A Sensible and Refreshing Move from the Fed

How can I not blog today?

We had the best day of the year by far Tuesday, with the Dow up more than 400 points! In a refreshing move at unleashing much-needed liquidity into the system, the Fed announced a Term Securities Lending Facility [TLFS], which provides for a line of up to $200 billion in treasury securities against collateral from its 20 prime dealers (banks, agencies etc.) in the form of MBS and other AAA paper. What does this mean?

1) For starters, this is literally a stamp of assurance from the Fed that it will not let the MBS/ABS securities go to zilch in value (which is what the market seemed to think apparently, given the run on Financial sector shares).

2) This also means big players like Citigroup (C), Goldman Sachs (GS), Merrill Lynch (MER) and even smaller players (including troubled ones like Thornburg (TMA) and Caryle) can borrow treasury securities by providing AAA MBS paper (this includes paper sold by banks, Freddie Mae (FRE), Fannie Mac (FNM)) as collateral. They in turn can loan these treasuries to investors in return for cash... thus providing much needed liquidity to these players.

This has been by far the best move by a central agency to address the situation in a sane manner. Rate cuts won't take us far and would in turn put us in danger of stagflation. Subsidies to troubled borrowers would address part of the issue, but in a non-meritocratic way.

This brilliant move by the Fed was even more powerful since it was coordinated with the ECB, Bank of England etc., each of them providing additional liquidity building measures totaling over $45 billion. There might be some feeling this Fed move is again reactive, but no one has been successful at predicting the depths to which the MBS and ABS markets have fallen, and even the larger debt market in general. Who would have imagined economic confidence in US waning to such an extent that default swaps on German bonds start getting priced lower than that on US treasuries?? We are in an abnormal economic situation and any balanced moves by the Fed to address the liquidity crunch will help stabilize the market and bring credit and lending back on track. This would not remove credit issues but would at least provide more breathing room for the large players.

Financials were up big time, with Citi leading with a 9%+ gain. Troubled players like Thornburg also saw big upside moves. I feel most of the financials have enough momentum now to erase the near-term decline they had over the past 2-3 weeks. However, the FOMC announcement of rate cut next week might provide a damper - I don't think a sane Fed would try to appease the market with a 50 bps+ cut. This might cause short term negative momentum. I just hope the Fed plays the move along with good forward-looking commentary to ease market jitters.

In addition to the good news from the Fed, consumer confidence index measures from Germany and supply/manufacturing indices from Germany and Japan provided enough of a hint that all's not bad. Europe and Japan still seem to keep enough momentum - meaning well for most of the large global US corporations and money center banks. Bad for the dollar perhaps, since strength in Europe means the ECB or Bank of England would not be forced to come down from their hawkish rate stances. However, once the Fed controls unbridled rate cut expectations next week, the dollar should rally back to $1.45-$1.48 levels against the Euro again.

On the micro-side, if you had locked in January calls at a strike price of 25 for C early Tuesday, it's difficult to imagine you would lose money by year's end.

Disclosure: None

Comments

[Tony Soprano:]

Excellent!!!

Thanks for taking the time to blog and point out some very good facts that need to be stated. Your blog is non-emotional and unlike most blogs sticks to the facts.

Please come by the Bada Bing for a drink. I would love to have you.

2008 Mar 12 09:10 AM

[NoFate:]

Here is an analogy ...your teenager has maxed out their credit cards and is to a point they can no longer make payments. You step in as a co-signer and get the limits on the cards doubled.

Is this the right decision? This is what the Fed did for the banks yesterday.

What they should have done is "tough love." Step on their damn necks and tell them to take their proper write-downs (that are hidden on their SIVs or are still inflated due to "mark to myth").

Until there is trust and responsibility, more liquidity will not solve the problem.

2008 Mar 12 01:31 PM

[Robster:]

Freddie Mae and Fannie Mac? Oh well both debt portfolios are rubbish anyway. Your sweet smelling, rose tinted outlook for the economy is endearing. The housing market is still in decline - you need to accept that.

2008 Mar 12 02:41 PM

[Tony Soprano:]

for Mr NoFate

"Here is an analogy ...your teenager has maxed out their credit cards and is to a point they can no longer make payments. You step in as a co-signer and get the limits on the cards doubled.

Is this the right decision? This is what the Fed did for the banks yesterday."

It’s a good simple story and to a large degree I agree with your story. Here is my view of the story.

The son does use a credit card but instead of spending it on himself he wants to lend out the money and become loan shark. His idea is to lend out as much money that he can. In the mean time people that he is lending out to all live on an island. The island depends on a dike system to keep the island from going underwater. The dikes take an enormous amount of power to run. The islanders are taxed a lot to keep the power going..

The loan business is slow starting and the son wants it to grow much faster. His rich daddy is still backing him up and thinks his son is remarkable. The son's new business plan offers loan owners interest in a new waterfront country club if they barrow more. They see it as a steal and it makes them feel rich so they barrow more. His new business plan is a success for many years. The new country club is well under construction. Most of the people on the island are happy and think they have it made. The son pockets a good deal of wealth but he always wants more and more.

As more time passes, the cost of the power to run the dikes starts to increase rapidly. Sadly some of the islanders become sick. The doctors on the island suspect the Avian virus. Some even die and others cannot work. Unemployment starts to rise dramatically and the power for the dikes continues to rise.

Not all of the islanders owe money to the son. Many are still wealthy and never liked what the son has done and they are very much concerned about the rising cost to power for the dikes. More time passes and construction cost for the country club increases as well. Construction on the project starts to slow down. Many on the island start to become angry.

