Category: intervention

Peak profits, stock prices?

Recently a respected colleague said our strategy was rational but markets, and the world for that matter, were highly irrational.  After participating in financial markets for the last 25 years I thought my experiences allowed me to see it all-wrong!  So after reflecting on our irrational state of affairs the logical side compiled some of the glaring data sets signifying a massive market top. 

First, a chart created by John Hussman ( indicates how much excess we’ve witnessed in corporate profitability vs GDP lately.  Keep in mind his data includes financials which to this day remain a subsidized black box.  (Click on image to enlarge).New Picture (1)

Of course this hasn’t stopped wall street from expecting further net margin expansion:


Profit margin growth

Before Wall Street follows Congress out the door for the holidays maybe they should scrutinize this:

profits vs labor

To derive this unprecedented profit picture both consumers and government went on a spending binge.  US national debt, through 5 years of record deficits, added almost $7.7 trillion to our balance sheet-can you say malinvestment?personal savings govt deficits profits


Now, if we remove the creators of financial alchemy we notice the real economy topped many quarters ago. 


Nonfinl corp profits

So if you care to break away from CNBS and look at the graphs above rational behavior would suggest profit taking and or short exposure.  In fact, it was just 7 years ago that many of these same signals were sent to the market yet we were labeled as the boys crying wolf.  If your timing is perfect the crowd labels you a genius but too early, a chump. 



Global asset deflation: nowhere to run, nowhere to hide

Over the past several months global stocks, bonds and currency markets have hit a wall.  Just 6-8 months earlier the central banks of Europe, Japan and the US were signaling endless monetary accommodation which initially emboldened global speculators and their reach-for-yield mantra.  Now we look around for evidence or confirmation that the four year stimulus experiment is DOA.

First, emerging market stocks, bonds and currencies have all dropped somewhere between 7% and 12% the last few months as the carry trade (borrowing in low cost currencies in order to buy higher returning risk assets, thus capturing the spread) comes off the boil.  Second, political commentary out of China confirms our earlier thoughts that a credit bubble for the ages has begun to burst.  Since the central banking talking heads opened their mouths last month, Shibor rates (Chinese overnight unsecured lending rate amongst 16 largest banks)  have spiked to levels not seen since 2004:


Here is the latest on the Chinese banking system from Bloomberg:

Policy makers could be taking advantage of tight funding to “punish” some small banks, which previously used low interbank rates to finance purchases of higher-yielding bonds, Bank of America Merrill economists led by Lu Ting wrote in a report. Tight interbank liquidity could last until early July, according to the report.

‘Warning Shot’

“The PBOC [People’s Bank of China] clearly has an agenda here,” said Patrick Perret-Green, a former head of Citigroup Inc.’s Asian rates and foreign exchange who works at Mint Partners in London. “To fire a massive warning shot across the banks’ bows and to see who is swimming naked. Moreover, it fits in well with the new disciplinarian approach” adopted by the government, he said.

Chinese regulators are forcing trust funds and wealth managers to shift assets into publicly traded securities as they seek to curb lending that doesn’t involve local banks, so-called shadow banking, according to Fitch Ratings.

The tightening is “emblematic of some of the shadow banking issues coming to the fore as well as some of the tight liquidity associated with wealth management product issuance, and the crackdown on some shadow channels,” Charlene Chu, Fitch’s head of China financial institutions, said in a June 18 interview. She earlier estimated China’s total credit, including off-balance-sheet loans, swelled to 198 percent of gross domestic product in 2012 from 125 percent four years earlier, exceeding increases in the ratio before banking crises in Japan and South Korea. In Japan, the measure surged 45 percentage points from 1985 to 1990, and in South Korea, it gained 47 percentage points from 1994 to 1998, Fitch said in July 2011. [Emphasis mine.  Japan and South Korea experienced bubble economies during these periods which both burst.]

Look at the massive growth in nonbank (shadow) lending in China post 2008 credit crisis while keeping in mind most of this was indirectly backed by the largest banks under the “wealth management” label:

Chinese shadow banking

Maybe this is why China made the news last week when a proposed 15.5 billion renminbi bond offering failed (for the first time in nearly 2 years), receiving only 9.5 billion renminbi.

