In Globally Contained Liquidity Crunch I pointed out that the Fed was providing temporary loans (as repos) not capital to the markets. While true I missed something. What I missed involves the collateral the Fed is willing to take for those short term loans.
Mr. Practical was right there with The Fed's Path.
It has now become obvious to me the path of the Fed. No, Mr. Bernanke is not going to be tough on markets. He is not going to give the medicine that is needed. He has chosen his path, the seeds of which were planted in his November 2002 speech about monetization (dropping dollars from helicopters).
The Fed today injected $65 bln of repos, extending credit to banks to shore up their liquidity needs. Normally the Fed only accepts treasuries as collateral. But the banks no longer have enough treasuries, or they don't want to sell their "safe" assets in exchange for credit. But they do have lots of risky assets like CDOs that everyone wants to get rid of. The Fed bent over and today announced they will take those "off their hands".
This is alchemy finance in its truest form. All it will do is stave off the inevitable and make it worse when it happens.
Read that last sentence again. This is the same mistake Japan made.
Credit Addicts On Withdrawal
Central Bankers worldwide have now all panicked in unison. And the stock markets are not even down 10% from the recent highs. The DOW is still up on the year. This means they central bankers are really spooked. And this sure as hell is not an inflation scare.
Kevin Depew on Minyanville was talking about Credit Addiction in points 1 thru 5 of "Five Things". Let's take a look at point #4: Like All Enablers, They "Didn't Know".
* As recently as Tuesday the FOMC warned of the continuing risks of inflation.
* The European Central Bank, in its monthly report noted in Number 3 actually said its monetary policy is still "on the accommodative side."
* Yes, that's the same report that was released a day after the ECB injected a record amount of liquidity into the banking system.
* A day after the Bank of Japan, which maintains it has successfully defeated its bout with deflation, pumped 1 trillion yen into the money market in coordination with the U.S. and European central banks.
* So what's next? The same thing that happens whenever any junkie reaches the end of the ability to expand his or her addiction.
* A deflationary cutback.
* What does it mean for a junkie to enter a period of "deflationary cutback"?
* Well, consider for a moment how an addiction begins. Ordinary, normal people in the early stages of addiction are typically able to service both their habit and their outside obligations - family, work, etc.
* In the final stages of addiction, all those obligations - to family, to work, to friends - are sacrificed in order to service the addition.
* If the addiction is to credit/debt, then everything must be sacrificed to service that debt. The ability to expand the addiction has concluded.
* We know what happens next: enabling (and the negative consequences) or (real) intervention (kick the habit).
* Neither are pretty, which is what makes the choice between the two so hard.
* Until the end, even among friends and family, the path of least resistance is to enable the addict.
The Credit High Has Worn Off
Bloomberg is reporting Central Banks Add Cash to Avert Crisis of Confidence.
The Federal Reserve, in a second day of action in concert with the European Central Bank, provided $38 billion of reserves and pledged further funds "as necessary," in a statement unprecedented since the aftermath of the Sept. 11, 2001, attacks. The European Central Bank loaned 61.05 billion euros ($83.6 billion) after injecting a record amount yesterday.
In the U.S., the federal funds rate opened at 6 percent, the highest in six years. The rate, which normally fluctuates around the Fed's target, fell to 5 percent after the New York Fed bought assets including mortgage-backed securities in three operations over a six-hour period. The $38 billion was the highest amount of temporary funds since Sept. 12, 2001.
Today, the Fed said in an unscheduled statement that it will add money to the system as needed to steer the federal funds rate "close to" the 5.25 percent target. Officials also noted that direct loans through the Fed's discount window are available "as always."
Countrywide Financial Corp., the biggest U.S. mortgage lender, today said it faces "unprecedented disruptions" that may hurt profit. Countrywide won't be able to sell as many of its loans as expected because investor demand has dried up, the Calabasas, California-based company said. NIBC Bank NV in the Netherlands posted losses from U.S. credit investments.
Countrywide is hooked on "credit crack". They continuously need more of it. I talked about Countrywide (CFC) last week. The overnight gyrations of CFC (gapping down to $24.76 and recovering all the way back up to $28.08 before settling at $27.86 down about 2.8% perhaps tells a story. If so what is that story? Is the Fed accepting mortgage backed garbage from CFC as collateral?
Gold was up on Friday, perhaps in response to Bernanke's three repo actions accepting mortgage assets that no one else wants as collateral. Then again perhaps gold was responding to something else (which is why one must be cautious about such casual correlations). Nonetheless the 24 hour chart from Kitco was interesting.
The above chart is thanks to Kitco and is a snapshot taken 16:41 EST on Friday August 10. Whether or not gold was acting the way it did because of Bernanke's panic is hard to say. What's easier to say is that is how we should expect gold to behave if the Fed is willing to take toxic waste as collateral for temporary loans.
But enabling addicts (which is what the Fed is doing) is morally wrong. See High Rate CDs and other Moral Hazards for more on that topic.
And the thing about addiction is that over time it takes stronger and stronger doses to achieve the same high. In 1980 it took $1 in debt to add $1 to the GDP. Today it takes closer to $7 or $8 in debt to add $1 to GDP and that of course presumes one believes today's GDP figures.
The problem with such addiction is that stronger and stronger doses eventually kills the patient. This is where we are today. Some junkies (consumers) have finally realized this on their own accord, most far too late to do any good, as debt has already hollowed out their livelihood just as heroin would have done. Some dealers (banks and brokerage houses) have belatedly realized the same thing and have stopped extending credit to credit junkies. A violent withdrawal is now underway. An enabling Fed is attempting to halt this "credit withdrawal" but as Succo suggests, the Fed is fighting a losing battle.