179 comments on DrumBeat: August 13, 2007
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179 comments on DrumBeat: August 13, 2007
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A new guest Round-Up by ilargi has been posted at TOD:Canada.
In a café Sunday afternoon, this old Bowie song was playing. Only when going back to the articles for the Round-Up, did it hit home. The addiction theme pops up time and again. Junkie behavior describes the market, and money that came from nowhere, from ashes, is now on its way back there. Hitting an all-time low?!
It’s Monday , August 13, and tons of people await the coming week with sweaty palms. We thought it best to wait till Tuesday to post a new Round-Up, Monday could be real crazy after all, but we decided against it. There’s too much good material. If need be, we can always update. The Fed is buying waste outright, and European and Asian institutional investors are knee-deep in that same waste. One thing should be clear: the money vehicles that all this is based on, are barely in their teens. And someone soon, having lost $billions, will question their legal status, and ask for an ID.
The Fed's Path
Bonddad is talking about such things over at DailyKos. This whole thing is quite unprecedented. The government starts taking on poorly understood risk in the form of these mashed up CDOs? How crazy is that? We won't know for another few months but I think its right up there with the Iraq invasion in terms of "seemed like a good idea at the time".
http://www.dailykos.com/story/2007/8/13/71555/9633
The Federal Reserve System never buys stocks. I do not recall whether or not its charter permits it to buy equities, but it never does that. What the Fed buys is Treasury Securities. In addition, the Fed has very broad powers to lend--usually to banks, but the Fed has the legal power to lend almost any amount to almost anybody.
As I have stated before, the power of the Federal Reserve System to inject liquidity into financial markets is (for all intents and purposes) unlimited. Watch what Ben says, but even more watch what he does: The helicopters are flying. For the time being the fight against inflation is on the back burner, but the fight against the credit crunch is on "high" on all the front burners.
Never underestimate the power of the Fed.
Note that credit is a flow concept while money is a stock. By increasing the flow of credit the stock of money can be increased; that is exactly what is happening now.
Don, I have to agree that none of us can comprehend (entirely) the power of the central banks.
But in more IMMEDIATE matters, all this cash flow is entirely PRE-EMPTIVE. They are worried about Wednesday, Aug. 15th - Hedge fund redemption day. I suspect that is what Cramer is ranting about last week too...the storm that is coming. Which the FED hopes this free CASH will wash away.
However, I don't know if the FED has enough money to stop PANIC, if and when it occurs. And, there is just enough fear in the air to trigger panic at any moment.
Speaking of storms - Anyone else watching Invest 90L
Which should become a TD later today and seems to have a nice clean path straight into high SSTs and a good probability of turning into the gulf. But it's arrival would be at least a week and a bit away (more time to nash teeth).
As of 11AM EDT, Invest 90L...Now, Tropical Depression FOUR.
They have been using the term "vigorous" alot associated with this one.
NOAA advisories on FOUR
And here's the Reuters story:
Storm forming over Atlantic
I'm no geologist, but I can read a weather map.
http://www.theoildrum.com/node/2865#comment-225273
The door is open for a while.
I was going to buy oil futures today but it's getting too close to the 22nd of the month, when fundamentals rarely drive the price.
Last night, this was the first threat this year that the local weather people took seriously as "a possibility".
Best Hopes for High Shear Winds,
Alan
Sorry Alan not this time..
Best hopes for the eastern seaboard having done sensible construction... But thats unlikely... Historically these storms hammer hard when developing this strong.
http://www.wunderground.com/data/dhc_archive_charts/at_2004_charts/at200...
http://www.wunderground.com/data/dhc_archive_charts/at_2004_charts/at200...
http://www.wunderground.com/data/dhc_archive_charts/at_1992_charts/at199...
http://www.wunderground.com/data/dhc_archive_charts/at_1989_charts/at198...
http://www.wunderground.com/data/dhc_archive_charts/at_1935_charts/at193...
http://www.wunderground.com/data/dhc_archive_charts/at_1928_charts/at192...
http://www.wunderground.com/data/dhc_archive_charts/at_1996_charts/at199...
Worst Case 60mph forward movement slamming into NYC.
http://www.wunderground.com/data/dhc_archive_charts/at_1938_charts/at193...
