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Five Things You Need to Know: Labor Costs Give Bernanke the Green Light for 50; Fed to the Rescue?; Enhanced Fed Action; Tip of the Iceberg II; Point/Counterpoint: The Subprime Rescue Plan


What you need to know (and what it means)!


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Labor Costs Give Bernanke the Green Light for 50

Worker productivity accelerated more than expected in the third quarter, conveniently causing labor costs to drop by the most in four years.

  • Worker productivity rose at an annual rate of 6.3%, the most since 2003 and up from a 2.2% pace in the second quarter, the Labor Department reported.
  • This pushed labor expenses down 2.2%, just in time to reduce the "threat of inflation" in labor costs ahead of the Fed's meeting next week.
  • Unit labor costs were expected to drop 1.2%, according to a Bloomberg survey.
  • You may recall that worker productivity was one of former Fed Chairman Alan Greenpsan's pet measures, especially productivity at non-financial corporations.
  • Non-financial productivity jumped 4.2% in the third quarter, double the second quarter's 2.1% increase.

2. Fed to the Rescue?

The Federal Reserve next week will likely cut interest-rates for the third time this year. But will that be enough to repair credit markets?

  • Trading in Fed Funds Futures suggest the market fully expects a 25 basis point rate cut, with an increasing number, two-thirds, anticipating a 50 basis point rate cut.
  • Is that why equity markets have suddenly been behaving better? Possibly.
  • The past week we've seen improvement in many of the equities indicators we follow.
  • Now certainly rate cuts help boost liquidity, but this time it's not solely about liquidity.
  • The larger issue is credit aversion and the repudiation of debt.
  • Over that, the Fed is powerless; they can provide liquidity all day, but in the end it is up to consumers to accept it in order to make it effective.

3. Enhanced Fed Action

In recognition of the limitation of Fed policy noted in today's Number Two, a growing chorus of market watchers is calling for more "unique" measures. Apparently, the present concoction of lower rates and a multi-pronged fiscal bailout of structured investment vehicles and subprime borrowers isn't quite enough.

  • Stephen Cecchetti, a former research director at the New York Fed told Bloomberg that one possibility to "enhance" Fed action next week is to triple the length of discount-window financing to 90 days from 30 days.
  • Recently San Francisco Fed President Janet Yellen said she was disappointed in banks' refusing to use the Fed's discount window.
  • "The discount window has not been as used, or been as helpful at addressing liquidity issues, as I would have hoped,'' she said in Seattle earlier this week.
  • Certainly lengthening the borrowing terms to 90 days would help, as would lowering the discount rate to closer to the Fed Funds rate.
  • But what, exactly is thing we call the Fed discount rate?
  • What does it do?
  • Why won't banks use it?
  • And how is it different from the Federal funds rate?
  • The discount rate is the interest rate charged to banks on loans they receive from their regional Federal Reserve Bank's lending facility.
  • The discount rate is the cost of money available to Big Banks through the Fed's discount "window."
  • Or put another way, the discount rate is the "Big Boys" rate... sort of like the rate mob bosses charge one another.
  • The Fed Funds rate is the rate for all other banks... sort of like the rate the loan sharks who work for the mob bosses charge one another.
  • You and me? We get charged whatever the individual loan sharks decide.
  • So why the stigma attached to going to the Fed's discount window?
  • The Fed is normally considered the last resort for banks, which usually borrow from each other.
  • And once upon a time it was considered pretty embarrassing to borrow money through the discount window.
  • Why? For the same reason Legs Diamond doesn't want to be seen showing up hat in hand at Owney Madden's place asking for a loan.
  • People, they get ideas, see. And when people get ideas, that's no good! No good!
  • The discount window is a "safety valve" and helps relieve liquidity "strains". The New York Federal Reserve explains it on their web site this way:

    "The Discount Window functions as a safety valve in relieving pressures in reserve markets; extensions of credit can help alleviate liquidity strains in a depository institution and in the banking system as a whole. It also helps ensure the basic stability of the payment system by supplying liquidity during times of systemic stress."
  • Oh, so the Fed is just acting to preserve basic stability by supplying liquidity during a time of systemic stress.
  • Whew! That's a... wait, systemic stress?

