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EJ
08-23-07, 06:58 PM
http://www.itulip.com/images/bendove.gifBernanke: Talks the Dove, Acts the Hawk

On the Goldman Sachs client call last week, we heard ex-Fed governor Larry Meyer intone that the Fed intended to stop the credit bubble collapse using the discount window in new and creative ways, providing liquidity selectively without lowering the Fed funds rate and flushing the whole system with money, Greenspan-style.

We have long wondered how the Bernanke Fed planned to fight an asset price deflation. As expressed in No Deflation. Disinflation followed by lots of inflation (http://itulip.com/forums/showthread.php?p=2795#post2795), we heard the Fed saying it planned to fight asset price deflation using every trick in the book, and then a few that aren't in the book.

Now we appear to have our answer, or at least a good part of it. What the Bernanke Fed has for the past few weeks been trying to do is prevent a runaway asset price deflation, keep the banking system whole, and at the same time not create a moral hazard by bailing out speculators who should be allowed to fail, all without producing excess liquidity that will lead to another set of asset bubbles.

Here's the Fed's program.

Federal Reserve Bank of New York Staff Reports

Rediscounting under Aggregate Risk with Moral Hazard - Staff Report no. 296 - August 2007 (http://www.newyorkfed.org/research/staff_reports/sr296.pdf)

James T. E. Chapman and Antoine Martin

This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in the paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.What is says is that there will be no Fed Funds rate cut in response to the credit bubble collapse. The easy money Greenspan Fed put is gone. Welcome to the Open Market Operations Fed or OMOF. It's motto: Liquidity Without Asset Price Inflation.

Mechanically, here's how it works. The Fed will only do business directly with banks that maintained good loan practices and are the most credit-worthy. Lenders of various flavors such as investment banks and hedge funds that took on a lot of bad loans can only deal with the banks that deal directly with the Fed. They do not have access to the new and improved discount window on their own. The credit-worthy banks can use the weak creditors' assets as collateral to borrow from the Fed.

For example, a distressed hedge fund can't access the Fed directly but can take the mortgage-backed securities they hold and bring them to a credit-worthy bank that does have access to the Fed. That bank uses the paper as collateral for a one month loan. That's why Bank of America, Wachovia, Citigroup, and JP Morgan all hit up the discount window at the same time, each for the same $500 million amount yesterday, to let hedge funds and others know where to go to put up their asset backed securities and CDOs and other paper as collateral for loans. The banks borrow from the Fed, and the hedge funds borrow from the banks. Hedge funds and others can still fail, but in an orderly way versus a simultaneous dumping of assets into a frozen market. The Fed can turn the discount window knob as need to control the rate of failure, averting the dreaded "break in the chain of payments."

While its too early to call an all-clear on the debt deflation at the top of the debt pyramid, evidence is that this new system is working–so far. Even the secondary market in CDOs is opening up, as we heard from a company that structures them that contacted us yesterday. While these events are not definitive, we will use the occasion to invite our respected friends Mish and Rick Ackerman, who were expecting at this point in the process an uncontrolled deflation, to come over the dark side, the one that acknowledges that central banks have a big bag of tricks to fight asset price deflation. C'mon down, boys!

Of course, there are still plenty of signs that the debt default danger is far from over, even at the top where cures can be targeted and the crisis is thus more readily managed. iTuliper Charles Mackay posted this note today from Justin Oliver at Canaccord Adams:
The unprecedented spread between US TBill and LIBOR rates is suggesting a heretofore unseen attack on the global financial system. There is clearly something going on that the large banks are privy to, that we are not as they are clearly not willing to lend to each other without a massive risk premium. It is inconceivable that equities can continue to trade relatively unaffected by a complete backing up of the credit markets.For now the new OMOF approach appears to be succeeding, but it is far too early to say whether this approach, while very clever, will ultimately allow $13 trillion in fictitious value in the housing market dissipate without causing significant damage to either the credit markets or economy. There remain millions of homeowners underwater on their mortgages.

Today iTulip's recently appointed new ShadowFed Chairman Finster (http://itulip.com/forums/member.php?u=245) discusses Bill Gross's appeal today to the Bush administration to bail out homeowners for prevent a "destructive housing deflation."
Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money <hr style="color: rgb(153, 255, 153);" size="1"> <!-- / icon and title --> <!-- message --> Today Bloomberg published the following report.
Pimco's Gross Urges Bush to Bail Out U.S. Homeowners (http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a2tJMmJRicQs)

By Patricia Kuo

Aug. 23 (Bloomberg) -- Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co., urged the Bush administration, rather than the Federal Reserve, to bail out U.S. homeowners to avoid ``destructive housing deflation.''Let’s dig into this a little bit.

Pimco's Gross Urges Bush to Bail Out U.S. HomeownersNo, Bill. Bush doesn’t have that kind of money.

Gross advised President George W. Bush to set up a ``Reconstruction Mortgage Corporation'' and ``write some checks'' to bail out homeownersOh … I see. You want Bush to use MY money. How generous of you. more... (http://itulip.com/forums/showthread.php?p=14658#poststop)
If Gross is asking, clearly at the street level a bailout is needed that the OMOF system will not address.

What are the implications of OMOF for the equity markets? Short term negative, and long term negative.

Short term, markets have priced in at least one rate cut. If it's needed, that's because the U.S. economy has fallen into recession; the drop in primary demand that is now pushing down oil prices has created self-reinforcing recessionary processes in the economy. Long term, markets have already priced in a Next Bubble, as if Greenspan were still in charge. Markets are still digesting this new evidence that the new Fed chair who rode in on a helicopter full of money turns out to be the first asset inflation fighter we've seen in over 20 years.

He talks dove and acts the hawk. What does this mean long term? We don't know yet. But it looks like our expectations of creative asset deflation management were well founded. And, as usual, you heard it here first.

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jk
08-23-07, 07:15 PM
2 points:

1. the fed, lowering the discount rate said it would accept mbs, but my understanding is that that meant only mortgages with federal guarantees. not cdo's stuffed with subprime interest only, neg-am, option arms. so i'm not sure that your friendly neighborhood hedge fund is going to be able to borrow on holdings like that. does this fit with your understanding, ej?

