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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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The de-evolution of our economy and culture continues. Thank you Lucifer!
Would it be related to the $9.3 billion in derivative losses that Fannie and Freddie just posted in their Q3 statements?
http://www.theatlantic.com/business/archive/2011/11/fannie-and-freddie-need-another-14-billion-but-losses-may-be-slowing/248186/
Don't worry about Freddie and Fannie...they were fixed. Govt leaders have said so.
The super committee is just election year window dressing for public consumption and possible diversionary explanation later of market maneuvering. I’m with belief this is more in line with union thug style ‘friendly messaging’ that the administration wishes no further embarrassments in the coming year. Instincts can speak volumes especially if something doesn’t past the smell or JDLR test of the limbic system.
When hard decisions need to be made and the deciders are averse to make them, the issue will be relegated to a "Blue Ribbon Panel", "Super Committee", "XXX Commission", etc. There, the issue morphs into nothingness.
Ain't that the truth!
I saw something about the repubs on the Stupor Committee having proposed a plan for $1.2 Trillion of deficit reduction. And I remember thinking, "Okay, that's a start but it's still not enough. The U.S. gov't's deficit this year is something like $1.7 Trillion."
Then I read further.
They're proposing a plan for $1.2 Trillion of "deficit reduction" OVER A TEN YEAR PERIOD!
It's utterly meaningless, a complete abdication of responsibility. And they can't even agree on that. And here I'd thought I couldn't have more contempt for our congresscritters than I already did. I was wrong.
Well, you look at some the wired things BOA are doing, and some of the stranger goings-on with Mortgage servicers and you've got to wonder, how did these same guys get bailedout? I mean, there isn't ANY grey area with regards to their willing intent to commit fraud - it can be proved - and now the FED is there propping these tools up, month-by-month? With Home Equity somewhat questionable, can it really be argued in the interests of National Security?
Every right they violate is in the interest of "National Security" and/or your "personal security." That includes taxing you thru inflation and whatever other device they contrive.
Reg T
he he he - I gotta tell my Iowa farmer buddy, whose land is regularly trespassed by hunters and dumpers, about your sign
The RBA has also increased its repo margin on 'securities' other than government bonds, at the same time lowering the credit rating from A to BBB.
It would seem to be a global phenomenon.
Another possible reason is to try to protect itself if, within the smoke of large rolls, it wanted to conceal net sales.
Do they know something about the GSE's, or just noticed the Prime-x trend?
Maybe reason for FED's move is fear of fallout from
>>>
First Felony Charges Brought Against Robosigners
<<<
headlined elsewhere on ZH.
If the Fed stayed out of the MBS market they wouldn't have to worry about rolling their MBS purchases.
Is the Fed hedging against the after affects of the super commitees decision/indecision?
Something tells me that the Fed is more akin to the bookie taking bets on a fixer.
But I'm all suspicious like that.
mfg is the canary in the coal mine imo...way too many traders screwed...if celente can get screwed well good luck
BIDLESS
It's just a bag over inflation's head. It'll prolly get some lipstick and a wig later.
Bruce,
I am in general agreement but I have an additional perspective on three of your bullet points:
* 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.
Exactly! I view Bernanke as one of Obama's supporters in DC. I have opined months ago about Ben being Wall Street's bitch. I think he has been told he MUST get the upper hand on the banks.
* 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.
Bad news does not age well or come as a welcome surprise. MFG was both and will get worse before it gets better. This is a signal that if anyone else has bad news,whisper it in Ben's ear now.
* 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.
One of the "more than meets the eye" items maybe news that the Foreclosure Fraud Settlement is a No Go. This may be the public display meant to warn the banks to keep the bonus pool really small because they are about to get reamed for a lot more than $ 20 Bn.
Is it just me? Or does the whole "MBS dollar rolls" sound like a Repo 105 to anyone else?
barliman
thanks bruce. these times are a bit breathless, at times.
Very Good article Bruce.. there is something going on and we will see some time later on..
