month Libor has dropped by over 20 basis points from last night's fix and the TED spread is totally cratering (wide=bad, narrow=good.)  For those who are not intimately familiar with the money markets, they are akin to the basic plumbing of the financial markets.  Trillions of dollars of simultaneous stimulation by governments around the world is finally starting to work.  Since stocks tend to lag the credit markets (as evidenced by the fact that it took a year for the stock market to figure out the complete and total debacle occurring in the bond market), I suspect that it may take some time for the news to filter through and the for the panic to subside.  The VIX is still trading over 70 although down from its peak of 80.  These are still incredible levels and I suspect that the VIX will start to decline.  To all of the options traders out there, I wish you a happy expiration Friday.  It's certainly been the most incredible options expiration cycle I have ever witnessed in my life, and if you are an options market maker and you're still standing after this month, Congratulations, you've earned every penny.  In honor of those that made it through the panic, I offer a video for your amusement.  The following is the layman's version of what it must've been like to trade on the floor of any exchange in the past two weeks: 

TAF Undersubscribed. Seriously?

The results of the TAF are out and they are perplexing to say the least.  The stop-out rate was 1.39% with only $138.092 billion submitted out of the total of $150 billion in funding available.  1.39% was the minimum that dealers were allowed to bid and comes in roughly 300 basis points BELOW Libor.  The maturity date of this loan is January 2, 2009 so it covered year-end.  I find these results to be incredibly perplexing.  If dealers are desperate for term funding, particularly over year-end, why was this auction not oversubscribed?  Any bank with room in their balance sheets should be purchasing assets at Libor and then shoveling them to the Fed through the TAF.  In any event, banks are getting a great financing deal with two-month money coming at 1.39%.  Does the Fed really even need to ease?  Other thoughts and comments are welcome.         

Libor Leaps Higher As Banks Continue to Hoard Cash

Overnight Libor settled at 6.88% in London and three-month Libor leapt another 20 basis points to 4.05%, indicating continued severe dislocations in the money markets. I reiterate my "ZOINKS!" from the day before. Never have I seen the Fed work its liquidity pump so hard to to so little avail. It appears as if the Fed has lost all control of the money markets as the global banking community runs around in circles with its hair on fire. It makes you wonder why anyone would think that another interest rate cut can possibly help the frantic situation.

The banking bailout dujour was a $9.2 billion injection by the French and Belgian governments into Dexia, the world's biggest investor in local governments. In addition to arranging loans for municipalities all over the world, Dexia also insures US municipal bonds. If you are an owner of US munis, you may want to send your friends in France and Belgium a thank you note for bailing you out.

Speaking of bailouts, the Senate has vowed to pass the bailout bill tomorrow. Equity futures are supposedly rallying on the hope that this will actually happen. No doubt another interesting trading day filled with volatility awaits us all.

Fed Pumps ANOTHER $630 Billion Into Money Markets

The Fed doubled its swap lines with foreign central banks by $330 billion to $620 billion. The US central bank also tripled the size of the Term Auction Facility (28 day loans) from $150 billion to $450 billion. To quote an old friend named Scooby Doo: "ZOINKS!" Clearly the inevitability of the passage of the bailout bill has done nothing to ease the strains in the money markets. Banks are terrified to lend to each other, understandbly since the possibility of another banking failure increases by the minute. The question remains: If the Fed had to inject an additional $630 billion into the money market TODAY alone with little result, what makes anyone think that a $700 billion bailout bill that won't go into effect for weeks will help asuage the panic in the market? I don't know about you, but I'm staying in my bunker with some canned goods. Somebody let me know when it's safe to come out.