2. what are the implications for the dollar? everyone and his brother have been waiting for the fed to cut and assuming that the dollar would dive post haste. long term, it's hard to see the dollar holding value against THINGS, but it might certainly hold value and ?even appreciate against other pieces of paper. your thoughts?

EJ
08-23-07, 07:25 PM
2 points:

1. the fed, lowering the discount rate said it would accept mbs, but my understanding is that that meant only mortgages with federal guarantees. not cdo's stuffed with subprime interest only, neg-am, option arms. so i'm not sure that your friendly neighborhood hedge fund is going to be able to borrow on holdings like that. does this fit with your understanding, ej?

It's up to the market made by the credit-worthy banks what is and isn't valued. Read the doc, but my interpretation is that anything goes as long as the bank is willing to buy it from the hedge fund to use as collateral for a loan. Of course, the bank makes money doing this. Citibank, BoA, etc., ain't stupid.


2. what are the implications for the dollar? everyone and his brother have been waiting for the fed to cut and assuming that the dollar would dive post haste. long term, it's hard to see the dollar holding value against THINGS, but it might certainly hold value and ?even appreciate against other pieces of paper. your thoughts?


Not just waiting. At least one cut is priced in. My best guess is that when the markets finish processing this major change in Fed policy, the dollar rises. Unless the new FOMO Fed regime fails, in which case not only a rate cut but several will be needed. Then the dollar tanks.

Finster
08-23-07, 08:19 PM
Bernanke is said to have been one of the chief proponents of the idea that the Fed shouldn't target asset prices. See, for example, http://www.princeton.edu/~bernanke/asset.doc. Clearly an idea endorsed by Greenspan circa 1995-1999. Since, as I've argued extensively here at iTulip, asset prices lead those for consumer goods, that they're in effect the canary in the inflation mine, it would be a welcome development if Bernanke's views on the matter have changed.

"Welcome to the Open Market Operations Fed or OMOF. It's motto: Liquidity Without Asset Price Inflation." The Bernanke Fed at least seems to be trying. The new discount window strategy is an admirably clever and out of the box use of a tool that has been gathering dust in relative obscurity for so many years. If it can be used in such a limited way as to grease the sticky wheels in credit markets without encouraging further asset price inflation, it could turn out to have been a stroke of genius.

That said, it seems almost inevitable that the Fed will be under tremendous pressure to countenance higher inflation. Even in the 1970s, the US was a net creditor to the rest of the world. It is now a net debtor to the tune of trillions of dollars. Unless it outright defaults - not exactly an attractive option itself - the only way to mitigate that debt burden would be to pay it off in depreciated dollars. Inflation of course has problems of its own, not least further reinforcing debt as a way of life for the American consumer and therefore yet further aggravating the original problem, but the prospect of a US willing to consuming less than it produces in order to retire debt the old fashioned way seems unlikely any time soon.

zoog
08-23-07, 08:20 PM
It's up to the market made by the credit-worthy banks what is and isn't valued. Read the doc, but my interpretation is that anything goes as long as the bank is willing to buy it from the hedge fund to use as collateral for a loan. Of course, the bank makes money doing this. Citibank, BoA, etc., ain't stupid.


WASHINGTON (MarketWatch) -- Few U.S. banks have taken advantage of the Federal Reserve's offer last Friday to lend them unlimited amounts of money at 5.75%, Fed data released Thursday show.

As of Wednesday, outstanding loans from the Federal Reserve's discount window totaled $2 billion, exactly the amount four major banks said Wednesday that they had borrowed to show solidarity with the Fed's attempt to ease the crunch on short-term credit.Doesn't seem to be much of a market, at least so far.


The Fed is probably disappointed, economists said.

"We suspect that the Fed would ultimately like to see $20 billion -- or even $50 billion -- of discount-window borrowing," wrote David Greenlaw, an economist for Morgan Stanley, ahead of the Fed status report. To get that much liquidity, it might take a much lower discount rate, perhaps 5.25%, Greenlaw said.

jk
08-23-07, 08:58 PM
the blog "sudden debt"
http://suddendebt.blogspot.com/
makes a good point about this program:



The top four US banks tapped the Fed's Discount window yesterday for $500 million each (what a coincidence, each wanted exactly the same amount!). In fact, the banks had absolutely no desire to borrow, so Citi, BofA, JPMorgan and Wachovia were frog marched to the window and told in no uncertain terms by Bernanke and Dodd to borrow on behalf of their customers facing insolvency, or else. The banks did the absolute minimum they could get away with and took their leave, saying the will come back...soon.

The Discount Window is open to banks, but the credit and liquidity problems currently reside mostly with their leveraged customers (mortgage originators, hedge funds, etc). The banks are supposed to take their customers' collateral (loans, ABS, CDO's, etc.) and back-to-back it with the Fed, thus becoming a "liquidity intermediary", since the Fed cannot deal directly with such riff-raff. In money broking this is called a "switch".

Problem is, the customers could decide (or be forced) to default on the bank loans, sticking them with the obligation to repay the Fed and to keep the collateral in exchange. But who wants that collateral...

The whole show was intended to exhibit the smooth co-operation between government, banks and the liquidity-challenged, but ended up looking like throwing a party where one showed up, forcing the organizers to rustle up four gents in rented tuxes to pose for the society photographers and make comments, like: "We are ever so pleased to be here, at such a wonderful bash. Oh, quick everyone, look over there - is that Clint Eastwood I spot over by the exit? Let me go and see..."

When I first commented on the Discount rate cut a few days ago, I pointed out that only around $200 million were outstanding on average, thus the rate cut was meaningless unless the amounts started going much higher, allowing the money to reach those that needed it. A couple of days passed and the big banks were not willing to do the necessary "switches", so phone calls were made, arms were twisted and...presto, the tuxes were rented. But $2 billion is a drop in the bucket, so we shall see what ensues.

so, who wants to hold the garbage loans? or, more precisely, what will incentivize the citi's and boa's to intermediate?

lb
08-23-07, 09:40 PM
If what happened with CFC and BoA is an indicator of how this is going to play out, it will fail. The banks are just too greedy.

Pervilis Spurius
08-23-07, 10:19 PM
Dialing down the discount rate will incentivize them to intermediate more as I read it.

I keep thinking:
Gozar the Gozarian hath spoken to the American Economy, "Choose the form of your Destructor!"
The choice made is this modified Discount Window-Primary Dealer OMO model. It's no Stay-Puffed Marshmallow Man.