Over in Russia and Korea we see even more instability permeating the credit landscape.

Romania’s Finance Ministry rejected all bids at a seven-year bond sale yesterday because of market volatility, while South Korea raised less than 10 percent of the amount planned in an auction of inflation-linked bonds. Russia scrapped a sale of 15-year ruble-denominated bonds June 19, the second time it canceled an auction this month, and Colombia pared an offering of 20-year peso debt by 40 percent. A cash shortage led to failures last week of China Ministry of Finance debt sales.

More than $6.9 billion left funds investing in developing-nation debt in the four weeks to June 19, the most since 2011, according to Morgan Stanley, citing EPFR Global data. The exodus is reversing the $3.9 trillion of cash that flowed into emerging markets the past four years as China’s annual economic growth averaged 9.2 percent and spurred demand for Brazilian iron ore, Russian oil and gas and Chilean copper.

Romania rejected all 688 million lei ($200 million) of bids at a bond sale yesterday because of “unacceptable price offers,” according to an e-mailed statement from the central bank. It was the first failure since August.

South Korea sold just 9 percent of the 600 billion won ($524 million) it targeted from 10-year inflation-linked bonds this week. Colombia’s government pared an auction on June 19 of 20-year inflation-linked peso bonds by 40 percent, to 150 billion pesos ($77 million).

Russia canceled planned sales of 10 billion rubles ($311 million) of notes this week, citing a lack of demand within an acceptable yield range of 7.70 percent to 7.75 percent. Yields on ruble bonds due in 2028 jumped 30 basis points, or 0.30 percentage point, yesterday to 8.1 percent, the highest level since the debt was sold in January.

After endless monetary interventions the prior 3-4 years governments around the world temporarily created the illusion that interest rates would stay below nominal GDP growth targets.  The sleight of hand only lasted this long because so many of the “professional money managers” never questioned the actions of central bankers (a.k.a. asset inflationistas) .  As currencies, bonds and stock markets decline in unison around the world, one might pose the question “Have central bankers lost control of their monetary experiment?”  Or better yet, why would so many “investors” believe that a group of central banks with combined reserves of $11.5 trillion could levitate with over $240 trillion in global assets?   Which then begs the question,  where does one hide?

Obama/Bernanke science project now on red alert

Over the past few years we’ve chronicled the build and unwind of the greatest credit bubble in history while most market observers continued to embrace the almighty central planners. Time and time again either the Federal Reserve or the US Treasury appeared on the crime scene with extraordinary measures all fraught with precarious unintendid consequences.

First, the countless interventions involving GSEs, money center banks and AIG all had one common denominator: “save the bondholder.” In all cases the US government stepped into various private sector businesses, took a significant equity ownership interest alongside the prior destroyers of capital, and preserved bondholders, consequently crowding out the future investment capacity of remaining and prospective entrepreneurs. For example, AIG is now 79.9% owned by the US taxpayer thanks to over $180 billion in bailout funds, some of which found their way into the hands of multiple Wall Street beneficiaries, namely Goldman Sachs and Deutsche Bank. Fannie Mae and Freddie Mac are categorized as “works in progress” courtesy of ex-Treasury Secretary Hank Paulson’s “conservatorship” scheme while the Obama administration tinkers with alternative strategies. Meanwhile, these propped-up entities are classified as off balance sheet budget items requiring over $100 billion in bailout funds since last fall with projections of another $300 billion before year end!

Second, the money center banks, specifically Citigroup and Bank of America, are ridiculously insolvent yet the Bush/Obama triage unit remains hell bent on emulating the Japanese model of keeping the zombies alive at any cost. Most of the life support was provided by the $700 billion TARP boondoggle.

Third, FDIC debt guarantees enabled additional dead men walking, such as Morgan Stanley, Goldman Sachs, JP Morgan and countless others, the opportunity to sell debt at below-market interest rates in the hope of recapitalizing the murky lenders during the recovery process.

