Category: monetary policy

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:

Shibor-overview

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?

Fred Hickey compares today’s central banks to 19th century patent medicine factories

Fred Hickey, editor of The High-Tech Strategist ($150/year, thehightechstrategist@yahoo.com), grew up in Lowell, Massachusetts, known as the “Birthplace of the American Industrial Revolution.”  In his latest HTS he discusses the genesis of the patent medicine industry in his hometown during the mid-1800s:

For a time, Lowell became America’s largest industrial center…  In addition to the textile factories, other industries grew up in the city around the same time, including patent medicine factories – Father John’s Medicine and J.C. Ayer & Co. among them.

Dr. J.C. Ayer founded J.C. Ayer & Co. in Lowell and his factory became one of the largest of its kind in the world.  Advertising was the key to success…, with the company distributing millions of copies of its free “almanac” (propaganda) annually around the world – in eight languages, including Chinese.  A sample from the almanac:

“The skillful pilot steers his ship through all dangers and guides her safely to port.  So the skillful physician pilots his patient through the perils of sickness to perfect health.  In cases of General Debility, so common at present day, he recommends the use of Ayer’s Sarsaparilla, because of its superior efficacy in aiding the formation of pure and vigorous blood, thereby restoring the normal condition to every fibre, organ, nerve, and muscle of the body.  It cures others and will cure you.  This standard remedy is compounded of the best tonics and alternatives known to science, and its superior qualities as blood-purifier and invigorator have stood the test of nearly half a century.”

Ayer became fabulously wealthy, amassing a fortune of some $20 million – quite a sum for the time.

Though Dr. Ayer never practiced medicine, the cover of each J.C. Ayer almanac was decorated with classical engravings such as one showing the Greek physician Hippocrates standing atop the earth declaring: “Heal the sick.”  What was not to believe with such evidence coming from a great doctor?

Hickey goes on the draw the parallel to central banking:

 Today, we look back and laugh – how could these people be so gullible?  Yet, the world is currently under the spell of its own modern-day quacks – known as central bankers.  Central bankers are touted as having the cure for all of our financial problems.  Their tonic, with the scientifically-sounding name of “quantitative easing,” or QE for short, is guaranteed to restore our financial health, to cleanse us from all our ills.  Whether the cause is spending beyond our means (perennial trillion dollar deficits and gigantic debts), making entitlement promises we cannot keep, building a gigantic welfare state of dependents, having a dysfunctional (and sometimes corrupt) government, constructing a byzantine tax system, tying up our businesses in a web of regulations, enabling “too-big-to-fail” banks to grow monstrously bigger – all can be cured with the magical elixir called QE.

Our skillful physician pilots (brandishing their doctorates from Princeton and M.I.T.) have discovered a miracle cure to be sure – at least that’s what one hears all day long from the talking heads on CNBC…  The media dissects Bernanke’s every utterance for clues as to whether he will supply more of the miracle or not.  The cameras are always on – even when he’s just laying out lame jokes at a Princeton commencement ceremony.

The QE medicine is seductive and addictive…

The best part yet – the QE medicine that he and other central bankers around the world are ladling out tastes so good… With QE, stocks will never fall on Tuesdays (20 straight up Tuesdays in a row), stock markets will never again have a 5% “correction,” (nearing 200 days without a 5% decline), investors can lever up with margin debt to record levels ($384 billion and counting – exceeding the 2007 pre-crash level)…  Investors have become so addicted to the QE wonder drug than even the merest hint of a lower dosage (tapering) sends up cries of anguish from the financial world.  Stock prices wobble; interest rates soar and CNBC anchors throw hissy-fits.

Other than the hallucinogenic effects, is the drug working?

Despite an additional $6 trillion of deficit spending, 0% interest rates and trillions of dollars of newly-created high-powered monetary reserves by the Federal Reserve (QE) that has driven asset inflation sharply higher (stocks, bonds, farmland, art and gold); over the past 4+ years we have experienced the slowest economic recovery in post-war history…  Last month investors celebrated a pathetic 165,000 jobs created, when 278,000 of those jobs were part-time.  In other words, we lost another 113,000 full-time jobs.  The U-6 unemployment rate (including part-time workers unable to find full-time work) ticked UP to 13.9%… With jobs hard to get and real inflation-adjusted incomes falling, the average American consumer is under pressure.  Witness the fairly miserable first quarter sales results from America’s largest retailers reported last month.  Same-store sales fell year-over-year at Wal-Mart, Target, Kohl’s and Sears…  Yesterday we received the Institute for Supply Management’s (ISM) report for May which, at a reading of 49.0, showed the biggest contraction in American manufacturing activity in four years – since the “Great Recession” of 2009…  I’ve been going through scores of first quarter earnings reports and conference calls from the largest technology companies.  The numbers and commentary were consistently gloomy – it was the worst batch of results I’ve seen since the end of the Great Recession.

