Show Me The Money! / Hussman

On top of Hussman´s post i think it is good advice to read Turning a BB Gun Into a Machine Gun? from Russ Winter on the latest Fed and central bank action around the world. While i agree with Hussman on the data and facts i think Bernanke and the Fed have given the wrong message to the market. Too bad that the $index and the long end of the yield cirve didn´t play out like they have hoped .....

Zusätzlich zu den Ausfühtungen von Hussman ist es ratsam sich Turning a BB Gun Into a Machine Gun? von Russ Winter hinsichtlich der Notenbankaktionen in letzter Zeit durchzulesen. So sehr ich auch mit Hussman was die Faktenlage angeht übereinstimme so sehr muß man jedoch auch sagen das Bernanke und die Fed dem Markt praktisch eine Einladung gegeben haben die zwar kurzfristig gute Laune verspricht mittel bis langfristig aber kontraproduktiv sein wird. Dumm nur das sowohl der $Index als auch das lange Ende der Zinskurve die Partystimmung nicht teilen kann .....

These quotes sums it up ........Diese Zitate treffen es ziemlich gut

Scott Reamer / Minyanville

Bravo to Ron Paul for giving voice to the hundreds of millions or pensioners,savers, working stiffs, poor, fixed income beneficiaries, laborers, gasoline-, bread-, milk-, and egg-buyers who weren’t able to ask Mr. Bernanke why he – like every Fed chairman before him since 1913 – screwed them for the benefit of the top 5% of the population of this country.

Bernanke: The anti-Robin Hood / Fleckenstein

The Federal Bank of Guardian Angels roared down Wall Street last Tuesday. Its mission -- to bail out the stock market -- was a success (for now).

But the rate cut was no gift to Main Street, which lies outside the
loop of crony capitalism.

Bobble-head Fed Long ago, the Fed abdicated its responsibility under then-Chairman Alan Greenspan. But now chief Ben Bernanke and the boys at the Fed have taken irresponsibility to a new level, where they have clearly demonstrated that they work for Wall Street -- and when Wall Street says jump, the Fed asks, how high?

I don't quite have the database to research this, but I seriously doubt that we've ever experienced a 10% fed funds rate cut, or discount rate cuts of better than 15%, with the stock market a few percentage points off an all-time high.

Show Me The Money!
Investors were cheered last week when the Federal Reserve lowered its target for the Federal Funds Rate by 50 basis points, and lowered the Discount Rate (the interest rate it charges on loans to the banking system) by 50 basis points as well. It's important to emphasize that the impact of these changes is mainly psychological, and outside of a pool of a few billion dollars, won't have any effective bearing on the “liquidity” of the banking system, nor on the solvency of $3.4 trillion in real estate loans, and $6.3 trillion in total bank lending. ...

Much ado about nothing
....If you examine the data you'll find that the total level of “liquidity” that the FOMC deals with is minuscule in relation to a $13.8 trillion economy, and the variation is even smaller. The total reserves of the U.S. banking system are about $40-$45 billion, and are very stable. The Fed simply does not “inject” meaningful amounts of “liquidity” to the banking system.

Indeed, the latest cuts in Fed controlled interest rates were effected without any injection of “liquidity” into the banking system at all. Total borrowings by depository institutions from the Federal Reserve (i.e. borrowings at the Discount Rate) actually fell last week to $2.421 billion, from $3.158 billion the preceding week. That couple of billion dollars is the sum total of all outstanding borrowings at the Discount Rate. Though these figures are still higher than the typical level of discount window borrowing (a few hundred million), they are minuscule. Yet these are the figures that investors are revved up about as if this “liquidity” will save the mortgage market.

Meanwhile, there has been no material change in the “liquidity” provided by the Federal Reserve in the federal funds market either. It's kind of funny (and just a little pathetic) how the press and investors get all excited every time the FOMC does an open market operation, as if they represent fresh “injections” of liquidity into the banking system. They are generally nothing but rollovers of existing repurchase agreements.