Finally, the Federal Reserve – under fearless leader Ben Bernanke – has assured the American people that his science project, a.k.a. Shadow Banking II, will revitalize the private sector credit machine since over 60% of all US lending the past decade took place in the toxic off balance sheet world (Shadow Banking I). Predictably, his reliance on the same incompetent rating agencies and questionable collateral never comes up when presenting his plan. One simple question comes to mind regarding the Fed’s current balance sheet vs. several years ago: “How will the Fed remove all of this temporary liquidity when the balance sheet two years ago was primarily short term T-bills vs. longer-term structured finance instruments today?” Of course the answer is they won’t be able to remove any of it without creating hyperinflation.

In summary, the US government, in cahoots with the privately-owned Federal Reserve, intervened in an unprecedented fashion in order to preserve the US dollar fiat monetary system. It took conservatorship of Fannie and Freddie, the Bear Stearns bailout, TARP, FDIC guaranteed debt, and a plethora of “temporary” Federal Reserve credit facilities as well as permanent government credit backstops totaling $12.7 trillion to prevent the mother of all bank runs.

Until now the economic and investment minyans have applauded the work of Alan Greenspan’s worthy successor, but what lies ahead should make any supporter of central planning awfully concerned. Ladies and gentlemen, the dollar reserve currency system is now teetering on the edge thanks to the latest decisions by the Obama/Bernanke administration. Instead of allowing bank receivership or worthy bankruptcy law to remove the misallocated private sector debt in our lopsided system, team Obama has created additional bailouts resulting in a projected record budget deficit of $2.2 trillion for 2009 (an unprecedented 20% of GDP). This year alone sends over $1 trillion to the Wall Street dealers who created the fiasco with no mention whatsoever of the epic fraud from various participants, some now on the Obama team roster (Rubin, Geithner, et al.). The $1 trillion happens to be roughly 8 years of productivity in this country so expect government handouts to crowd out potentially thousands of new businesses and related jobs. (Despite the current government-created economic drought, the public sector parasite must be well-fed.) On cue, team Obama – literally televised daily – continues to tell the American people not to worry since his recent stimulus plan will create thousands of new government jobs similar to FDR’s New Deal.

By 2011 some economists project another several trillion in borrowing needs, taking the national debt above $15 trillion with an economy contracting by another 10%. This begs the question: “Who will lend us money to operate the USS of A?” Clearly scientist-in-chief Bernanke is now in the final phase of his lab experiment since earlier test results have all been negative. Showing signs of desperation, beginning in December of last year Bernanke discussed the possibility of extraordinary measures by the Fed, specifically buying mortgage-backed securities and longer-term Treasuries in hopes of controlling the long end of the yield curve. Germany tried this in the ’20s and we all know how that ended up. Since Bernanke’s trial balloon in December, the 10-year Treasury yield has climbed from 2.28% to over 3.45% as of Friday’s close. Subsequent to the December speech Bernanke has implemented his quantitative easing experiment as the Fed announced in March it would buy $750 billion in mortgage-backed securities and $300 billion in Treasury notes and bonds. $113 billion has been committed to buying Treasuries year-to-date. Not only has the yield spiked on the 10-year, but the US dollar index has declined by approximately 11%! Note to Bernanke: your experiment is an unmitigated disaster; please refrain from any more of this economic insanity! (Fortunately, Dr. Ron Paul has now garnered momentum in his quest to strip Mr. Bernanke of these insidious actions.)

It is said the road to hell is paved with good intentions. In this case, the perpetrators of the crime of the century are simply motivated by saving their own bacon.

AIG: America’s Insolvent Guarantor

Since the Fall of 2008 the US government has committed over $11 trillion in new credit and or credit backstops to prevent the collapse of our modern day banking system. Closer examination of various TARP and other bailout recipients reveal the extraordinary demands of American International Group (AIG) which after Monday surpassed the $173 billion level. Hard to imagine when AIG had assured shareholders just one year ago that “excess capital was $14.5-19.5 billion”. At the same time we were commenting on how credit default swaps would follow sub prime lending as disaster du jour with AIG leading the charge. Of course as a taxpayer and reluctant current shareholder of AIG I have to ask how did we get here and how high does this bailout number get over the next several years?