Discount Window Borrowings Surge

Thursday afternoon's Federal Reserve balance sheet release was filled with painful evidence of how serious the liquidity squeeze remains for banks and dealers.  The significant increase in borrowing from the Fed would have been bigger news were it not overshadowed by the FDIC's seizure of WaMu and the fight over Paulson's $700 billion bailout package.  Primary dealers borrowed $105 billion from the Primary Dealer Credit Facility on September 24th, a shocking amount considering the stigma associated with borrowing from the discount window.  If you were curious why Goldman Sachs asked Warren Buffett for an investment or why the storied investment bank converted itself into a bank holding company, this is the answer.  Finding short-term financing is growing increasingly difficult and the Fed can't seem to create new lending facilities fast enough to keep up with demand for dollars.  Banks borrowed $72 billion from the new asset-backed commercial paper money market or mutual fund liquidity facility, a non-recourse loan facility offered to US depository institutions and bank holding companies to finance purchases of ABCP from money market funds.  The Fed is also accepting equities through the discount window, which I'm certain indicates that the financial apocalypse is upon us.  The loan to AIG has increased from $28 to $44 billion within a week.  I suppose AIG is still determined to pay off the loan and remain a non-government owned company, but it does not appear to be moving in the right direction.  The good news is, we still haven't lost any money on the Bear Stearns loan, although the last time the asset was valued was June 30th.  I'm awaiting the quarterly update and I'm assuming it is not good.

If the money markets don't thaw soon, and there is very little reason to believe that they will after WaMu's failure and the stall-out of the Paulson plan, the Fed will likely need another loan from the Treasury so it can increase its lending to the dealer community.  This is commonly known as running the printing press in a third world nation.  In the US, it's just Bernanke and Paulson doing what they do best; juicing up Wall Street so it can live to fight another day.  The Financial Times is reporting that Morgan Stanley lost close to a third of the assets in its prime brokerage last week (hundreds of billions of dollars) as hedge funds fled to rival banks.  The rumor circulated all last week, but was only published as news in a major financial publication for the first time tonight.  This is yet another unintended consequence of Lehman's failure.  Hedge fund clients are concerned that if Morgan fails due to the severe liquidity squeeze, they will wind up like Lehman's clients; unable to access their assets in a wildly fluctuating market.  Needless to say, concerns about the future of Morgan will likely hurt the market tomorrow.  At least this time, they won't blame the shorts.     

Fed Borrows $100 Billion From Treasury

Treasury Department announced today that it is auctioning a total of $100 billion in bills to boost the Fed's liquidity programs.  This is IN ADDITION to the $100 billion it announced yesterday (updated with correct information.)  The good news is that the Treasury is still considered a good enough credit to allow it to borrow money for free.  Yesterday's auction of $40 billion of 35-day bills had a stop-out rate near zero.  Today's two auctions of $30 billion 20-day bills and $30 billion in 76-day bills (see update below) also had stop-out rates of .10% and .25% respectively.  The bad news is that it implies that investors are hoarding treasuries and avoiding nearly every other money market instrument (see related story below on money markets.)  According to the Wall Street Journal, the US commercial paper market shrank by $52 billion in a week and rates have soared.  What are the implications of this?  Any company that has to issue CP to fund their operations may run into liquidity problems.  The Fed releases its balance sheet this afternoon which will provide an interesting insight into how much the Fed's holdings have changed in the past week.

Update:  The $30 billion in 20-day cash management bills auctioned today had a stop out rate of 0.10% and was three times oversubscribed.  Gulp! 

Money Markets in a Panic, As Turmoil Continues

The Fed injected $50 billion in liquidity into the money markets to counter a spike in the overnight repo market.  The overnight repo rate opened at 5.75% as banks scrambled to find financing from reluctant lenders.  The panic in the capital markets continues unabated.  The repo rate declined once the Fed intervened in the money markets with extra liquidity.  This injection was earlier than the Fed ordinarily conducts its daily money market operations, indicating they stand ready to act again if necessary.  The Fed's actions followed on the heels of liquidity injections by other Central Banks around the world.

I believe it is virtually a foregone conclusion that the Fed cuts the fed funds target and the discount rate today by 50 basis points.  Although this will probably weaken the dollar and is not an ideal act, it is a better option than watching another financial institution implode.  A 50 basis point cut should help the banking system by lowering financing costs, although the seizure in the money markets may continue for some time, particularly over year end.  Everyone send a thank you note to the rating agencies for helping this situation along with their extremely tardy downgrade of AIG and WaMu yesterday after the market's plunge.  