At this stage of recovery something is terribly wrong.  Let me clue you in on a little secret – money printing doesn’t work.

The Japanese chugged plenty of this medicine…

Japan was the first to try “QE” to resolve its problems (though it was certainly not the first to try money printing).  They’ve been attempting to lift their economy out of a decades-long recession for many years.  The Bank of Japan (BOJ) tripled its balance sheet but did nothing to address the real underlying causes of the disease.  They did not address their lifetime employment system that hobbles business flexibility.  They did little to correct the ridiculous rules and regulations that suffocate the agricultural, medical and retail industries.  They raised taxes.  They massively increased government spending, wasting trillions of dollars and causing a debt pileup (235% of GDP and still rising) – the likes of which the world has never seen from a developed country.  As one would expect, the attempt failed spectacularly.

Yet the American snake oil salesmen claimed they didn’t drink enough!

Dr. Bernanke, and other high priests of central planning (including Paul Krugman) lectured the Japanese that their problem was they weren’t swilling enough of the QE tonic fast enough.  For a decade the BOJ resisted, always citing concerns over inflation.  Finally, Shinzo Abe was swept into power on the campaign promise of more licorice for everyone! After eliminating the key inflation-phobes (Masaaki Shirakawa) from the BOJ and replacing them with Bernanke-like clones (Haruhiko Kuroda), the new era of “Abenomics” was on…  The BOJ announced a plan to double its monetary base (high-powered money) within two years.  In other words, they opted to chug the whole bottle of medicine at once.

After discussing the post-WWI German experiment in money printing gone awry (Weimar hyperinflation), Hickey sees the American experiment ending badly:

Despite this horrific central banker record, U.S. investors still want to believe that Father Ben’s QE medicine will eventually work.  But just because the crowd believes this fantasy, doesn’t mean I have to.  As long as the Fed continues to print tens of billions of dollars a month, stocks can continue to climb higher, but the gap between the economic reality (poor) and the stock valuations (euphoric) widens to ever more dangerous levels.  Another crash is coming and I intend to avoid it – once again.

In conclusion, Fred Hickey offers an antidote to the QE drug:

Throughout history, the antidote to money debasement has always been gold.

Japanese government bonds take biggest 2-day hit in 5 years

As Tyler Durden of Zero Hedge reported, 10-year JGBs took their worst 2-day plunge since the financial meltdown of Q4, 2008:

The last 2 days have seen JGB prices plunge at the fastest rate since the post-Lehman debacles in Sept/Oct 2008 smashing back to 13 month highs.  5Y yields are surging even more – trading above 34bps now (up from 9.9bps on March 5th). These are simply astronomical moves in the context of JGB history and strongly suggest Abe & Kuroda are anything but in control of the quadrillion Yen domestic bond market as they jawbone inflation expectations into the psychology of the people.

Meanwhile, the Japanese yen has fallen off a cliff as the Bank of Japan (BoJ) opens the monetary floodgates:

Jeff Berwick, editor of The Dollar Vigilante Blog weighs in on the bond vigilantes calling the BoJ’s bluff:

Traders should take note of Japanese Government Bond prices.  On April 4th the Bank of Japan made the announcement that they intended to DOUBLE the money supply and buy government bonds roughly equaling $80B a month.  Does this number sound familiar?  It should since the US Federal Reserve’s own quantitative easing program is roughly $85 B a month.  An important data point to remember here is that the Japanese economy is only 1/3 the size of the US economy, but its own quantitative easing program equals that of the US.   To say Japan is “doubling down” on the same failed policy approach it has taken for the last 20 years would be a bit of a misnomer.  This is Japan’s “all in” move as I try to keep the gambling metaphor rolling.  A gamble is exactly what this is, a very big gamble with no precedent in economic history.

