Will The Fed’s New Loan Facility Work?

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The Fed last week introduced another scheme called “Term Securities Lending Facility,” which allows it to lend to securities dealers on top of funds already injected in the system. I am losing count, but it appears to be the third attempt in the last few months to get a handle on the credit crises.

Bill Fleckenstein reflects on this latest attempt and while it is doomed to fail in his latest article. Here are some highlights:

I guess the sight of all those suffering hedge funds and brokers was just too much to bear.

Now, I realize the Fed was created to provide a liquidity backstop in times of emergency. But the Fed has abused its privilege for so long — by being the creator and proponent of excess liquidity and the problems it causes — that, in my book, the Fed is nothing short of an abomination. The reality that’s eluded Fed “experts” is simple: Credits in much of the financial system are simply no good. And creating liquidity and stalling for time won’t make those credits good.

I find it stunning that the Fed is willing to open up its tool kit when faced with liquidity problems — spawned from bubbles of its own making — and yet while those bubbles were inflating, the Fed kept it snapped shut tight.
…
This action by the Fed will temporarily alleviate some pressure, but it will not change the fundamental problem: Home prices were in a bubble that has now burst. People making median salaries in this country can’t afford to buy houses. And even folks who make more money often own more house than they can afford.

The Fed’s move set off a big rally on Wall Street, but it lasted just one day. This problem is going to run its course. There’s no bubble to bail out the housing bubble.

As to the folks who think commodities may be the next bubble: They might be right.

But exploding commodity prices will not help. They’re not going to make housing more affordable because less of people’s paychecks will be available for mortgage payments.
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Before its implementation, the chance of the Fed buying a piece of paper that could deteriorate rapidly over the course of a couple of repo terms would have been small. But now that the Fed, through this facility, is willing to accept (exchange for Treasurys, actually) “AAA-rated” paper — and remember that the rating agencies are suspect — it’s not inconceivable that the following could occur:

The Fed might actually start taking paper at one price and then find out (by the time XYZ financial institution is supposed to take it back) that the paper is trading at a different price. Inquiring minds would like to know what the Fed would do about these losses if the repo’ing entity was determined not to take back the collateral.

Creating liquidity and stalling for time won’t make those credits good. Credit is contracting all across the financial system, in America as well as around the globe. At the same time, credits are going bad. Both of these problems keep lapping up against each other, and their magnitude will render bailouts useless.

Despite that glaring reality, the Fed remains intent on monetizing whatever needs to be monetized, as Chairman Ben Bernanke thinks this can prevent the underlying mass of home-price issues and the economic consequences of the burst housing bubble from doing what they will do.

But in the end, he’s going to shred the currency market and at some point the Treasury market. And, though Greenspan deserves all the blame, Bernanke will likely get it — with history erroneously declaring him to be the worst Fed chairman ever.

While the Fed’s attempt may postpone the inevitable, I agree with Bill that it will not solve the underlying problem that we’re in a housing/credit bubble that has burst and that bad debt is permeating through the entire financial system. No amount of Fed or government intervention will help companies survive long term if the bad debt issue is not addressed sooner rather than later.

Too Big To Fail?

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The biggest news item last Friday and all weekend has been the collapse of Bear Stearns after their stock value got sliced in half.

Had it not been for the intervention of the Fed via JP Morgan, the markets would have tanked big time. To me, it was a clear case of a company being to big to let go because of the ramifications for all Wall Street firms. It’s not that Bear Stearns is the biggest player on Wall Street; they are big enough via their complex derivative trading schemes and tied in with many other investment banking firms that one failure would have had devastating effects on the other players as well.

I talked about this interconnectivity in “Counter Party Risk,” describing how leverage and derivatives have created a worldwide spider web tying international banks together in a scheme that will only hold if everyone sticks to their end of the bargain. If one fails, the domino effect can’t be calculated until the last domino has fallen since no one knows exactly who is tied into this web with how much capital or leverage. The Fed will be absolutely helpless because of the vast amounts of money involved.

I recently posted that derivative contracts are valued worldwide around $50 trillion. I guess I was wrong as recent reports put that number closer to $500 trillion. Mish over at Economic Trend Analysis made reference to the following chart from the Office of the Comptroller regarding derivative contracts (the comments are his, not mine):

click on chart to enlarge
These are mind boggling numbers and, based on the fact that all of these holdings are intertwined, one failure will cause many others to follow. Therefore it is simply in the best interest of the Fed and Wall Street in general, or the government for that matter, not to let anyone collapse.

However, given the enormous numbers involved, I have no idea what kind of a lifeline needs to be thrown to pull the participants out of this cesspool of worthless securities. But I do know that this environment can be extremely hazardous to your financial health if you haven’t sold your domestic and international equity funds. Events could now unfold at warp speed.

Sunday Musings: Staying Put?

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Whenever financial markets slide into bear market territory, there are bound to be numerous articles appearing online or in print touting the “benefits” of staying put with your investments. It is as if nothing has been learned from the all too recent bear market of 2000-2003.

MarketWatch featured such a story titled “Grit and bear it.” Let’s look at some of the ideas:

Wall Street giant Bear Stearns is severely wounded and the natural instinct for many investors is to run, not just from financial-services stocks but from the entire market.

But the financial crisis that struck Bear Stearns Cos. Inc. on Friday — while the latest and possibly not the last shoe to drop in the widening credit crisis — is still no reason for investors to dump stocks and hide out in cash or Treasury bonds.

“It’s too late to be bearish, but it’s too early to be bullish,” said Bernard Baumohl, managing director of investment advisory firm The Economic Outlook Group LLC. “Until the dust settles, we’re advising clients to stay put.”

For Baumohl, a model portfolio today would be highly defensive — 40% cash; 50% stocks, mostly outside of the U.S.; and 10% in precious metals. But he wouldn’t suggest overhauling your own portfolio now to fit that cautious bill.

