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The Fed makes a weird move
The Federal Reserve has taken an unusual step this week. To my knowledge the action is without precedent. There was no prior announcement or discussion preceding the new measures. By itself, this is atypical for Bernanke's Fed. Ben doesn’t like to surprise markets. He did this time (I'm sure he personally approved the move). Some details and thoughts on what it might mean.
For years the NY Fed has conducted "Dollar Rolls" of MBS securities with the Primary Dealers. These transactions provide liquidity to the MBS market. The Fed’s description:
The Federal Reserve uses agency MBS dollar rolls as a supplemental tool to address temporary imbalances in market supply and demand. A dollar roll is a transaction conducted at market prices that generally involves the purchase or sale of agency MBS for delivery in the current month, with the simultaneous agreement to resell or repurchase substantially similar (although not necessarily the same) securities on a specified future date.
Still confused? So am I. My conclusion is that this is benign. The Fed is just providing order and a degree of predictability to an important capital market. I also don’t know how much of this is going on. This Reuters article suggests that it is a Trillion dollar market. (Would love some help on the #s?)
Why would the Fed establish a new margin requirement on something that has been going on fine without one for years? Why now? The answer is easy. It’s the fallout from MFG.
In a dollar roll the Fed has no principal risk with the counter-party. The cash and securities are settled through a clearinghouse. But they do have risk in the event the counter-party fails during the 30-day roll. If that were to happen, the Fed would have to replace the position with another party and in the process could suffer a loss.
In an effort to avoid this loss the Fed has established a new 2.5% margin on all MBS dollar rolls. From the Journal:
The Federal Reserve said it will be increasing collateral requirements on 21 primary-dealer banks in transactions dealing with mortgage-backed securities, in a move that would be aimed at securing an extra layer of protection against settlement risks with its counter parties.
Random thoughts:
* What kind of message does this send? (It was communicated to the PDs via a conference call!) It sends a very mixed message in my direction. Essentially the Fed is saying, “We’re not so sure we can trust all of you”. Of course this position is justified given that MFG (an ex PD) went into the tank in a matter of days.
It would have been nice if the Fed had taken a different approach and said:
We’ve looked very close. MFG was the only bad apple. It won’t happen again. We’re comfortable with our counter party risk. No need for changes in margins or haircuts.
But they didn’t say that. In fact they have said/done quite the opposite. So to me, it sends an ominous message.
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* A shot at the numbers. Say it was a trillion dollar market. That would mean that at any point and time there would be about $80b outstanding. 2.5% of 80 large comes to a neat $2b. That’s not so much money for the PDs. But this is equity money. There is a cost to equity these days at the big firms. There is not one of them that has excess tier 1.
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* I have heard that all the PDs are bellyaching big time over this. It will eat into their profits. I also heard that some of the European banks that are also PDs (BNP, Barclays, Credit Swiss, Deutche Bank, UBS) are really pissed. This is not a good time for them to be asking the Head Offices for an additional allocation of capital.
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* I don’t think this is all that profitable of a business for the PDs. It’s just part of the grind of financing Agency MBS paper. This is a slap in the face of the PDs.
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*This appears to be very bad timing by the Fed. We shall see if anyone (other than me) interprets the new margin requirements as a warning sign. I believe we are on very shaky ground on the matter of sovereign debt and the brokers who make the system work. We can’t afford to let a few more straws fall on the wobbly camel. I think the Fed may have just added to the fray of concerns.
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*I’m making a big deal of this. I think it may prove to be important. Anytime that the Fed does something unanticipated it’s worth noting. There is always something more than meets the eye. The timing is odd. The optics are terrible. The Fed is making credit harder to get (very big numbers involved in MBS land) at what may prove to be exactly the worst moment.
Ben Bernanke has often spoken on the history of the depression. He has pointed at the errors of the FRB in 1937 when credit was tightened and a second leg of deflation started. He has said he would not make that same mistake again. I wonder if he just did. Sometimes small things bring big results in our complex markets.
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At one time we hired public emploees to work for the people..... Then one day about 90 years ago these people discovered CAPITALISM! Next the government went into business for THEIR OWN BENEFIT. This is the simplest way to explain what is happening so people can understand it.