Taxes receipts to pay for the power for the dikes starts to diminish. Some of the islanders want to raise taxes to pay for the power. The islanders that are sick are not paying taxes. A meeting is called. The meeting is a failure and the son goes into hiding. However, the islanders come up with another plan but still many on the island do not like the newer plan as well

The newer plan requires the islanders to barrow more money but from the mainland. The wealthy on the island do not like this plan because it will require them to pay more taxes in the future. However, some of the middle class people on the island become restless and crime increases.

The islanders are at a serious crossroad. Damned if they do and damned if they don’t. Many on the island say the island will sink completely underwater if new monies are not borrowed. Others do not agree and feel the island will be on okay without the additional debt.

I’m not going to finish this story. I will let your imagination do the rest.

My point is we can let GM or Ford go under and we will still have cars. However, we cannot take this chance with the banks. Banks are the corner stone, hence the island metaphor, of our capitalism. If the banks sink we all sink. We cannot afford to take the slightest chance that this will spread further and sink us all. At the same time its a shame that a lot of our mortgage companies, brokerages firms and money center banks let this happen.

2008 Mar 12 06:35 PM

[Reinko:]

Not often you read an article written by somebody pretending to understand macro economics but who in fact is a Greenspan micro economic clone.

From the latest Federal Reserve Z1 release (never read by Promod Radhakrishnan of course) you can calculate that the entire US economy needs 4 trillion of new debt in the year 2008 in order to stay 'profitable'.

Here is a link to a light version of the Z1 release Promod Radhakrishnan:

www.federalreserve.gov...

But 4 trillion is about 30% of the gross domestic product and is far above the total profits of the entire US corporate sector...

No no, seldom you read such a dumb article with stuff like, quote:

We had the best day of the year by far Tuesday, with the Dow up more than 400 points!

Comment on the quote: It is well known that Wall Street traders neglect elementary macro economics, very likely they do not understand it...

2008 Mar 12 06:46 PM

[Reinko:]

For Tony Saprano:

Since when barrow you money instead of borrowing it?
I am from Holland and most of us live under sea level and I can tell you this: your banks are doomed no matter how much you USA folks try to barrow from fareighners.

2008 Mar 12 06:53 PM

[Ex15:26:]

Tony, that is funny stuff. I just want to know who on the islands wins the immunity idol for this week. Those darn challenges are a killer.

I like Tony's "Odessey"-like approach to posting, but I don't have the time.
Today's more sensible market action shows that someone still isn't buying what the Fed is selling. The news moved the market yesterday (and frankly it hurt my account a bit-but it's not a real loss until it's realized and it was such a nice chance to add), but now everyone has to or say.....
What has changed? -NOTHING- If the FED created another new tool (only $250 B) things must be really really bad.
I believe this is just like other rallies lately, an opportunity for me to unload some of my longer term core holdings and add more SDS, QID, SKF, and DXD.
Be careful and always use stops!

2008 Mar 13 12:01 AM

[Promod Radh...:]

Reinko, pardon my exuberance associated with a good day at the market. I just though a massive up-day after long gloomy weeks deserved some cheer.

As for macro economics, i cannot agree more with you on the fact that deficit budgets, over reliance on consumer spending and over dependence on foreign investment in treasuries and US assets won't keep the economy stable and growing for long. There are obvisouly fundamental changes required - hopefully some of that to start coming with the next government in power. However, we are not really in a time where we could/should cry over macr economic ills and the fact that a crash is bound to happen. All said, i don't hold a view that a 200 bn kitty is enough to avoid slow down or recession completely. However, we need the establishment to think forward, think positive and take steps that would smoothen the slow down and make it bearable for the economy and all of us. If we keep a prudish you-did-wrong appraoch with the money center banks, how would you expect them to lend for homes and education...and in that case, how would you expect the economy to stay resilient.

Just to recap - this single Fed move won't make for a turn of the tide. However, we need multiple steps like these to bring some sanity to the credit/fixed income markets.

Tony, likd your story :-)

2008 Mar 13 08:10 AM

[sasian:]

Ena Vathiaar.. Dont you think the time has come for.. The Physician has to Heal Himself.. The Fed has to Heal itself(and the financial system)..
Macro-Micro is not in question as much as the importance of simple ethics which crooked thinking let fall by the wayside...

2008 Mar 13 10:21 AM

[Reinko:]

To Promod Radhakrishnan.

Thanks for the reaction, I agree with you: a lot needs to be changed from the macro point of view. In principle the debt problems need to be dealt with and the size of that is already giant:

With the Z1 release in your hand and given the development of total debt over the last seven years, the US economy needs 4 trillion US$ more debt this year.

A light version would be: Pay the interest only (that is some unknown number between 2 and 3 trillion that is now borrowed and not really paid).

So in fact this credit crises is a welcome thing: It prevents building up more debt at a too fast speed.

That is what the USA, but also the UK, has to go through.
Yet you hear never anyone on this, for example that McCain republican figure only talks about lower taxes and dumb minded stuff like that. Well more debt is not the answer.
I don't think a new government will deal with the problems just like the present did not; in fact vice president Dick Cheney even has stated 'deficit's don't matter'.

At last: Don't take my words from my first comment too personnel, I am just annoyed that the discussion never goes about the real problems, not in politics and not in the media. So that has nothing to do with you as a person.

Yet it is wise to keep an eye on the Federal Reserve, her Z1 and H3 releases always bring much more wisdom than any newspaper can...

2008 Mar 13 06:37 PM