Open market operations come in two flavors: permanent and temporary. As I've frequently noted, about 99% of the monetary base created by the Federal Reserve represents gradual and predictable increases in the amount of currency in circulation. Year-to-date, the Federal Reserve engaged in what it classifies as “permanent” open market purchases amounting to $1.9 billion in February, $6.1 billion in April, and $2.7 billion in May, for a year-to-date “permanent” increase of $10.7 billion in the monetary base. Not surprisingly, most of this has been drawn off as currency in circulation, which has increased by $9.1 billion since January. Simply put, “permanent” open market operations are simply the way the Fed increases currency in circulation. It is simply incorrect to believe that these open market operations add meaningfully to the “liquidity” from which banks are able to make loans.

Temporary open market operations generally take the form of “repurchase agreements” whereby the Fed takes collateral in the form of Treasury securities or U.S. government backed agency securities, and provides funds to banks for periods typically ranging from 1 day to 2 weeks. At the end of that period, the banks are obligated to repurchase the securities from the Fed at the sale price, plus interest.

Since reserves are only required on checking deposits, the total amount of reserves in the U.S. banking system is only about $40 to $45 billion. Banks don't hold stack a pile of idle cash in a corner of the vault to maintain these reserves. Instead, they hold securities like Treasury bills and U.S. government-backed agency notes, and if they find themselves in need of reserves, they just pledge these securities to the Federal Reserve as collateral.

Look at the last month of data. We know that total bank reserves during this period have ranged between about $40 to $45 billion. Using data on the last 25 FOMC operations reported by the New York Fed, we can tie out the amount of outstanding repurchase agreements on any given day. Recall that total reserves include those obtained through discount rate borrowing and Fed repos (though “nonborrowed reserves” exclude discount borrowings). Evidently, the majority of the reserves in the U.S. banking system are represented by a continuous rollover of outstanding “temporary” repurchase agreements. If one set of repurchase agreements for $10 billion matures 3 days from now, you can pretty well predict that the Fed will enter new repurchase agreements of nearly this amount when the existing agreements expire. As a result, the total amount of repos outstanding is fairly stable. On balance, the Fed injected nothing – repeat nothing – this week.
Importantly, investors are misled when they interpret each new repurchase agreement as if it is a “new injection of liquidity” into the banking system. The bulk of these repos do nothing more than to replace the ones that are due. .....

Simon Says
The simple fact is that while the Federal Reserve lowered the Fed Funds Rate and the Discount Rate last week, it did not do so by “injecting” any new funds at all into the banking system. Rather, the Fed lowered these rates strictly by announcing they were now lower.

It's easy to understand this in the context of the Discount Rate, because the Fed is the only entity that charges that rate. With Fed Funds, you can understand how the announcement alone can change the rate by understanding a) that the entire variation in bank reserves that determines the Fed Funds rate amounts to only a few billion dollars, and b) banks are generally willing to follow the rate “called out” by the Fed so long as it doesn't affect the spread they earn.

Outside of the banking system, you'll notice that while Fed-controlled interest rates dropped last week, market-controlled interest rates rose. Treasury yields increased at nearly all maturities, as did mortgage rates, including those on 30-year conventional mortgages. Indeed, the only “relief” to borrowers was on rates tied to LIBOR, which fell. But even this is not “new purchasing power” for the economy, because the drop was matched by a reduction in deposit rates, so any relief to borrowers with rates tied to LIBOR came entirely at the expense of savers.

Again, the argument is not that interest rates are irrelevant, or that there is no relationship between total government liabilities and inflation (though the tightest relationship is between government spending growth, regardless of how it is financed, and inflation – particularly over horizons of 4-5 years). The argument is that there is no credible mechanism by which Fed actions control the economy.

The bottom line – the much celebrated move by the Fed last week created no new liquidity, no new reserves, and no new purchasing power. Given all that, it's unlikely that all of this will result in any material improvement in the solvency of the mortgage market

Market Climate
..... Presently, the trailing net P/E on the S&P 500 is 17.9, with a dividend yield of just 1.84 and a price/revenue multiple of 1.55.