4. Tip of the Iceberg II

Speaking of systemic stress... remember Orange County, CA? We alluded to it last week when first discussing the Florida State Board of Administration fund debacle.

  • According to Bloomberg, Orange County, California, the same Orange County that was bankrupted in 1994 by bad derivatives bets tied to interest rates, apparently bought structured investment vehicles (SIVs) similar to the ones that have caused losses in the Florida public investment pool.
  • According to Bloomberg, $460 million, 20% of the county's $2.3 billion Extended Fund is invested in SIVs that may face credit-rating cuts.
  • The county overall holds a total of $837 million of SIV debt, including $152 million in its $3.5 billion of money-market funds that isn't under ratings review, Bloomberg reported.
  • Florida, Connecticut, Massachusetts, Montana, Maine and King County, Washington also have disclosed investments in SIVs.

5. Point/Counterpoint: The Subprime Rescue Plan


The Subprime Rescue Plan Will Help Save Our Home

By Richard Jones

Thank you Treasury Secretary Hank Paulson, thank you! With news of this subprime rescue plan you and the mortgage industry are proposing, we finally are able to see some welcome relief on the horizon. Why, mortgage lenders everywhere are signing up left and right to endorse the plan. Yes, relief is finally here!

I don't mind telling you, the little missus and I were worried. In 2002 we took out a $500,000 Option ARM mortgage, an adjustable rate mortgage with the option of making interest only payments for the first five years with a five-year incremental step-up in payments.

Everything was looking fine for the first five years. Our initial monthly payment on the Option ARM mortgage was around $1,600. Over the past five years it has slowly crept up to $2100. That extra $500 is beginning to hurt. In August, however, our mortgage lender sent us a note telling us what the 2008 payment is going to be. Prepare to grab the seat of your pants: $4,100!!!! That's right, $4,100!!! Who can afford a payment like that?!?!

Even worse, thanks to what they call "negative amortization," whatever that means, they say our original loan balance of $500,000 is now $535,000!!! How did that happen?!?! Obviously we were worried. That kind of mortgage payment would ruin us. We'd have to sell... assuming we could find a buyer. And I don't even know that we could sell for a price that covers the $535,000 mortgage!

Well, thanks to this subprime rescue plan we're back in business! Our refinancing papers are already in. We're going to take down a fixed-rate mortgage this time at a payment we can handle. Looks like things really do work out in the end, just like those mortgage ads say. My wife and I can sleep at night again. Thank you Treasury Secretary Paulson!


Mr. Jones, I'm Afraid There's a Little Problem With Your Refinancing Application

By Darren Salisbury, Mortgage Loan Officer

Is this Robert Jones? I meant Richard, sorry. Richard Jones at 233511 Magnolia Stone Haven Wintergardengreen Court Acres Estates? Ok, good. Wow, uh... Mr. Jones, I, uh, I hate to be the bearer of bad news here, but there seems to be a slight problem, with, ah, with your refinancing application. No, no we got your check for the $500 processing fee, no problem there. That's not refundable, by the way, just want to be clear on that. Right. Yeah, it, uh, just kind of looks like we're not going to be able to approve this refinancing package. It just doesn't fall into any of the groups the subprime rescue plan has outlined.

Yes, I'm sure. Whoa, absolutely, I agree $4,100 a month is way, way too high for a house in, ah, where are you? Right, Magnolia Stone Haven Wintergardengreen Court Acres Estates.

Hey, did the developer ever finish the community pool and recreation facilities there? Wow, I'm surprised at that. They were the same developers as Crystal Glen Squire Thirstwood Cove Hammock Lake and they finished the community pool and rec center on that development six or eight months before they abandoned it. Well, on the bright side, with the upcoming Fed rate cut and all next week, maybe they'll come back and finish it. Would certainly help the resale value.

Yes, I checked on that and unfortunately you're outside the GSE guidelines and, look, Fannie Mae and Freddie Mac ain't exactly in the best position to be making rescue loans these days. Have you tried taking in some boarders, maybe raising some cash by renting out the east wing? Ok, just a thought. Well, good luck with everything. If it gets down to the wire, give me a ring back. My brother-in-law handles distressed property sales.

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