Fed Rally on Garbage Paper!
5 Day Dow Jones Industrials, 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
>
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
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» 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
Thank you Ben. I had been in a bit of a funk as I dont like one way markets, but lo! a fed induced counter trend rally. It took all of 30 seconds this morning to put on a fresh faced short position. Now to do the dishes and the vacuuming.
Posted by: cathompson | Mar 11, 2008 10:49:38 AM
Crazy Short? An end of day fade could set up a week that leads to Black Monday v 2.0.
Posted by: Byno | Mar 11, 2008 10:49:39 AM
Idunno much about high finance, but it seems like this TSLF is just one big washing machine, designed to clean the banks' and insurers' books with American citizens' taxes. Consider that this news comes (not only perfectly timed for the market, as Barry points out) the same morning (as Dick "Dick" Cheney is in Saudi begging them to increase output) as this: "Moody's, S&P Defer Cuts on AAA Subprime, Hiding Loss". Good thing! -- if they had cut the ratings, they wouldn't qualify as TSLF collateral!
http://www.bloomberg.com/apps/news?pid=20601109&sid=aRLWzHsF16lY&refer=home
Posted by: CT | Mar 11, 2008 10:52:08 AM
This move by the Fed has desperation written all over it.
Posted by: dwkunkel | Mar 11, 2008 10:53:11 AM
I am curious. If pledged collateral declines in value, who recognizes the loss? Is this not but a mechanism to postpone the inevitable?
Posted by: Barley | Mar 11, 2008 10:53:53 AM
Does this mean they are only going to cut rates by 50 basis points next Tuesday?
Posted by: GRL | Mar 11, 2008 11:00:07 AM
It was really comical to see both the Bloomberg stories on one page (one announcing the Fed's willingness to accept private-label AAA MBS, and the other pointing out much of it doesn't deserve the AAA.)
Of course, the Bloomberg article on the Fed move didn't even make note of their own article on ratings. Duh.
Posted by: Bob_in_MA | Mar 11, 2008 11:12:37 AM
It's always been about helping the brokers and banks. Does anyone really believe they care about homeowners? It's all smoke and mirrors to keep everyone stupid. The rate cuts weren't about reducing mortgage rates, but rather, to allow the B & Bs to extrecate themselves from their wrong way bets. Lending long and borrowing short wasn't working when the yield curve wasn't steep enough. Look at the curve today.
Posted by: SPECTRE of Deflation | Mar 11, 2008 11:20:35 AM
Crazy short? I’m already crazy short; in fact I added some FXP this morning when it was down 13%.
IMO, this is just another Fed induced counter-trend, sucker’s rally. The Fed action will only postpone the inevitable by a few days or weeks.
There is much more bad financial news coming,
Warnings and losses from investment banks this month.
A smaller rate cut on the 18th – ½ instead of ¾.
Perhaps a failure or two in hedge funds or a regional bank, more margin calls, a municipality filing for bankruptcy, etc.
It is almost certain that some of these things will occur and the fear level will rise again.
And that is just financial news, just think of all the bad economic news we will be seeing in the coming weeks and months – job losses, inflation or deflation, etc.
If you are short, stay the course. Don’t them let scare you out of your positions.
If you need encouragement read Roubini or this article at Marketwatch.
http://www.rgemonitor.com/blog/roubini/248801
http://www.marketwatch.com/news/story/derivatives-new-ticking-time-bomb/story.aspx?guid=%7BB9E54A5D%2D4796%2D4D0D%2DAC9E%2DD9124B59D436%7D
Posted by: KJ Foehr | Mar 11, 2008 11:21:22 AM
Barry,
You are hitting 'em hard this morning. Another great story.
I'm not a finance guy, so, anybody reading please jump in as needed...
This looks like the Fed is "buying" up bad paper before it gets downgraded in a containment move. The Fed will keep the true effects of the bad paper from being felt.
However, since the Fed is not actually "buying" the paper, and instead is merely extending the loan period of it, they can strip out and "write off" all the bad bits, and repackage any part of it that is indeed worthy. Or, simply disappear the lot.
It would seem that getting rid of the M3 report makes something like the above _a lot_ easier to slip past most people.
Posted by: Mike Nomad | Mar 11, 2008 11:26:00 AM
I'm sure glad all these banks and securities firms - the TAF and TSLF beneficiaries - that are so desperately in need of capital are paying big dividends (i.e. desperate attempt to keep themselves in the dividend indices) and are paying big management bonuses...