Indeed, only two of those “second Discount Rate cuts” occurred with the S&P 500 P/E above 15 and advisory bullishness running over 50%. Those instances were December 1971 and January 2001. The average subsequent performance of the S&P 500 following those cuts was -1.22 over 3 months, 0.92% over 6 months, and 3.17% over the following year. Knowing What Ain't True / Hussman
A year-over-year CPI figure of about 4% or more, as I've mentioned before, is statistically baked-in-the-cake by November.

.....In precious metals, the Strategic Total Return Fund continues to have about 10% of assets in these shares. While this market appears overbought in the near term, we've already clipped our exposure enough to allow for some retrenchment, and given the continued favorable Market Climate overall, there is no reason to lighten our position so much that we would have to hope for weakness in order to reestablish a base position. As our position stands, we'll be inclined to increase our exposure on any substantial weakness, but we also don't have any need to “chase” the market in order to obtain exposure, should precious metals move higher from here.

The Fed Blinked.....Let The Bailout Begin.....Got GOLD :-)

Golden times ahead.... Things must be really ugly ( read Bank Run on CFC )...... First higher than usual repos, then taking MBS as collateral for the repos, now the discount rate cut, next week...... Havn´t found the word "CONTAINED" in the release :-)

Goldene Zeiten .... Die Dinge dürften wirklich nicht zum Besten stehen ( siehe Bank Run on CFC ) ...... Zuerst die erhöhte Aktivität der Repos, dann die ungewöhnliche Maßnahme auch ABS als Sicherheit zu akzeptieren, nun die Senkung des Discountsatzes, nächste Woche.... Konnte das Wort "CONTAINED" nicht in dem veröffentlichten Text finden.... :-)

Thanks to Wall Street Follies

Fed Cuts Discount Rate to 5.75% to Ease Credit Crunch
The Federal Reserve unexpectedly cut the discount rate and said it's prepared to take further action to ``mitigate'' damage to the economy from the rout in global credit markets.

The central bank reduced the rate at which the Fed makes direct loans to banks by 0.5 percentage point to 5.75 percent. Policy makers kept their benchmark federal funds rate target unchanged at 5.25 percent. Today's action is the first reduction in borrowing costs between scheduled meetings of the Federal Open Market Committee since 2001 and Ben S. Bernanke's first as Fed chairman.

``Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth,'' the FOMC said in a statement released in Washington. ``The downside risks have increased appreciably.''

The committee is ``prepared to act as needed to mitigate the adverse effects on the economy arising from disruptions in financial markets,'' the statement said. The Fed's Board of Governors released a separate statement announcing the discount- rate cut

Adding Funds
Until today, the Fed had been injecting extra funds into the banking system to meet rising demand for cash. That didn't help companies much in getting access to capital. The amount of commercial paper outstanding, a key financing tool, has fallen the most since the 2001 terror attacks.

The Fed said in cutting the discount rate, it was approving requests from the boards of directors of the New York and San Francisco district banks. Among the New York Fed's directors are JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon, Lehman CEO Richard Fuld and General Electric Co. CEO Jeffrey Immelt.

Thanks again to Wall Street Follies

Via the WSJ Explaining the Discount Window
The discount window is a channel for banks and thrifts to borrow directly from the Fed rather than in the markets. Until a few years ago, the discount rate was set below the fed funds rate and loans were subject to numerous conditions. Banks were reluctant to access the window because it was associated with a stigma usually reserved for distressed banks. A few years ago the Fed overhauled the discount window to try and alleviate that stigma; the rate was then set one percentage point above the funds rate and subject to far fewer conditions. In spite of that, discount window borrowing has remained paltry. Discount lending averaged just $11 million in the week ended Aug. 15. Although that was up from $1 million in the prior week it was puny compared to the billions of dollars the Fed has regularly injected into the financial system through open market operations.

