Saturday, March 22, 2008

A Historic 9 Days for the Federal Reserve

I've kept writing since a week ago Tuesday, these are some of the most incredible moves we have seen by the Federal Reserve. Even though we've discussed them a week ago Tuesday [Mar 11: Fed Rides to the Rescue], last Friday [Mar 14: Bear Stearns Getting Secured Financing from JP Morgan and NY Fed], Sunday evening [Mar 16: More Fed Actions!], and even Friday when the Fed put a cherry on top [Mar 20: What the Banks Want the Banks Get - Fed Expanding Junk It Will Take In] - it is worth putting them all in one story and for those newer to the market realize the historic level of "free market" interference that is happening. While Wall Street equity traders cheer (as they get their tax payer backstop), a US citizen must ask what is the Federal Reserve finally seeing that is scaring them into such historical action? Probably the same things the Roubini's of the world have been warning [Scary Stat of the Day: Roubini Calling for $1 Trillion-$3 Trillion in Losses] .... that should scare people, but instead it emboldens them to take more risk. This is the true meaning of "moral hazard".

Moral Hazard? Will this change Wall Street's ways? hahah - you made me laugh. Not in this compensation system in America where in CEO roulette - heads you win, tails you still win. Especially not in the financial system where heads you win, tails you win, and if it lands on its side the taxpayer pays the bill! [Wall Street Culture Not Likely to Change] And the Federal Reserve is helping it all along - such nice people. See, this is the irony in it all, there is no way for these people to lose. None. Never. The banking system is the US. It cannot be allowed to falter - it is now intertwined to such a degree (and levered!) nothing like the early 90s S&L bailout (when 1000+ S&Ls failed) could be allowed to happen. To do so, risks global collapse. So keep taking risk, keep rewarding yourselves with tons of bonuses and pay outs, and then when a few go under the underlings/peons will lose their jobs and 401ks, but the taxpayer will make sure the system keeps on ticking? And don't forget those retention bonuses to keep those excellent risk managers in their CEO/CFO/CIO posts. Excellent.
  • And so analysts believe the sale of Bear Stearns to JPMorgan Chase & Co. for a stunning $2 per share ultimately won't have that much of an impact on how Wall Street conducts business.
  • In fact, bankers and traders are under even more pressure to reap big returns because of the ongoing credit crisis, and risk is just part of the game.
  • Indeed, the past decade has seen a number of investing fiascoes that Wall Street doesn't appear to have learned much from. Krosby noted the go-go Internet days -- when untested high-tech companies reaped piles of cash in public offerings. The lesson then was, don't put a lot of money into a venture that isn't on fairly solid ground -- but mortgages granted to people with poor credit are quite akin to high-tech firms that had never turned a profit. In both cases, investors gleefully looked past the risk.
The biggest risk now is if these moves truly don't put a backstop under the situation - I've been saying for a while now the implicit trust that the Federal Reserve can fix everything is really all that buffets this market from a much larger fall. I have no idea if the Federal Reserve is big enough and can print enough or it's actions are enough to support a multi trillion global shadow banking system. But they are trying and the actions truly are unprecedented in scope. For now they seem to have restored the feeling that everything will be ok. But the story is not over yet - we'll see how things continue to play out.
  • The Federal Reserve has taken its boldest action since the Great Depression, invoking rarely used powers in an effort to contain a panic threatening to undermine the economy. The central bank acted with speed the White House and Congress only could envy.
  • The Fed is largely free from many constraints that bog down other policymakers. Also, it is the only U.S. institution with the authority and ability to create money out of thin air.
  • For now, the steps orchestrated by Chairman Ben Bernanke, in the first critical test of his leadership since succeeding Alan Greenspan in early 2006, are earning praise from the Bush administration, Congress and presidential contenders Barack Obama, Hillary Rodham Clinton and John McCain. (of course they are, bailout nation - we do NOT care who pays the bills, the grandchildren and their grandchildren can worry about it - all we care about is political polls in the here and now)