Cape Verde storms always worried me. I posted yesterday I grew up in the Flordia Keys.. They suck and usually rip things apart...
Bermuda High is working against us this year and EXPLOSIVE heat in the oceans.
http://www.ssd.noaa.gov/PS/TROP/DATA/RT/SST/ATL/20.jpg
http://www.wunderground.com/data/640x480/atlm_shear.gif And that is SCARY!! its so favorable...
Somebody is going to get hurt its just a matter of where the wobble is going. Right now the NHC places it hurricane heading just south of Haiti.. We will see how that goes there is still quite a bit of time while it moves this way.
Give Jeff Masters blog a look and then start placing bets on 100$ oil.
While you are at it, take a look at the Tropical Discussion link. They note this:
---
TROPICAL WEATHER OUTLOOK
NWS TPC/NATIONAL HURRICANE CENTER MIAMI FL
1130 AM EDT MON AUG 13 2007
SATELLITE IMAGES AND SURFACE OBSERVATIONS INDICATE THAT A BROAD LOW PRESSURE AREA HAS FORMED IN THE SOUTHEASTERN GULF OF MEXICO ABOUT 90 MILES NORTH-NORTHEAST OF CANCUN MEXICO. UPPER-LEVEL WINDS ARE BECOMING MORE FAVORABLE FOR DEVELOPMENT OF THIS SYSTEM...AND A TROPICAL DEPRESSION COULD FORM LATER TODAY OR TOMORROW AS THE LOW MOVES TO THE WEST-NORTHWEST AT 10 TO 15 MPH.
---
That storm could reach U.S. landfall before TS #4, which is still out in the Atlantic. That depends on the track, of course. It's worth noting that the weather station at Key West has been reporting record low minimum temperatures for a couple of weeks now. If that data is representative of warm water temperatures in the Gulf of Mexico, this little storm could pop into something big in a hurry.
http://www.ssd.noaa.gov/goes/east/gmex/ir2-l.jpg
E. Swanson
Jeff Master's (and others) don't believe it could develop beyond a weak TD (*at this point*, of course).
However, if it slows over that nice warm water...who knows.
With the new data and Hunter data, I imagine Jeff will be revising his comments shortly.
NOAA says Hurricane by Friday Morning
Never Underestimate The Power Of The Fed!
stealth dollars
My understanding is that in it's history the Fed has only accepted TBills as collateral from banks needing these cash infusions. Last week, the Fed accepted the CDO's and mortgage obligations that the banks are having difficulty finding buyers for.
If that is correct, the Fed essentially took the toxic mortgage investments off the banks books and gave them $$.
The US taxpayer foots the bill for the toxic investments by way of a depreciating currency while the banks and institutions enjoyed the profits in the past years.
The key question is: what did the banks have to provide as collateral during last weeks Fed interventions?
R. Winter's explanation:
http://wallstreetexaminer.com/blogs/winter/?p=980
Inhaling deeply on a fatty, he continued “We’ve been tinkering with our model, which served us well for Enron and the Telecoms in ‘02, and our stress testing shows that the probability of loss in the senior tranche is close to zero.”
Oh man,,I'm dying,,I'm laughing so hard, Thanks , I needed that this morning.
Laughter is the best medicine,
Thanks Bro
Strictly speaking, the Fed can lend as much as it wants to to any bank with no collateral at all. To the best of my recollection, the Fed charter does not limit its lending power to collateralized loans, and it has certainly loaned money before with no liquid collateral for the loan.
When it comes to making purchases (as opposed to loans) during Open Market Operations (OMO), the Fed buys only Treasury securities. It never buys mortgages, never buys corporate bonds, never buys equities. Buying Treasury (i.e. U.S. Treasury) securities is the main way in which the Fed injects liquidity into the system. Every time the Fed buys a Treasury bill (or note or bond) the check that the Fed writes is new money; it is trading new money for another asset, namely, a Treasury security. Typically the Fed does not buy new securities directly from the Treasury but rather deals through certain selected (a few dozen, I think) brokers on an "open market," and hence the name "Open Market Operations."
