Is Bernanke Hinting Something About the Fed's Rate Plans?
With stocks falling close to a 2 year low yesterday, Fed President Ben Bernanke attempted to stabilize the stock market and the US dollar by saying that they they are considering “extending the duration” of their emergency lending facilities to investment banks.
The Fed is clearly worried about the volatility in stocks and they have good reason to be because in as little as 2 months, the Dow has plunged 15 percent.
But more importantly, is Bernanke trying to tell us something about interest rates?
To extend the availability of emergency lending facilities means that there could still be liquidity problems in the financial markets. Keeping the lifeline open to banks and raising borrowing costs at the same time would actually be counterproductive, especially if they expect these banks to tap the lifeline. Bernanke is hinting to us that raising interest rates this year, even by 25bp is not a done deal.
Oil prices have fallen below $137 a barrel and if crude continues to drop, the Fed’s decision about interest rates will have been made for them. Bernanke and his colleagues are becoming extremely sensitive to market prices which could be very dangerous but for the time being it’s working.
The notion of the Fed being the lender of the last resort has helped US stocks and the US dollar recover.
Fed fund futures are currently pricing in a 45 percent chance that interest rates will be increased in September, down from a 65 percent chance a week ago. As for the October meeting, there is only a 53 percent chance that rates will be increased; the odds for December are about the same.
If the duration of the emergency lending facility is actually increased, then there is no way that the Fed will raise interest rates in 2008. But if yesterday’s volatility is not repeated and stocks bottom, then Bernanke’s comments Tuesday would be nothing more than an attempt to stabilize the equity markets.
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This article has 16 comments:
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Lex Luz
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45 Comments
Jul 08 01:37 PMI am quite sure that there's something I'm missing here and would appreciate some education on this. No sarcasm implied despite my strong language. Thanks.
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Corson
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4 Comments
Jul 08 01:46 PM-
kashirin
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12 Comments
My Website
Jul 08 01:51 PMProbably holding a bag. day after day she publishes permabull articles that have nothing with reality.
Why she always appear on the frontpage with that useless staff?
What I see fed is cornered and that have no other choice but to inflate to save their bank buddies.
Lien please answer how is 1.5% from historic low corresponds with your statement about US$ recovery?
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User 118015
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309 Comments
Jul 08 01:53 PM-
Reinko
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346 Comments
Jul 08 02:08 PMThe notion of the Fed being the lender of the last resort has helped US stocks and the US dollar recover.
And to Lex: Right now the FED has five programs of 'providing liquidity' to the markets, the total effect on de despository institutions (the commercial banks, not the investment banks) can be seen in the FED h3 release.
Look in the column 'non borrowed reserves', those are the real reserves of the commercial banks. Link:
www.federalreserve.gov.../
You are right with your 'we'll take you MBS crap in exchange for treasuries' but that is only the program for the primary (Federal bond) dealers.
In practice lots of that pleged collateral is worth only 70 cents on the dollar, stuff like that comes from the so called 'banking books' where mark to market value is not done very often.
(Banks have market books and bank books.)
So it is only a matter of time, the down writings will continue for a long long time because some easy calculations yield that there could be up to 10 trillion in US family home equity vaporize.
If from that loss only 20% makes it to the banking books we are looking at 2000 billion in down writings related to family housing only.
And what the value is all that collaterized debt obligation stuff is, nobody knows but it is still often 'investment grade AAA' rated and thus acceptable for the FED to take as collateral.
In case you still think the FED has it all under control because they understand the situation: At the end of 2006 Bernanke stated that the high housing prices were just a mere reflection of a strong US economy...
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Reinko
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346 Comments
Jul 08 02:15 PMIn the link under the column 'non borrowed reserves' you see a minus 124 billion number, for years on a row the real reserves were about plus 40 billion so the FED has about 165 billion in 'grade investment' collateral.
This is also one of the ways to avoid down writings; when it is temporary gone as collateral and is on the balances of the FED, it is not marked to market value.
Conclusion: In reality lots of banks have to be under water when it comes to their reserves, without new capital the tax payer will likely pay the bill over and over again.