...cuz they so afraid to lose all this financial "talent" to other firms? Which other firms? The other firms that are also so afraid to lose their under-performing talent? Those "smart-money" SWF's that bought Citi at 30? To the "Fed?"
Four things to do: 1) stop letting these corporate managements prevent investor agitation 2) Pay bankers future bonuses in the financial product they create 3) Shut of the TAF, TSLF et al. money spigot(s) to these dividend paying banks and 4) raise Fed funds rates.
Posted by: VennData | Mar 11, 2008 11:29:35 AM
A band-aid.
The beginning of the downturn.
Posted by: Rod | Mar 11, 2008 11:31:01 AM
Here is a waaaay cool infoporn chart of AAA bonds in the ABX issue:
http://www.bloomberg.com/apps/data?pid=avimage&iid=iQUy2GaasArs
Posted by: Will T | Mar 11, 2008 11:32:00 AM
Of course, the Bloomberg article on the Fed move didn't even make note of their own article on ratings. Duh. Bob in Mass.
--
Funny. Rule 1 for weathermen (courtesy of Don Kent of WBZ, Boston): look out the window before you give your forecast. Rule 1 for reporters: read your own @#$%^ publication before you start typing.
Posted by: Douglas Watts | Mar 11, 2008 11:32:50 AM
How does the Fed "write off" the bad paper? Somewhere we write off the bad paper and will pay for it via increased comodity prices and higher taxes. I do not think this works at all since much of this toxic paper is held by hedge funds, towns in Norway, etc. The Fed cannot backstop all of it and as a result the unwind will continue sans some banks that the fed has backstopped. The recession/depression (depends on your job situation and neighborhood) will continue as well except that the Fed is 200 billion poorer and with fewer options. Way to go Ben!
Posted by: larster | Mar 11, 2008 11:37:38 AM
Why is it that bullets bounce off Superman's chest but when you throw the empty gun at him, he ducks?
Posted by: Ross | Mar 11, 2008 11:38:14 AM
Barley's "I am curious. If pledged collateral declines in value, who recognizes the loss?"
The Fed. Thanks for asking.
---
If there is an end of day fade I think it will be countered by a new rumor... Gotta end the week flat, at minimum.
Posted by: mhm | Mar 11, 2008 11:41:12 AM
Why did they do this?
Raw display of power to show 'free market' traders who runs things.
I told you they'd be buying everything soon. I wonder how long it will be before they start buying shares straight off the market instead of just through liquidity proxies
This won't end until people stop accepting US dollars and most people still have no clue the true value of their paper dollars
Posted by: DavidB | Mar 11, 2008 11:43:15 AM
Our credit markets are finally a complete and accurate variation of a good ole fashion ponzi scheme built on fraudulent misrepresentation of debt. We all know it.
"No recession at any cost seems to be the Feds' philosophy in light of the latest massive cash infusion to Banks"
Man is this going to end in tears.
Posted by: Stuart | Mar 11, 2008 11:45:17 AM
I think it should be clarified, the Fed isn't assuming the losses on this paper. They are just providing a way for dealers to make it liquid so the financial system doesn't get stuck in a margin call spiral. These dealers can't just give the paper to the fed if it defaults, they are still responsible for the debt. Also, the fed has been sterilizing these injections, which means when they lend out new money, they withdraw it from somewhere else. So this shouldn't affect inflation at all, except in the knee-jerk reaction by commodity specs.
Posted by: Roo | Mar 11, 2008 11:47:20 AM
"the bad news is it will do nothing to help the Housing market, or stop the decline in House prices."
Barry - Why is it bad news that the Fed isn't propping up house prices? Deflating the housing bubble is a good and necessary thing, n'est-ce pas?
Posted by: mappo | Mar 11, 2008 11:48:32 AM
I guess they did this because Goldman barked yesterday and if you don't jump when Goldman barks you could wind up with prostitutes in your bed on the front page of the NYT
Posted by: DavidB | Mar 11, 2008 11:54:46 AM
And we're descending back to base camp...nice, with all the oxygen.
Posted by: Jay | Mar 11, 2008 11:56:47 AM
Roo is absolutely right. The Euro gave back a week's worth of gains on the announcement digestion, and commodities look flat overall -- I think this is a clear sign that the FED is not going to cut as much as anticipated and the currency and commodity markets have figured out as much.
The real panic will come when people realize that this is not a liquidity issue but a solvency issue, and I think we are very close to that point.
Posted by: mikkel | Mar 11, 2008 11:58:18 AM