THE GOVERNMENT IS JUST ANOTHER GANG,,, the biggest gang with the most guns. We are just 'FOOD' (a resource) to be eaten for their benefit,,, Nothing complicated can be said about what has happened here.
Bruce Krasting:
What if this is not a mistake?
Some people seem to think that Carter would have had a better chance to get re-elected in 1980 if The Federal Reserve had not raised the interest rates so much.
Someone might have already mentioned it, but is it possible that this nothing more that a back burn, to burn the fuel out of the path of the larger fire headed our way, or a burning of the hay bail to force the rats out?
Self regulating runs counter to what the human animal actually does with a Bic lighter some of the time.
I'm waiting for the rats with a stick and a Bic, and maybe a grenade or two. These seem to be some very big, self regulating rats.
OK, so maybe I should dispense with the stick and bring out the heavy artillary maybe an RPG and a couple of Sidewinders.
Wonder how big the crater will be.
If the counterparty PD goes under between purchase and repurchase, the Fed is stuck with the turds.
--------- Did you forget shit runs downhill? The taxpayer sits at the bottom of the totem pole.
Always remember the Fed's ONLY mandate is to bail out banks. Everything else is window dressing.
At the same time the USA's most important foreign policy instrument is the reserve status of the dollar. We bailout foreign banks to maintain that status. These banks' core reserves are US treauries, and the whole world economy is built, or collateralized, on dollar reserves. Comined with our military which preserves a Pax Americana, the world is forced to sing our song whether they like it or not. All things considered its MUCH less invasive than what Hitler had in mind, or Napoleon for that matter.
If EU banks start going down, its the beginning of the end for the dollar reserve status, which would be the end of the US hegemony over world finance, which IS our Empire. The Fed is doing very little right now, because they are waiting to see what happens in Europe. They don't want to jump in, only to have the tables turned on them with unanticipated events. That's scary because it means NOBODY knows what's going on over there.
"Always remember the Fed's ONLY mandate is to bail out banks. Everything else is window dressing."
Very astute observation. We the people don't own shares in the Fed, "we" can't even buy the shares, not as individuals, nor our treasury. It is the fiduciary duty of the board to look out for the shareholders above all else, and if they did not do so, we would hold them derelict in their duties.
Au Contrare , Anyone holding FRN dollars owns shares of the FED.
Yeah its scary because in the end the US has to bailout all endangered systemic banks of this world. Including the swiss giants UBS and Credit Suisse
Today's new swear word: Technocrat
Today's relevant concept: Unintended consequences
Brilliant. Also, it appears that a person has to have formerly worked for Goldman Sachs (Monti, Papademos, Draghi) to be called a technocrat.
Dow is down 116. I think this post by Bruce must be making the rounds.
Put this in the context of the Fed paying the same banks a fraction of a percent to keep their reserves parked at the Fed.
Left hand doesn't know what the right hand is doing ...
They're trying to control where the money's going?
If the Fed was actually a branch of government it would be more than happy to risk potentially socializing losses in order to avoid introducing instability into a market just to try to protect itself. Hint: it's not a branch of government.
The Fed was established as an agent of Congress, to do Congress' bidding in carrying out a narrowly-defined group of tasks.
Hint: The Fed is an agent of the Legislative Branch of the Federal Government.
Technically, you are correct. The Fed is not a branch of government. But, then, nobody has ever claimed it was. But it is an agent of a branch of government. Those who have problems understanding this might study up on the independencies and obligations of agency. That will clear up a lot of confusion that seems to exist over what the Fed actually is and who it is subject to.
You've got it backwards, the Fed is an agent of the banks, intended to influence congress and the policies of congress for the benefit of the banks.
Hint: You're wrong
Addison Wiggins: <<
"Through quantitative easing efforts alone," says Euro Pacific Capital's Michael Pento, "Ben Bernanke has added $1.8 trillion of longer-term GSE debt and mortgage-backed securities (MBS)."
Think about that for a moment. The Fed's entire balance sheet totaled around $800 billion before the 2008 crash, nearly all of it Treasuries. Now the Fed holds more than double that amount in mortgage derivatives alone, junk that the banks needed to clear off their own balance sheets.
"As the size of the Fed's balance sheet ballooned," continues Mr. Pento, "the dollar amount of capital held at the Fed has remained fairly constant. Today, the Fed has $52.5 billion of capital backing a $2.7 trillion balance sheet.