If we rewind the tape back to the Summer of 2007 most market participants envied AIG, the world’s largest insurance company. How could you not after hearing statements like this from one of their top brass:

“It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar in any of those transactions.”

~ Joseph J. Cassano, a former A.I.G. executive, August 2007

Just 12 months later the shadow banking system was imploding and former Treasury secretary Hank Paulson called Goldman CEO Lloyd Blankfein and several other counterparties to discuss implications of AIG’s swap exposure. Unbeknown to many at the time was Goldman’s counterparty importance to AIG, specifically both credit default and interest rate swap exposure. Unfortunately 70% of the derivative market trades under-the-counter so specifics on CDS and interest rate swaps is difficult to decipher, until now. After reporting a quarterly loss of $61 billion last week, the largest quarterly loss in U.S. history, AIG’s largest shareholders demanded details on where the bailout money was dispersed. The list of culprits comes as no surprise.

Goldman Sachs Group Inc and a parade of European banks were the major beneficiaries of $93 billion in payments from AIG — more than half of the U.S. taxpayer money spent to rescue the massive insurer. Revelations that billions of U.S. taxpayer dollars were funneled through AIG to Goldman Sachs — one of Wall Street’s most politically connected firms — and to European banks including Deutsche Bank, France’s Societe Generale and the UK’s Barclays could stoke further outrage at the entire U.S. bank bailout.

It doesn’t to me seem fair that the American taxpayer has got to bear the 100 percent of the downside,” said Campbell Harvey, a finance professor at Duke University. “A hedge is not a hedge if you did not factor in the counterparty risk. And the U.S. taxpayer should not be obligated to make people whole for hedges that were not properly executed.”

My Comments: In a little over 12 months the largest insurer in the world has now become part of the zombie gang joining other former leveraged high fliers such as Citigroup, Fannie Mae and Freddie Mac. Latest disclosure documents from AIG put potential CDS exposure north of $500 billion. When adding interest rate swap exposure to the mix the total derivative book exceeded $1.5 trillion! Are derivatives becoming a problem now that the asset inflation game has come to a grinding halt? Citibank, Bank of America , HSBC Bank USA , Wells Fargo Bank and J.P. Morgan Chase reported that their “current” net loss risks from derivatives — insurance-like bets tied to a loan or other underlying asset — surged to $587 billion as of Dec. 31, 2008 . Buried in end-of-the-year regulatory reports that McClatchy has reviewed, the figures reflect a jump of 49 percent in just 90 days.

As the shell game continues we get closer to the real players in this collapsing fraud, primarily the insolvent TARP recipients who require yet another open ended capital conduit. Is it any surprise that the AIG bailout money flows through to politically connected zombies such as Goldman, Merrill (now Bank of America) and Deutsche Bank? Or that Bernanke makes a 60 Minutes infomercial Sunday night assuring the American people that money center banks will not fail based on his “new”reflation experiment?

Finally, we look at the Obama administration where Turbo Tax Timmy Geithner is assigned to the AIG bonus scandal hoping the distraction preoccupies most of main street. Unfortunately this too shall backfire since many of these potential bonus recipients know where all of the counterparty skeletons reside in this open ended bailout sham. Note to the administration: Be careful what you wish for.

Paulson’s gift to the bears

It’s official: The U.S. economy is headed for its worst recession in three decades. Henry Paulson’s scheme to keep Fannie Mae and Freddie Mac on government life support and bail out its creditors (i.e. Wall Street, Big Banks, and Bill Gross at PIMCO) removes any doubt. The only question remaining: Will this downturn rival the Big Kahuna of the 1930s?

Paulson was interviewed today on Bloomberg. Here is the money quote:

“No one likes to put the taxpayer into situations like this. No one does; I certainly don’t. Government intervention is not something I came down here wanting to espouse, but it sure is better than the alternative.”

The alternative, of course, is that Paulson’s friends are actually forced to take huge losses on their reckless, ill-fated loans to Fannie and Freddie. Unthinkable! Paulson assures the naïve interviewer that the taxpayer will come before the shareholder, forgetting to mention the shareholder has already been wiped out, putting the taxpayer last in line behind the creditors. Under Hanky Pank’s scheme, the taxpayer is simply the bagholder of last resort. Paulson was obviously a quick study under former Goldman Sachs CEO and Treasury Secretary, “Mr. Bailout” himself, Robert Rubin.

