Liquidity, Solvency, And Timing

Tyler Durden's picture

Via Peter Tchir of TF Market Advisors

In 2007 and 2008 the Fed instituted all sorts of programs to enhance liquidity. It was the first time they went beyond simple rate cuts (which they also employed).  In the end it didn't help much.  It ensured that banks could fund the positions they wanted, but it didn't stop the sell-off in assets, because the banks didn't want the risk.  No one wanted the risk.  Corporate bonds and mortgages had gotten priced too tightly and banks and hedge funds had far too much leveraged exposure.  No matter what the Fed did in terms of providing liquidity, they couldn't stem the tide.

In 2009 the Fed continued to add new liquidity tools.  TALF and QE helped a lot, but by 2009, hedge funds, and even banks wanted assets, they just didn't have the money or capital to buy them.  The liquidity that was provided was used because many investors thought the assets were CHEAP!

There are clearly liquidity problems again, but they are directly tied to solvency.  The Euro basis swap isn't getting worse because US banks don't have money to lend to European banks, they don't want to lend to European banks.  The risk/reward at these spreads isn't deemed attractive.  The European banks can borrow from the ECB swap lines if they need, but unless they are willing to pay some real rates that reflect the risk, they won't encourage other banks to lend to them.  Short term lending is the first to go, because there is limited profit opportunity as a lender and lots of downside.

Liquidity concerns and even some capital concerns are driving down Italian and Spanish bonds, but behind that, there are real solvency concerns.  Additional liquidity tools don't really do much.  Stocks rallied hard the day the globally co-ordinated swap lines were put in place, and the basis swap traded back to -80 on the day.  That was on September 15th.  From there, the market got worse.  Maybe we should be worried the Fed knows something we don't about how bad it is and are trying this ploy again, because it is one of the few things they can do to help Europe?