Analysts Weigh In About the Fed and the Economy

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Includes: BAC, C, JPM, WFC
by: Michael Panzner

In the "The Bone Rattler," I discussed that rare breed: analysts who are allowed to speak the truth about what is going on in the financial world.

When it comes to the "blogosphere," however, there are no small number of knowledgeable and talented individuals who are not only capable of holding their own against the best that Wall Street has to offer, but who are not constrained by the securities industry's inherent conflicts of interest.

Among those who have long been chronicling the excesses, abuses, absurdities, and disastrous consequences stemming from an era of bubble and house-of-cards building is Mike "Mish" Shedlock. He publishes a blog, Mish's Global Economic Trend Analysis, which is one of my daily "must reads."

In "Now We Know Who and Why," Mish sees right through the likely Fed-orchestrated dog and pony show intended to show that everything is back to normal after the upheavals of recent weeks.

This story begins with "Unusual Statements by Major Banks" made August 22 so let's start there.

Citigroup Inc. (NYSE:C), JPMorgan Chase & Co. (NYSE:JPM), Bank of America Corp. (NYSE:BAC) and Wachovia Corp. (NASDAQ:WB) each stressed they themselves have "substantial liquidity" and the ability to borrow money elsewhere.

In a joint statement, the latter three said they decided to borrow directly from the central bank to demonstrate "the potential value of the Fed's primary credit facility" and encourage its use by other banks.

"The companies believe it is important at this time to take a leadership role in demonstrating the potential value of the Fed's primary credit facility and to encourage its use by other financial institutions," their statement said. The three added that they hoped their actions would "promote broad acceptance of the use of the facility.

In Brave Face Masks Bold Lie I offered an opinion:

This is either blatant stupidity or a bold face lie. I believe the latter. How can one "restore liquidity" by borrowing money that one supposedly does not need? The statement makes no sense.

As for Citigroup, what exactly does borrowing money "on behalf of its clients" mean? What clients? Who is in trouble here?

By making this look like a respectable thing to do (it's not), it likely covers up the likely fact that someone is in trouble. [italics mine] Inquiring minds might no be saying "Mish, you are talking conspiracy." Of course I am. But like most conspiracies this one is in plain sight. We simply do not have all the i's dotted and t's crossed in regards to the details.

A well respected source whose opinion I respect offered this viewpoint anonymously: "Basically this is a PR move coordinated by Fed to hide the fact that going to window is emergency move. It hides the fact that some banks have to.

Now We Know Who And Why

Citigroup's "client" was Citigroup itself. It needed the money for Citigroup Global Markets, a brokerage subsidiary. And because of restrictions, Citigroup could not borrow from the discount window for that subsidiary. But those restrictions were lifted as the Fed bends rules to help two big banks as the following story shows.

If the Federal Reserve is waiving a fundamental principle in banking regulation, the credit crunch must still be sapping the strength of America's biggest banks. Fortune's Peter Eavis documents an unusual Fed move.

In a clear sign that the credit crunch is still affecting the nation's largest financial institutions, the Federal Reserve agreed this week to bend key banking regulations to help out Citigroup (C) and Bank of America (BAC), according to documents posted Friday on the Fed's web site.

The Aug. 20 letters from the Fed to Citigroup and Bank of America state that the Fed, which regulates large parts of the U.S. financial system, has agreed to exempt both banks from rules that effectively limit the amount of lending that their federally-insured banks can do with their brokerage affiliates. The exemption, which is temporary, means, for example, that Citigroup's Citibank entity can substantially increase funding to Citigroup Global Markets, its brokerage subsidiary. Citigroup and Bank of America requested the exemptions, according to the letters, to provide liquidity to those holding mortgage loans, mortgage-backed securities, and other securities.

So, how serious is this rule-bending? Very. One of the central tenets of banking regulation is that banks with federally insured deposits should never be over-exposed to brokerage subsidiaries; indeed, for decades financial institutions were legally required to keep the two units completely separate. This move by the Fed eats away at the principle.