When the Fed wishes to reduce liquidity in the system it sells Treasury securities on the open market, and the money from these sales is, in effect, annihilated. It vanishes into thin air, just as the Fed can create money out of thin air when it buys Treasury securities on the open market.
Don,
I asked this very question last week. "Why doesn't the Fed just create some money and give it to banks to maintain liquidity, in the short run, so that assets (including mortgages) can be readjusted and lower payment schedules can be set up on devalued housing stock." My thought was that the Fed doesn't need to inject cash to the full value of the bad loans only enough to allow house prices to reset and new more valid loans to be set up so that the new owner can make a lower payment re-establishing liquidity.
The answer was that the Fed can't own equities so they can't create cash to cover the liquidity crunch..
You are saying the Fed can't own equities but it can hold them as collateral on a loan? I know a loan has to be paid back but this is a semantics statement. The value of these mortgage products appear to be just as unreliable as a stock traded on the market.
Since the paper is not going to reflect the new value of the housing stock (as house prices fall) how is the Fed valuing the loan?
Just curious for an explanation. My thought was that the big banks will have to make up the difference using profits from some better financial instrument which would reduce the profitability of finance stocks a bit going forward.
The Fed values its loans at face value. I say again, the power of the Fed to lend to banks is unlimited. They can quite literally take a dead bank that is insolvent and breathe life back into it. Typically the Fed does not take drastic action like that, but if push comes to shove the Fed has the legal power to lend without limit.
Now it has been very very very careful not to abuse this power; it does revive dead very large banks because these have been decreed "too large to fail," and the Fed has the legal authority to revive any failed bank unless it has officially gone through the liquidation process. For that matter, the Fed has the power (though it has never used it) to lend unlimited amounts of money to nonfinancial corporations. Thus if push came to shove, the Fed could bail out Ford and G.M. and every other large corporation in America. Rather than do this, the Fed leans on Congress to make special appropriations to bail out major corporations; but the Fed has enormous powers to fight debt deflation directly, and if need be, they would use these powers.
Also it should be noted that the Fed can act almost instantly: Half an hour after a decision is made (and a crisis decision typically is made in less than an hour) the action can be put into effect. Thus if there is a financial crisis at 1:20 p.m. Eastern Time, the Fed can resolve this with decisive action within ninety minutes--and possibly less than that.
In addition to the power of Open Market Operations, the Fed can make announcements as to what it will do, and these announcements have 100% credibility, because the Fed always has the power and the will to follow through with any of its plans for actions.
In my opinion, those who are concerned about the dangers of a credit crunch and debt default deflation simply do not understand the powers of the Fed. Bernanke hase spoken. Thus it shall be.
Ipse dixit.
Don, thanks for the distinction.
So to my original question about a loan. How does the Fed get paid back? What are the terms? If I understand you right the Fed will be paid back exactly the amount it loaned. But over what time frame?
That last one has me scratching my head. I am assuming they can loan for any time horizon out to 30 years? Never called?
By creating a loan they increase money supply and by getting paid (or call in a loan) they decrease the money supply?
If true they could build into the system the ability to create subtle deflation in the future to counteract some as yet inflationary event?
The Fed can renew any loans it makes over and over again if it wants to. Now in practice this does not happen; typically when the Fed lends money to a bank through the discount window it gets paid back fairly quickly--often in a matter of weeks. Now how it arranges to get paid back, ah now there is some white magic involved: Frequently the Fed will arrange a merger or buyout so that an insolvent bank is taken over by a larger and stronger bank. I cannot recall when the Fed last wrote off a loan as uncollectable, but if it wanted to do so, it could, and it could do so without practical limit.
The Fed has the power to create bank reserves, and these bank reserves tend to become "high powered" money, i.e., new money that is created as a multiple (say about 3) of the original new reserves. Now the Fed cannot force the banking system to create new money by lending out new reserves, but typically this happens. Even if a bank finds no credit-worthy businesses to lend to it can buy U.S. government securities and thereby lend money to the government. In extreme cases, this results in "monetization" of the debt, whereby government debt becomes, in effect, money, and the government deficit new money. Thus the Fed can cooperate with the Treasury to, in effect, print money without limit. (Of course the printing presses do not literally run faster to create new currency; instead demand deposits (checking accounts) are created.)
