Fed Rally on Garbage Paper!

Tuesday, March 11, 2008 | 09:49 AM

5 Day Dow Jones Industrials, 3 minute chart
Dow_5_day_3_minute_chart

~~~

Perfect timing by the Fed in their surprise, $200B lending:

As we have noted recently, markets have been moderately oversold, with negative sentiment high, and  disbelief in the economic recession still surprisingly widespread (Some are even claiming that the credit crunch is a myth).

The Fed action came at a time when the markets were ripe for an oversold bounce.

Before we continue, let'sd understand what the Fed actually did: Rather than merely expanding the existing Term Auction Facility (TAF), they went several steps further. They created a new credit facility, the Term Securities Lending Facility (TSLF).

Then, they empowered the TSLF to accept a broad range of private collateral -- "AAA" private mortgages in addition to those that are agency paper.

Note the quality of the paper the Fed is accepting, via a recent Bloomberg report:

"Even after downgrading almost 10,000 subprime-mortgage bonds, Standard & Poor's and Moody's Investors Service haven't cut the ones that matter most: AAA securities that are the mainstays of bank and insurance company investments.
 
None of the 80 AAA securities in ABX indexes that track subprime bonds meet the criteria S&P had even before it toughened ratings standards in February, according to data compiled by Bloomberg. A bond sold by Deutsche Bank AG in May 2006 is AAA at both companies even though 43 percent of the underlying mortgages are delinquent.
 
Sticking to the rules would strip at least $120 billion in bonds of their AAA status, extending the pain of a mortgage crisis that's triggered $188 billion in writedowns for the world's largest financial firms. AAA debt fell as low as 61 cents on the dollar after record home foreclosures and a decline to AA may push the value of the debt to 26 cents, according to Credit Suisse Group." (emphasis added)

If I read the Fed release correctly, this is the junky paper the Fed will be accepting as collateral.

Why did they do this?

-New pressures on ALL agency spreads;
-Rising mortgage rates despite FOMC rate cuts;
-Ongoing limited credit availablility;
-Dramatic widening spreads between mortgage-backed paper and US Treasuries

The good news is this will help brokers and banks; the bad news is  it will do nothing to help the Housing market, or stop the decline in House prices. Nor will it help resolve the inverted pyramid of derivatives that sits atop Housing. And, one has to believe it will only add to inflationary pressures.

No recession at any cost seems to be the Feds' philosophy in light of the latest massive cash infusion to Banks...

~~~

Watch this rally towards the end of the day. If it fades, it will be time to get crazy short . . .

20 Day Dow Jones Industrials, 3 minute chart
20_day_3_minute_dow



>

Sources:
Fed to Lend $200 Billion, Take on Mortgage Securities
Scott Lanman
Bloomberg, March 11 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=aMxbCGWcY5J0&

Moody's, S&P Defer Cuts on AAA Subprime, Hiding Loss
Mark Pittman
Bloomberg, March 11 2008
http://www.bloomberg.com/apps/news?pid=20601109&sid=aRLWzHsF16lY&

Portfolio Strategy | Crunch Mythology
Ken Fisher
Forbes 03.24.08, 12:00 AM ET
http://www.forbes.com/home/columnists/forbes/2008/0324/168.html

Tuesday, March 11, 2008 | 09:49 AM | Permalink | Comments (80) | TrackBack (3)
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Listed below are links to weblogs that reference Fed Rally on Garbage Paper!:

» 28 Days Later from Interfluidity
When the TAF program was first announced, it was billed as a temporary facility. The announcement was in December, and some suggested it was intended to help banks m... [Read More]

Tracked on Mar 11, 2008 1:29:41 PM

» Bove: Fed Rescue for Bear Stearns from The Big Picture
The Federal Reserve's actions today may have been strongly influenced by Bear Stearns' problem.-Dick Bove, Punk Ziegel Co. Go figure: This morning's announcement by the Fed seemed to be designed to help the brokers and their fixed-income hedge fund cli... [Read More]

Tracked on Mar 11, 2008 5:46:58 PM

» Why the Fed Bailed Out the iBanks from The Big Picture
This is the best explanation I have seen as to why the Fed set up the TSLF, and allowed it to accept less than stellar paper:The real problem began in late February, as several of Wall Street's biggest investment banks prepared to close their books for... [Read More]

Tracked on Mar 12, 2008 8:16:27 PM

Comments

biggest welfare queens on Wall St? i'd have to say Bear Stearns and Lehman. at least for today. they really kicked this thing off. i think it's very important that the over-paid schemers who made fortunes getting us into this mess, be bailed out by the Fed. otherwise, how will we ever get out of this mess?

Posted by: scorpio | Mar 11, 2008 10:44:50 AM

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