What are the consequences of rapidly increasing government spending, monetizing $80B a month in debt, and flooding the market with yen?  It is hard to miss the headlines as the Yen on the futures exchange is now trading at below 100 yen to the USD for the first time in four years.

Berwick offers an explanation as to why bondholders are beginning to act more rationally:

Why are bonds trading lower?  Think about this from a prudent lender’s point of view and you will have your answer.  If I give you yen, and you give me a security (bond) that says you will give me back my yen with interest in 10 years, then why would I sit with that security and let you pay me back with a devalued currency?  Well, in Japan bondholders appear to be speaking with their market participation.  Bond holders are doing exactly what they should be doing.  Bond holders should be liquidating bonds and converting money out of yen into non-yen denominated securities and investments (note all the M&A activity from Japanese companies in the last seven months as the smart money runs and not walks out of Japan and the yen).

How can the savers in Japan be sitting idly by and watching the purchasing power of their savings being destroyed?  We are on the first chapter of a very ugly time in Japan where policy makers decisions will strain the very social fabric of the country.  We will have a front row seat to the failings of the Keynesian economic philosophy.  It will not be pretty for Japan. And it could very well be the first major event in The End Of The Monetary System As We Know It.

Last Friday, in his Daily Rap, Bill Fleckenstein mentioned the possibility of a Japanese canary in the sovereign debt coal mine:

Japan was the epicenter of fireworks that spread around the world, as last night their equity market rallied 3% even as their debt market had a bit of a nasty spill. However, it must be kept in perspective that the change was rather small and rates have only backed up to where they were in February. So it is not exactly huge trouble, but it could be the start of a shift. At the moment, the bond and currency markets are declining in Japan. Should that continue and should the bond market worsen materially, it would be an early sign of what an eventual funding crisis would look like.

Of course, as long as Japan’s central bank is buying such huge amounts of paper it can thwart that for a time, but it could be the first sign of a bond market anywhere revolting against the printing press. As I say, it is very early days and I don’t want to make too much of it, but a trickle can eventually become a flood, and a trickle has to start somewhere.

Over three weeks ago, in our Q1 letter to investors, we mentioned the possibility of a “Wizard of Oz moment” as the BoJ accelerated its monetary experiment:

Two weeks ago, the Bank of Japan announced a doubling of its asset purchase program.  In Pavlovian response, speculators bid up Japanese government bonds strongly, with the 10-year yielding just under 0.40%.  The following day those gains completely evaporated.  Had the BoJ lost control and the market called its bluff?

For now Goldilocks prevails, but for how long?  Fleckenstein considers the glaring (and widening) disconnects:

So we continue to be in the most perverse sweet spot in the history of the money-printing era that began over 20 years ago. Between the BOJ and the Fed, we are printing about $1.8 trillion a year, along with massive deficit spending, and those policies are regarded as a panacea for equities and just fine for bonds, but horrible for assets that protect one against inflation. Of course, that makes no sense, but when you are in a warped environment (and this is the most warped ever), crazy things not only happen, they lead to even crazier outcomes until the madness finally stops, after which all hell breaks loose.

So much for the notion that central bankers are in control.  Did the global reach-for-yield bubble just go “pop”?

High yield bond offerings set record in January

According to an article in today’s Bloomberg, “corporations sold $25.9 billion of junk-rated debt in 2010, the fastest start to a year on record.” The market for riskier debt has since cooled:

“Three months ago, every piece of spaghetti stuck to the wall,” said Jason Brady, a managing director who invests $54 billion at Thornburg Investment Management Inc. in Santa Fe, New Mexico. “Now it seems, the market is more price sensitive.”

The securities slid 1.16 percent this month after gaining 1.52 percent in January and 57.5 percent in 2009, according to Bank of Merrill Lynch data. Merrill Lynch’s Global Broad Market Corporate Index showed.

The extra yield investors demand to own high-yield debt instead of Treasuries has grown to 688 basis points from this year’s low of 599 basis points, or 5.99 percentage points, on Jan. 11, according to the Bank of America Merrill Lynch U.S. High-Yield Master II Index.

One of the many disastrous consequences of the Fed’s zero interest rate policy is the enticing of investors to reach for yield. Last year $460 million fled money market funds for riskier pastures, even high yield debt. As the old Wall Street saying goes, “more money is lost reaching for yield than at the point of a gun.”