"Prior to the bursting of the credit bubble, the public was shocked to learn that our biggest investment banks were levered 30-to-1. When asset values fell, those banks were quickly wiped out. But now the Fed is holding many of the same types of assets and is levered 51-to-1! If the value of their portfolio were to fall by just 2%, the Fed itself would be wiped out.">>
http://news.yahoo.com/next-financial-crisis-hellish-way-204303737.html
By refusing to mark to market, it's difficult to know the real value of that portfolio. Eventually though, paper will reach maturity and losses will be impossible to ignore any longer. At that point, when it's clear to all that the Fed is deeply in the red the shortfall will be either printed away (inflation) or made whole via taxation (austerity).
Either way, the little people pay for it. Fucked up world we live in.
it may be a matter of semantics but put it this way "We're doing business with people we don't trust.."
you reported some time ago that the Fed "added" several PD's. and at the time you questioned their motives. when you start doing "slightly" illegal things, you must bring in some less than reliable institutions. the Fed is not officially just like the CIA!
It's a prelude to the Fed buying the mortgages. Drives the price down.
the Fed is more concerned with keeping mortgage prices UP. besides they're spending your money.
Bruce, to your post yesterday, it does appear that the >125LTV HARP 2.0 loans will be non-TBA eligible, meaning, if they are priced to TBA levels, there will be an interest rate subsidy. Pricing is yet to be determined, but this is something to watch - my bet is Fannie and Freddie take them on balance sheet at subsidized rates.
Before my morning coffee, I glanced at the title of this post and mistakenly read it as "Fed Makes Wierd Movie" and thought they really had gone full retard.
End game -- just closing the barn door.
If you ask yourself what is the knock effect of them doing this and ask yourself what does the fed gain by doing this you have your answer.
The knock on effect is to shrink liquidity to kill off some of the smaller players by making them ripe for failure. They will be absorbed by the likes of JPM.
or
It will put the system under so much pressure that the printing press has to be turned on.
The next question is who are they targeting? Wouldn't be the Europeans by any chance would it? If the Europeans are being squeezed then it stands to reason Ben is trying to force them to print which eases the way for the Fed to print to "combat currency manipulation".
This may be the Feds way of telling Merkel etc to get with the program.
the fed giveth and the fed taketh away
i'm not sure how all this works but i wonder if they want to limit the PD's ability to front-run
or if the fed wants to buy mbs this way they get them on the cheap
force liquidation of mbs, the funds have to go somewhere, maybe they hope they go into equities
like i said, i've no real idea but wasn't seeing these possibilities mentioned and just wanted to give my 2 cents worth
The problem the Fed sees is that Occupy Wall Street is going to turn into Occupy Foreclosed Homes.
Where to begin? The collapse is around us.
>>>turn into Occupy Foreclosed Homes.<<<
That's already happening with people not paying their mortgages for 2+ years before they leave. What if they never left or refused?
What if vacant, foreclosed home were suddenly occupied?
Local law enforcement would be hard pressed to do much of anything in some communities with high vacancy rates.
Squatting may make a real comeback.
Who'd have thunk it. The Feds worried about getting a cushion on it's deals with primary dealers, many of which are european banks. Why these boys can't possibly be in any trouble can they? Every day the TED spread goes wider but it can't mean anything. Why they just had a stress test and they all passed (even Dexia and Unicredit), no problems here, just move on. sarc
I'm Sure Steve Liesman will ask Bernacke about this at the next press conference
"Prior to the bursting of the credit bubble, the public was shocked to learn that our biggest investment banks were levered 30-to-1. When asset values fell, those banks were quickly wiped out. But now the Fed is holding many of the same types of assets and is levered 51-to-1! If the value of their portfolio were to fall by just 2%, the Fed itself would be wiped out."
-Mark Mobius
http://news.yahoo.com/next-financial-crisis-hellish-way-204303737.html
Pretty fuckn' scarry or a blessing, either way this will be among the most painful events to hit the planet.
I've heard this sentiment before, but I don't understand. How can an institution be 'wiped out' by a fall in asset prices if it is able to create 'money' at will?
Do you mean "the Fed will be wiped out unless it prints money" ? Or am I missing something ?
