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Five Things You Need to Know: Fed Treating Quarters Like Manhole Covers; What Does "Global Coordinated Liquidity Injection" Mean?; Unprecedented? Not by a Longshot; Consumer Credit Contraction; Cleveland Introduced to Deflation


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. Fed Treating Quarters Like Manhole Covers!

Man, sometimes the Fed treats a quarter like pocket lint, sometime like a manhole cover. The consensus last night was Bernanke's quarter point cuts in the Fed Funds and Discount rates fell squarely in the manhole cover department. Cheapskate! Now, however, we know there was a method to the Fed's madness. Let's look at what that method is.

2. Global Coordinated Liquidity Injection? What Does That Mean?

In Five Things yesterday we looked at the importance of the Fed's move with the Discount rate. While pundits yesterday afternoon decried the "paltry" 25 basis point Fed Funds rate cute, the markets were busy focusing on more important matters; namely, the paltry 25 basis point cut in the Fed's Discount rate.

It bears repeating that this is not a stock market problem unless you are a financial stock. But hey, there are literally thousands of stocks out there that are not financial stocks. No, this is a credit market problem. Consequently, the perceived disappointment yesterday was the refusal by the Fed to make the Discount window more attractive. Now we know why they chose that course of action: Global Coordinated Liquidity Injection.

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Uh, ok... but what does all that mumbo jumbo really mean? In order to understand it, let's step back for a moment and consider again why cash-strapped banks were not lined up at the Fed's Discount window to fill their pockets.

The Fed's Discount rate is the cost of money available to Big Banks through the Fed's Discount "window." The Fed is considered the lender of last resort for banks, which usually borrow from each other. So the stigma from borrowing publicly through the Fed's Discount window is pretty severe. In fact, it's severe enough that some capital-starved banks have been selling off stakes to outside investors under less attractive terms. The Discount window is really the Payday Loan shop for banks, although the lending terms are far more attractive than Payday Loan terms. The problem is, who wants their neighbors to see them standing in line at the Payday Loan shack?

So how does this relate to today's Global Coordinated Liquidity Injection? Simple, the Fed has moved the Discount window terms behind a fire wall of sorts so that banks can obtain similar amounts of money, under similar Discount window terms, using identical Discount window collateral, but under conditions of anonymity.

The Fed's FAQ release on the Term Auction Facility (TAF) - the fancy econo-geek name by which this Global Coordinated Liquidity Injection is formally known - notes:

Will the Federal Reserve release information about individual Bids or Participants?

The data on Bids of individual Participants or of Participants will not be made public, except as required by law.

Ok, so how do we relate this move in credit markets back to stocks. The bottom line for equities is this is "bullish" but not bullish. Wall Street is about herding behavior. And as the equities indicators were already positive heading into this week the herd was primed to move higher. The move by the Fed today helps open up the credit markets, allowing banks to get access to capital anonymously.

Let's not get hysterical, though. This is not the end of the world. But it's not the beginning either. The Fed wants ammo to deploy throughout 2008 when consumer credit deterioration begins to accelerate. Consumer credit is more of an equity market problem than the current credit market problem among large banks. Remember, we are still near all-time nominal highs in stocks. The Fed needs the Fed Funds rate and the Discount rate to be above 4% to attack declining confidence and equity markets next year when Main Street comes under pressure. Always save your ammo until you see the whites of their eyes.

3. Unprecedented? Not by a Longshot

Some are calling today's coordinated move by global central banks unprecedented? Is it? Not really. But that doesn't mean it's not extraordinary. In fact, the extraordinary nature of it is why we say it's "bullish" but not bullish. These types of things just don't happen when times are good. To understand the present credit market conditions in context, let's go back to... Shhhhh... don't say this too loudly... 1930.

What happened in 1930? The formation of the Bank for International Settlements (BIS). The BIS essentially laid the groundwork for global coordinated liquidity facilitation. After the end of World War I there was a deep distrust among countries, which magnified the global credit contraction conditions. Debt was massive at that time. Global markets seized up.

According to Gianni Toniolo, author of "Central Bank Cooperation at the Bank for International Settlements, 1930-1973," Montagu Norman, governor of the Bank of England, wrote a letter in 1925 to his counterpart at the Federal Reserve Bank of New York, Benjamin Strong, saying, "I rather hope that next summer, we may be able to inaugurate a private and eclectic Central Banks' 'Club,' small at first, large in the future." That "hope" eventually became the BIS.

Calm down, conspiracy theorists. The purpose was less nefarious than pragmatic. How can borrowing and lending begin again if no one wants to borrow or lend? Just as hyperinflations don't distinguish between productive and non-productive capital avenues, neither do deflationary credit contractions. It is easy to say with righteous indignation Just let the markets run their course!... until we are part of the course over which those markets are trampling.

There's just one little problem. The BIS was initially a failure. Among the first loans the bank intermediated were packages to Austria and Germany, neither of which helped those countries avoid financial crises. What is important is not that the BIS failed to stop financial crises, but why. The answer is that markets eventually chew through fiscal and monetary intervention in spite of us. So frequently, in fact, almost always, the cure is far worse than the disease. Just something to think about.

4. On the Horizon: Consumer Credit Contraction

Bank of America (BAC) this morning barely had time to announce their dismal news before the Global Coordinated Liquidity Injection distracted us. Chief Executive Officer Kenneth Lewis said fourth-quarter earnings will be "quite disappointing'' and credit markets "will probably remain challenging into next year.''

  • Lewis said writedowns for debt instruments known as collateralized debt obligations, or CDOs, is "unknowable.''
  • Additionally, the bank said it would probably be forced to suspend their share buyback program until 2009.
  • But the real eye opener was something new in Bank of America's comments; consumer credit deterioration.
  • According to BAC, they are seeing increasing consumer credit losses coming.
  • The thesis that credit issues are isolated to big banks and weak borrowers is coming to an end.
  • See today's Number Five for more credit contraction...

5. Cleveland Introduced to Deflation

According to, the website for "Everything Cleveland," Cleveland Mayor Frank Jackson said the city is working to stave off a money crunch that could jeopardize large capital projects on the horizon.

  • At stake are projects ranging from roads and bridges to a $1.5 billion plan for the city's Warehouse District, all of which rely on the city's ability to borrow money.
  • "There's no room for us to borrow money," Jackson said in an interview with the Plain Dealer.
  • Why the problem?
  • Largely because declining real estate values, and successful property tax appeals by property owners, have cut into the assessed value of real estate.
  • "What I don't want is anyone to interpret this in any way to discourage investment or induce panic that the world is ending, because it's not," the mayor said.
  • No, it's not ending, it's just deflating.
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