Hey Bruce, the details on the HARP Obama refinance program were released yesterday! I know you speculated quite a lot recently on what the revised rules would be. What are your thoughts on the new refinance rules? Looks like there is no appraisal requirements and loan adjustment fees have been capped at .75, so borrowers will get rates in the 4.25% range and possibly below!
I'll take a look. Yes, borrowers who qualify will get sub 4% new mortgages.
Thanks.
b
I read it to be a back door bail out. After a HARP-2 refi, the GSE gives up claim against the bank even if the original loan was one of the naughty ones.
Bruce
looks like bernank is draining a little water out of the pool to see who's wearing trunks and who's going euro,he doesn't know who without draining the tub a schmig.
Faux prudence?
"forensic accounting." picking over the bones always reveals something. With a class action lawsuit to shake Corzine down to his last cuff link more will be revealed.
Bullish!
BTFD
21 primary dealers comes to 100m per dealer. Seems to me that if they can keep their noses clean any avoid having to appear before Judge Rakoff one time per year they've got the $ for collateral right there.
ZH readers should check out the WSJ story for themselves since it points out that paying margin in transactions with the Fed is a typical thing. The author complains on behalf of his banker friends here. On the other hand he would complain and blame Obummer if he heard the Fed wasn't taking collateral on these now risky transactions.
Generally appreciate the reporting with BK stories and the insider experience and visibility he provides. Can do without the spin and breathless tone that often accompanies it.
I enjoy his stories about rubbing elbows at the elite cocktail parties he attends in Greenwich.
OMG Ooh La La.
A couple of years ago I was at a luncheon where the Bernack was the speaker. He was asked about the qualiity of of the collateral they accpepted. He said it was their best judgement about it. Maybe even the Fed is getting nervous about what they accept.
"Maybe even the Fed is getting nervous about what they accept."
Only if people demand to look behind the curtain!
I can't help but think that OWS is having a part in this. Politicians can only hold off the hordes for so long. The response is, however, that which it always is, a distraction from what it's really all about... A "new reality" will be painted and people's attention will be diverted to It, and while energies are spent trying to crack this nut TPTB will be rolling out the next "new reality." This dance WILL stop: that which cannot go on forever won't.
There is likely nobody at OWS paying attention to this announcement, let alone understands it.
More margin = shit gonna hit the fan and we need cash. The grand, final deflationary sag / scare the sheeple is about to begin?
"More margin = shit gonna hit the fan and we need cash."
But can't they essentially just print whatever they want whenever they want to?
serfdom has arrived
I disagree with Bruce that this is "benign". The Fed has no business doing repos in the private-label market. By its own charter (not that that matters) the Fed is not supposed to buy paper that isn't "full faith and credit". Yes, they can loan against collateral in dire circumstances, but repos are not loans. If the counterparty PD goes under between purchase and repurchase, the Fed is stuck with the turds. Even when the repos involve agency debt, keep in mind that Fannie/Freddie/FHA paper explicitly does NOT have federal guarantees.
Yeah, I know, "the Fed must intervene to provide liquidity in the MBS market". NO. A lack of liquidity in the MBS market is the primary signal that the market is withdrawing from this junk, and for good reason: It's JUNK, created through fraud. So "providing liquidity" is a euphemism for "the Fed will buy your mistakes with the taxpayers' future".
This is Argentina without the cheap steaks.
The FED is not relegated to "full faith and credit"
See Public Law 106-122 and Section 10B of the Federal Reserve Act.
The Fed can directly monetize Residential Mortages (and presumbly bundles of them) into Federal Reserve Notes.
Maybe the FED just got advance knowledge that the MBS market is about to tank because of State prosecutions due to robi signing. Every registry of deeds is literally a crimes seen filled with self-authentcated evidence of uttering false documents.
Maybe Neveda is the first hole in the dyke.
I see it as a take-down move in this game of Bankster Royale.
We know Jefferies is likely on the chopping-block, question is, who else?
http://www.ny.frb.org/markets/pridealers_current.html
Edit: Or, maybe I should ask, which other PDs are left in the commodity futures market that need to be taken down in order to kill it, leaving only JPM and GS standing?