In fact, he expects to boost his clients’ allocation to stocks later this year.

“At this stage we are close to a bottoming in the stock market,” Baumohl said, “but it’s probably going to bounce around at the trough for at least another three to five months. It will be sometime until the second half of the year when finally people will jump back into the market and take advantage of the distressed prices.”

Of course, that’s small comfort now, with Bear Stearns on a precarious edge and investors anxious about what comes next.

“It’s a symptom of the entire financial-services sector,” said Michael Cuggino, manager of the Permanent Portfolio Fund. “I don’t think that ultimately Bear Stearns will be the only one to have this sort of thing occur. I don’t think they’re the only firm that can experience such liquidity crises.”

I just have to shake my head when reading such nonsense. Don’t these people realize that we are in bear market territory and may very well be witnessing the unwinding of the largest credit bubble ever created? Bear Stearns almost collapsed on Friday had it not been for a last minute Fed bailout. Without it, the ramifications for Wall Street might have been devastating. Next time, the Fed or any other while knight might not step in and then what?

These jokers in the above article are touting a model portfolio and talking about a bottom in the market. These stories are very similar to those I remember from late 2000.

My point about this ranting is simply that no one can foresee the future. Prices and price direction are the only things that are real because they can be measured. And right now, price direction points south meaning that if we continue in that direction, bullish portfolios will once again be annihilated.

I prefer reading qualified information from individuals with no axe to grind. I suggest you do the same and stay away from the nauseous repetitiveness of financial reality TV shows. While this may be great entertainment, be aware that’s all it is. My personal tolerance is about 5 minutes when watching botox enhanced individuals attempting to tell me what the market will do in the future or which mutual fund is a great buy.

Keep the big picture in mind; right now, the time is to be conservative and mostly on the sidelines.

Another One Bites The Dust

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Not only have investments in Subprime slime wreaked havoc with banks and hedge funds, a ridiculous amount of leverage has made the problem far worse and added to the rather sudden demise of various institutions. The latest victim was Carlyle Capital, which went from recently owning some $22 billion in mortgage securities to now expecting that lenders will seize its assets.

Lenders are as much to blame for having to take possible losses since they provided Carlyle Capital with $20 for every dollar of initial capital. The mathematical formula is very simple:

Excessive Leverage + Subprime Investments = Collapse

I am sure that we will not have heard the last of this hedge fund debacle and there will be more to come despite S & P’s assurance that the “End of Subprime mortgage write-downs may be in sight.”

The operative word here is “may.” Yeah right, tip of the iceberg is more like it. Bear Stearns appears to be the next victim. What about the upcoming difficulties with Alt-A and Pay Option ARM mortgages, which are due to reset by the millions over the next few years. I hope I am wrong, but I am pretty sure that most financial institutions have not yet disclosed all of their potential write-downs.

On a positive subject, reader Bradley submitted the latest information on the federal tax rebate:

President George Bush said each one of us would get a $600.00 tax rebate. It was previously slated to be $800.00, but they dropped it to a $600.00 tax rebate because of various budget problems.

Now, if we spend that money at Wal-Mart, all the money will go to China, if we spend it on computers, most of the money will go to Korea or India.

If we spend it on gasoline it will all go to the Arabs—and none of these scenarios will help the American economy.

We need to keep that money here in America—so the only way to keep it here at home is to drink beer, gamble, or spend it on prostitution. Currently it seems that these are the only businesses still left in the U.S.

To that I am pleased to add that (former) NY Governor Spitzer is apparently leading this charge on the highest level to support these efforts.

No Load Fund/ETF Tracker updated through 3/13/2008

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My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Huge swings in the markets and an emergency rescue funding plan of Bear Stearns kept traders on edge.

Our Trend Tracking Index (TTI) for domestic funds/ETFs remains now -1.22% below its long-term trend line (red), which means we are in bear market territory.



The international index dropped to -10.06% below its own trend line, keeping us in a sell mode for that arena as well.



For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

Evaluation Time

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Wall Street’s high about the Fed’s $200 billion intervention was replaced by more rational thinking in that some of the main concerns like weak housing and continued credit concerns had not been really resolved but still remain a serious problem to be dealt with.

The markets retreated and received no support to the upside with oil prices topping $110/barrel. While the Fed’s decision most likely was the right one, it will not solve the underlying problem that many banks and financial institutions are drowning in a sea of ever declining mortgage assets that simply can’t be liquidated.

On that subject, a reader commented to my Tuesday post “Feeding The Bears” as follows:

The Fed is merely attempting to unlock a jammed market and we can only hope that they will succeed. The dimensions of the problems in the financial market are to a larger measure a result of an accounting convention known as mark to market which makes only sense in a highly liquid and efficient market. Once a market jams, mark to market account perpetuates a downward spiral we are seeing today.

While the reader is correct, I have to add that lack of marking assets to market via off balance sheet entries as well as “mark to model” or “mark to fantasy” accounting gimmicks has greatly accelerated the credit crisis most institutions are currently in. Banks brought the current problem on themselves by not marking to market earlier on as is customary in the financial industry.

Whenever a company decides to avoid reality, they can use the available (legal) tools to do so. This would be no different than if I as an investment advisor were to contact my custodian and ask to mark my client’s assets to my model, because we had a bad month, and I don’t want clients to see that at this time. Yeah right, for me (and my custodian) to do so is illegal—if it weren’t, I’m sure that would go over real well with my clients, if there were any left.

Allowing financial assets not to be marked to market contributes to abuse and the hiding of losses. This may work for a company and allow it to stay afloat temporarily but, during the unwinding of the largest credit/real estate bubble the world has ever seen, it will merely postpone the inevitable.