The initial reaction of the stock market was to celebrate with a 300 point rally in the DJIA. Our guess is the euphoria will fade quickly as investors realize bailout money does not grow on trees, and the cash will either be taxed, borrowed or printed. The only question: How much will the final tab run?

The more pressing concern, however, is the economy. This economy needs to break its addiction to cheap credit, remove the waste of the previous credit binge, shed its political parasites (e.g., friends of Hank), and rebuild on a solid foundation. Every intervention prolongs the process and deepens the malaise. A wholesale government takeover of the mortgage market virtually guarantees the economy will be mired in deep recession for years.

The only winners (besides whiners like Bill Gross)? Those who are short the market.

Note to self: Move those inflation hedges from the attic to the front hall closet.

Credit market update

Since massive intervention beginning 12 months ago we take a glance at modern central banking’s unintended consequences:

Mortgage Market

  • 30 year conforming mortgage rates have increased by 75 basis points, jumbos 175 basis points
  • Mortgage loan applications are down 34% year over year
  • Prime mortgages for less than $417,000 had a delinquency rate of 2.44% in May, up 77% from last year. Prime jumbo loans over $417,000 had a 4.03% delinquency rate in May, up 263% from last year
  • Approximately 15% of all subprime mortgages and 7% of all Alt-A mortgages are in delinquency
  • Almost one-third of U.S. homeowners who bought in the last five years now owe more on their mortgages
  • Fannie and Freddie now comprise approximately 80% of the $12 trillion residential mortgage market
  • Difference between yields on Fannie/Freddie MBS and borrowing rates adjusted for prepayment risk increased from 10 basis points in Jan ’08 to 65 basis points this week
  • Private securitizations reached just $131 billion (1st half ’08) down sharply from $1 trillion in the same period last year
  • Fannie’s current-coupon 30-year fixed-rate bonds currently yield 6.02 percent, 212 basis points more than Treasuries, 26 basis points from the 22-year high of 238 basis points reached March 6, 2008
  • 75 percent of U.S. banks surveyed indicated they tightened standards on prime mortgage loans, up from 60 percent in the previous survey, the Federal Reserve
  • 80.7% of survey respondents said they were tightening standards on commercial real estate loans up from 78.6% a quarter earlier and the highest on record.

Credit Market

  • 66.6% of lenders said they were tightening standards on credit card borrowers up from 32.4% a quarter earlier and the highest since the Fed began collecting data in 1996. 67.4% are making it tougher to get other consumer loans, up from 44.4% and another record.
  • Federal Reserve has now lent approximately 2/3 of their balance sheet to broker dealers/banks
  • Interbank lending still problematic as Libor remains elevated
  • Spread between 10-year Baa-rated bonds — the lowest investment grade rating — and U.S. Treasurys increased to 326 basis points
  • Foresight Analytics estimates that land- and construction-loan delinquencies reached 8% in the second quarter for commercial banks, up from 7.1% in the first quarter and 2.3% in the year-earlier period
  • Estimated $700 billion in HELOCs on bank balance sheets and based on foreclosure/delinquency 25% should default leading to $175 billion in write offs

GSE bailout bill may cost taxpayer over $1 trillion

When President Bush named Hank Paulson treasury secretary several years ago the media welcomed the free market supporter with open arms. Today we see the man’s true colors as both he and Bush have now capitulated by endorsing the most recent GSE bailout bill potentially costing you and I over $1 trillion!

The reversal upends admonitions Bush made starting almost a year ago. “A federal bailout of lenders would only encourage a recurrence of the problem,” Bush said Aug. 31, 2007. No way, he said May 6, would he allow “a costly bailout for lenders and speculators.” The warning was repeated several times this month.

Enactment constitutes “a very important message that we are sending to investors around the world” that would play a key role in “turning the corner” on the housing crisis, Paulson told reporters. “This is about not only our housing markets, but it’s about our capital markets more broadly,” Paulson, 62, said today in a Bloomberg Television interview. “This goes well beyond the two institutions — Fannie and Freddie — it has to do with investors in the United States and investors all over the world.”