The Fed's also in a corner with printing right now and that's why they resist QE3 even if they're dreaming about doing it. If they print openly, gold gets out of control and they also go out of business.
They'll take a printing hoiiday. A presumption that Bernanke has a clue is a big leap..
TO FREE OURSELVES, RESTORE FREE MARKET CAPITALISM AND REESTABLISH OUR CONSTITUTIONAL REPUBLIC, WE MUST FIRST ELIMINATE THE MOST PERNICIOUS CORRUPTING FORCE OF ALL.
END THE FED!
See:
Money Power And The Central Bank: Life Is But A MEME
END THE FED: THE FIRST STEP IN RESTORING OUR CONSTITUTIONAL REPUBLIC
“First they ignore you, then they laugh at you, then they fight you, then you win.” - Mahatma Gandhi Reconstructing The Occupy Movement: MSM Obfuscation and The Truth14 Reasons Why We Should Nationalize The Federal Reserve
Also see how Banksy has drawn upon WB7's work:
Even the Fed Can’t Value Financials’ Risk
Would an imminent MBS-focused QE3 make this easier for PDs to swallow?
Could this somehow be prep for large scale MBS buying or is it most certainly MFG related?
Bruce,
Since the Fed has been changing its focus from money printing and asset purchases to inducing the deployment of excess reserves via increased reverse repo activity, it is unlikely that we will see another round of QE focused on treasuries comparable to the first two rounds. The balance sheets of large banks and repo counterparties will absorb the supply of short term treasuries, while the Fed can continue to purchase the long end under the directive of Operation Twist. However, it is possible that more asset purchases of MBS will become necessary in the future if housing continues to deteriorate and MBS pricing declines. The Fed cannot allow true price discovery in this market because it will be another headwind for banks balance sheets, as these assets will need to reflect ongoing market prices. Therefore, I expect that we could see future quantitative easing in the form of a reduced rate for excess reserves to increase the rate at which banks put these reserves back to work, as well as asset purchases of MBS to keep prices of these securities artificially inflated. So, could this latest move by the Fed be a precursor to this additional easing by slowing the transaction volume of MBS securities and therefore forestalling true price discovery until such time that they are ready to announce additional purchases of these securities?
Another angle is the Home Affordable Refinance Program Obama floated not long ago (Bruce covered it a few weeks back). If those mortgages are re-fi'ed, that means a principal pay off to the original mortgage holder right? Since the Fed is pregnant with all those MBS, the Fed could see sufficient cash flow in the form of principal payments as a result (with the new debt transfering to the off gov balance sheet of Fannie/Freddie).
That is a lot of potential money the Fed could use to buy whatever it wants. This is cash to the banks too, if they still have any MBS hidden somewhere.
It would be a "QE", but they would be a lot more flexible in how they spent it and it is quite under the radar.
What do they buy? I have no freaking idea.
Regards,
Cooter
horrors, if you are going to buy and sell ou need to post 2.5%. name another business that gets away with this crap. I had to buy some new eye wear, had to put 50% down, does the mechanic allow 2.5% down. the stuff that goes on there hould never been allowed on the first place.
the entire fin
You're right of course. The new margin is 2.5%. The old margin was 0.00%. So this was 100% leverage for the PDs. And that probably should not have been the case as you state.
To me the important thing is the direction/timing. Margins have been increased. That reduces the supply of credit/liquidity.
From where we were to where we are, this is a big change.
I think this is bullish on the long term. Here is the reason why.
On an overarching theme, I suspect there is agreement that the global financial system needs to be fixed. In essence, the barn door will be closed after the horses got out. The horses will be rounded up and led back to their stalls.
Globally, Germany is pushing for transaction taxes which affect the jurisdiction of Britain, who in turn hosted AIGFP. Germany will ensure that changes will be made so that various European jurisdictions will follow the same rule book. Once that is adopted, I suspect the rules will change to protect the taxpayers' wallets.
Now here we have the Fed placing a risk mitigation structure around primary dealers. Clearly the major banks are having fences built around them to direct their navigational abilities. The question is what direction do these navigational changes point to? It looks like a long term objective where there are global banking rules that protect the taxpayer.
Interesting and thoughful comment. Certainly bold on ZH where folks are often very negative regarding the outlook of the current system.
I guess this falls in the "part of something is better than all of nothing" bucket.
