Watch What They Do, and Less on What They Say
Listen to Dr. Jeff on the Fed. Here are a few factoids to reinforce what the Fed is actually doing at present:
Fed funds have averaged 5.25% over the past five days, and 5.00% over the past fifteen, since the crisis began. The Fed’s last permanent injection of liquidity was May 3rd. That’s a pretty long time for no injection, even in a tightening cycle. The monetary base is flat, growing little over the last year. If policy changed recently, I can’t see it. Policy change doesn’t show up in the monetary aggregates either, but lag effects dominate here. We won’t know about discount window borrowings until this evening, but I don’t expect much 3 month LIBOR is back around 5.60%, and the 3-month T-bill around 4% (rallying today). A TED spread at 1.6% indicates a lot of fear. Kinda surprised that swap spreads have not budged much.
In summary, the Fed hasn’t done much yet, aside from loosening up leverage requirements for some of the big banks, and allowing low quality collateral to come to the discount window. Though I don’t want the Fed to loosen, I don’t think they have much choice here. I expect an ordinary announcement by the end of the year cutting the Fed funds target.
After that, I was pleasantly surprised to find that Calculated Risk and Econbrowser agreed with me. Good company to be in. After the close today, I wasn’t surprised to find that the discount window moves still haven’t done much. Everyone will be listening to Bernanke tomorrow, but he won’t give any policy cues, most likely. He has charted out a different course than the one Greenspan took; the hard question is whether he can maintain a policy of limited liquidity in the face of deteriorating conditions, and avoid the charge of favoritism, or, sloppy bank solvency management. After all, credit is offered to few parties, and solvency rules are getting bent for the biggest banks. That said, his tactics are more in line with the pre-Greenspan era. But as this goes on, the commercial paper world shrinks for the third straight week, mainly due to the collapse of ABCP.
Looking around the world, there are a variety of news bits:
- The Bank of England lends 1.6 billion pounds at the penalty rate of 6.75%. Barclays plc was the borrower, again, supposedly over a clearing mess-up. I am feeling more edgy about my Barclays stock. Repeated problems in clearing should not happen, particularly during a period of market stress.
- Cheyne Finance begins a partial wind-up of its operations. Amazing what what happens when liquidity is no longer cheaply available to finance assets. This also points up the difference between ABCP sponsored by a bank, where they might bail it out to preserve relationships (as with the Development Bank of Singapore), and sponsorship from a hedge fund, where the balance sheet can’t fix the problems, even if they wanted to.
- With all of the fixed-income assets that Chinese banks have taken out of the US, is it any surprise that they took down a significant slug of subprime ABS? I know from experience; new fixed-income investors tend to be more trusting of complexity than more experienced investors. Failure brings maturity, and risk-based pricing.
- See Yen run. Run Yen, run. Amid all of this stress, we may have the slow unwind of the carry trade. It has not become a rout yet, but who can tell. I am still a bull on the yen, but I have no positions there.
- Amid the lack of liquidity in the US markets, foreign firms seeking debt capital go elsewhere. Gerdau, the Brazilian steelmaker, seeks a international syndicated loan deal, rather than a deal in the US bond markets. Just another sign of the times. If you want to have a strong capital market for foreign entities, you must keep your domestic markets functioning, and that the US has not done.
Closer to home, State Street has certainly had its difficulties with an underperforming short-term bond fund, and their own relatively large exposure to ABCP conduits. Aside from the reputational hit, it’s possible that State Street won’t suffer too much damage from the conduits, they may be financing assets of good quality.
So why conduits? It allowed banks to do more business, while keeping it off of their balance sheets, thus maximizing their returns on assets and equity. The banks may offer liquidity to the conduits during hard times, which brings some of the problems back during a crisis.
As a final note, all of the credit stress has led banks to tighten credit standards, and has limited the ability to finance first mortgage and home equity loans. So where do strapped consumers go? Credit cards. This can last for three to six months, but eventually the credit gambit will end in a trail of losses for all lenders involved, particularly those who have low or questionable security.
Full disclosure: long BCS