The moral hazard is now concentrated in these Four Horsemen. If this works, it looks like they will be the prime beneficiaries of the "more orderly" disinflation of asset prices. BoA's $2B convertible preferred in CFC should give them a prime seat at CFC's bankruptcy table. Choice pickings? Maybe Sapiens and Tet are getting in my head but, this looks more like the "land grab" they were alluding to on another thread.

nksantabarbara
08-23-07, 10:25 PM
I'm not as sophisticated as you guys on this stuff but is seems to me that the bottom line is that such tactics lead to a recession led by housing, followed by cuts in the real estate sector jobs, followed by lowered earnings from banks and retailers, and finally stock prices dropping to reflect lowered earnings (could happen in advance but who knows). There is a great deal of demand built into all companies' earrnings worldwide that will need to be unwound and with debt contracting, multiples will contract - a double whamy on the market. This is a self reinforcing cycle on debt because most of the lbo's of recent were contructed with massively optimistic cash flow projections and some of these companies will default. There has been a very very low default rate on junk bonds and that is the only reason why credit spreads are so tight. The Fed can slow the unwinding of leverage, but cannot stop the depreciation of the primary object of speculation (housing and assets in generall). I don't see how this plays out well for equities, which need to drop in value just as housing does. It all just happens slower.

Pervilis Spurius
08-24-07, 01:23 AM
It’s late and maybe I am not thinking correctly, just getting tired and cynical. I can’t get this Fed model out of my head. The Fed won’t budge on the FF Rate, so no new activity is being generated here. Instead they are attempting to steer everyone to the discount window via the Fab Four. The Fed document promotes the idea that by injecting liquidity this way they can minimize moral hazard and motivate the Fab Four and any secondary dealers to increase their “credit monitoring”. In a strict sense, I agree that this will be the outcome of this policy. However, the real world effect is that the Fed has just anointed the Fab Four the worst form of Undertaker: those who rent caskets.

With the discount rate at 6.25% the “credit needy” are still suffering rate adjustment shock. Until just recently, the needy have been able to borrow at ~5%, for some of the PE deals I imagine it was less. Now they suddenly have to pay something north of 6.25%?

Going back to the BoA deal with CFC that I mentioned in my previous post, BoA is essentially acting as the shady Undertaker for CFC. They rented the casket (the $2 billion convertible preferred, convertible at the below market price of $18) for 7.25% (net rental income of 100bp). Looking at the share volume over the last two days, it’s conceivable that BoA shorted an equivalent amount of shares to net out the conversion for a profit of ~$500 million. So, there’s the nonrefundable deposit! When CFC goes to zero, they get the casket back and can even steal any jewelry the dead body is wearing at the bankruptcy (funeral).

Now that’s what I call “credit monitoring”.

At a 6.25 % discount window, I think these are the only kind of liquidity injections we will see through this model. If that’s the case, the crash is still imminent.

If the Fed lowers the discount rate significantly, even significantly under the FF Rate, the market for casket rentals will expand and competition increase and rental costs to the needy will go down. We may even see some resurrections, but I really don’t think that’s the purpose of this policy. After all, the Undertakers are motivated to tightly monitor that credit!

The net effect of this is that the undeserving (USIPs) will get no caskets. They will get buried in mass graves. Meanwhile, the profits from the casket rental business will help shore up the Undertakers against risk exposure the Fed isn’t willing to insure them against.

I think this is ONLY the method the Fed plans to use to mop up the speculative excess (the barf after the all night Hairy Buffalo Party) while protecting the banking system.. In the end, they must inflate.

It’s still very early innings for this policy, the Fed has just created a new market, the casket rental market.

bart
08-24-07, 03:33 AM
Today iTulip's recently appointed new ShadowFed Chairman discusses Bill Gross's appeal to the Bush administration to bail out said strapped homeowners.
Pimco's Gross Urges Bush to Bail Out U.S. Homeowners... with taxpayer money <hr style="color: rgb(153, 255, 153);" size="1"> <!-- / icon and title --> <!-- message --> Today Bloomberg published the following report.
Pimco's Gross Urges Bush to Bail Out U.S. Homeowners (http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a2tJMmJRicQs)

By Patricia Kuo

Aug. 23 (Bloomberg) -- Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co., urged the Bush administration, rather than the Federal Reserve, to bail out U.S. homeowners to avoid ``destructive housing deflation.''Let’s dig into this a little bit.

Pimco's Gross Urges Bush to Bail Out U.S. HomeownersNo, Bill. Bush doesn’t have that kind of money.

Gross advised President George W. Bush to set up a ``Reconstruction Mortgage Corporation'' and ``write some checks'' to bail out homeownersOh … I see. You want Bush to use MY money. How generous of you. more... (http://itulip.com/forums/showthread.php?p=14658#poststop)




...recently appointed new ShadowFed Chairman...


Congratulations Finster!

bart
08-24-07, 03:39 AM
Doesn't seem to be much of a market, at least so far.

The facts say otherwise.

The recent reporting week shows total discount window borrowings at $1.54 billion (the previous week was $.27 billion). That's a record high, by far.

August 1997, the previous high, was about $1.1 billion.

sparki
08-24-07, 03:42 AM
Moin from Germany,

the Economist is writing...

http://www.economist.com/finance/displaystory.cfm?story_id=9687709

The Fed has been offering 85% of face value for AAA-rated paper presented at its discount window, even collateralised-debt obligations stuffed with subprime mortgages (as long as they are not—yet—impaired).

Has anybody heard similar things and can provide another link?

If this is true i think this image is well deserved.... :-)

http://img182.imageshack.us/img182/281/cartoonbernankebailoutiq2.jpg

fogger
08-24-07, 03:55 AM
In other words, the well connected are getting deep discounts on real assets.

GRG55
08-24-07, 08:53 AM
...The new discount window strategy is an admirably clever and out of the box use of a tool that has been gathering dust in relative obscurity for so many years. If it can be used in such a limited way as to grease the sticky wheels in credit markets without encouraging further asset price inflation, it could turn out to have been a stroke of genius.