Fed officials hope that reducing the penalty rate associated with the window and lengthening the term of loans to 30 days from one further lifts the stigma and gives it a tool to supplement open market operations for reliquefying markets. Open market operations, under which the Fed buys and sells securities to adjust the supply of bank reserves and keep the federal funds rate on target, primarily operate through a network of primary dealers, some of whom are large banks. Thus, they have only indirect impact as a supply of funds for the thousands of banks that are not active in the money market. The discount window however is available to any bank or thrift, and the terms are easier than for fed funds loans. For example, banks may submit mortgage loans, including subprime loans that aren’t impaired, as collateral, and many probably will.

> The yield on the 10 year just spiked 9 points......

> Die Rendite der 10 Jahresanleihen ist gerade um 9 Punkte gen Norden gesprungen

Disclosure: Long Gold, Goldmines (HUI), NAK , Short KBW Mortgage Finance Index (including Countrywide), Homebuilder (Index), WCI, REITs (Index)

Carry Trade & Economist Summary

The Economist has a good sample of what happened during the last weeks. As an example i have taken the report on the carry trade. I hope the links work without subscription. O top off this you can click at the labels to get more on last weeks topics. Please leave a comment if a certain Link doesn´t work.

Der Economist hat eine ziemlich gute Übersicht was in den letzten Wochen abgegangen ist. Beispielhaft habe ich mir mal den Report zum Carry Trade herausgepickt. Ich hoffe das die Links auch ohne Abo funktionieren. Hinterlaßt bitte einen Kommentar wenn ein bestimmter Link nicht abzurufen ist.
Banks in trouble
A liquidity squeeze "Bankers' mistrust"
Funding difficulties "A conduit to nowhere"
Hedge funds "Behind the veil"
Financial contagion "Mortgage flu"
Should central banks act as buyers of last resort?

Not-yet-desperate housewives
Is Mrs Watanabe doing her bit for global stability?

IN MOST of the world in the past week, attention has been on highly leveraged hedge funds that have been forced to dump assets bought on margin. In Japan, however, a different species of margin trader has—until now, at least—stood firm: the housewife. On her shoulders may lie responsibility for some of the stability of the global financial system.

On August 15th the Japanese currency climbed to a 4½-month high against the dollar and continued to surge against the New Zealand dollar, raising concerns about the sustainability of the carry trade, through which investors borrow in cheap yen to buy higher-yielding assets elsewhere. This had made fortunes for international investors but, lately, Japanese retail investors had become the carry trade's greatest enthusiasts.

> The latest strenght of the Greenback is worth mentioning and if the $ will sustain these trend it will be unusual. I doubt that that this will last. Brad Setzer is also wondering The dollar, still a currency that you run to?

> Die Stärke des US $ in den letzten Wochen des Chaos ist zumindest wenn dieser Trend anhält recht ungewöhlich. Ich glaube das dies nicht von Dauer sein wird. Brad Setzer stellt sich die gleiche Frage The dollar, still a currency that you run to?

The metaphorical Mr and Mrs Watanabe account for around 30% of the foreign-exchange market in Tokyo by value and volume of transactions, according to currency traders, double the share of a year ago. Meanwhile, the size of the retail market has more than doubled to about $15 billion a day.

One reason for the surge is margin trading. Brokers are offering leverage of as much as 200 times the down-payment (though the average is more like 20 to 40 times).

In July Japanese retail investors' short positions on the yen (a bet that it would fall) exceeded the amount taken by traders on the Chicago Mercantile Exchange, a foreign-exchange trading hub. “The gnomes of Zurich were accused in their day of destabilising markets. The housewives of Tokyo are apparently acting to stabilise them,” boasted Kiyohiko Nishimura, a Bank of Japan board member, in July.

Strikingly, as the yen appreciated, retail traders, rather than dump their positions, saw a buying opportunity and sold yen for other currencies, softening its rise. “The Japanese government has not intervened—they've not had to, because the Watanabe-sans have been selling yen for them,” says James Gow of FXOnline Japan, a retail broker.

About "Conduits" And "Off Balance Sheet" Vehicles.....

