What Does the Fed Know That We Don’t?

Phoenix Capital Research's picture

The thought that should be on every investor’s mind today is “Why did the Fed have to stage the coordinated intervention yesterday?’

 

Put another way, what exactly does the Fed know that we don’t?

 

The whole thing smells fishy to me. Aside from the fact that the Fed clearly leaked its intentions as early as Monday night (hence the reason stocks rallied while credit markets weakened), there’s something peculiar about the fact the Fed chose to do this at the end of November.

 

Why November 30? Why not today or Tuesday?

 

I think the answer is that the Fed stepped in to help its institutional investor/ hedge fund buddies. November was a horrible month for this crowd. And with Bank of America approaching $5 per share (a level which would require many institutions to liquidate due to regulations), the Fed was also helping out its favorite insolvent bank as well.

 

Aside from this, Europe was approaching the End Game.  Germany won’t permit the ECB to print nor to issue Euro-bonds. The EFSF plan was dead before arrival, failing to even stage a 3 billion Euro bond auction without having to step in and buy the bonds itself. And the IMF wasn’t going to be an option either.

 

Put another way, ALL other bailout options had failed for Europe. The Fed was the lender/ intervener of last resort. That alone should have everyone worried as it indicates just how dire things had become in Europe.

 

However, there’s something far more worrisome about the Fed’s move which is that: IT SOLVES NOTHING.

 

Europe is facing a solvency crisis. Lowering the cost of borrowing Dollars does absolutely ZERO to help European banks raise capital. All it does is provide even more easy credit… which of course is the entire problem to begin with.

 

Banks across Europe are leveraged at an average of 26 to 1. This means that they own 26 times more assets (read: loans made to consumers, businesses, etc) than they do equity.

 

At these leverage levels, if the assets fall even 4% in value, you’ve wiped out ALL equity, rendering the bank bankrupt.

 

In this situation, providing more liquidity to these banks helps in terms of short-term operations, but it does nothing to address the core issue which is too little capital and too much leverage.

 

So this move, as dramatic as it was for the stock market has done NOTHING to solve Europe's solvency crisis.

 

Indeed, we have reports that a large European bank was on the verge of collapse last night. Things are so bad that Germany has drawn up legislation to allow countries to leave the Euro while remaining in the EU.

 

I believe Germany itself will be using this option in the next few weeks as it realizes that it cannot and will not be able to prop up the Euro any longer (even Germany doesn't have the 1 TRILLION Euros' in capital that European banks need).

 

So do not be fooled. The Fed's move today didn't fix anything. At most its bought the markets a few weeks' time before the whole mess comes crashing down.

 

Neither math nor common sense indicate that this will turn out well. Indeed, when this mess finally comes undone, it’s going to make Lehman look like a joke. We’re now talking about entire countries collapsing, not just private institutions.

 

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Good Investing!

 

Graham Summers

 

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