That said, it seems almost inevitable that the Fed will be under tremendous pressure to countenance higher inflation. Even in the 1970s, the US was a net creditor to the rest of the world. It is now a net debtor to the tune of trillions of dollars. Unless it outright defaults - not exactly an attractive option itself - the only way to mitigate that debt burden would be to pay it off in depreciated dollars. Inflation of course has problems of its own, not least further reinforcing debt as a way of life for the American consumer and therefore yet further aggravating the original problem, but the prospect of a US willing to consuming less than it produces in order to retire debt the old fashioned way seems unlikely any time soon.

Although the mechanics of the Feds actions may be "new", it does not appear inconsistent with EJ's "Disinflation followed by more Inflation" sequencing.

Presently the Fed appears to want to inject just enough liquidity to prevent disinflation from turning into outright deflation (I still think that is Bernanke's primary fear). Once the weakest debtors and creditors have been eliminated (liquidated assets and debt write-offs, respectively), and the political pressure becomes unbearable, it's not difficult to imagine the Fed mitigating the remaining debt burden by inflation. Time will tell.

GRG55
08-24-07, 09:05 AM
...Going back to the BoA deal with CFC that I mentioned in my previous post, BoA is essentially acting as the shady Undertaker for CFC. They rented the casket (the $2 billion convertible preferred, convertible at the below market price of $18) for 7.25% (net rental income of 100bp). Looking at the share volume over the last two days, it’s conceivable that BoA shorted an equivalent amount of shares to net out the conversion for a profit of ~$500 million. So, there’s the nonrefundable deposit! When CFC goes to zero, they get the casket back and can even steal any jewelry the dead body is wearing at the bankruptcy (funeral)...

Under the terms of the deal BoA is barred from shorting CFC for 18 months.

sparki
08-24-07, 09:10 AM
Moin again,

Professor Bear at Ben´s blog has provided this link to my question

<a href="http://www.atimes.com/atimes/Global_Economy/IH24Dj02.html">
Central bank impotence and market liquidity
/ Asia Times</a>

Chairman Bernanke has now summoned his own clean-up team into action. The Fed hopes that by assuring banks that they can now access cash on less punitive terms from the Fed discount window, collateralized by the full “marked to model” face value of mortgage-backed securities, rather than the true distressed value as “marked to market”, for which they could find no buyers at any price in recent weeks as the market for such securities has seized up, it can jumpstart market seizure for mortgage-backed commercial paper and securities.’

lb
08-24-07, 09:28 AM
Under the terms of the deal BoA is barred from shorting CFC for 18 months.
I haven't seen the details yet, but I thought they were barred from selling their shares, theoretically they could lend them to someone else. However, CFC is still nowhere near the reg. SHO list last time I checked.

Pervilis Spurius
08-24-07, 09:35 AM
Under the terms of the deal BoA is barred from shorting CFC for 18 months.

I read it as they were barred from trading in CFC stock after conversion for 18 months.

ratfink
08-24-07, 09:48 AM
The banks borrow from the Fed, and the hedge funds borrow from the banks. Hedge funds and others can still fail, but in an orderly way versus a simultaneous dumping of assets into a frozen market.

EJ,
<o></o>
Great find, and this would make a lot of sense of the last week's news.
<o></o>
I can see how this could mitigate the “uncontrolled” part of “uncontrolled debt deflation”; I just wonder how much of a brake this can put on the long term unwind. It seems to me that they have figured out a straightforward and technically efficient way to eliminate the liquidity issue caused by the lock-up in markets due to fear, which, in the short term, will buffer the movement down. Those positioned to take advantage of their anointment as the elect few gain the ability to glean through the pickings brought to their own doorsteps and make the movement down, if not orderly, then maybe less of a panic. These seem like beneficial short term advantages to keep the markets from stopping entirely.
<o></o>
The gleanings they assess and bid on are still the result of the previous times of moral hazard, though, and for their own solvency they are going to have to set the discounts deep to avoid just concentrating the risk at a higher level. In the longer term this seems orderly only in the same sense as Napoleon’s return from <st1:country-region w:st="on"><st1>Russia</st1></st1:country-region>.

Charles Mackay
08-24-07, 11:17 AM
If the FIRE economy is allowed to "mark to market" then we will have a deflationary depression. On the other hand if the FED is able to keep the $74 trillion in debt and obligations "marked to model" a little longer by this OMOF strategy then we will continue the exponential phase of debt growth that we are currently on now. There is no way out of this logrithmic growth in debt because our GDP can't service it! Eventually market participants (particularly Europeans and Asians) will probably boycott dollar based debt.

Ben and his buddies would like you to play this as a developing deflationary event. In other words, buy their paper and shun hard assets. They need to get you back in the barn because right now you are running around on the loose.

When have you heard bearish pronouncements like the ones that came out of Bloomberg, Goldman, and the MSM before the top and during the top like happened this time? Never in my investing history.

metalman
08-24-07, 11:19 AM
jumpstart market seizure for mortgage-backed commercial paper and securities.’

markets don't seize assets, creditors do. in this case, they're buying them cheap with cheap money from the fed. markets do seize up, tho.

i wonder... when a hedge funds puts up some cdos as collateral for a fed loan, how are they priced?

Finster
08-24-07, 11:21 AM
...The Fed has been offering 85% of face value for AAA-rated paper presented at its discount window, even collateralised-debt obligations stuffed with subprime mortgages (as long as they are not—yet—impaired)....

This looks more impressive on the surface than it is. Remember the ratings agencies - firms paid by the issuers, not the buyers of debt - have been slapping these AAA ratings on stuff that has been trading like junk. There is a mess of a conflict of interest here, reminiscent of the fallout from the last bubble. Remember when Wall Street sell-side analysts were under fire for issuing "buy" recos on stocks they were actually deeply suspicious of?

Investors - mostly institutional - have been shirking their due diligence, effectively offloading onto third parties who depended on the sellers of the paper for their livelihood. This AAA rated paper was always just junk suffering from grade inflation.

EJ
08-24-07, 11:30 AM
markets don't seize assets, creditors do. in this case, they're buying them cheap with cheap money from the fed. markets do seize up, tho.

i wonder... when a hedge funds puts up some cdos as collateral for a fed loan, how are they priced?

That is one of the more clever aspects of OMOF system. It creates a market where markets have previously frozen up. If only one bank stepped in to borrow $500M at the window to use to buy hedge fund and investment bank assets, then there'd be no pricing mechanism. Citi, BoA, etc., compete for the assets. The remaining mystery is how a market is to made for a glut of overpriced houses without a fed funds rate cut.