Fed's Lending Facilities Subsidize Egregious Wall Street Executive Compensation

Thomas Montag just received $40 million to start work today as Merrill Lynch's new head of sales.  Mr. Montag is clearly a brilliant salesman, having negotiated such a rich deal from Merrill.  Not only has Merrill been forced to raise billions to replenish its capital as it has lost an insane amount of money in the past year, but the investment bank didn't even need to steal Mr. Montag away from a competitor.  Mr. Montag left Goldman in December and was presumably collecting unemployment checks from the government when Merrill's John Thain drove up in a Wells Fargo armored car filled with bars of gold and handed Mr. Montag the keys.

It seems that despite enormous losses, layoffs, incensed shareholders, government handouts, and the Fed's extreme generosity, Wall Street hasn't changed its tune.  Although bonuses are supposedly discretionary, banking executives continue to claim that it is necessary to compensate "talent" with millions of dollars in bonuses or risk losing them to competitors.  Frankly, shareholders should know this fact and anyone who views Wall Street compensation practices to be distasteful shouldn't own the stocks.  My beef is therefore not with the banks themselves, or with shareholders.  It is with the Fed.

Since the credit crisis began, the Federal Reserve has jumped through fire-rimmed hoops to concoct new lending facilities to keep the banking community afloat.  Without these lending facilities, it is my belief that several banks, in addition to Bear Stearns, would've collapsed under the weight of illiquid mortgage securities due to severe restrictions in the money markets.  Until the credit crisis began, the Fed never accepted mortgages (with the exception of agency pass-throughs) as collateral against its repo loans during open market operations with Wall Street.  The Fed couldn't accurately price mortgages and didn't want to be faced with the prospect of selling illiquid securities in the event of a default by a counterparty.  The beauty of a repo is that if the couterparty defaults on your loan, you can immediately turn around and sell the securities and be made whole.  When there is no market for the securities you are holding as collateral against the loan, you cannot recoup your money.  That is the precise reason why money markets froze last summer and have failed to recover.  Previously liquid securities have become less liquid and it is hard to determine where securities would be liquidated in the event of a default.  The Fed is now assuming that liquidation risk as it enters into repos using questionable collateral.  Furthermore, the Fed has lowered interest rates a number of times in the face of rising inflationary pressures, also in an attempt to bail out the banking sector, and is offering loans to Wall Street on illiquid collateral at roughly 2%.  Initially these lending facilities were supposed to be temporary until credit markets thawed.  But the Fed just extended them through January 2009.  In my opinion, as Wall Street's new regulator, the Fed had (and probably still has) a unique opportunity to make a bold statement.  In return for access to the discount window, the TAF and the TSLF, Wall Street should not be allowed to pay out cash bonuses until the "temporary" lending facilities cease to exist and the Fed is no longer exposed to potential losses from its illiquid holdings.  If shareholders want to continue to throw money at these institutions that have continually misled them about the risks on their balance sheets, that is fine with me.  But being on the hook as a taxpayer for a bank failure that could cause the Fed to take losses immediately after Wall Street paid out record bonuses in 2007 really pisses me off.  If Mr. Bernanke wants to avoid looking like a shill for Wall Street, he needs to step up his game.  If we're going to socialize the losses, we should get some protection.  It is incredibly hard for me to believe that banks are even considering paying out bonuses in the face of enormous losses.  But a $40 million guarantee to a new hire that has yet to make a penny for a bank that just posted $10 billion worth of losses in the past two weeks is evidence that the culture hasn't changed.

It has been a year since Jim Cramer went off his meds and ranted on CNBC about the Fed needing to open the discount window.  Bear Stearns proceeded to pay out $3.4 billion in compensation for 2007, a 21% decline from the prior year, despite a 94% decline in net income from the prior year and then went bust a few months later.  Some believe that had Bernanke opened the discount window earlier, Bear would still be around.  I believe that had the bank preserved some cash by not paying out bonuses, it might still be around.  I'll let my readers draw their own conclusions.  For nostalgia's sake, I'm including the Crazy Cramer video.  Enjoy...  