Corporate debt déj

As the WSJ reported yesterday in an article titled, “Borrowing for Dividends Raises Worries,” Fed chairman Bernanke’s zero interest rate policy (ZIRP) has given new life to old habits:

Borrowing from bondholders to pay shareholder dividends is “a hallmark of an earlier credit era,” Jeffrey Rosenberg, head of credit strategy at Bank of America Merrill Lynch, wrote in a report Friday. Such deals were popular in 2003 and 2004, the last time the Federal Reserve lowered its benchmark interest rate to historically low levels, keeping it at 1% for more than a year.

In fact, under captain Alan Greenspan, the Fed began its historic and fatal maiden voyage towards ZIRP in January, 2001. As the corporate credit spigot opened up, such luminaries as Tyco, Enron, and WorldCom rushed to raise money. In fact, WorldCom’s pulled off a record-breaking $11.9 billion debt offering in May, 2001. The company, with $103.9 billion in assets, was sunk 14 months later. Only the women and children were saved.

Of course, there were more serious consequences to the Fed artificially lowering rates in order to contain the tech bust, such as lighting a fuse under the housing and credit bubbles, encouraging recklessness, punishing thrift, and putting off the day of reckoning. Human nature being what it is – especially within the power elite – nothing was learned.

As Mark Twain remarked, “history doesn’t repeat, it rhymes.”

(Thanks to Sal Pramas.)

Corporate debt déj

As the WSJ reported yesterday in an article titled, “Borrowing for Dividends Raises Worries,” Fed chairman Bernanke’s zero interest rate policy (ZIRP) has given new life to old habits:

Borrowing from bondholders to pay shareholder dividends is “a hallmark of an earlier credit era,” Jeffrey Rosenberg, head of credit strategy at Bank of America Merrill Lynch, wrote in a report Friday. Such deals were popular in 2003 and 2004, the last time the Federal Reserve lowered its benchmark interest rate to historically low levels, keeping it at 1% for more than a year.

In fact, under captain Alan Greenspan, the Fed began its historic and fatal maiden voyage towards ZIRP in January, 2001. As the corporate credit spigot opened up, such luminaries as Tyco, Enron, and WorldCom rushed to raise money. In fact, WorldCom’s pulled off a record-breaking $11.9 billion debt offering in May, 2001. The company, with $103.9 billion in assets, was sunk 14 months later. Only the women and children were saved.

Of course, there were more serious consequences to the Fed artificially lowering rates in order to contain the tech bust, such as lighting a fuse under the housing and credit bubbles, encouraging recklessness, punishing thrift, and putting off the day of reckoning. Human nature being what it is – especially within the power elite – nothing was learned.

As Mark Twain remarked, “history doesn’t repeat, it rhymes.”

(Thanks to Sal Pramas.)

Corporate debt déj

As the WSJ reported yesterday in an article titled, “Borrowing for Dividends Raises Worries,” Fed chairman Bernanke’s zero interest rate policy (ZIRP) has given new life to old habits:

Borrowing from bondholders to pay shareholder dividends is “a hallmark of an earlier credit era,” Jeffrey Rosenberg, head of credit strategy at Bank of America Merrill Lynch, wrote in a report Friday. Such deals were popular in 2003 and 2004, the last time the Federal Reserve lowered its benchmark interest rate to historically low levels, keeping it at 1% for more than a year.

In fact, under captain Alan Greenspan, the Fed began its historic and fatal maiden voyage towards ZIRP in January, 2001. As the corporate credit spigot opened up, such luminaries as Tyco, Enron, and WorldCom rushed to raise money. In fact, WorldCom’s pulled off a record-breaking $11.9 billion debt offering in May, 2001. The company, with $103.9 billion in assets, was sunk 14 months later. Only the women and children were saved.

Of course, there were more serious consequences to the Fed artificially lowering rates in order to contain the tech bust, such as lighting a fuse under the housing and credit bubbles, encouraging recklessness, punishing thrift, and putting off the day of reckoning. Human nature being what it is – especially within the power elite – nothing was learned.

As Mark Twain remarked, “history doesn’t repeat, it rhymes.”

(Thanks to Sal Pramas.)

