Yes and Not Yes

Today, the U.S. Federal Reserve and four other central banks teamed up to get hundreds of billions of dollars in fresh funds to the credit markets. The Fed allowed financial firms to use securities backed by home mortgages as collateral for these central bank loans. The markets were up sharply as a result: e.g., the Dow climbed 416.66 for its biggest gain in over 5 years.

A Bounce or a Rally?

So, will this bounce turn into a meaningful rally? I seriously doubt it. There is a still a lot of bad news out there; some of it lurking out in the open, temporarily forgotten, and I bet there is still a lot more bad news people are keeping to themselves, hoping they won’t have to make any announcements, betting they can ride this storm out, but this storm has yet to shake out all the bad apples from the tree. The arrogant and unprincipled will fall while the modest and prudent will rise to take their place in the end.

Bad News is Still Out There

Let me give you a sample of some of the bad news still out there. For starters, Standard & Poor’s and Moody’s Investors Service have not cut ratings on any of the AAA securities that track subprime bonds; this despite downgrading over 10,000 of the lesser-rated subprime-mortgage bonds. When one of these ratings agencies decides it has to cut a rating on of their AAAs, I think the market will react adversely, and I don’t think it will be much longer before this happens. The Fed is running out of ammunition to correct the markets and I don’t think it can keep dropping the money bombs ad infinitum.

Also, all the highly-leveraged hedge funds are reeling from this credit crunch, some unable to meet margin calls, as lenders are asking for more collateral and Bloomberg is reporting that the Fed has lost control of inflation when you look at the negative yields for the TIPS. I could probably go on, but I just don’t have the time.

With all this in mind, I think the traders and financial institutions were very grateful for this slight reprieve from all their troubles, but I feel that this will be a small bounce, leading to yet another great opportunity for going short.

An Interesting Theory

One last thing I want to mention is Market Ticker’s analysis of what he thinks really happened today. Here is a large excerpt from his post:

We were almost certainly on the verge of the collapse of one or more of the primary dealers AND international banks FOR THE SECOND TIME IN JUST A FEW DAYS!

Remember, The Fed just took an “extraordinary” action in expanding the TAF!

Their only defense the primary dealers had to being forced to buy back those treasuries at a huge loss is to borrow even more of them from The Fed.

BUT THEY WERE OUT OF COLLATERAL TO POST OTHER THAN THESE MORTGAGE AND OTHER “AAA” BONDS!

What’s worse, this short squeeze was being fed by people who did NOT want agency paper at any price; they were generating it by dumping the agencies and buying Ts. They have figured out that its contaminated (see below) and are freaking out about the potential for serious shortfalls or outright defaults.

Remember - “AAA” means “as safe as the US Government.”

Except that lately, we’ve learned that its not - that the claim is a lie.

So The Fed decides that they’re going to put in place a “swap” and let the primaries exchange Treasuries (of which they have several hundred billion) for “Agency and other AAA” paper - mortgages. The intent is to “pair” the two, thereby halting the spread widening and thus stopping the short squeeze.

The action today was nothing more or less than an attempt to stabilize Agency spreads which were blowing wide in a historic short squeeze that was threatening to collapse major financial institutions!

Yet if you listen to CNBS, including Fast Money, you hear these guys saying that “The Fed Injected 200 billion in money.”

NO THEY DID NOT! IN FACT, THEY EXPLICITLY INJECTED EXACTLY ZERO DOLLARS INTO THE SYSTEM; A SWAP OF ONE SECURITY FOR ANOTHER OF IDENTICAL SIZE AND FACE IS A BIG FAT NET ZERO IN TERMS OF BALANCE SHEET AND MONEY SUPPLY IMPACT.

I find this analysis simply amazing. It is something you would never see reported by the mainstream media. This to me seems like an extremely plausible explanation for today’s events. And even if this analysis is wrong, I still just wanted to highlight it as a shining example of the great thinking powers some people possess.