The Oil Drum

'When the Feds Big Guns Fail, Call in China'

http://www.atimes.com/atimes/Global_Economy/IH21Dj01.html

By Julian Delasantellis

'In the 1939 movie adaptation of L Frank Baum's 1900 novel The Wonderful Wizard of Oz, all the characters were in awe of the tremendous magisterial power of the Wizard. Dorothy, the friends she met on her journey (the Tin Man, the Cowardly Lion, the Scarecrow), and all the other various citizens of Munchkinland, they all believed that it was the Wizard, in his castle in the Emerald City, who possessed the powers to make all their problems right, to make all their lives sweet.

Then Dorothy's little dog Toto pulled away the curtains that concealed the Wizard's supposed magic machine, and found only smoke and mirrors; as for the Wizard himself, he was just a rather ordinary little man.

Last week, chance and circumstance pulled down the curtains covering the smoke and mirrors of the operations of the US Federal Reserve. Behind them, instead of a magical wizard able to contain the raging crisis now spreading across the world's financial markets, we find the chairman of the United States Federal Reserve, Ben Bernanke.

And his magic is proving to be as ineffective in curing the ills of the world's financial markets as was the Wizard's in getting Dorothy back to Kansas...snip...

The market in what is called commercial paper, very short-term (frequently no more than a day or two) corporate borrowing of money needed to fund a company's temporary funds shortage (or lending of funds from companies with a funds surplus) has closed for companies thought to have even the remotest connection with the subprime-mortgage debt in peril; no amount of open market operations will reach these borrowers...snip...

After being ensconced around 5.30% all year, this rate climbed to almost 5.90% in the midst of the Fed interventions; that means that wherever the money the Fed was attempting to put in the markets was going, it wasn't getting to the US.

So where were the billions of dollars in Fed intervention going? The market for US government-guaranteed three-month Treasury bills is one short-term money market where the Fed probably has not wanted to have the effect that it has. Rates in this market saw an astounding fall last week, dropping almost 130 points, to reach just under 3.6% at their lows in the middle of the week...snip...

Those commentators who say this entire crisis is overblown, that the world is still awash with liquidity, are correct, up to a point. There continues to be huge supplies of liquidity in the world's markets. The problem is that a lot of financial institutions now need some immediate contact with some of that liquidity, and are not getting it. One of those might be Countrywide Financial, the largest US mortgage lender. Countrywide's stock has declined 60% in a month, and it burned through its entire $11 billion emergency line of credit in a few hours on Thursday. Thus the Fed discount-rate move on Friday...snip...

That's why it's such a problem that the Fed's Friday discount-rate cut had so little effect. If what comes out of the barrel on firing your most powerful weapon is only a little stick with a flag that says "Bang" on it, your enemies, in this case the markets, will see that there's nothing you can do to deter them, to frighten them, to change their course of action. Panic will set in, perhaps worse than before; past the curtains, the smoke and mirrors, the Wizard is seen as impotent...snip...

SWF (Chinese Soverign Wealth Fund) may swoop in and buy, at the bargain prices generated by the crisis, the discounted mortgage securities at the core of the crisis. Then, since they're also now selling at fire-sale prices, they may buy up some of the finance companies themselves - a rumor circulated around Wall Street last week that agents acting on behalf of China's still-nascent SWF were making inquiries related to picking up Countrywide Financial on the cheap. As Pettis puts it, "The large-scale shift of global reserves into what are being called sovereign wealth funds may provide the party with at least one more bowl of industrial-strength punch."...snip...

If the US does allow China to bail it out of a mess solely of its own creation, the US will prove itself less of a world superpower and more of a poor, hapless junkie walking into a pawnshop, desperate to sell another bit of its hard-earned family heritage built up over 200-plus years for just one more fix of plasma TVs, MP3 players, Barbie dolls and all the rest of the catalogue of cheap Chinese manufacture on which Americans are now hooked'...snip...