EJ
08-24-07, 11:35 AM
EJ,
<o></o>
Great find, and this would make a lot of sense of the last week's news.
<o></o>
I can see how this could mitigate the “uncontrolled” part of “uncontrolled debt deflation”; I just wonder how much of a brake this can put on the long term unwind. It seems to me that they have figured out a straightforward and technically efficient way to eliminate the liquidity issue caused by the lock-up in markets due to fear, which, in the short term, will buffer the movement down. Those positioned to take advantage of their anointment as the elect few gain the ability to glean through the pickings brought to their own doorsteps and make the movement down, if not orderly, then maybe less of a panic. These seem like beneficial short term advantages to keep the markets from stopping entirely.
<o></o>
The gleanings they assess and bid on are still the result of the previous times of moral hazard, though, and for their own solvency they are going to have to set the discounts deep to avoid just concentrating the risk at a higher level. In the longer term this seems orderly only in the same sense as Napoleon’s return from <st1:country-region w:st="on"><st1>Russia</st1></st1:country-region>.

I don't want to over-state the importance of this one method. Again, as there is no precedent, there is no way of evaluating whether the OMOF system will work long term. It does serve as evidence to support our belief that the Fed has thought this through and likely has more ideas than this one. The old maxim "don't fight the Fed" meant don't discount the Fed's ability to step in and support the system with rate cuts. Now it means don't underestimate the range of market engineering options that the Fed may develop and institute.

jk
08-24-07, 12:19 PM
The old maxim "don't fight the Fed" meant don't discount the Fed's ability to step in and support the system with rate cuts. Now it means don't underestimate the range of market engineering options that the Fed may develop and institute.

does this throw ka-poom theory in doubt? or does it just mean it happens more slowly and less extremely?

jeffolie
08-24-07, 12:54 PM
I have 2 problems with this approach:

1. Only $2B was taken from the Discount window. This is not enough to bailout even 2 large hedge funds as Bear Stearns found out.

2. The Discount window loans are for only 30 days. This postpones the day of reckoning to mid September while the redemption fiasco for hedge funds is at the end of September.

Still, the reality is that the equity markets and ABX index have calmed. So, the Fed's approach is temporarily working very well.

bart
08-24-07, 12:57 PM
I have 2 problems with this approach:

1. Only $2B was taken from the Discount window. This is not enough to bailout even 2 large hedge funds as Bear Stearns found out.

2. The Discount window loans are for only 30 days. This postpones the day of reckoning to mid September while the redemption fiasco for hedge funds is at the end of September.

Still, the reality is that the equity markets and ABX index have calmed. So, the Fed's approach is temporarily working very well.


1. True. I view as more of a confidence building attempt than a real move.

2. They can be rolled over as many times as desired.

Spartacus
08-24-07, 02:26 PM
http://www.itulip.com/forums/showthread.php?p=14690#post14690

This type of operation had become hightly dis-favored for a long, long time and now is apparently being resurrected and repurposed.

Spartacus
08-24-07, 02:34 PM
but does that count the money that actually made it to the troubled end-user?

So far all we know is that the banks have that money - has anyone borrowed it from them (did they actually intermediate? or is the money just sitting there? )


The facts say otherwise.

The recent reporting week shows total discount window borrowings at $1.54 billion (the previous week was $.27 billion). That's a record high, by far.

August 1997, the previous high, was about $1.1 billion.

bart
08-24-07, 02:46 PM
but does that count the money that actually made it to the troubled end-user?

So far all we know is that the banks have that money - has anyone borrowed it from them (did they actually intermediate? or is the money just sitting there? )


I don't believe it was intended to arrive at the end user.

I view as more of a confidence building attempt than a real move. In other words, it doesn't matter if it has been loaned out or not.
One of my favorite definitions of money is "an idea backed by confidence", and one of the primary jobs of a central bank is to support its currency.

Note that I'm not disagreeing with EJ's OMOF concept either.

zoog
08-24-07, 02:59 PM
I don't believe it was intended to arrive at the end user.

I view as more of a confidence building attempt than a real move. In other words, it doesn't matter if it has been loaned out or not.
One of my favorite definitions of money is "an idea backed by confidence", and one of the primary jobs of a central bank is to support its currency.

Note that I'm not disagreeing with EJ's OMOF concept either.

So do you view this as more of a way to improve the dollar value vs other currencies?

(speculating now) It seems to me that at some point they will have to lower the federal funds rate, but obviously don't want to do that while the $USD index is hovering down near 80. I'm sure they are now and will continue doing anything they can to raise that level higher before making that rate cut, (if such a cut becomes necessary in the future).

EJ
08-24-07, 03:11 PM
does this throw ka-poom theory in doubt? or does it just mean it happens more slowly and less extremely?

It confirms the portion of Ka-Poom Theory that predicts that during the unwinding of the Greenspan credit bubble (debt deflation) we are not likely to see monetary deflation, that is, a negative inflation rate. The debt deflation will largely occur via the dollar depreciation, inflationary Poom part of the process. The Fed's recent action supports the idea that no run-for-the-hills, banking system failure driven run-away money supply collapse is in the offing, with commodity prices due to fall in price by half–I heard this from some commentators last week. Instead, we will experience disinflation, that is, a falling rate of inflation and a rising dollar along with falling demand UNTIL the Fed acts to stimulate domestic demand.

Despite the short term rise in the bonar, the negative long term prospects for the bonar remains. From today's WSJ:

How a Gulf Petro-State
Invests Its Oil Riches

Kuwait's Mr. Al-Sa'ad
Likes Asian Real Estate
But Is Cool to Treasurys
By HENNY SENDER
August 24, 2007; Page A1

KUWAIT CITY -- Kuwait is a world away from New Haven, Conn. But when a government investment fund here got a new chief in 2004, one of the first things he did was commission a study of the sophisticated ways Yale University invests its endowment.

It was a sign that Bader Al-Sa'ad intended to shake things up at the huge but sleepy Kuwait Investment Authority.