Sure, the temporary nature of the move makes it look slightly less serious, but the Fed didn't give a date in the letter for when this exemption will end. In addition, the sheer size of the potential lending capacity at Citigroup and Bank of America - $25 billion each - is a cause for unease.

Indeed, this move to exempt Citigroup casts a whole new light on the discount window borrowing that was revealed earlier this week. At the time, the gloss put on the discount window advances was that they were orderly and almost symbolic in nature. But if that were the case, why the need to use these exemptions to rush the funds to the brokerages?

Don't forget: The Federal Reserve is in crisis management at the moment. However, it doesn't want to show any signs of panic. That means no rushed cuts in interest rates. It also means that it wants banks to quickly take the big charges that will inevitably come from holding toxic debt securities. And it will do all it can behind the scenes to work with the banks to help them get through this upheaval. But waiving one of the most important banking regulations can only add nervousness to the market. And that's what the Fed did Monday in these disturbing letters to the nation's two largest banks.

The above story was not released until 4:40 EDT on Friday (long after the market closed).

Someone is dotting some i's, and crossing some t's.

Flashback to August 20, 2007

The Fed Board of Governors wrote to Patrick S. Antrim, Assistant General Counsel Bank of America Corporation allowing an exemption from section 23A of the Federal Reserve Act Regulation W so that Citigroup could borrow money for Citigroup Global Markets.

Notes: The Fed servers have been blasted with people attempting to read that PDF and it can freeze up your system (it did mine) while attempting to get through. If it was a text doc I would snip it, but it is a big image scan of not tremendous resolution. Eventually I got through. Firefox users may want to try opening that in IE so you do not lose all Firefox windows.

Massive Exemptions

The Wall Street Journal article Citigroup Gets Fed Help on Using Discount Window has most of the information in easy to understand terms.

The Fed, in a letter sent to Citigroup Monday, exempted it from the limit on how much its bank unit, Citibank N.A., can lend to its affiliated broker-dealer, Citigroup Global Markets. In the letter, the Fed said it would permit Citibank to lend up to $25 billion to “market participants in need of short term liquidity to finance their holdings of certain mortgage loans and related assets,” and it could channel the transactions through Citigroup Global Markets in the form of offsetting repurchase agreements, which are short-term loans secured by financial assets.

On Wednesday Citi, J.P. Morgan Chase & Co., Bank of America Corp. and Wachovia Corp. each said they had borrowed $500 million from the discount window. A spokeswoman for Citigroup declined to comment on the bank’s request for the exemption and its approval. Both J.P. Morgan and Bank of America have received similar exemptions, people familiar with the matter said.

New Rules

Early Friday, long before this story was widely reported elsewhere Minyanville's Mr. Practical was commenting on the Fed's rule changes.

New Rules

The Fed is changing the rules of finance faster than the average man can think. The discount window in the past, borrowing directly from the Fed, has been like going to the emergency room. It has been a place of last resort for sick banks. Now the Fed wants (needs) to make it the place where everyone goes.

First, they lowered the [discount] rate. Then they changed the collateral they were willing to take from pristine treasuries to riskier assets, the assets that every bank now is stuffed with. Today they made a change that removes further restrictions in the source of collateral.

Essentially the Fed is trying various means to get credit (liquidity) to banks that are seizing up because the market does not want to give it to them. The more risky the assets the Fed is willing to accumulate, the more markets become nationalized: the government itself making credit decisions.

Stay tuned for more new rules as the Fed desperately plugs the holes in the dike that keep popping up.

Thanks Mr. Practical. But the cracks keep getting bigger and bigger and there is no way to contain them. I am still expecting the next big shoe to drop: Commercial Real Estate as discussed in the closing remarks of Foolish Concerns, Foolish Optimism, Foolish Logic. There is another big shoe to drop too, and that shoe is jobs.

Bernanke has his hands full and there are simply too many crack to plug. He will fail.

Unfortunately, I agree.