January 2008


Today Feds had to give $5 bln at 2.17% with treasury collateral. Even after that it was a drain of $24 bln. But the most interesting is that the mortgage-backed sloshing flopped from $23 to $5 bln. The banks got stuffed with mortgages again, but they are still refusing to borrow above 2.17% with non-crappy collateral. This 87 bps below the target rate even after 125 bps of cuts. Frankly I’m puzzled.

I also want to say about consumer spending and prisoner dilemma. The government tells us all the time how they want us to spend more in those troubled times. At the same time it’s obvious that right now is a good time to actually curb your spending and pay off some debts. The employment, real estate and social security prospects are not so bright, putting aside at least 15%-20% of your income is a very good idea. The prisoner dilemma is that the economy will avoid a very hard lending only if we all start spending like mad, much more than before, but when some people defect tho ones who still spend are the real losers. In that situation defecting is much better. And you don’t need more proof that the administration is valuing its own political interests well above the interests of the real people. Not that it should surprise you

Two days ago Feds conducted the new Taf auction with stop-out rate of 3.123% (thanks That Guy Drinks Beer). Today they conducted the unexpected add of $17 bln with stop-out rates between 3.05% and 3.17%, almost all agency and mortgage collateral.

People at capitalstool board see two things here:

  • Feds are preparing the market for some disappointment, adding money in front of announcement
  • Today rates are bouncing around 3.125%, pointing to 3/8% rate cut today

The usually boring Fed decisions are full of excitements nowadays!

The rates of foreclosures in San Diego:

San Diego foreclosures

According to Minsky theory there are three basic modus vivendi of a financial unit: hedge, speculative and Ponzi. For hedge units cash receipts exceed cash payment commitments, for speculative units they are equal and for Ponzi units cash receipts are insufficient to match obligations and require taking additional debt on a regular basis.

The main and major problem of our economy is that millions of families and thousands of businesses were able to run Ponzi scheme of operation for substantial amount of time, some of them for over a decade. That was possible thanks to the Autumn period of the Kondratieff wave, where interest rates are constantly falling thus providing the incentives to increase the debt levels substantially above the levels possible in previous periods. The last time U.S. economy was in Kondratieff Autumn in 1920s and it ended badly.

Every Ponzi unit eventually either bankrupts on its own personal pace or participates in a wider Minsky moment, i.e. widespread risk aversion of creditors away from Ponzi units.

The only two scenarios that can potentially prevent the bankruptcy of a Ponzi unit are:

  • Substantially increase the cash receipts on a permanent, not temporary basis
  • Substantially reduce the outstanding debt that will convert (upgrade) the Ponzi unit to at least the speculative unit

As far as I can see none of the proposed measures is addressing the problem even in a slightest manner. It was just used as an excuse for Bush and his GOPniks to push their personal agenda of cutting taxes for riches.

I outlined my own proposals in one of the previous posts

At this moment the way #1 is pretty much impossible for most, especially in a declining economic environment. The $800 will not help unless it is sent every month.

And the way #2 for most corporations and families means bankruptcy or foreclosure. Mish recently observed a trend of intentional foreclosures, i.e. a person decides to foreclose on “his” house not because he can’t keep up with the payments but because he observes that foreclosure is a sound financial decision in his case. So, instead of wasting budget money to prevent foreclosures they must work to make the foreclosure less painful. It’s not good to waste your time – it’s better to foreclose when you are young and still keep your savings than foreclose when you are old and maxed out on your credit cards

Next week there is another Fed meeting. I think we should expect a very interesting week.

Today the bank’s strike continued – they forced Feds to lend them $3.75 bln at 2.74%, which is 76 bps below target rate. Only 10 days ago they were happy to bid at 4.1%. I think they hint that it would be nice to have another 75 bps cut.

But there is another interesting thing to watch. Yesterday Uncle Ben wet his pants and gave them $7.5 bln with mortgage collateral. I think those mortgages are like hot potato and they won’t be happy to get all of them back. I’m curious to see what will be the bid to push them back to Feds?