The investments he has since pursued put his fund at the forefront of far-reaching change in how the oil wealth of the Persian Gulf is deployed. Instead of mostly U.S. Treasury securities, Kuwait now invests in things like higher-yielding bonds, Chinese office buildings and Asian private-equity funds. And, in a move with implications for the strength of the U.S.'s currency and economy, the Kuwait fund is de-emphasizing holdings priced in dollars.

How a Gulf Petro-State Invests Its Oil Riches (http://online.wsj.com/article/SB118791418416507326.html)
As to your rate of change question, recent events in the credit markets remind me of why I first conceived of Poom as a sudden process. As we saw over the past few weeks, imbalances build for long periods of time and then change is very sudden when the basis of confidence in market forces supporting the imbalance suddenly evaporates. Prices that no one thought could change so rapidly, such as in the yields on short term treasury bonds and munis, moved in ways that not even the most creative out-side-the-box thinkers imagined. The guys on the Goldman call this Wed were clearly dumbfounded, and not in the manner of comments coming from managers of failed hedge funds whose "How could we have known?" statements are earning the derision of commentators now (http://www.slate.com/id/2172224/fr/flyout). They just couldn't believe what they were seeing.

Similarly, when the Poom part of the process does happen it will be sudden and create extreme market dislocations.

bart
08-24-07, 03:13 PM
So do you view this as more of a way to improve the dollar value vs other currencies?

(speculating now) It seems to me that at some point they will have to lower the federal funds rate, but obviously don't want to do that while the $USD index is hovering down near 80. I'm sure they are now and will continue doing anything they can to raise that level higher before making that rate cut, (if such a cut becomes necessary in the future).


Assuming we're still talking about the discount rate cut, yes. It's both a way to shore up confidence in the dollar and in the "system" itself.

The down move today in the USDX is probably related to the large outflow from the Fed custodials account last week... which measures, among other things, international confidence in the dollar.

bart
08-24-07, 03:53 PM
The remaining mystery is how a market is to made for a glut of overpriced houses without a fed funds rate cut.


Here's one possible hint, but fairly esoteric. It's a record of the GSDS - Government Securities Dealer Stats - showing that there hasn't been much change in how the trading amongst the Fed's primary dealers for MBS instruments has been going.



http://www.nowandfutures.com/images/fed_gsds_components.png



http://www.nowandfutures.com/images/fed_gsds_components_roc.png



They've been in the $300-500 billion weekly range for quite a while with only two exceptions - no liquidity issues to speak of.

jk
08-24-07, 05:20 PM
As to your rate of change question, recent events in the credit markets remind me of why I first conceived of Poom as a sudden process. As we saw over the past few weeks, imbalances build for long periods of time and then change is very sudden when the basis of confidence in market forces supporting the imbalance suddenly evaporates. Prices that no one thought could change so rapidly, such as in the yields on short term treasury bonds and munis, moved in ways that not even the most creative out-side-the-box thinkers imagined. The guys on the Goldman call this Wed were clearly dumbfounded, and not in the manner of comments coming from managers of failed hedge funds whose "How could we have known?" statements are earning the derision of commentators now (http://www.slate.com/id/2172224/fr/flyout). They just couldn't believe what they were seeing.

Similarly, when the Poom part of the process does happen it will be sudden and create extreme market dislocations.
that's interesting. i thought you were crediting the fed with more creativity and more power than heretofore, and thus thought they could moderate these processes.

also, i had conceived of poom as a re-run of the 70's, and in fact the 70's have been the model for many commentators who talk about inflation ahead. then gold had an irregular run with its spike, of course, but other real assets [like real estate] had extended moves over long periods of time. it's much more daunting to conceive of moves comparable to the recent movement in tbills.

Charles Mackay
08-24-07, 06:07 PM
How a Gulf Petro-State
Invests Its Oil Riches

Kuwait's Mr. Al-Sa'ad
Likes Asian Real Estate
But Is Cool to Treasurys
By HENNY SENDER
August 24, 2007; Page A1

KUWAIT CITY -- Kuwait is a world away from New Haven, Conn. But when a government investment fund here got a new chief in 2004, one of the first things he did was commission a study of the sophisticated ways Yale University invests its endowment.

It was a sign that Bader Al-Sa'ad intended to shake things up at the huge but sleepy Kuwait Investment Authority.

The investments he has since pursued put his fund at the forefront of far-reaching change in how the oil wealth of the Persian Gulf is deployed. Instead of mostly U.S. Treasury securities, Kuwait now invests in things like higher-yielding bonds, Chinese office buildings and Asian private-equity funds. And, in a move with implications for the strength of the U.S.'s currency and economy, the Kuwait fund is de-emphasizing holdings priced in dollars.

How a Gulf Petro-State Invests Its Oil Riches (http://online.wsj.com/article/SB118791418416507326.html)


EJ, Bob Prechter thinks the explosion in Sovereign Country Funds is a massive contrary bell ringing top signal..... i.e.. After a historical 27 year bull market the dumb money (governments) decide that stocks are the place to be instead of staying in safe Treasury instruments.

I'm not a Prechtarian but I think that is a very very interesting observation.

jk
08-24-07, 07:01 PM
The down move today in the USDX is probably related to the large outflow from the Fed custodials account last week... which measures, among other things, international confidence in the dollar.
the down move in usdx looks like we're back to business as usual. dollar down, yen down, other currencies up, stocks up, gold up, oil up.

Finster
08-24-07, 07:39 PM
After a historical 27 year bull market the dumb money (governments) decide that stocks are the place to be instead of staying in safe Treasury instruments.

And we thought government ownership of the means of production died with communism ...

Tet
08-24-07, 07:41 PM
And we thought government ownership of the means of production died with communism ...
+2 under rated. We've become the Neobolsheviks some time ago.

Finster
08-24-07, 08:57 PM
+2 under rated. We've become the Neobolsheviks some time ago.

Still kinda funny how they never mention that when they report that an agency of the Chinese government is buying stakes in US companies. They're just "diversifying" from bonds into "stocks". Sounds like motherhood and apple pie that way, huh?

DemonD
08-25-07, 04:38 AM
In regards to the initial post - this is very bullish for the dollar then isn't it? After months and years of dollar depreciation, if the Fed is defending the dollar (for a change), wouldn't Fed actions in this manner lead to a rise of the dollar?

Especially if they hold steady on Fed Funds Rate in September?

