Archive for the 'Money' Category

The Bear Stearns FAQ

Published
by
Doug
on March 14, 2008
in Banks, Federal Reserve and Money
. 0 Comments

Bears

The Bear Facts - Portfolio.com

What happened to Bear Stearns?

It ran out of money.

That can’t be good if you’re a bank.

No. The stock is down over 40 percent today, and off more than 50 percent this week.

But surely the last thing this market needs right now is a bank failure?

Right. So the Fed is riding to the rescue, “allowing Bear Stearns to access liquidity as needed”.

Didn’t the Fed already do that, on Tuesday, when it announced a new “Term Securities Lending Facility” available to investment banks?

Yes, but the TSLF won’t go live until March 27. Bear Stearns couldn’t wait that long.

So was the TSLF announcement a failure?

It does look a bit like that. The TSLF was meant to boost confidence in the investment banks: when the markets have confidence in a bank, there are never any liquidity problems. The Fed might well have been hoping that the TSLF would provide enough of a generalized confidence boost that Bear Stearns in particular would be able to continue normal operations, at least until its money became available on March 27. But Bear didn’t participate in the big stock-market rally on Tuesday, and has been plagued by rumors of illiquidity and insolvency all week. Finally, today, it came clean and admitted it needed an emergency loan from the Fed. Oh, and that 400-point uptick in the Dow we saw on Tuesday as a result of the Fed announcement? We’ve already erased half those gains.

How about today’s announcement? Is the Fed’s money helping Bear at all?

It’s not helping the stock price, clearly. But it did helping the price of Bear’s credit default swaps, at least initially; they’re are a measure of how likely the market thinks Bear is to default. If you own Bear Stearns, you’re in a world of pain right now. But if you’re owed money by Bear Stearns, you do have some faith that the Fed will ensure you get it back in full - although obviously the market in Bear Stearns credit is extremely volatile right now.

Sounds like a bailout to me.

If it is a bailout, it’s a bailout of Bear’s creditors, not of its shareholders.

Why would the Fed do that?

Simple: Counterparty risk. Bear Stearns is a major broker-dealer; billions of dollars of obligations flow through it every day. If suddenly that flow was halted, and Bear defaulted on its obligations, there would be a huge risk to the entire financial system. As Herb Greenberg puts it, “if the hedge funds and rich folk get caught here, without a net, you imagine possible domino effect throughout the brokerage and banking industries as people start pulling out cash and heading for safer pastures, such as trust companies.” And the Fed simply can’t risk the entire banking industry imploding like that.

The FAQ goes on. Read it all.

Fed’s “Junk for Treasuries” Lending Program May Have Unintended Consequences

Published
by
Doug
on March 13, 2008
in Banks, Federal Reserve, Hedge Funds and Money
. 0 Comments

After the announcement late last night that Carlyle Capital could not come to an agreement with its creditors and that its assets would be seized as soon as possible, futures were down sharply as a result. Since March 12, the company has defaulted on approximately $16.6 billion of its indebtedness, with the remaining indebtedness is expected soon to go into default.

But interestingly enough, this instance of banks seizing assets of a hedge fund unable to meet margin calls might be the unintended consequence of the Fed’s recent announcement a couple of days ago to allow banks to swap mortgage-backed (most of which is essentially worthless) debt for Treasuries. Via Robert Peston of the BBC:

In fact, it’s arguable that the banks’ seizure of Carlyle’s $20bn-odd in assets has actually been encouraged by the Fed’s mortgages-for-Treasuries offer. Because the Fed’s new lending emergency lending facility allows the banks to swap mortgage-backed debt for Treasury Bills in a way that Carlyle could not do.

So it would be rational for the banks to take Carlyle’s assets and exchange them for top-quality, liquid US government bonds, rather than leave loans in place to a business, Carlyle, whose assets remained highly illiquid.

If that’s the case, there will be some very scared people in hedge-fund land today. Hedge funds that have borrowed from banks against the security of mortgage-backed debt could be about to see their assets sucked into the banking system and their businesses vanish.