On Federal Reserve Notes is printed the blasphemous sentence: "In God We Trust." God created the heavens and the earth, but the Fed in combination with the banking system and the borrowing public creates money. God has nothing to do with money, and in the olden days that phrase (which I find offensive) was not to be found on our currency and coins. Faith in the Fed--and nothing more--is what stands behind money, because there is no gold or silver backing up our currency any longer.
Money is based on trust. The Fed has a tough job in that it needs to create enough money to avoid credit crunches but not so much that the dollar goes the way of the Mexican peso over the past sixty years. I think that ultimately the Fed will lose the war against inflation because it will be fighting the recession/depression brought on by Peak Oil, but that day has not yet come.
Don Sailorman,
Was the last tme the Fed wrote off loans during the collapse of First City National Bank of Houston in the mid 1980's? At any rate, its very rare.
Bob Ebersole
I don't recall the details on that one. The big point is that if it wanted to, the Fed could lend money using brass spitoons as collateral and then write these loans off when a bank failed and could not be merged with a solvent bank.
Never again is the Fed going to allow a cascading series of bank failures to contract the money supply. Thus any liquidity squeeze or credit crunch can be and will be contained. We'll never see another situation of a run on banks; there is no way the Fed will ever again allow anything resembling the financial collapse of the Great Depression.
So, in light of what you said, do we really have a "free and fair" marketplace? Is our market free of partisanship? Does the Fed publicize all occasions where it intervenes in the "normal" market processes?
Bernanke has done an exceptionally good job of "open information" at the Fed. To prevent market manipulation from secret "leaked" information, some deliberations are quite properly kept secret for a period of time, but eventually all minutes of meetings go into the public domain. It is not in the Fed's interest to do things in a sneaky or underhanded way: The bright light of publicity is always shining on what the Fed says and does.
Insofar as is humanly possible, the Fed does act in the public interest and it does its actions in daylight; it wants its intentions and actions to be understood and publicized.
I have the highest opinion of the personal characters of the members of the Board of Governors of the Federal Reserve System. What I foresee is a Greek tragedy for these fine people who will eventually be forced to create inflation and then more inflation to mitigate the effects of Peak Oil. Sometimes the very best people, people of the highest integrity, can be forced by a situation to betray their trust.
We trust the Fed to keep the dollar from eroding in value more than two percent per year. At some point in the not too distant future, in my opinion, the Fed will be forced to choose between depression and a sharp upward move in the rate of inflation. The Fed will do what it takes to prevent recession spiralling downward into depression.
Now monetary policy is not a good tool with which to try to deal with the effects of Peak Oil. But monetary policy is all that the Fed has. The government has fiscal policy, and that will be used too; I expect to see deficits as a percentage of GDP to rise to levels not seen since World War II.
But I am not a doomer. Even hyperinflation does not destroy real assets, does not destroy real skills. To a large extent, the U.S. is a wealthy nation because of accumulated real (tangible) capital and also human capital of knowledge and skills embodied in people. Peak Oil, in my opinion, is going to lead to rates of inflation not seen in the U.S. since the Civil War, and I expect the dollar to equal the Mexican peso in value once again. But none of this implies doom for and destruction of the real economy.
God, dear God, in God we trust, I hope you're right!
The FDIC gets involved and the Fed hands it off to them.
The point of the liquidity injections is to keep good banks solvent. I don't know about the rest of you, but my money sits in banks and I'd rather not lose it on a "daily reserves" technicality.
I really think a lot of people are looking for an issue that simply doesn't exist. Banks lend billions to each other EVERY NIGHT day after day. The Fed is a bank. It also lends money to other banks. Usually not everyday, but it can. It does this so that my check doesn't bounce. And they can take a duck as collateral as long as the duck is investment grade and has a value.
LIBOR - London Inter Bank Overnight Rate
What the Fed does NOT have the power to do is to do all of the above and then ALSO prevent the US dollar from taking a crash dive. I don't think that there are many people that will be fooled by standing on 5.25% while these monetization ops are going on.
But all of the world's central banks are pumping like mad. Every major central bank. If this goes on we're going to get global massive inflation, maybe even global hyperinflation if it spirals out of control.