  • But the Fed's moves are raising questions about whether its regulatory powers, established in the early 20th century, need overhauling and whether it took on some responsibilities that Congress and the administration should have shouldered.
  • "I spent 35 years on Wall Street, have been a Fed watcher for a long time and I have never seen the potential for a more severe credit crisis than this one," said David Jones, chief economist at DMJ Advisors and a former Wall Street economist. "It looks like we turned the corner precisely because of what the Fed did."
  • Congress created the Fed in 1913 to prevent financial panics such as runs on banks and set it up as an independent entity. Its powers grew in 1933 and 1935. Although the Fed is subject to congressional oversight, its decisions do not have to be ratified by the president or Congress. Fed officials are not paid with money appropriated by Congress.
  • The system includes 12 Reserve Banks in major cities. These banks have their own boards of directors, two-thirds of whom are elected by commercial banks in the region and one-third by the Fed board in Washington.
  • In a remarkable week, the Fed: (1) engineered the fire sale of bankruptcy-headed Bear Stearns Cos. to J.P. Morgan Chase & Co. with a $30 billion loan. (2) offered emergency loans to other securities dealers under terms normally reserved for regulated banks. (3) slashed a key short-term interest rate by three quarters of a percentage point, to 2.25 percent. The cut was sixth since September. (and you forgot about the late Thursday actions of increasing the type of junk they will now allow the financial institutions to offload into the Fed balance sheet; and don't forget last week's $200 Billion action)
An interesting "opinion" (or fact?) piece on
  • In a financial crisis, the Federal Reserve has an obligation to become the lender of last resort, making cash available for banks that need it right away to prevent a systemwide meltdown. But for this crisis, the Fed has become the lender of first resort to a whole new group of financial institutions that are relying on the central bank to boost their profits.
  • Instead of lending only to firms that cannot find money elsewhere, the Fed apparently is lending to firms that can get the money elsewhere, yet at a higher cost than borrowing from the Fed. I say "apparently" because almost everything about the Fed's new primary dealer-lending facility is secret.
  • The New York Federal Reserve Bank, which runs the program, would not comment about who is borrowing or under what conditions they are borrowing. The only information that was from the Fed came Thursday in the weekly report on reserve balances, showing that the 20 primary dealers borrowed $28.8 billion on Wednesday and about $19 billion on Monday and Tuesday.
  • What executives have said, however, indicates that these firms are violating the spirit, if not the letter of the law. A spokesman for Goldman Sachs for instance, told MarketWatch's Alistair Barr that the firm has borrowed from the Fed and intends to do so again "if doing so makes sense from an economic and funding-diversification point of view." He said that the Fed was a good "alternative." In other words, the Fed is just another source of money for Goldman, and not the only one. Because the Fed's only charging 2.5% interest, it's a very "attractive" source of money
  • The Federal Reserve Act, the legal authority that makes the Fed a more honorable institution than the Mafia, states clearly that the central bank may lend money to companies that are not "depository institutions" (in other words, that are not commercial banks) only if that firm proves to the Fed that it is "unable to secure adequate credit accommodations from other banking institutions" and only "in unusual and exigent circumstances." On Sunday, the Fed board voted unanimously to declare these to be "unusual and exigent circumstances."
  • It's a judgment call by the New York Fed as to whether these firms can find credit elsewhere. In the middle of the worst liquidity crisis since the Great Depression, the New York Fed is understandably bending over backwards to supply credit now and ask questions later.
  • Being the lender of first resort could make the Fed's goal of stabilizing financial markets harder to achieve, because the Fed could be crowding out private-sector lending. How can anyone compete with the central bank? Any firm that doesn't have access to the Fed's cheap money is at a serious disadvantage.
Another article: after reading this it looks like this man is going to be the next Fed Chief .... he is doing the dirty work behind the scenes and already he appears to be the best friend of NYC banks so who better to fill their pockets to the brim in the future?

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