It’s not unusual for policy-makers to come up with a seemingly rational and well-considered plans, plans that in the end actually hurt more than they help. I wonder if the Fed foresaw this possibility? For some reason, I highly doubt it.

Market Bounce is Another Opportunity for Bears

Published
by
Doug
on March 11, 2008
in Economics, Federal Reserve, Markets and Money
. 0 Comments

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.

Who Will Challenge Conventional Wisdom?

Published
by
Doug
on February 28, 2008
in Asides, Economics and Money
. 0 Comments

Who will challenge the conventional wisdom that we, as a nation, can borrow and spend our way to prosperity and expect that prosperity to endure?

Dollar-Carry Trades?

Published
by
Doug
on February 27, 2008
in Asides, Economics, Markets and Money
. 0 Comments

An increase of dollar-carry trades is certainly a confirmation of how far our currency has fallen, but I wonder if it is also a sign of impending recession.

Fed Submits $210 Billion Via Temporary Open Market Operations

Published
by
Doug
on February 15, 2008
in Federal Reserve, Markets and Money
. 0 Comments

On Valentine’s Day, the Fed submitted $210 billion via temporary open market operations, $8.25 of which was accepted.

This is a huge submission by the Fed. I’ve heard rumors and talk of another bank being in trouble, but who knows when and what is going to happen.

A Record Budget Proposed by a Republican President

Published
by
Doug
on February 4, 2008
in Government, Money, POTUS, Politics and United States
. 0 Comments

A Republican president today proposed a record-setting budget of $3.1 trillion:

WASHINGTON - President Bush sent the nation’s first-ever $3 trillion budget proposal to Congress on Monday, contending that the spending blueprint will fulfill his chief responsibility to keep America safe.
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The $3.1 trillion proposed budget projects sizable increases in national security but forces the rest of government to pinch pennies. It seeks $196 billion in savings over five years in the government’s giant health care programs — Medicare and Medicaid.

But even with those restraints, the budget projects the deficits will soar to near-record levels of $410 billion this year and $407 billion in 2009, driven higher in part by efforts to revive the sagging economy with a $145 billion stimulus package.

Granted, we have a war on terror to support, but still, a good Republican president would have left office with total government spending as a percentage of GDP nearly unchanged. Ryan Ellis of American Shareholders Association says that for a Republican president to grow the size of government, as an opening bid in his last year of office, is not a good harbinger of where we’ll end up.

If a Republican president thinks its fine to grow government, just think how much the two Dem frontrunners will grow government. Another worry of mine is that people are growing accustomed to the idea of government entitlements. People have no conception of what three trillion is like. The number is hard to put into any sort of meaningful context. This is a dangerous situation when we’re talking about your, mine, and our money because I feel it gives the false impression that money is no object. Tim over at The Mess Greenspan Made says, “[N]o one really has any concept of just how big a number that is and, therefore, no one really seems to know or care if it is too big, too small, or just right.”

The fact that people might not care whether $3.1 trillion is too big, small, or just right is a scary prospect.

Problem With the Concensus Views About China

Published
by
Doug
on February 3, 2008
in China, Economics and Money
. 0 Comments

I just watched a very interesting presentation (and relatively short at about 27 minutes) by Dr. H. “Woody” Brock, President of Strategic Economic Decisions, about the threat of  China and the 5 general misconceptions of concensus views.

Here are the 5 questions Brock poses regarding the concensus views of China:

  • Is it true that a higher yuan would not improve the US trade deficit?
  • Do those who celebrate the virtues of “cheap Chinese imports now” not understand there is no free lunch?
  • Who says the very low US savings rate is in fact the principal reason for the vast US trade deficit?
  • Is it true that the Chinese will retaliate by “pulling out their money” and/or by reducing their ongoing purchases of US treasuries?
  • On what grounds is the yuan “only” undervalued by 15%-25%?

Brock addresses each of his questions in language that is easy to understand. Non-economists should be able to wrap their minds around the concepts which Brock discusses. 

