Added Liquidity Part of the Problem, Not the Solution 16 comments
-
Font Size:
-
Print
- TweetThis
This is mostly the result of my efforts trying to make sense in my own head of what has been happening for the past few dizzying weeks. Some parts are nothing more than my own guesswork. All are based on public info I've been reading. I decided to share it here hoping readers could help put together a better picture. Critiques and alternate explanations are sincerely welcome.
1. First of all, it's clear that the latest round of the crisis, starting with the Fannie (FNM) bailout and Lehman bankruptcy, is different from the Bear Stearns crisis in March. Bear's was first and foremost a liquidity crisis (there was a serious capital issue behind it but that was not the direct trigger). Fannie and Lehman failed not for lack of liquidity, but due to capital insolvency. Fed data show that Lehman never went to the discount window to get liquidity. Fannie, Freddie (FRE), and Lehman fell because the market had decided they were insolvent, thus refusing to extend any credit or do any business with them.
This is a subtle but important distinction. The fact that Fannie, Freddie, and Lehman failed despite plenty of available liquidity from the Fed proves beyond doubt that all the liquidity-based emergency measures by the Fed and other central banks, including the $630B from the Fed last Monday, were wrong-headed. Besides not solving the problem, in fact they created a false sense of security. In retrospect, if the Fed didn't open up the discount window to investment banks and bail out Bear Stearns, maybe Lehman would've been scared into de-levering much more aggressively.
2. The underlying trigger this time is not subprime. Subprime and Alt-A mortgages are to a significant degree known problems, thus not capable of triggering another round of panic and crisis. The current trigger is the prime mortgage market. This is evidenced by the sudden collapse of Fannie and Freddie. They had little exposure to subprime or Alt-A. Yet their delinquency rates shot up in August. This forced the market to reevaluate its assumptions about prime. If you've experienced an earthquake, you know how it feels when the assumption that the ground beneath your feet is solid and stable is no longer valid. You stop taking anything for granted. You re-examine everything. You panic.
3. The report of interbank lending seizing up has been greatly exaggerated. Libor rates, as quoted in London, have indeed been very high for the past two weeks. So have interbank rates in New York at 11a.m. But the New York overnight repo rate has been very close to 0 for the last week. What does this mean? It's the European banks that have been in trouble lately. US banks, buried to the eyeballs with the massive liquidity injection from Fed and knowing their counterparts in the US are in the same ironic dilemma, are quite willing to lend out the cash for some return, no matter how small.
This ironic dilemma faced by US banks, even before the Bailout Pork Package, is yet another proof of the ills of the Fed's wrong-headed rescue.
Does this present arbitrage opportunities? Surely it does, and with it comes the danger of contagion, this time from Europe. We shall see this week how it plays out. For now, the Libor has become little more than a symbolic benchmark (well, except for those paying for debt indexed off Libor). Interbank lending in Europe has seized up and become irrelevant since banks could go to their central banks, or to the Fed, through some arbitrage channel.
By blindly providing liquidity (as opposed to capital), central banks of the developed world have made credit risk irrelevant. It's a panic response to the panic. Whereas the original panic valued credit risk at infinity, the panic response made (temporarily) credit risk 0 -- but only for banks, the privileged few direct recipients of liquidity injections.
Will this massive pile of short-term liquidity cash trickle down the money supply chain?
Not a chance until the banks have capital relief, which is the real problem. They cannot use the short-term cash to expand the asset side of the balance sheet. Would they trust each other any better? No, they know all this impressive-sounding short-term cash doesn't solve the problem for their counterparts, just as it doesn't for themselves.
But I say this hold-up of cash at the top-end of the money supply chain is actually a good thing. Some people are suggesting lowering capital requirements, as opposed to temporary relief from mark-to-market and some sensible form of capital injections (of which the Bailout Pork Package is not), should be the fix.
Couple that with the massive liquidity now available and guess what will happen? Banks would be out on a shopping spree for all kinds of junk. It'd be Credit Crisis 2.0 before you know it.
The Fed must suck out the senseless excess liquidity, and fast, before Paulson starts using his infinite power and swapping cash (capital cash, that is) for junk.
Disclosure: None
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
David Fry
-
2
TraderMark
-
3
Don Dion
-
4
Cliff Wachtel
-
5
Mike Havrilla
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 16 comments:
Wait! We've done this before.
*
Excellent!
the inmates run this asylum....don't expect competence.
"Finally someone tells the truth....Fannie & Freddie were not buying subprime...they a buy only A and very little alt-A. Any mortgage lender will tell you that."
They were the *first ones in*!!! When the Clinton admin began its push for wider homeownership, the pressure was on the banks to lend regardless of creditworthiness. Once they began piling up these loans under pressure...the banks wanted them off their balance sheet and began pushing back for the ability to sell them off to F&F.
Over a year ago, it was noted that F&F had over 6% of their capital in subprime debt:
www.marketwatch.com/ne...={039A6514-2144-4BC7-B...
Get your facts right.
www.marketwatch.com/ne...?
guid={039A6514-2144-4B...
You might have to copy and paste it together.
Here's the first few paras:
[quote]
SAN FRANCISCO (MarketWatch) -- Fannie Mae and Freddie Mac could have $4.7 billion in unrealized losses from the deterioration in subprime mortgages, Citigroup's fixed-income strategy team estimated on Friday.
The bank's strategists said that probably won't be a big problem and argued that recent moves in the credit-derivatives market suggesting Fannie (FNM) and Freddie (FRE) are more risky have been overdone.
The estimated $4.7 billion in losses represent about 6% of the equity capital of the government-sponsored mortgage-finance giants, the strategists noted, adding that Fannie and Freddie's retained portfolios contain roughly $182 billion of subprime bonds, most of which are rated AAA.
By contrast, their total mortgages exposure is pegged at more than $3 trillion. Most of this is related to prime mortgages, which is supported by the fact that delinquencies in their guarantee portfolios have not increased so far this year, Citigroup said.
[end quote]
Note that this is over a year ago, and losses have mounted steeply since then, ending with the bailout of Fannie and Freddie.
No subprime at F&F???
Banks are flooded with cash. But such short-term liquidity cash is of no use to most of them. What they need is capital injection. How many will fail before Paulson gets around implementing the bailout plan? It would've been so much faster if the government would follow Buffet's GS model.
online.wsj.com/article...
A good point, though, that this has been spreading to prime for some time.
-- it would've been funny if it weren't so sad."
Oh don't worry...Section 110 of the bailout legislation allows a "federal housing manager" to dictate terms of a rewrite to a mortgage -- i.e. they can tell the lending institution that they need to lower the principal on a given mortgage. That's just about as good as lending directly -- the feds become the housing market...they decide the pricing. Kiss free-market economics goodbye, my friends!! Unless...we discard *EVERY* Congressman and Senator who voted for this pile of crap bill...send 'em ALL packing -- the new ones will then understand that order of business # 1 is to revoke the bailout bill and let FREE MARKETS work!!!
We REALLY need to be unified on this and make it happen!!!