Fed Extends Lending Facilities

The Fed announced it was extending investment banks' access to the discount window (the primary dealer credit facility) until January 30,2009.  The program was originally set to expire in September.  The Fed is also extending the Term Securities Lending Facility through January.  The TSLF has provides $200 billion in 28-day loans of Treasuries in return for other unsightly types of collateral.  The Fed is also authorizing auctioning of options of up to $50 billion on the TSLF for exercise in advance of periods where funding pressures are elevated (i.e. quarter ends).  The Fed will begin auctioning loans to commercial banks lasting 84 days in addition to the Term Auction Facility, which will begin August 11 and will alternate with the $75 billion in existing 28-day loans.  The total credit under that program will be $150 billion.  Furthermore, the Fed is increasing the size of a swap line with the ECB due to significant demand for dollar funding from the Fed.  Detailed explanations of all of these facilities (in addition to a very handy mortgage map) can be found here at the New York Federal Reserve's website.  In summary, funding problems persist in the money markets and the Fed believes it has to be a lender of last resort to ward off potential liquidity issues that could lead to banking failures.  That is the optimistic viewpoint.  The pessimists would say that the Fed is taking on the funding risks of a fragile US banking system.  If the liquidity issues wind up becoming solvency issues then the Fed and US taxpayer is on the hook.  I'll let you decide which side of the fence you land on this debate.  

Results of the TAF Expose True State of the Money Markets

The Fed posted the results of the Term Auction Facility, the 28-day term loan it offered to dealers today. The stop-out rate was 2.87%. Eighty-three bidders submitted a total of $88 billion in bids for the $50 billion in loans awarded. Demand continues to exist for financing from the Fed for unwanted collateral, as the rate is significantly higher than the fed funds target of 2.25%. However, the results were about 2.5 basis points lower than one-month libor, which is currently at 2.895%. This indicates that dealers consider trading with the Fed a privilege rather than a stigma. Although conditions in the credit markets have improved significantly in the past month, as evidenced by a reduction in swap spreads, the persistently high spread between libor and fed funds points to significant fears of hidden credit problems that have yet to be exposed. If banks were not afraid to lend money, they would be closing the gap between libor and fed funds by putting on massive arbitrage positions. If you told a bank a year ago that it could borrow at 2.25% and lend at 2.90% short-term, without taking any interest rate risk, it would've responded with "How many trillions of times can I do that trade?" These types of anomalies have never existed for such a prolonged period of time. It's just too juicy of a trade to go unexploited. So what is the story behind the persistence of this wide spread? I can only hazard a guess: Banks are still very nervous about the next shoe to drop.

Pain in the Money Markets Continues

The spread between overnight central bank rates and three month libor hit 77.5 in the US and 95.45 in the UK yesterday, getting dangerously close to levels seen when the crazy rumors about Bear's imminent bankruptcy were flying around. As it turns out, those crazy rumors were true, so banks are expecting something unexpected to hit. They may not know what it will be, but it's going to be really bad. They don't want to lend to each other. Again, the implications of this, if it continues, are far and wide. The less lending banks do to each other, the less avenues banks have to finance their inventory, leaving them unable to make new loans or buy new securities. An inability to obtain loans by consumers through mortgages, home equity loans, credit cards or auto loans puts a big damper on consumer spending. Consumer spending is 70% of GDP. The preliminary reports from the retailers this morning aren't looking too hot. Other than Walmart and Costco, other retailers reported sharper declines than expected in March. Everyone shopping at Walmart and Costco instead of the Gap and Limited? I think that's because you can't find bags of rice for hoarding at the Gap. If I were the Gap, I'd look into maybe supplementing my clothing line with a rice aisle. You know how Williams Sonoma puts the $40 bottle of olive oil next to its beautiful salad bowls to try to trick you into forgetting that you can get a bottle of olive oil for $5 from Walmart? It would be like that.

Profits? We Don't Need No Stinkin' Profits!

One question I like to ask frequently without ever receiving a satisfactory answer is the following: Where will future profits in the banking industry come from? Forget about all the write downs, despite the fact that they still aren't completely behind us, why should I buy any financial stocks now? Global debt issuance has plunged is all areas of the debt markets. According to the Financial Times, total debt issuance volumes were down 48% from a year ago. Down $1 TRILLION. That's with a capital T! Total syndicated loan volumes were down 47%. Structured finance was down 89% (ouch.) Debt underwriting was a large profit center for banks and brokers and that was just cut in half. With the Fed's frantic efforts to bail out the banks, one can make the argument that these markets will improve. But will they get back to prior levels? I don't know. Ask investors who are holding AAA CDO's trading at pennies on the dollar if they're ever going to buy another CDO again?