And hasn't finster already shown that we have had an actual dollar deflation, so wouldn't that disinflation assertion have been proven wrong? Or was "disinflation not deflation" talking about a longer time period than what finster's chart showed?

Interesting times indeed.

Finster
08-25-07, 01:18 PM
... And hasn't finster already shown that we have had an actual dollar deflation, so wouldn't that disinflation assertion have been proven wrong? Or was "disinflation not deflation" talking about a longer time period than what finster's chart showed?...

Your latter suspicion is correct, Demon. When we encounter brief periods of deflation, most people merely see disinflation because they're looking at statistics that lag, smooth out and blur the details. Consumer prices, especially. In the last significant deflation that occured in 2000-2002, for example, the monthly CPI only briefly went negative at the tail end of the deflationary phase, and to my recollection never actually dipped below zero on an annual basis. By the time that would have happened we were back to rip-roaring inflation.

This latest deflationary jag is also unlikely to produce deflationary readings in conventional consumer price statistics unless it goes on for quite a spell. It's still out-and-out deflation, but it takes a lot of it to move the needle in such crude measures.

Jim Nickerson
08-25-07, 01:55 PM
Your latter suspicion is correct, Demon. When we encounter brief periods of deflation, most people merely see disinflation because they're looking at statistics that lag, smooth out and blur the details. Consumer prices, especially. In the last significant deflation that occured in 2000-2002, for example, the monthly CPI only briefly went negative at the tail end of the deflationary phase, and to my recollection never actually dipped below zero on an annual basis. By the time that would have happened we were back to rip-roaring inflation.

This latest deflationary jag is also unlikely to produce deflationary readings in conventional consumer price statistics unless it goes on for quite a spell. It's still out-and-out deflation, but it takes a lot of it to move the needle in such crude measures.

Mr. Chairman,

Is "this latest deflationary jag" that which we were privileged to see in your Comments a week back, http://www.itulip.com/forums/showthread.php?p=14794#post14794

or is there actually a picture of the "latest deflationary jag" through today?

Why not put that graph up on iTulip weekly? I sure would like it if the Chairman could work that into his schedule along with all the other chairmanly duties.

Oh, and congratulations on being made Chairman, you deserve it, Finster.

DemonD
08-25-07, 03:12 PM
This latest deflationary jag is also unlikely to produce deflationary readings in conventional consumer price statistics unless it goes on for quite a spell. It's still out-and-out deflation, but it takes a lot of it to move the needle in such crude measures.

You know what's interesting is that my on-the-ground observation bears out deflation. Gasoline in Los Angeles has gone down significantly in the past 6 weeks, and for what reason? Supply remains tight, demand by all accounts appears high, and price per barrel of oil is still up significantly, so I wonder if this is what has happened with gas prices. I've definitely been convinced that the price of oil and gas is almost 100% correlated to the value of the currency, and if it truly is then this would be a bellweather of that.

jk
08-25-07, 03:27 PM
here's something else correlated with gas prices

http://www.pollkatz.homestead.com/files/gasindex-long_files/zzzBUSHINDEX_24497_image001.gif

Finster
08-25-07, 04:18 PM
Mr. Chairman,

Is "this latest deflationary jag" that which we were privileged to see in your Comments a week back, http://www.itulip.com/forums/showthread.php?p=14794#post14794

or is there actually a picture of the "latest deflationary jag" through today?

Why not put that graph up on iTulip weekly? I sure would like it if the Chairman could work that into his schedule along with all the other chairmanly duties.

Oh, and congratulations on being made Chairman, you deserve it, Finster.

Yes it is one and the same, Jim. Thanks. Re your graphic request:

http://users.zoominternet.net/~fwuthering/Posts/FDI20070825.png

zoog
08-25-07, 04:38 PM
here's something else correlated with gas prices

http://www.pollkatz.homestead.com/files/gasindex-long_files/zzzBUSHINDEX_24497_image001.gif

Nice. Bread and circuses.

bill
08-25-07, 07:29 PM
BoA's $2B convertible preferred in CFC should give them a prime seat at CFC's bankruptcy table. Choice pickings?


After reading this article I have to ask myself why BoA purchased this deal knowing the buy back agreements CFC signed with so many mortgages.
This report may shed some light on the details however without having a copy of the buy back agreements one can only speculate from this article.

http://www.nytimes.com/2007/08/23/business/23mortgage.html?_r=4&oref=slogin&oref=slogin&oref=slogin&oref=slogin