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Dan Walker
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75 Comments
Jul 08 02:31 PM-
ETFnerd
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39 Comments
Jul 08 02:44 PMCollateral does not leave the balance sheet when it is pledged to a lender. When collateral is pledged on an overnight (or a 28 day) borrowing, you'd better believe that it is mtm daily. In the case of the tri-party repos when the Fed is borrowing, the third party prices the collateral and make margin calls on deficiencies.
www.newyorkfed.org/abo...
There are two main types of settlement methods for repos: triparty and “delivery vs payment” or DVP. Fed repos are done via triparty settlement, which means that the Fed and the primary dealers use a triparty agent to manage the collateral. In a triparty repo, both parties to the repo must have cash and collateral accounts at the same triparty agent, which is by definition also a clearing bank. The triparty agent will ensure that collateral pledged is sufficient and meets eligibility requirements, and all parties agree to use collateral prices supplied by the triparty agent.
The Desk selects winning propositions on a competitive basis. Each dealer is requested to present the rates they are willing to pay for the agreements versus various types of collateral. The three types of general collateral, or GC, the Fed accepts are marketable U.S. Treasury securities (including STRIPS and TIPS), certain direct U.S. agency obligations, and certain agency “pass-throughs” (or Mortgage Backed Securities, often called MBS).
The significance of the “GC” designation on the collateral is that GC collateral is fungible. That is, the Fed is not looking for specific securities; rather it is looking for any of the eligible securities that do not have scarcity value. As such there are a number of securities that would satisfy the requirements, and neither the dealer nor the Fed needs to know which specific security or securities are going to ultimately be pledged to a winning proposition. The Desk establishes relative values across the three collateral types, and then uses these values to selects the best bids presented.
The New York Fed makes payment for the securities by crediting the reserve account of the dealer's triparty agent, a commercial bank. This act of crediting the bank's account actually creates reserve balances. When the repo matures, the dealer returns the loan plus interest, and the Fed returns the collateral. The return of funds to the Fed extinguishes the reserves that were originally created by the repo.
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kingofithaki
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6 Comments
My Website
Jul 08 03:05 PM-
balois
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15 Comments
Jul 08 04:06 PM“..freely admit to very limited knowledge..”
Do not despaire - instead you have a full bag of the most precious commodity in the world: Common sense!
My mother tongue is not English but listening to Uncle Ben, his speech appears to me thinly veiled panic speak. Burning the deck chairs on the Titanic. To keep warm pending the sinking of the ship.
I never thought I utter these words but why not cutting this agony short and nationalize Wall Street? The American and other people around the world would be grateful. They will have to pay the bill anyway. And government bureaucrats can hardly do worse. And they would be far less expensive. De facto they are in charge now already. One can reprivatize later but in the meantime, this would be a formidable opportunity to do away with arsenals full of weapons of financial mass destruction in control of private armies of mercenaries, posing as “investment bankers”.
Have a good day
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Reinko
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346 Comments
Jul 08 04:52 PMIt might very well be that the third party prices the collateral and that it is marked to market value on a daily basis, but the fact that the FED does not put a price on the offered collateral is strange.
Thanks for the link, I have to admit that I still did not flea through the New York FED where a lot of this stuff takes place.
But given the sheer size of the programs, would some significant mark to market from pleged collateral not make the news?
I have never observed such news.
For the time being I do not buy it that the pleged collateral is really worth what it says, because if it truly had such a value you could sell it on the markets so why take the trouble and get treasuries instead? Isn't the official goal to 'provide liquidity'?
When the pleged collateral would truly be that value, exchange with treasuries would not bring more liquidity... Lots of MSB securities simply are not worth their AAA ratings, this is a fact well known.
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To Kingofithaki:
Sorry I was not entirely correct, the mentioned 10 trillion is based on information I have from the Case Schiller index folks but this also includes some (but not all) commercial real estate.
I gave not the correct information, sorry about that.
But if you compare median family income to median housing value over the period 1996 to 2006 you arrive at the staggering conclusion that there could be over 50% of air in the top of the housing market.
And you say there are 11 trillion in house loans outstanding?
Well if you believe the Federal Reserve Z1 detail it is true, link:
www.federalreserve.gov...
It says: Mortgages at 10610.6 billion US$. (Or 11 trillion.)
It also says Federal debt standing at 5244.5 billion.....
Do you believe the total Federal debt is just 5 trillion?
And why not take a look at the total of debt the US financial sector has? It is 15945.7 billion US$ so that sector alone has over one gross domestic product of debt on herself.