Meanwhile, speaking of $1 trillion dollars, primary dealer fails surged to $1 trillion for the week ending march 26th, up $804 billion from the prior week. What does this actually mean? Let's assume that all the fails happened to one dealer (Dealer X.) Also assume that Dealer X has $1 trillion in inventory owned at an average rate of 5%, all treasuries, that he finances every day in the repo market which ordinarily trades around fed funds. The dollar value of a basis point on $1 million overnight is $.28. So every day, the dealer earns the difference between the interest he collects on his inventory ($1 trillion x 500 basis points x $.28 x 1 day=$140 million) = less what he pays to finance the inventory ($1 trillion x 225 basis points x $.28 x 1 day = $63 million.) Assuming no mark to market changes in his inventory, he should collect $77 million a day in carry. This is why banks love a steep yield curve. They can buy long-dated securities at a high rate, and finance them at a lower rate short term in the repo market, using very little capital. However, if a dealer fails to deliver collateral into a repo (which requires delivery versus payment), he is still obligated to pay the interest, even though he never actually gets the loan. This leaves the dealer no choice other than to take out another loan to finance the securities that he failed to deliver, thus essentially doubling his financing costs. Assuming Dealer X failed on his entire inventory, his financing charges just doubled reducing his profit in the above example to $14 million a day. This example is merely meant to explain the mathematics of fails and how excessive fails can cost dealers significant amounts of money. Furthermore, it is meant to show how great the dislocations are in the financing markets and that the Fed absolutely needed to intervene to swap treasuries for MBS to help alleviate some of the strains.

A closer look at the Fed report shows that the difference between reverse repos and repos for mortages, agencies, and corporates is approximately $1 trillion (total reverse repos for MBS, agency and corporates = $600 billion while repos = $1.6 trillion). So if dealers attempted to reduce their financing needs by not renewing any of their reverse repos in non-treasury securities, and merely focused on financing their inventory, they would be left with $1 trillion dollars to finance. That's with a capital T. And that's why dealer financing at the discount window has soared to $38 billion. Add this to the hundreds of billions lent by the Fed through the TAF and TSLF and the $30 billion loan to JP Morgan to buy Bear. Clearly, dealers really need the Fed, as other sources of financing for the $1 trillion in inventory has disappeared. The Fed is cooperating, which is good. Is it enough? If it were, would the fed funds rate have had an 8.5% trading range on 4/4/08, topping out at 10%? This debacle will only be over in my book, when dealers can get financed themselves without a crutch from the Fed. In the meantime, the world will continue to unwind its loser bets from the glory days of 2005-2007. And profits at dealers will suffer because they have nowhere to turn to sell their products. Can they make it all up in carry from the Fed's easy monetary policy? It's what the bulls think and it's why they all think the worst is behind us. But I'd bet against it.

Citi Defends Lehman, TSLF a success, No News Out of TMA

An analyst at Citi upgraded Lehman this morning. Just to show how much stock investors put into analyst upgrades from banks that are having their own issues, Lehman's stock reacted with a resounding $.35 rally on the news. I don't have a clue what is going on at Lehman or if any of the liquidity rumors are true. The options market seems to believe them. And given how rumors can become a self-fulfilling prophecy, I'd be very nervous about betting against them.
The TSLF auction seemed to go well yesterday indicating that the pressures in the money markets may not be as bad as everyone believed. The stock market reacted with a sell-off in financials, which I found somewhat perplexing.
We're still waiting for news on whether TMA is going to make it. No announcements were made on the results of the private placement, so I'm guessing it's not going to happen. In any event, I still contend that private placement or no private placement, owning the common stock is a bad idea.