Whenever i hear the phrase "off balance sheet" vehicles "Enron" and other accounting scandals are coming to my mind. It is often only a matter of time until the ticking time bomb is taking its toll. In the case of the German IKB and probably the Sachsen LB i think the board that has the oversight is just too incompetent to realize what is and was going on. On top of this it is clear that the Bafin ( banking oversight ) has done a lousy job and didn´t know anything about the immense risk that small German banks were taking. Maybe they should order this excellent artwork from the NYT to understand what kind of junk they have often as AAA in their books..... ( hat tip to Pancho Villa and Calculated Risk

Immer wenn ich den Begriff "Off Balance Sheet" höre ziehen vor meinem geistigen Auge immer wieder "Enron" und andere Skandale vorbei. Es ist fast immer nur eine Frage der Zeit bevor diese Konstruktionen große Probleme bereiten. Im Fall der IKB und wahrscheinlich auch der Landesbank Sachsen wird zudem deutlich das der Aufsichtsrat vollkommen inkompetent gewesen ist. Zudem sollte ernsthaft mal hinterfragt werden was die Bafin eigentlich so den ganzen Tag macht....... Evtl. sollten sie die Verantwortlichen mal diese diese gelungene Übersicht ansehen um zu versthen was die überhaupt als AAA in Ihren Büchern haben

Big hat tip to the reader who sent me this link!

Structured investment vehicles’ role in crisis

Policymakers and investors have been obsessed in recent years about the potential for a hedge fund collapse to spread financial panic. But it seems one of the biggest threats to stability is coming from the age-old risk of short-term borrowing to fund investments in illiquid long-term products.

In a corner of the market few people knew existed, regulators are scrambling to understand what is happening in structured investment vehicles (SIVs), a breed of often huge, mainly bank-run, programmes de­signed to profit from the difference between short-term borrowing rates and longer-term returns from structured product investments.

These have proliferated in recent years and control assets worth hundreds of billions of dollars. Depending on whether they are fully rated by credit rating agencies and on how strictly they have to conform to certain rules, they are known as SIVs, SIV-lites, or conduits.

> Here the German conduits / Übersicht der deutschen Conduits

They are typically quite opaque, invest in complex securities and often do not need to be displayed on a bank’s balance sheet.

It seems they have played a key role in last week’s liquidity crunch.

“We are in the middle of a mini-crisis in the commercial paper market, at least half of which is related to the SIV conduits,” says Robert McAdie, global head of credit strategy at Barclays.

These programmes typically invest in credit market instruments, such as US subprime mortgage-backed bonds and collateralised debt obligations. These assets tend to be the highly rated, supposedly safe versions of such debt, but in the recent fear-driven turmoil have shown just how illiquid and hard to value theycan be.

The profit for those who run such programmes comes from the fact that the assets pay fairly high yields, while the conduits and SIVs fund their purchases with short-term borrowings in which interest and principal payments are backed by financial assets that are deemed to have stable cash flow. Collectively this so-called “asset-backed commercial paper” – or ABCP – lasts for anything between a few days and a few months before needing to be refunded.

The problem could be thrown into relief when billions of dollars of ABCP mature today and on Wednesday, with great un­certainty as to whether this can be refinanced.

Everything in this market depends on investors in the ABCP market maintaining their faith in the programmes and the assets they hold. With the current rush for the exits in many structured credit markets, this faith has been evaporating wholesale. No investors are sure exactly what assets SIVs and conduits are holding, or how damaged those holdings might be.

Thanks to the fantastic Randy Glasbergen

While many non-SIV funds – such as those run by BNP, Axa and others that have hit trouble recently – were able to stop investors pulling their cash out, SIVs and conduits who see their funding expire on a regular basis have no such luxury.

In the case of a blip in the market, SIVs and conduits are supported by liquidity facilities from highly rated, mainstream banks. This means banks must step in to provide finance if the SIV cannot raise commercial paper in the normal way, unless the SIVs’ assets suffer significant ratings downgrades. Typically, the credit line provided by the sponsoring bank and a group of others in a syndicate must cover 100 per cent of outstanding commercial paper.

These funding lines have rarely been drawn in recent years, because liquidity has been abundant in the ABCP market as almost everywhere else in the financial world. As recently as mid-June, the European commercial paper market was seeing records levels of issuance.

