Five Things You Need to Know: Foreigners Bail!; The Bernanke Put Defined; Communists - They're Just Like Us!; Do Over!; Fifth Thing Now Record Sixth Thing!
What you need to know (and what it means)!
Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
1. Foreigners Bail!
Sometimes a picture really is worth a thousand words, instead of being merely a substitute for actually having to sit down and write sentences about something.
- Take today's Treasury data on foreign investment flows.
- Turns out foreigners in August sold a record amount of U.S. financial assets.
- Total holdings of equities, notes and bonds fell a net $69.3 billion after an increase of $19.2 billion in July, the Treasury Department reported.
- Economists predicted international investors would buy a net $60 billion worth in August, based on a Bloomberg News survey.
- Of course, this data is lagging. It simply shows what has already happened.
- More than likely foreign net purchases increased in September.
- But the key takeaway is how quickly, and to what extent, our foreign "helpers" abandoned their posts at the first sign of trouble.
- The chart below tells the story.
Click Chart to Enlarge
2. The Bernanke Put Defined
Federal Reserve Chairman Ben S. Bernanke made a very important speech before the Economic Club of New York late yesterday. In it he outlined the recent issues facing credit markets, as well as his view of exactly what the Federal Reserve's role should be in managing the crisis.
- The U.S. subprime mortgage market is small relative to the enormous size of global financial markets.
- In reality, it's small relative to the size of U.S. markets.
- So why, Bernanke asks, was the impact of subprime developments on the markets apparently so large?
- "To some extent, the outsized effects of the subprime mortgage problems on financial markets may have reflected broader concerns that problems in the U.S. housing market might restrain overall economic growth," he notes on the one hand.
- "But the developments in subprime were perhaps more a trigger than a fundamental cause of the financial turmoil."
- Indeed, we have argued this for several years now.
- Subprime lending problems, rather than being the cause of financial turmoil, are merely one symptom - just one - of a more insidious attack; high-level autoimmunity.
- The immune system is the body's means of protection against microorganisms and other foreign substances.
- In simple terms, autoimmunity is the failure of an organism to recognize its own constituent parts as "self."
- This failure results in an immune response against its own cells and tissues.
- Low-level autoimmunity can be beneficial.
- High-level autoimmunity, an inappropriate internal response, the body, literally, attacking itself from within, is unhealthy.
- Because the effects of the Fed's artificially induced credit demand are so large, literally, systemic, and because the Fed's response is itself an attack of this body's healthy organs, the result is an autoimmune disorder that the Fed is both simultaneously engineering and trying to fight.
- No wonder Bernanke must answer why the effects of such a tiny segment of the market - subprime - is apparently having such an outsized impact internally.
- "The episode led investors to become more uncertain about valuations of a range of complex or opaque structured credit products, not just those backed by subprime mortgages," Bernanke says.
- "They also reacted to market developments by increasing their assessment of the risks associated with a number of assets and, to some degree, by reducing their willingness to take on risk more generally."
- Now, the Fed has several options for managing this risk aversion.
- One is to engage in open market operations.
- "To be clear," Bernanke notes, "an open market operation can provide market participants with increased liquidity; but the intervention does not directly increase participants' capital or allow them to shed risk. In essence, these operations are short-term loans collateralized by government securities."
- The point Bernanke is addressing here is the moral hazard of providing capital versus "providing liquidity."
- He believes there is a difference in liquidity and capital. We disagree, but will circle back to this in a moment.
- The second way the Fed manages this risk aversion is through the discount window.
- Loans through the discount window differ from open market operations in that they can be made directly to specific banks with strong demands for liquidity.
- "As with open market operations, however, Fed lending through the discount window provides banks with liquidity, not risk capital," Bernanke claims.
- Technically, this is true.
- Neither open market operations or discount window lending provide banks with capital... unless they occur in a circular type of perpetual motion.
- What happens, for example, if the Fed does 30-day repos... and just kept doing them every 30 days?
- Well, that's called monetization.
- Wait, isn't this just interpretation, speculation on your part? It was. Until last night.
- The keys to the entire kingdom were - inadvertently or intentionally, we're not sure - offered up last night when Bernanke made the following statement.
- "Access to a backstop source of liquidity in turn reduces the incentives of banks to limit the credit they provide to their customers and counterparties."
- Read that statement carefully. It's the one key sentence in the entire speech.
- The misunderstanding that is perpetuated is that the Fed by "providing liquidity" is not actually "providing credit."
- What Bernanke's statement means is that, in reality, the two are synonymous.
- There can be no question that having "a backstop source of liquidity" can reduce a bank's incentives to limit credit.
- And therein lies the issue.
- By providing that backstop (liquidity) the Fed is inducing the extension of credit.
- This will work as long as appetites for credit are amenable.
- So far, the market has been attempting to battle this disorder internally, attacking itself in the process, creating a systemic disorder.
- One day, the patient will stop responding.
3. Communists - They're Just Like Us!
As a child of the Reagan era, there are certain phrases I never expected to hear, among them:
- "We should help the mentally ill, not make them homeless."
- "Let's sell a stake in the bank to the Communists."
Man, that last one is a doozy, isn't it? Can you imagine President Reagan looking the American people in the eye and telling them we're selling stakes in our banks to the Chinese government?
- So what to make of the fact that China Citic Group, a midsize lender majority-owned by the Chinese government, may buy a stake in Bear Stearns (BSC)?
- China Banking Regulatory Commission Vice Chairman Jiang Dingzhi confirmed yesterday that China Citic Bank, a midsize lender majority-owned by the Chinese government, has made a bid for an investment in Bear Stearns.
- Interestingly, his comments were made at what the Wall Street Journal called a "key Communist Party meeting in Beijing."
- Oh, the irony.
- Look, it's not that communists, generally speaking, make bad investors, it's that... oh wait, actually they do make bad investors.
- Well, that's a very good question.
- No one quite knows for sure, becau.. wait, actually it turns out they do know the answer for sure.
- They make bad investors BECAUSE THEY ARE COMMUNISTS!
4. Do Over!
The ABX indexes, which are used to track the subprime-mortgage market, may need to change their criteria because securitizations have fallen so low there may not be enough bonds to fill a new series, according to Bloomberg.
- The ABX contracts are commonly used by investors to either speculate on or hedge against risk that the underlying securities won't be repaid.
- More than half of the 20 subprime bond deals needed to create a new index have closed, less than the number available at this point leading up to the most recent creation, according to Ben Logan, managing director for product development at London-based Markit Group Ltd.
- Previous versions of the indexes, created in January 2006 by securities firms including Goldman Sachs Group Inc. and Deutsche Bank, became popular vehicles for hedge funds and banks to bet against the subprime market, the Bloomberg article noted.
- The going is rough for the current ABX indexes.
- Today we are seeing new lows in the BBB- tranch of the ABX indices.
- The bid side is 23, down from yesterday's 25 and 27 two days prior.
- For the record that's a 15% decline in four days.
6. Fifth Thing Now Record Sixth Thing!
Wait, what happened to Number Five? Ask this guy.
We were toiling away this morning, struggling to hammer out a Fifth Thing and, to be perfectly honest, it appeared we were going to fail and actually run - for the first time ever - a Five Things deficit. Then that guy in the photo called us and told us a whole group of things had come together to provide a liquidity backstop, if you will, and that our Fifth Thing was now this Sixth Thing. For the record, that's a profit!
The Fifth Thing is now an off balance sheet item. We will probably write it down tomorrow.
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