What Matters Today

In my opinion, two very important indicators of the problems in the credit markets will be released today. The Fed will initiate its TSLF, a 28-day swap of treasuries for MBS. The results of this auction will be extremely important as it will illustrate the severity of the financing problems of the banks over quarter end. The Fed is set to auction $75 billion. If the auction is a success, this is very good news for the fixed income markets and spreads should tighten between treasuries and agency mortgages, because it will be an indication that the Fed has the firepower to control the problem. If the auction is not a success and spreads in the repo market remain wide due to hoarding of treasuries out of fear, it is an indication that the problem is too big for the Fed to fix. I will be waiting for the results to be announced and will hopefully be able to interpret them. If the news in the money markets is bad, I don't believe that the financials can rally.
The other bit of important news should be an update on the situation surrounding Thornburg (TMA, which I have covered extensively in earlier posts.) Although some may wonder why the future of a nearly bankrupt mortgage REIT matters, I believe it is a very important indicator of market psychology. If TMA cannot raise $700 million for the balance of the private placement (yielding 18% and offering the purchasers 48% of the equity at $.01) then the repo lenders will be forced to seize the assets of the company and liquidate. Again, the last thing any bank or broker needs right now is more assets, particularly over quarter end. Furthermore, these assets are alt-a mortgages which face the prospect of deteriorating significantly if the housing market worsens (which appears inevitable.) If these two important events fail today, I think the market could sell off significantly. Otherwise, maybe I'll start to believe all those pundits last weekend who came out and announced that we'd seen the bottom.

When Can I Go To The Discount Window?

Bernake is currently wracking his brains for yet another facility to thrust at the bond market to bring investors back from the brink of the abyss. It seems like every time he introduces a potential solution, the market breathes a big sigh of relief before resuming its frenzied panic. While it's true that spreads in the bond market tightened last week overall and equities didn't fall off of a cliff, major dislocations remained in the money markets. Despite the fact that the Fed is going to flood the market with Treasuries this week when it commences the $200 billion TSLF( Term Securities Lending Facility), investors are still hoarding treasuries as evidenced by the divergence in repo rates before the long weekend. My sources tell me that treasuries were trading with a zero handle (down to .15) while other collateral was getting financed at much higher rates. Why would investors be hoarding treasuries at ridiculous prices if they knew that a huge slug of supply was going to hit the market in less than a week? I can only hazard a guess: Because all fixed income investors care about right now is getting their principal back. They want to own the most liquid, most secure investment on the planet and that is still US treasuries. So the good news is, even though we may be on the brink of economic mayhem, at least investors still hoard US treasuries and not, say Thai bonds. The bad news is, nobody is concerned with treasury prices getting whacked when the Fed blasts the market on March 27th. And that might mean that $200 billion is not enough. The repo market is HUGE. Literally trillions of dollars change hands every day. While Bernake is addressing the right problem with the TSLF, it may not be large enough.

According to Bloomberg, the Fed is contemplating buying mortgages outright as another solution to the credit (or rather lack of credit) problem. So, let's review everything the Fed has tried so far: They've injected record amounts of liquidity into the repo market. They've agreed to accept anything including spare tires as collateral against their loans. They've promised to provide cash over quarter ends, year ends, out of helicopters. They gave JP Morgan a call option on Bear's stock with a $2 strike price by guaranteeing $30 billion in Bear's debt. They opened up the discount window to those evil primary dealers. And now they want to buy mortgages outright from investors? I have a better idea. Why not open up the discount window to all of America? Everyone complains that the Government is bailing out Wall Street but not Main Street. I have a few credit cards that need refinancing. Wouldn't it be much easier if I could just call up Ben and get some cash, instead of waiting for some dumb lender to have room on his balance sheet again? The funny thing is, if I called Ben Bernake and asked him to open the discount window to me, he would rub his chin and say "Yes, of course! Let everyone come to the discount window! Here's $10 grand! Take it! Take $20! Just take my money! Take my money!!"

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...

The Fed's Move...

Bernake and his cronies have announced a new lending facility that will lend treasuries to primary dealers in return for agency debt for 28 day periods (according to Bloomberg).  The interesting thing is that they will accept agency and non-agency AAA rated private-label residential mortgages as collateral.  What's interesting about this, is that back in the old days when I used to be a repo trader (90's), the fed never accepted anything other than treasuries or agency bullets as collateral in their repos.  This was because they could not price the securities.  So my question is, did the Fed suddenly get more sophisticated in its pricing abilities?  Or are they just willing to do anything to bail out the banks?  In any case, the market loves the news, futures are up sharply.  Given the rumors floating around yesterday about Bear Stearns going bankrupt, this is good news in the short term.  However, if defaults continue to increase in mortgages, the Fed is just delaying the inevitable outcome that banks will have to continue to write-down more assets as they go bad.