Greenspan defends his legacy

On Tuesday, the Wall Street Journal published an abridged version of several interviews with Alan Greenspan in which he defended his actions from 2001-2005 which many believe fomented a massive credit bubble (present company included). In addition, interviewer Greg Ip ran a front page story on the critique and defense of post-millenial Greenspan. Ip framed the debate along the interventionist paradigm with this line:

The Fed’s low rates and laissez-faire regulatory oversight during his final years are widely blamed for sowing the seeds of today’s financial crisis — one that began in the U.S. housing market and is now battering banks, stock markets, borrowers and consumers around the world.

According to the prevalent interventionist mindset, we’re allowed to criticize the policies of the Fed, but never the institution or the system itself. Strange, Greenspan is supposed to be a disciple of Ayn Rand, complete with free market pedigree. Yet he was a lousy forecaster in both the private and public sector, and did stints as a government employee before taking the position as arguably the most powerful central planner in the world for 19 years. Is it not a total contradiction for anyone to use “Fed” and “laissez-faire” in the same sentence?

The Fed is like a broken candy machine and the chairman’s job is to dispense candy. By definition, a policy of lowering rates to 1% is intended to crank up the machine; sugar highs among the kiddies are the predictable result. Regulating the distribution of candy either limits the amount of candy (contrary to the stated policy) or attempts to means test the recipients (an exercise in futility). Keep in mind, the Fed chairman is a child himself, and owes his priviledged position to the other children hooked on chocolate. As Greenspan said in the Q&A:

I have always seriously questioned [bank examiners’] ability to do more than what counter-party surveillance would do. What evidence do we have that this actually works? Because I know that internal auditors of a bank have significant difficulties in spotting problems and malfeasance within a bank, and the outside auditors obviously have less than the inside auditors. The capabilities of regulators are still less. The problem is not the lack of regulation, but unrealistic expectations about what regulators are able to anticipate and prevent.

How ironic that Greenspan is concerned about moral hazard here (and rightly so), yet was guilty of creating the mother of all moral hazards by attempting to suppress every crisis, beginning with the ’87 Crash. He adopts humility when attempting to regulate the activity of lenders and borrowers, yet very little with regard to the pricing of short-term credit.

Greenspan, Bernanke and every other central banker see the world through an interventionist lens. The boom-bust cycle is never caused by their manipulations of the credit markets, but always seen as an unsavory side effect of capitalism or a “dynamic economy.” The role of central bankers is to mop up the mess and prevent its spreading. They honestly believe this was the lesson of the Great Depression and Japan during the 1990s (even though central bank induced credit expansions caused both bubbles and massive government intervention prolonged and deepened each correction.) This is why Greenspan flooded the system with cheap credit during the tech bust (an insurance policy against the possibility of a Japan-style deflation), and why Bernanke is doing the same today. As Jim Grant wrote in his latest issue, “Who better to manage crises than the institution that instigates them?”

How can the cure be more of what caused the disease in the first place? Einstein defined insanity as “doing the same thing over and over again and expecting different results.”

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.

Dude, I need a bailout

Last week ended with the dynamic duo, Bush and Bernanke, delivering a one two punch to the bears. Beginning late Thursday someone from the White house leaked a subprime bailout plan which would be subsidized by HUD secretary Alphonso Jackson and the FHA. Recall several weeks back when Alphonso boarded a bird set for China where he tested the appetite for additional mortgage backed securities. Friday the world waited for Ben Bernanke where his Jackson Hole clan listened to the Fed chairman convey a sense of control over the subprime debacle. Bernanke clearly changed his tone from the earlier Humphrey Hawkins meeting this Summer-why? Maybe because foreclosures continue to hit record highs. Or maybe because the primary funding source for non-agency mortgage-backed securities hit a wall.

Prior to the political show we heard from the bond king himself, Bill Gross, asking for a government bailout for all housing, not just subprime. Shouldn’t bond market vigilantes be up in arms over such obvious measures to induce inflation? Wasn’t Bill the leader of this pack in another life?

The reflationary efforts led by global central bankers fueled one of the greatest credit bubbles of all time. As the next Fed meeting approaches global financial markets will prepare themselves for a continuation of the Greenspan put or the dawn of a new era. Either way, they’ve clearly forgotten the quote from economist, J.K. Galbraith: “Financial operations do not lend themselves to innovation… The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version”.

WordPress Themes