In detail the bill added over 700 pages in the past 24 hours, which included several shocking inclusions:

– Fannie Mae and Freddie Mac already own $6.9 billion of foreclosed homes. Almost as much property as the entire rest of the other 8,500 commercial banks – combined.

– Assuming the default rate stops rising immediately, it’s likely that around 10% of Fannie and Freddie’s owned and guaranteed mortgages will end up in foreclosure. Assuming a 50% recovery rate, that’s a $250 billion loss.

– $2.5B line of credit to the Treasury (Fannie & Freddie) is “open-ended”

– Unlimited– Treasury now allowed to buy all ‘F & F’ housing securities

– Congress no longer involved in appropriating funds (Treasury now does)

– New housing trust fund totalling $500-700 billion which resembles a similar proposal submitted by Bank of America months ago.

– No changes in existing GSE model

– Ultimate cost to US taxpayer $1.1 trillion according to S&P

My Comments: The ongoing intervention comes as no surprise yet this bill all but guarantees a nationalization in residential lending. Equity holders and taxpayers will bear the cost while Wall Street benefits. Have the US citizens learned anything from government intervention?

Libor problems expose central bank incompetency

Rolling back the tape to August 2007 we’ve witnessed several failed attempts by global central banks when trying to alleviate the international credit crunch. Massive interest rate cuts by the US interventionists have resulted in climbing credit spreads across the entire debt market. Of late the powers at be instituted numerous credit facilities to both banks and brokers in a last ditch effort to keep the walking dead from following the Bear Stearns demise. Of course, when looking at Libor, one of the few remaining barometers in credit land, the rational investor should question the “knowledge and wisdom” of the Bernanke Fed.

Since the introduction of temporary and permanent lending facilities from the man behind the curtain the US Fed’s balance sheet has swapped out over $300 billion in treasuries for questionable mortgage backed securities. The unintended consequence has been a banking system reluctant to lend to one another since the Fed will take just about anything as collateral and lend at reasonably low rates. Based on the most recent auction results the Fed will have lent over 50% of their treasuries to the banking/brokerage community by the middle of June!

Commentary the other day by Federal Reserve Governor Richard Fisher should tell us everything about the impotency of our central bankers:

“This is a new development,” Federal Reserve Bank of Dallas President Richard Fisher said during an appearance in Chicago. “I need to learn more.”

Maybe Mr. Fisher, Mr. Bernanke and the other Fed members should take notes when Mr. Volcker speaks:

“A direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in times of crisis: lend freely at high rates against good collateral,” Volcker told the Economic Club of New York on April 8. “It tests it to the point of no return.”

My Comments: Ongoing intervention by global central bankers continues to distort the credit landscape. As banks and brokers drag their feet on mark to market issues related to Level 2 and 3 assets while failing to disclose off balance sheet exposure the lender of last resort has entered the arena. Unfortunately, the policies implemented have failed miserably leaving the obvious question to ponder: How much of the worthless collateral temporarily inherited by the Fed will ultimately end up being owned by the US taxpayer?

"Council on Foreign Relations Fund" collapses

As bailout fever spreads like wildfire we are hit with the shocker of 2008: “Carlyle Capital (aka the Council on Foreign Relations Fund) Nears Collapse as Rescue Talks Fail.”

Carlyle Group said creditors plan to seize the assets of its mortgage-bond fund after it failed to meet more than $400 million of margin calls on mortgage- backed collateral that plunged in value.

Carlyle Capital Corp., which began to buckle a week ago from the strain of shrinking home-loan assets, said in a statement it defaulted on about $16.6 billion of debt as of yesterday. The fund fell 87 percent in Amsterdam trading. Carlyle Group, co-founded by David Rubenstein, tapped public markets for $300 million in July to fuel the fund just as rising foreclosures caused credit markets to seize up.