However, what sparked last week’s turmoil – and the dramatic intervention by central banks – was a pernicious chain of events. As it became apparent this summer that the US subprime problems were worsening and infecting a broader range of structured products, some investors in the ABCP market started to worry about whether SIVs were also sitting on losses.

The rush to sell structured products by hedge funds facing redemptions and other investors meant those market values that could be ascertained were being marked down heavily. As a result, by mid-July some investors decided to stop buying ABCP paper from SIVs suspected of subprime exposure.

The German bank IKB was an early victim. Another victim could be the Landesbank Sachsen. Like many local peers, it had a conduit – called Rhineland Funding – which had ex­panded rapidly and had almost €20bn ($27.3bn, £13.5bn) worth of outstanding commercial paper in the markets in July. In mid-July, ABCP investors refused to roll over some of these notes.

Rhineland asked IKB to provide a credit line, as the rules of SIVs require. But it appears the German bank did not have enough cash to meet this request and was unable to liquidate enough assets to plug the gap. This threatened to trigger IKB’s collapse, until KFW, the state-owned German bank, stepped in and offeredan €8bn credit facility.

German officials hoped this action would stop growing panic in the sector. But it may have had the reverse effect: investors started to shun almost all commercial paper issued by SIVs.

“This is an environment where there has been a big loss in confidence and nobody is distinguishing between apples and oranges,” notes Mr McAdie.

By early August, the problems in the ABCP market had become so serious that some European banks were preparing for additional calls on credit lines to SIVs. But the banks are also grappling with a backlog of unsold leveraged loans, which is placing additional pressure on their balance sheets.

So early this month some European banks – and a few US institutions as well – quietly started trying to raise new credit lines themselves. That, however, triggered additional alarm, as rumours spread about the potential losses at SIVs – on top of problems in other corners of the financial world.

Consequently, by the middle of last week, some banks started shutting credit lines to a sweeping list of institutions. “Commercial paper is now being funded on an overnight basis. The banks will not roll paper for three months,” says Dominic Konstam, head of interest rate strategy for Credit Suisse. ....

Policymakers hope that some of this panic will dissipate this week following the massive emergency injections of liquidity by the ECB and US Federal Reserve. And indeed, by the end of last week, borrowing rates were stabilising. There were signs vulture funds were circling, ready to pick up ABCP paper at bargain prices.

“What some people are hoping is that the bottom fishers will appear and help the market self-correct,” says one big ABCP issuer.

However, nobody close to this sector expects to see a quick solution soon. Commercial paper interest rates have not yet fallen, irrespective of central banks’ actions. In New York on Friday, they closed at their highest level for six years.

There is deep uncertain­ty about what the central banks will do next – making ABCP players even more reluc­tant to start issuing and trading again. “Nobody is going to handle commercial paper if they think the Fed could be about to cut rates or do some­thing else completely unexpected overnight,” explains one. 

However, the third, most pernicious problem is that it is becoming clear central banks cannot resolve the biggest problem – a lack of clarity about valuations in structured credit markets and the almost complete loss of confidence that is infecting even the biggest and most diversified of conduit-type programmes.

Hardly a Bailout / Hussman

Excellent sober analysis what the Fed and other Central Banks have done as you would expect from Hussman. There has been lots of confusion and misreporting what really happened last week. Click on the headline to read the entire piece. In combination with Mish´s take you should get a 360 degree view of the implications from this massive injection.

Wie man das von Hussman erwarten kann einer erstklassige nüchterne Analyse was genau von Seiten der Notenbanken in der letzten Woche veranstaltet worden ist. Klickt bitte auf die Überschrift um den kompletten Report zu lesen. Um das Bild abzurunden empfiehlt sich Obendrein Mish´s Post
The Federal Reserve did exactly what it was supposed to do on Friday.

As I've noted before, under most conditions, the Federal Reserve is irrelevant in the sense that (since the early 1990's when reserve requirements were removed on all but demand deposits) there is no longer a link between bank reserves and the volume of lending in the banking system. However, the Fed certainly has a role to play during bank runs and other crises where the demand for the monetary base soars.