This year alone the entire US economy will pick up so much new debt that this is about 20 to 25% of the gross domestic product; this new debt is needed to finance only 1% of GDP growth...
Not a country to invest in if you would ask me.
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Reinko
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346 Comments
Jul 08 05:14 PMI did read the file from your link, but it offers no proof whatsoever that pledged collateral is marked to market value on a daily basis.
If you have some proof I would like that!
All I see that there is some 'haircut' applied, but again the main problem with the primary dealer stuff is that the FED does not make the price for the collateral pledged.
Let me quote from your link:
The collateral pledged by dealers towards the repo has a “haircut” applied, which means they are valued at slightly less than market value. This haircut reflects the underlying risk of the collateral and protects the Fed against a change in its value. Haircuts are therefore specific to classes of collateral. For example, a U.S. Treasury bill might have one haircut rate, while an agency coupon might have a different haircut.
Comment: Haircuts are only a few percent while lots of that mortgage backed securities are just impossible to value because the origins cannot be traced. Therefore most of that MBS can at most be 70 cents on the dollar and in the future it will be worse...
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Reinko
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346 Comments
Jul 08 05:21 PMAt the end of your linked file we have:
This act re-creates the reserve balances that were extinguished on the front leg of the transaction.
You can find it in the one last paragraph, for me this implies that the EXACT value at the end is the same as in the front leg stuff.
In short: It is on banking books where mark to market does not take place very often.
Here is the link again:
www.newyorkfed.org/abo...
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archman82011
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135 Comments
Jul 08 05:29 PMYikes. That is scary.
On top of everything else, the Fed cannot raise interest rates for a very important and secret reason.
The government, Fed, super wealthy americans, and investment banks don't want rates to start going higher yet, for that means the dollar would start to go up.
You see all those groups that I just mentioned have highly secret trading accounts that americans don't know about, that hold only commodities, that have done up tremendously in value over the past few years. Until those accounts are liquidated, the dollar has to be held down for as long as possible.
Don't think they exist? Think again.
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2009 is more of the same 2008
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51 Comments
Jul 08 09:15 PM-
icandoitdon
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408 Comments
Jul 08 10:40 PMlet's see...that's 18 months from now. from today's close that's an increase of 75%. i'm no market historian and i'm too lazy to look it up but i doubt there is an 18 month period in market history during which the dow jones increased by 75%.
other than faith, what do you base your forecast on? which sectors will lead this charge....
is it the financials that can't issue new loans because they lack the capital base and have been/will be forced to dilute the hell out of current owners because their stocks are at 10 year lows?
is it the energy and agricultural sectors that each show signs of topping out after multi-year historic runs?
is it the retail sector that is over-stored and just beginning to take a hatchet to their capital spending plans to conserve cash?
is it the industrial sector that is just starting to face the most significant economic slowdown since the dot com boom and who are being impacted as we speak by the inflationary surge in input costs?
is it the tech sector that sells to all of the handicapped above, whose stocks are still a fraction of what they were 8 years ago?
which sectors should we be long? i know that if there were an index linked to government bailouts of incompetent wall street banks i'd load up on it. it's the only sure thing i can think of in this market.
regarding the 90% of loans that are still performing...they don't matter. that's right....they're irrelevant. the ignorant/greedy/deceit... (pick your favorite term) greasy-haired leaders of those finanial institutions that got us in this pickle got us there because they were overleveraged.
quiz i bet you can pass:
question: when $1 of capital is supporting $30 of loans, what default rate is necessary to wipe out 100% of capital assuming every loan is recoverable at 50%?
answer: 6.66%
it's the few loans that go bad that always get an institution into trouble and it has happened because every one of these firms is overleveraged. and that's the reason they are loathe to take write downs...they have a thin capital base and even they understand that it's their capital base that permits them to lend.
second quiz:
question: who is more stupid than an (state your favorite nationality here) investor who provides a capital infusion to a big, illiquid financial institution that proceeds to lose half it's value in the 6 months following the capital infusion?
answer: a financial institution that pays a 10% dividend while selling stock at 10 year lows to raise more capital.
i always suspected that your average leader of a financial institution is either stupid, greedy or a well dressed crook. now i am certain of it. after this mess i'm certain of it.