The Financial Times reports a rare bit of encouraging news on the credit crisis front, namely, that investment banks have been making less use of the Fed’s liquidity facilities of late:
Direct borrowing from its new primary dealer credit facility fell $8bn from $34bn (£17bn) to $26bn in the week to April 9, the Fed said. Meanwhile, the central bank also said that its latest swap auction of Treasury securities was undersubscribed.
But should we then conclude that investment banks are in improved health? After all, Goldman CEO Lloyd Blankfein asserted that the industry is more than half way through the debt contraction.
This optimistic assessment seems at odds with facts on the ground. Yes, we in a period of relative calm, but each time this has happened of late, a new eruption of problems has led to panic, worries of systemic collapse, and new moves by the Fed, And even more worrisome, each time the intensity of the outbreak has increased.
Let’s consider some less than pretty realities. Some investment banks have been classifying more and more assets as Level 3. That gives them lots of freedom in how they value them. The markets appear to be tolerating this expedient, even though the sources who speak to me about the industry view the firms as being considerable weakened and at risk. For instance, it seems to be a commonly held view that Lehman is in every bit as bad shape as Bear was, but Lehman is a better citizen than the soon-to-be-history trading firm and the Fed wasn’t going to let two firms go under (in other words, the industry participants I’ve been in contact with are not of the view that Bear was solvent. That admittedly may be sample bias, since this blog no doubt appeals to cynics).
Moreover, there are plenty of shoes yet to drop. Interbank cash hoarding is on the rise despite the Fed’s heroic efforts; a bottom of the housing market is nowhere in sight (and we won’t know how low it will go in the mortgage market until we know the end game for residential real estate); commercial real estate losses have only started. But scariest by far is the credit default swaps market.
I happened to meet with a hedge fund yesterday (unlevered, BTW) and it comments in passing were telling. They are seeing very large volumes of mortgage paper even though, this fund has not bought a single mortgage and expect that there is even more that would be offered if buyers were stepping forward. In addition, credit default swaps traders tell them that that market is in perilous shape. A great deal of the protection was written by hedge funds, who were typically levered. When they get into trouble, their problems will redound to the investment banks, both through their exposure as CDS counterparties and as lenders to failed hedge funds.
The fact that CDS traders are discussing such a grim viewpoint with people outside their firms (let’s fact it, most businesspeople don’t go around saying their product is about to implode) suggests that it is a common knowledge in the dealer community. I wonder if this topic is getting short shrift for a reason. The media has been known to overlook the foibles and failings of public figures until they are on the ropes. There may be similar self-censorship operating here, since the press probably does not want to be accused of fomenting panic.
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As late as January, the Fed seemed to be pressing the banks to mark at least _some_ of their losses, e.g. CLO write-downs, and take repos at auction, maintaining a facade of normalcy. Now, after having to prop up the ibanks too, the Fed et. al. appear to have decided, er, no, please DON’T make your losses public: we don’t have that much money. Hide them in Level 3 as Mark-to-Mendacity, rebundle them and shuffle around, use any dodge old accounting dodge, or just don’t pick up the phone. In short, the Fed Rescue of the Subcrime Bubble is in do-over mode, trying to shift on the fly from LTCM-style collective action to Japan-style collective-fabulation. None of this is a solution, just a slightly more gradual dissolution.
On what’s the next uranium-toed boot to drop, I’m all ears to know. However, cash-hoarding and the attendant spread spikes point the way, as these actions have been the bow wave of each successive instability point: those in the know feel a hit coming and clench up. . . . Do we have time for a stiff drink before we fly into the mountain??
it is astounding that the WSJ could write an article celebrating Lehman’s “success” at securtizing product to dump on the Fed is a sign of the times. Desperation is everywhere, percalating one assume, right up to the whiote house. We gewt the WSJ re Fed options beyond rate cuts (and the Taylor paper) and then the latest PR all clear offensive by the I-banks, namely Lehman, but now MS and GS. The park avenue ulema must be thinking we bet the farm on highly leveraged vehicles, now what? Taking down the I-banks would be the WWII equivilant of the enola gay’s little boy. So if there is any doubt that they will stiop at nothing think about the geopolitical alternative.
End of empire
A return to business as usual may be worse than the crisis. The financial policies of the current world governments will eventually precipitate a collapse.
As CS pointed out, the bids may be low because dealers don’t have enough eligible (i.e. highly rated) collateral to pledge.
And, “the press probably does not want to be accused of fomenting panic.” What press are you reading?!
I’m no expert, but couldn’t the downgrade of AMBAC have an effect on what the banks can use as collateral with the FED? I thought they could only borrow against AAA grade assets. The downgrade could also signal the reason for the WaMu’s and Citi’s actions in the past couple of days.
Fed is thinking about allowing repo of equities at 110% of par
Re: “facility fell $8bn from $34bn “
That was just a matter of window dressing for the qtr that just ended, thus, the big push to build up the books and transfer out bad debt in exchange for fresh short term reserves, is like magic for now — up until the end of the next qtr, which will see ramped up demand phased in as needed.