The Dow is waffling now after yesterday’s rally…but even with that rally the Dow is still down more than 10% for the year. The economic numbers are still bad. The systemic issues still exist, and the confidence in the Fed to solve those issues is still lacking.
So now what? The Fed has apparently staved off a systemic collapse, but just barely. It’s had to take unprecedented steps to save the economy. The problems that created the crisis still haven’t been addressed and will not be until we have a new President, and by then it may be too late.
Meanwhile JP Morgan and Goldman Sachs are the first to line up at the Fed’s new money trough.
Goldman Sachs Group Inc. and Morgan Stanley, the two biggest U.S. securities firms, said they’ve used a lending facility created by the Federal Reserve to ease concerns that Wall Street faced a cash shortage.
“We have tested the window because we want to remove the stigma from the window,” Morgan Stanley Chief Financial Officer Colm Kelleher said in an interview today, referring to the Fed lending program. “It’s meant to be there for normal business. It’s not meant to be there as a last-recourse thing.”
That last statement is an extraordinary lie. The Fed’s discount window has always been the resort of a company facing insolvency. It literally is the lender of last resort and always has been. Because it was at a discount rate, and to keep banks from taking the money at the lower rate and then turning around and loaning it back out at a higher rate, the Fed has historically required banks to show that the discount window was their only remaining option.
Now we’re suddenly supposed to believe the discount window is standard operating procedure? Bullshit. Seriously. It is SOP now because banks like Goldman and Morgan are happily snapping up cheap cash to stay afloat. They need it. They have too much leveraged junk on the books to stay open without it. There’s no stigma left in going to the bread line if everyone you know is already there.
It’s now standard for these banks to “test the window”. We’re in uncharted territory here. The lender of last resort is now the lender of first preference. It has to be done or these banks will go under. Think about it. Only because of these extraordinary measures did the Fed avoid a collapse of the banking system. It’s keeping the system on life support.
This has gone far beyond bailout, we’re talking about the virtual socialization of America’s largest investment banks on the taxpayer’s dime.
Goldman spokesman Michael DuVally said his firm is also “testing” the Fed facility, started March 17, and will use it regularly “if doing so makes sense from an economic and funding diversification point of view.” Lehman Brothers Holdings Inc. CFO Erin Callan said yesterday the Fed window was “very attractive” and provided an alternative form of financing.
Why not take cheap cash and loan it out?
Only there’s a problem. There’s nobody around to loan it to. Markets are still frozen up because nobody believes the banks anymore. They know they are lying about their positions. Liquidity is fine, solvency is another thing.
Mortgage rates are still high despite the rate cuts. More money won’t help with that unless people are willing to refinance. Banks don’t want to do that…why should they? They’re getting all the cheap cash they need from the Fed to fatten up their bottom lines.
On top of that, Fannie Mae and Freddie Mac will happily take more garbage mortgage junk off your hands.
The regulator of Fannie Mae and Freddie Mac eased capital requirements for the two housing finance agencies, allowing them to pump up to $200 billion into the distressed U.S.mortgage market.
The regulator, the Office of Federal Housing Enterprise Oversight, said it was lowering to 20 percent from 30 percent the amount of extra capital the companies had been required to hold after their accounting irregularities, and will consider further reductions.
In addition, the companies will begin to raise “significant capital,” OFHEO said in a joint statement with Fannie Mae and Freddie Mac.
“This capacity will permit them to do more in the jumbo temporary conforming market, subprime refinancing and loan modifications areas,” OFHEO said, referring to the easing of the capital constraints.
So another $200 billion tossed into the markets to keep the banks afloat. Who is going to pay for the worthless paper that F&F are buying? Look in the mirror.
The problems that are behind the crisis are still there, and people are talking about who is next but now, with the Discount Window as standard fare, that may not be an apparent problem.
Fancy a game of dominoes? It has been the pursuit of choice on Wall Street for the past week, after Bear Stearns began its death spiral, the one question on everyone’s lips. Which bank is next?
On different days, there have been different answers. Lehman Brothers, most often. UBS, perhaps. For the first time yesterday, the most common answer was: no one.
Where investors had been bracing themselves for horrors in the latest round of quarterly financial results from brokers, the figures yesterday from the first two out of the traps – Lehman and Goldman Sachs – proved a little less bad than feared.
More importantly, executives at both banks focused heavily on setting out just how much cash and liquid assets they have on the books, relative to their short-term trading liabilities.
The collapse of Bear Stearns has changed the picture, in two important ways. Firstly, the Federal Reserve has learnt what to do. As well as promising to underwrite JPMorgan Chase’s takeover of Bear, it has re-activated a Depression-era rule allowing securities firms to borrow directly from the Fed.
Bear couldn’t do that, meaning it had nowhere to go to offload the illiquid mortgage securities its toxic balance sheet was laced with. Any bank in a jam from now on will be able to go directly to the Fed’s discount window and trade in its hard-to-sell assets as collateral for highly liquid government bonds or cash, which it can in turn use to fund its short-term liabilities and keep trading.
Secondly, Bear’s rivals have learnt what not to do. The hapless Alan Schwartz, chief executive of Bear, fulminated about the “fiction” and “innuendo” scaring clients and trading partners away last week, but in neither his stock exchange statement insisting all was well on Monday, nor his television appearance on Wednesday, could he offer more than broad-brush promises that Bear’s liquidity position was strong.
Lehman Brothers was touted last week as the “next weakest” of the Wall Street titans, a close rival of Bear and also one of the leading players in mortgage-related derivatives and in other esoteric corners of the battered credit markets.
But in the last few days, and again on a conference call with investors and analysts yesterday, Lehman has provided a masterclass in how to prevent stock market rumours from turning into a crisis of confidence that engulfs the bank. To borrow a phrase: education, education, education.
So what gives? Is it over? Will this save the banks, the dollar, and the economy? Have we hit the bottom? Hardly.
Once again, the Fed has staved off ruination, but at a massive cost. It can only keep this up so long before it runs out of cash, and with the dollar plummeting, that day will come soon. If people stop buying treasuries, then the Fed is toast. The systemic issues are still there.
The Fed is playing out the clock. As it has to take more drastic measures to do, people will have less confidence in the US dollar. This time the Fed was able to stop the destruction.
Are you willing to bet the Fed will be able to stop the cascade of defaults next time? It could be next week, it could be next month or next quarter…or tomorrow. It’s running out of rate to cut and money to inject.
When the Fed runs out of either, the game ends. That day is most likely coming before the end of the year.
Be prepared.