One of Carlyle Group’s talking heads – I’m sorry, “advisor” – was also the head of that incredibly efficient SEC which sat idle during the last mania. Here are a few of his brilliant comments:

The fund’s losses were caused by “excessive leverage,” said Arthur Levitt, a senior Carlyle adviser, in a Bloomberg Radio interview today. “This did not affect the overall Carlyle enterprise,” said Levitt, former chairman of the Securities and Exchange Commission and a board member of Bloomberg LP, the parent of Bloomberg News. ”This was a single fund, and I suspect as this plays out, you are going to see a lot of other private-equity companies, a lot of banks, going down the same road,” he said.

My comments: Why would someone like Arthur Levitt watch one of his funds, which he advises, take leverage to 32-1? Additionally, where was Carlyle Group’s Chairman Lou Gerstner during this irresponsible behavior? If the most politically-connected private equity group in the world can’t be saved by the Fed, remaining credit fund managers may want to order some sleeping pills.

Fed down to their last few bullets

Wall Street began the week with fear in the financial air as rumors circulated Bear Stearns was unable to meet redemptions from hedge fund clients. The Banking Index probed new lows while T-bill rates followed. Adding to credit concerns were significant spikes in credit spreads, primarily MBS as Fannie/Freddie paper spreads blew wide open exceeding the moves witnessed during the 1998 LTCM debacle. A continuation of margin calls beginning last week pressured hedge fund and other credit related speculators who purged MBS of all flavors to stay alive. Within 24 hours Bernanke and the fearless Fed arrived on the scene with yet another attempt to stop the bleeding:

The Federal Reserve announced today an expansion of its securities lending program. Under this new Term Securities Lending Facility (TSLF), the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label
residential MBS. The TSLF is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally. As is the case with the current securities lending program, securities will be made available through an auction process.

Understand this experiment is quite different from the Temporary Auction Facility (TAF) which was introduced several months ago and actually offers cash for MBS collateral. Of course the main objective for the Fed’s TAF was lowering the Fed funds target rate.

I find it interesting that JP Morgan and Bank of America decided to make unprecedented margin calls last week when spreads had already widened the prior week or so. Is 25-1 leverage finally impacting credit availability at the largest commercial banks? How about the immeasurable levels of off balance sheet structured finance experiments gone bad?

Today we read about numerous credit related hedge funds who effectively froze redemptions for partners recently. Of course this is attributed to FASB 157 which went into effect in November, 2007, leading to numerous mark-to-market problems for the mark-to-make-believe world. Some of the twilight zone casualties emerged this morning:

Drake Management LLC, the New York- based-firm started by former BlackRock Inc. money managers, may shut its largest hedge fund, while GO Capital Asset management BV blocked clients from withdrawing cash from one of its funds.
Drake told investors today that it would either liquidate its $3 billion Global Opportunities fund, continue to restrict redemptions or allow clients to shift assets to a new fund. Separately, Amsterdam-based GO Capital prevented customers from taking money out of its $880 million Global Opportunities Fund, saying in a March 11 letter that “current market circumstances don’t allow the fund to sell investments at a reasonable price.”

Hedge funds with more than $5.4 billion have been forced to liquidate or sell assets since Feb. 15 as contagion from the U.S. subprime slump spreads. Others include Peloton Partners LLP’s $1.8 billion ABS Fund, Tequesta Capital Advisor’s mortgage fund and Focus Capital Investors LLC, which invested in mid size Swiss companies.

Finally, as we’ve said from day one, the Fed’s balance sheet is a paltry $866 billion which pails in comparison to the outstanding $43+ trillion of debt in the system. One more bullet has been fired leaving the central planners with fewer rounds of ammunition.

Counting the currency swaps with the foreign central banks, the Fed has now committed more than half of its combined securities and loan portfolio of $832 billion, Lou Crandall, chief economist for Wrightson ICAP noted. ‘The Fed won’t have run completely out of ammunition after these operations, but it is reaching deeper into its balance sheet than before.”

My comments: Bailout talk fills the airwaves so we ask the question: Does Bernanke have enough bullets in the chamber to keep the primary dealers alive until Congress approves a massive mortgage bailout plan? Remember the Fed does not want to destroy themselves so collateral must be blessed by the government in order to keep the Ponzi alive.

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