What the market is trying to do is kill the bad credit in its midst. This is a contraction. This is what the market has done historically when faced with bad credit. But the Fed is not letting it contract because the last really big contraction (1929) scared the pants off these guys. They are literally terrified of that, leading to what Don points out - the Fed is the lender of last resort.
They think they can regain control (of the financial system) even at the end of a hyperinflation but they are terrified that they cannot regain control after a deflation. This is their motivation, yet even still the market is trying to deflate which leads me to believe that Ben and friends are going to have to pump even harder which should make the next 12-24 months really really really interesting on the inflation front. Either that or all this new liquidity finds a new sucker bubble into which to get sucked.
"The greatest shortcoming of the human race is our inability to understand the exponential function." -- Dr. Albert Bartlett
Into the Grey Zone
Hmmm...perhaps this explains Rove's early exit from the sinking ship. I really believe it is a sign that they are going to abandon Bushie before it gets truly nasty. Look for Cheney to have a long stay at the hospital starting in the near future....another by-pass surgery or something that requires he leave his position.
>My understanding is that in it's history the Fed has only accepted TBills as collateral from banks needing these cash infusions. Last week, the Fed accepted the CDO's and mortgage obligations that the banks are having difficulty finding buyers for.
If that is correct, the Fed essentially took the toxic mortgage investments off the banks books and gave them $$.
The US taxpayer foots the bill for the toxic investments by way of a depreciating currency while the banks and institutions enjoyed the profits in the past years.
The key question is: what did the banks have to provide as collateral during last weeks Fed interventions?
They did not! They lent out money (with interest charges ~5.25%). I do believe that over in Europe some toxic financial assets were sold off to gov'ts (bailout). Europe has inject about a $250 Billion USD so far. To the best of my knowledge, No US gov't funds have been used to bail anyone out.
There are some large hedge funds in the US (Citadel) that have been buying up the assets of liquidated hedge funds. I assume that they are trying out Richard Rainwaters strategy to turn millions into billions. Although I seriously doubt they have much success.
http://www.marketwatch.com/News/Story/credit-market-wobbles-some-hedge/s...
The debt the Fed purchased was higher quality than is being described.
Here's a Bloomberg article with a lot of details:
http://www.bloomberg.com/apps/news?pid=20601103&sid=a9hrkahO0I3I&refer=us
Here's a choice quote:
The Fed accepted mortgage-backed debt issued or guaranteed by federal agencies, so-called agency debt and Treasuries as collateral for today's repos.
Federal agencies probably means Freddie and Fannie. And their guidelines keep most sub-prime and border line borrowers out of their portfolios (still a lot of risk here, but it's not like the Fed is accepting sub-prime blocks of mortgages).
As well, the Fed regularly does repos with mortgage backed securities, just search this link for "mortgage" (the link is the last 25 transactions of the Temporary Open Market Desk of the New York Fed):
http://www.newyorkfed.org/markets/omo/dmm/temp.cfm?SHOWMORE=TRUE
The real difference was the volume of repos.
No, they don't buy stocks. What they do is lend banks money for a short period against which the banks have to offer something as collateral.
Normally the Fed would only accept things like US Treasuries as collateral. What is new about Fridays actions is that the Fed accepted CDOs and MBS as collateral, lending money at the papers face value when it is, in reality, worth nothing.
The Fed can't fix the problem by lending people ever more money. The problem isn't that the banks are illiquid, it is that they are insolvent and that is something the Fed can't fix.
Those CDOs aren't worthless, its just hard to determine value. If I'm reading it correctly they've(hedge funds) taken to swirling various levels of risk into single instruments and calling that hedging, rather than packing prime /w prime and crud /w crud ... so now the bad stuff is everywhere, in unknown quantities, and those who expect to buy high grade investments are sitting on their hands.
What did the Fed take on? We don't know but one would assume that a sucker buyer trying to stop a panic got saddled with a higher amount of crud than the average.
Its going to implode, I just hope its a controlled implosion like 1987 rather than an ass over teacup detonation like 10/1929.
I think we can assume that the best case scenario will merely leave all of us working stiffs a wee bit poorer. That's the best case...