I just got my Currency Wars book, so I am still mulling how things are going to play out with regard to a global monetary framework. I think that is the central issue facing the world; keep it or burn it down and start over with something else.
Lots of risk in that second option for those that have a seat at the table today. Lots of risk.
Regards,
Cooter
"I suspect the rules will change to protect the taxpayers' wallets."
Boy, I haven't considered the idea that any of our rulers would attempt to protect taxpayers wallets in a long, long time. It was kinda refreshing. I'm not buyin' it but it was fun for a sec.
"It looks like a long term objective where there are global banking rules that protect the taxpayer."
Don't confuse the CLAN of rallying themselves when they are encircled with looking to do good in the eyes of the taxpayer.
We're talking The System. The "taxpayer" is merely a part of The System.
Anything that is done to look like The System is addressing The Taxpayer is merely a distraction to lead away from their power being challenged.
The horses may be led back, but the barn's so full of shit (debt) that they'd drown in it, never mind there being any semblance of horses increasing (credit growth).
BTW - When is it that you think that Canuckland is going to start imploding? I'd pegged it to China.
Western Canada will do okay but Eastern Canada dives when the US dives. That will be after the 2012 Presidental elections. China will tank but I don't think commodities will take a hit like they did in 2008. When China tanks it will take the bond market with it. There is $4 in the bond market for every dollar in the equity market. I'm guessing governments will print and there will be a run to anything "safe" which includes precious metals and certain commodities.
The barn is full of crap and it needs to be cleaned out. TARP et al bought time now is the time to clean things up. We should see signs of that taking place.
Greece is a good place to start. As pressure builds in Europe for Germany to give ground, a point will be reached where geopolitical judo kicks in and Germany effects Greece's exit. That judo move will cause a cascading effect in the other euro countries which will force them to clean up their little barns.
"Western Canada will do okay"
Built-in bias? I mean, I like Western Canada, but mostly because I'm closer to it, AND, I fetched my wife from there. I do have a bit of an awareness of things up there.
I'm thinking that if China goes into melt-down mode (which is anything other than robust growth) that that will cause $$ to leave B.C.. Lots of rich Chinese kids pumping money into the Vancouver engine. If this starts to dry up (mom and dad recall their offspring) then the essential growth environment will be put in a bind. I say all of this because I was able to experience/see it first-hand: my wife had rented out rooms to such folks, and she did it out of necessity- in order to pay her mortgage, which, had she not listened to me and sold her home, she'd be upside down on by now (instead she managed to come out just slightly above the water line). This is playing out all over the place: MASSIVE mortgages on the edge. I'm thinking that a few retreating Chinese will be the initial push down the staircase. Other signs have been appearing for a while, stuff like cuts in services etc. (not arguing that this is bad, just pointing out that this is hardly a sign one sees during an expansionary period- you're either expanding, static, though only momentarily, or contracting).
I think you are both correct. I think CH's comments refer to the area in total where your comments center on Vancouver.
Vancouver is in a bubble. Huge Chinese money has flooded in, driving property costs through the stratosphere. Will it crash? Probably. If a property was bought with 100% cash and not debt (anyone seen numbers?) it would certainly be where a Chinese immigrant would want to live when the world economy hits the brick wall. I think this is the case, because financing those property values takes serious monthly income. You sure as hell can't do it working in the local market, with rare exception. So, some may move back home, and prices will come down, but I think a lot of properties were bought with cash as a roof in a stable country is priceless for the things coming.
I would also note that "western Canada" is very agrarian in terms of economy. Ranching, farming, lumber, mining, and oil. It didn't put on a lot of "economic fat" like finance, insurance, and real estate (among others).
Personally I think commodities will nominally perform very well in the shit storm that is coming primarily because commodities track real inflation. When the nominal inflation hits, commodities have one of the best seats in the house, making western Canada attractive. If the money supply was stable and not rapidly expanding, commodities would reflect this by being very stable in price.
Regards,
Cooter
I agree with everything you said. Also, when the SHTF who will be the counterparties paying out the CDS and other instruments used to profit on the fall of the bond market?
"Do I still get my Bonus?"
The Banker asks.
Because Jefferies is about to go down?
Yeah, maybe. Plus: Rough water ahead boys, time to batten down the hatches.