That's exactly what the Fed did on Friday. Contrary to the apparent belief of investors, the Fed did not shift its policy, nor did it “bail out” the mortgage-backed securities market by “buying” them from banks.

What actually happened is that the Federal Funds rate shot to about 6% on Friday morning, and the FOMC brought it down to its target rate by entering into 3-day repurchase agreements . The banks sold securities to the Fed on Friday, and are obligated to buy them back from the Fed on Monday at the sale price, plus interest. Such open market operations are designed to ease the immediate demand for liquidity, and to give the banks and dealers more time to find buyers in the open market for the securities they are trying to liquidate.

This was not a major policy shift. Again, it was an effort to keep the Federal Funds rate at the current target of 5.25%, in the face of demand for base money that was pushing the Fed Funds rate to 6%.

These repurchase (RP) agreements fall into three increasingly broad “tranches:” 1) Treasury securities, then 2) federal agency debt, and finally 3) mortgage backed securities issued or fully guaranteed by federal agencies. “Today's RPs were of this type,” noted The Federal Reserve Bank of New York , which conducts the Fed's open market operations. So the Fed was not taking in the toxic, leveraged, exotic stuff.

Economist Steven Cecchetti concurs, “A quick look at the history of these temporary open market operations shows that they have been taking mortgage-backed securities as collateral for repo for some time. The quantities have normally been small (between $100 mil and $2 bil) but they have been doing it. So this is not what I would call an ‘intervention in the mortgage-backed securities market.' And it is not unusual.”

> SCHADENFREUDE that Greenspan new book is hitting the shelves just at the time his legacy is almost gone to zero.......

> Kann mit meiner SCHADENFREUDE nicht wirklich hinterm Berg halten das just zu Zeiten wenn von seinem Glanz der Lack komplett abgesplittert ist sein Buch die Regale entern wird.....

Now, the size of the operation ($38 billion) was unusual, as was the scale with which the Fed allowed dealers to submit mortgage-backed securities as collateral, rather than simply Treasury and agency securities. My impression is that in doing so, the Fed had no intent of “bailing out” the mortgage backed market, or of creating a huge “moral hazard” by absorbing losses for the irresponsible behavior of lenders. Rather, the Fed had to allow submission of mortgage-backed securities because that's what the banks actually own, and it's precisely the collateral for which the banks can't find a buyer.

Look at Treasury bill yields – they're dropping sharply again because investors are scrambling for default-free securities as a safe haven. Banks and dealers have no problem selling those puppies on the open market, so there's no reason to enter a Fed repo to do it. But banks have drawers full of the mortgage-backed stuff that they can't get rid of, so the Fed bought them more time by allowing them to post those securities as collateral for 3 days. Most likely, the Fed will have to do it again on Monday, but in any event, these are not securities that are going into the “investments” column of the Fed's balance sheet. They are simply collateral taken for short-term credit extended. The Fed does not assume a risk of loss unless the bank defaults on the repurchase agreement with the Fed

A few interesting details – in the midst of Friday morning's panic, banks would have liked to have done more. At the 8:25 AM operation, $31 billion of securities were submitted by the banks for repo, and $19 billion were accepted by the Fed. At 10:55 AM, $41 billion were submitted, and just $16 billion were accepted. But by 1:50 PM, the scramble for funds had eased somewhat - $11 billion were submitted, and $3 billion were accepted.

Given that about $1.4 trillion of interest-only adjustable-rate mortgages were issued in 2005 and 2006, and hundreds of billions in sub-prime mortgages are already delinquent, a $38 billion repurchase operation by the Fed, where the securities posted as collateral have to be bought back by the banks unless the banks default, is hardly a “rescue operation.”

The Fed has an interest in stabilizing the banking system and the real economy. It has no interest in taking the private sector's loss for the irresponsible lending practices of recent years, nor in saving overly aggressive hedge funds from the losses on their leveraged bets. Again, the Fed did exactly what it was supposed to do on Friday. There will inevitably be enormous losses taken as a result of mortgage defaults – but don't assume it will be the Fed that takes them.