I also want to point to the important change in my language. I used to say “Feds drained funds”, “Feds added”.  I’m not saying that anymore. When banks are bidding to borrow at 2.74% and Feds are refusing to lend too much I’m saying that this new monetary policy is controlled by banks, not Feds.

I also want to observe that Feds are reluctant to lend too much with agency and mortgage collateral – I think it happens because they want to drain some long-term treasury notes in order to control the mortgage rates, as 30-year fixed mortgage is loosely correlated with 10Y yields

At today auction the Feds gave $6.25 bln at 2.42%, which is 108 bps below current target rate and 183 bps below last week target. 1.83% rate cut in 3 days – ouch! Without this particular add it would be a drain, so Feds had to cut rates by 1.83% and the sloshing is still below January 17.

Another interesting exercise is to count bullets. Bernanke, as a good cowboy in old western had 19 bullets. So far he fired 9, 10 more remain in his gun. He is expected to fire 4 more bullets at the next 3 meetings and only 6 will be left for the remaining of the downturn. Double ouch!

A must see video – Jim Cramer is calling a great stock market for the rest of 2007 and 2008 as late as 3 months ago, when it was absolutely obvious that the game is over. He was not just making the bad calls, but the worst is that he was lying that he did not, as if there is no record. Well, there is. The great Rick Santelli is putting him down.

It’s amazing, Cramer has his own show on CNBC, but each time I look at him (or at most of his colleagues at that station) – he knows nothing about investing and stock market. Nothing. And this is amazing that, apparently, it doesn’t matter

Today I see the pattern I saw several times in the last year: bad stocks go up, good stocks go down, the overall environment is suspicious.

I think it means that some players are giving up and close their short positions on stocks they (properly) consider “bad” and to maintain the same market bias they also have to sell some of the longs positions as well. In my previous experience the opposite trade was always profitable.

Check yourself, scan your favorite list of “good” and “bad” stocks and verify that everything is upside-down.

Overall it means money are just leaving the market and at some time later that will show up as another step down. Connecting with my previous post that broker-dealers show no interest to borrow from the Feds it seems that the capital is either disappearing or moving away from the market. Or both

The most important short-term problem that got us here was the refusal of the gang of 20 to borrow at the current Fed funds rate.

Today Feds did an emergency 75 bps cut. We need to watch the reaction. Will the banks borrow at 3.50% or not? I they will I will start to take some profit on my shorts. If not – just watch out, the only market hope up to now was that Feds will cut. So the Feds did, and now there is no hope out there, only reality

Update: the banks came only with $5 bln of bids with treasury collateral at the highest rate of 1.85%. This is well below the rate of 3.5%, so effectively we had no rate cut today. It doesn’t matter what’s the rate if nobody borrows. They are refusing to take money, Feds can’t push the string. I’m not covering any shorts

Update2: Juan Carlos Arroyo Calderon said:

I think you all just witnessed blackmail.

These assholes could have sold off in an orderly way, but they decided to trigger a crisis to get what they wanted with a lower rate cut.

That’s my story, and I’m sticking to it

It’s possible.  I think the only problem is that there are 20 banks and it would take a lot of winking to form a gang against Feds

I’ve scanned some blogs about the sudden fall-out of non-borrowed reserves of depository institutions from $42 bln in November to $200 mln last week. It looks scary, but let’s wait for some professional explanation before we panic.

From my side I see the definition -

Nonborrowed Reserves – measure of banking system reserves, consisting of Total Reserves (member bank deposits in Federal Reserve Banks, plus vault cash), less funds borrowed (Borrowed Reserves) at the Federal Reserve Discount Window

As far as I see the Taf is counted. The difference between Taf and Discount window is that banks borrow from discount window when they are in the deep doo-doo but they borrow from Taf because they can.

If outstanding Taf is about $30 bln then real non-borrowed reserves are somewhere between $200 mln and $30 bln, but the picture is blurry. Effectively the Taf killed our ability to properly evaluate this number. For now let wait and see what happens

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