Fed's Strategy to Halt Debt Meltdown is Not Working

In yet another attempt to to halt the global debt meltdown now in progress, the Fed Lowered the Discount Rate and Expanded Lending to Primary Dealers in an emergency weekend meeting.

In its first weekend emergency action in almost three decades, the central bank lowered the so-called discount rate by a quarter of a percentage point to 3.25 percent.

The Fed also will lend to the 20 firms that buy Treasury securities directly from it. In a further step, the Fed will provide up to $30 billion to JPMorgan Chase & Co. to help it finance the purchase of Bear Stearns Cos. after a run on Wall Street's fifth-largest securities firm...

"It is a serious extension of putting the Federal Reserve's balance sheet in harm's way," said Vincent Reinhart, former director of the Division of Monetary Affairs at the Fed and now a scholar at the American Enterprise Institute in Washington. "That's got to tell you the economy is in a pretty precarious state. We learned that Bear Stearns's balance sheet on close examination was worth a 10th of its market value," said Reinhart.

Yesterday's events are "nothing like the 1970s, which was about fighting inflation," said David M. Jones, a former New York Fed economist. "This is fighting a negative, self-reinforcing process" of sliding collateral values, tighter bank credit and weakening of economic conditions, he said.

Nothing Like The 70's

Nothing like the 70's is right. Here is proof.

Yield Curve As Of March 16, 2008



click on chart for sharper image

Are short term interest rates at 1.16% (and falling) indicative of stagflation? Certainly not. You can kiss stagflation theories goodbye on the basis of the above chart. Somehow the myth persists.

Primary Dealer Credit Facility

Here is the Federal Reserve press release announcing the Primary Dealer Credit Facility.

The Federal Reserve has announced that the Federal Reserve Bank of New York has been granted the authority to establish a Primary Dealer Credit Facility [PDCF]. This facility is intended to improve the ability of primary dealers to provide financing to participants in securitization markets and promote the orderly functioning of financial markets more generally.

The PDCF will provide overnight funding to primary dealers in exchange for a specified range of collateral, including all collateral eligible for tri-party repurchase agreements arranged by the Federal Reserve Bank of New York, as well as all investment-grade corporate securities, municipal securities, mortgage-backed securities and asset-backed securities for which a price is available.

The PDCF will remain in operation for a minimum period of six months and may be extended as conditions warrant to foster the functioning of financial markets.

Facility Failures

• The TAF (Term Auction Facility) failed to restore liquidity.
• The TSLF (Term Securities Lending Facility) failed to restore liquidity. See The Fed's Swap Meet for more on the TSLF.
• The PDCF (Primary Dealer Credit Facility) will be the next "facility" to fail.

Bear Stearns Implodes

The Fed's emergency weekend actions above are all part of a failing effort to contain the fallout from the demise of Bear Stearns. On Friday Bear Stearns was worth $30 a share. Sunday evening Bear Stearns was worth $2 a share as PUT Buyers Celebrate Bear Stearns' Demise.

However, to get JPMorgan to commit to the deal, the Fed has agreed to fund up to $30 billion of Bear Stearns’ less liquid assets.

The stated book value of Bear Stearns last Friday was $80 billion. My quick math shows the actual book value of Bear Stearns was as little as -$28 billion taking into account Fed guarantees. That should put some new meaning to the term "Marked To Market".

Think all that debt on the books of Lehman (LEH), Morgan Stanley (MS), Goldman Sachs (GS), Citigroup (C), Merrill Lynch (MER), Bank of America (BAC), etc., is worth what is claimed? Think again. More revaluations are coming.

Comments

[crashof2008:]

I am filming a documentary entitled "The Crash of 2008". Portions of
what will be used in parts of the film are now available at:

www.youtube.com/user/C...

I was a market maker in derivative securities and have read hundreds of
research papers published by individual Federal Reserve branches. I
found the most informative ones to be from Kansas City and Atlanta.

Additionally, I have reviewed scores of research papers by various
Federal Reserve branches prior to publication.

Matt Dubuque
The Crash of 2008

2008 Mar 17 11:32 PM

[Manifestor:]

I don't see any disclosures from the author. To quote Trader Mark in seekingalpha.com/artic...

"Amazing what the power of rumors is doing in this market. Some powerful hedge funds who have the ears of journalists must be making some huge dollars in this era, simply by betting short and starting worst case scenario rumors. Anything to make a buck... not that they'd do anything like that (ahem)" ...

summarizes very well the situation here. I would add internet bloggers in addition to the journalists mentioned in the above quote.

2008 Mar 18 12:30 AM

[ballsschweaty:]

Just watch what the market does after today's 100 basis point cut in Fed Funds. I hope you're aggressively short the stock market.

2008 Mar 18 08:42 AM

[jimmy46:]

I don't agree that this move will fail.
The previous actions pumped money into the markets,
but it went into commodities.
The current action specifies debt securities that have
been illiquid.
This increase in liquidity will help greatly,
especially companies like TMA that borrowed
short to lend long.

2008 Mar 18 12:35 PM

[snakyjake:]

I didn't understand why you don't see stagflation? I live in an area where the housing market hasn't crashed and employment is still strong. What I do notice is that prices have gone up on everything. For me, I feel inflation and growth dramatically slowing down.

2008 Mar 18 12:54 PM