Published: August 23, 2007
<NYT_TEXT>Expanding rapidly as the nation’s largest home mortgage company, Countrywide Home Loans quietly promised investors who bought its loans that it would repurchase some if homeowners got into financial difficulties.
But now that Countrywide itself is struggling, it may not be able to do so, making it even harder for troubled borrowers to reduce their interest rates or make other changes to their loans to avoid foreclosure.
The possibility that Countrywide may have to buy back mortgages that it sold comes on the heels of its announcement last week that the tightening credit markets had forced it to draw on its $11.5 billion line of credit from a consortium of banks, a move that sent the market plummeting.
But yesterday, Bank of America (http://topics.nytimes.com/top/news/business/companies/bank_of_america_corporation/index.html?inline=nyt-org) agreed to invest $2 billion in Countrywide, buying preferred shares that carry an interest rate of 7.25 percent and can be converted into common stock at $18 each.
“Bank of America’s investment in Countrywide represents a vote of confidence and strengthens our balance sheet, enabling us to position Countrywide for future growth and success,” Angelo R. Mozilo, chief executive of Countrywide, said in a statement.
Countrywide, with its stock depressed, had been seen as a prospect for a takeover. But any obligation the company has to buy back loans may complicate discussions with potential investors or buyers.
The repurchase obligations are discussed in Countrywide’s prospectuses and pooling and servicing agreements that cover about $122 billion worth of mortgages packaged and sold to investors from early 2004 to April 1 of this year.
The agreements said that Countrywide Home Loans, a unit of Countrywide Financial (http://www.nytimes.com/mem/MWredirect.html?MW=http://custom.marketwatch.com/custom/nyt-com/html-companyprofile.asp&symb=CFC), would buy back mortgages in the pools if their terms were changed to help borrowers remain current. Such changes are known as loan modifications. In general, it is difficult for homeowners to get loans modified if they are in a securitization pool.
It is unclear how many modified loans are involved. But it would cost $1.2 billion for the company to repurchase 1 percent of the loans in the pools at issue. Repurchasing 5 percent would cost $6.1 billion. When such buybacks are made, the original amount of the loan is paid into the pool and divided among the investors.
Under the terms of the loan pools, the decision to modify a mortgage is left to the company that services it. Servicers deal directly with borrowers, taking in monthly mortgage payments and sending them out to the investors in the pools. Most of Countrywide’s loans are serviced by its Home Loan Servicing unit.
But Countrywide’s servicing unit may have less incentive to help troubled borrowers who are interested in working out their loans, analysts said, because doing so could put the parent company on the hook to buy back a loan.
“With the volume of adjustable-rate mortgages that Countrywide has originated, their liquidity crunch potentially eliminates a viable tool to keep mortgages affordable in the face of impending interest rate resets,” said Kevin Byers, a principal at Parkside Associates, a consulting firm in Atlanta and an authority on securitizations.
According to company figures, last year 45 percent of Countrywide’s loans had adjustable rates; many begin with low rates and adjust to much higher levels.
Agreeing to buy back loans that are modified is highly unusual and perhaps unique among pools issued by companies like Countrywide, Mr. Byers said. Pools backed by mortgages issued by Fannie Mae (http://www.nytimes.com/mem/MWredirect.html?MW=http://custom.marketwatch.com/custom/nyt-com/html-companyprofile.asp&symb=FNM) and other government-sponsored entities typically include such language.
It is likely that Countrywide put the language into its agreements as an incentive to make its mortgage pools more attractive to investors, in turn generating more money for Countrywide when it sold them.
A Countrywide spokesman, Rick Simon, said that the company’s servicing unit was interested only in keeping loans performing and that its modification decisions would be based on that goal.
“Investors rate servicers based on their ability to keep loans in a performing state and to turn nonperforming loans into performing loans,” he said. “The fees collected for servicing are based on the loans performing.”
Loans that reach foreclosure are expensive for both lenders and servicers, Mr. Simon added.
But servicers must also consider the interests of investors who bought the mortgage pools for the cash flow they generate. If the cash flow drops because of loan modifications, some investors will be unhappy.
Mr. Simon would not say how many loans Countrywide had modified and bought back as a result of the pooling agreements. But Countrywide’s financial statements from last year show that it bought fewer delinquent loans out of securitization entities than in previous years. Those purchases totaled $1.5 billion last year, down from $3.8 billion in 2005 and $3.4 billion in 2004.
Under most agreements, the amount of loans that can be modified in any pool is limited to 5 percent, unless the mortgage borrowers are defaulting or seem to be about to default. Mr. Simon said that the pooling agreements indicating that Countrywide was obligated to buy back modified loans applied only to mortgages that are not in danger of defaulting.
But the language in the pooling agreements from 2004 through much of 2007 does not state this clearly. Only as of April 1 do Countrywide’s pool terms begin stating that the company is not required to repurchase modified loans.
Mr. Simon said this change in language was made to clarify the original intent of the agreements.
Many subprime loans being serviced by Countrywide are in trouble. As of June 30, almost one in four subprime loans serviced by the company were delinquent, up from 15 percent in the period a year ago. Almost 10 percent were delinquent by 90 days or more versus last year’s rate of 5.35 percent.
Loans can be modified to try to keep homeowners from losing their property. Major changes like reducing the interest rate are considered a loan modification.
Lesser changes are not, strictly speaking, modifications. Getting a delinquent borrower current on a loan by adding the payments that are owed is considered a forbearance, not a loan modification.
<NYT_UPDATE_BOTTOM></NYT_UPDATE_BOTTOM></NYT_TEXT>

jk
08-25-07, 07:41 PM
cfc only has to buy back the pools if it allows modifications on the mortgage terms. ergo, no modifications if you got your mortgage from cfc. go straight to foreclosure, do not pass go.
rumor has it that boa was the source of most [all?] of the 11billion credit line, so it was already in pretty deep. the deal it got on its convertible preferred was pretty juicy and accretive to boa earnings.

Charles Mackay
08-26-07, 08:17 PM
This article by Lee Adler supports the "Act like a hawk" implications outlined by EJ above.

Media Gets It Wrong- The Fed is DRAINING! - WSE Pro

by Lee Adler

Contrary to what the financial infomercial media would have you believe, the Fed continues to steadily and consistently drain liquidity from the markets.

They didn’t conduct any open market operations today, allowing $3.5 billion from the repo pool, and for the second week in a row they announced that at next week’s Treasury auctions they would not renew $5 billion of 4 week T bills which they hold. These actions result in the 5 day net dropping to an unbelievable $14 billion drain. The Fed acted to drain reserves with the Fed Funds rate at 4.88 overnight. It would appear that their new, but unstated, target is around 5%. The only question is when will they make it official.

Compare this 5 day drain with the nonsense being reported by clueless “journalists” in the financial infomercial media. Most reports that I have seen are reporting only the amounts added by the Fed without considering the expirations. Some stories reported $26 billion in Fed adds over the last week. Others reported over $120 billion in the last couple of weeks. Both are flat dead wrong, and misleading to the market and to the public. The Fed is NOT adding liquidity to the system in any way. And the $2 billion borrowed at the discount window by the 4 whoresmen of the banking business doesn’t change a thing. Based on the Fed data last night, not a single other bank came to the window.

Making matters worse, foreign central banks dumped Treasuries for an unprecedented fourth week in a row.

Verrocchio
08-27-07, 12:12 AM
OMOF or OMFG? <grin>

In a serious vein, a second Fed move that runs parallel to the OMOF scheme is reported on Friday, 8/24, on CNNMoney.com (Fortune). The article reports that the Fed permitted Citigroup and BofA to lift the limits on the percentage of capital that they are allowed to loan to their brokerage affiliates from 10% to around 30%. This temporary exemption allows them to provide liquidity to the affiliates (holding mortgage-related loans and securities).

http://money.cnn.com/2007/08/24/magazines/fortune/eavis_citigroup.fortune/index.htm?postversion=2007082415

lb
08-27-07, 08:22 PM
Not to be outdone, JP Morgan gets on the list.

http://www.federalreserve.gov/boarddocs/legalint/FederalReserveAct/2007/20070820c/20070820c.pdf