In conclusion, Brock attempts to answer what should be done about China using the paradigm of game theory. There are three factors that influences the outcome of bargaining between China and the U.S.: (1) the relative risk aversion of the bargaining nation, (2) the relative threat power, and (3) the relative coalitional muscle. Brock essentially says that although the U.S. in theory has the upper hand on two of these three factors, he is worried that the U.S. is incapable of capitalizing on its strengths in order to bargain successfully with China. Brock is worried about the future of the U.S. in relation to China and Asia.

Though I think everyone has heard of “the Chinese threat” or some such variation on that phrase, most don’t really understand the nature of the threat, which is largely economic in nature, though there is a growing military threat. This presentation does a good job providing some simplified concensus views of China and also his arguments that the concensus views are wrong. Watching this will help you understand better the nature of the threat from China.

Merrill to Repay Massachusetts City for CDO Purchase

Published
by
Doug
on February 1, 2008
in Banks, Business, Investing and Money
. 0 Comments

Merrill to Repay Massachusetts City for CDO Purchase:

Feb. 1 (Bloomberg) — Merrill Lynch & Co. agreed to pay Springfield, Massachusetts, $13.9 million to settle a dispute over collateralized debt obligations that tumbled in value.

The money will reimburse Springfield for the cost of the CDOs, securities tied to home loans and other debts shunned by investors as losses on subprime mortgages mounted. New York-based Merrill said it agreed to the refund after discovering its brokers bought the CDOs without the city’s “express permission.”

The money will reimburse Springfield for the cost of the CDOs, securities tied to home loans and other debts shunned by investors as losses on subprime mortgages mounted. New York-based Merrill said it agreed to the refund after discovering the purchase was made without the city’s consent.

How nice of them, considering the purchase was made without the city’s consent.

Opposing Roles of the Federal Reserve

Published
by
Doug
on January 24, 2008
in Economics, Federal Reserve, Markets and Money
. 0 Comments

I have been reading that one of the legacies of Alan Greenspan’s tenure at the Fed is his tolerance for experimentation, innovation, and greater risk-taking by the banks. I have no problem with innovation or risk-taking because they are some of the important factors that have have driven this economy and country. The only problem I do have with the Fed’s allowance for such risk-taking (only to bail out those who risked/gambled too much) is that I think it conflicts with the Fed’s own mission statement.

The Fed states that its duties fall into four general areas:

  • conducting the nation’s monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates
  • supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers
  • maintaining the stability of the financial system and containing systemic risk that may arise in financial markets
  • providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system

Now these are broad, general pronouncements, but I think there is an argument to be made that if the Fed is encouraging risk-taking that it is not following its duty of, say for example, “supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system.” Again, I have no problem with risk-taking, so I guess my beef is just a nit-picky one of lack of uniformity.

A second topic I want to discuss involves the effects the Fed’s policies have on the economy. I was googling around the web and I found an interesting powerpoint presentation that provides a summary of Edward Chancellor’s presentation to The Global Borrowers and Investors Forum on June 23, 2005. It’s entitled The Destabilizing Stability of the Greenspan Era and basically outlines three arguments against the Fed policy at that time (a policy which I’m just going to assume is still being followed by Bernanke).

The most interesting argument came from a Hyman Minsky hypothesis: “each stage [of the business cycle] nurtures forces that lead to its own destruction.” The three cyclical financial stats are described as “hedge,” “speculative,” and “Ponzi.” I don’t think there could be a more apt description of what occurred in the most recent of failed business cycles, the subprime market.

But getting back to one of the general themes: the pursuit of stabilization can lead to destabilization. Very Sophoclean in that the attempts to avoid the prophecy in the end actually fulfill the prophecy. But in the real world, we can never tell that if those steps weren’t taken that things would have been worse.

In an attempt to sum up, though the Fed may have given itself conflicting roles and duties and though it may destabilize by its attempts to stabilize, the Fed must in the end do its best to protect the economy through whatever means and authority it has. Meanwhile I’ll continue to be amused by apparent contradictions and will try to better understand what is going on in the world.