Strange days: Federal Reserve to take stocks in exchange for cash

Amongst the financial news today is something that is truly strange and new.  For the first time in almost a century, the Federal Reserve has announced it will lend out money in exchange for equities (shares of stock).  According the the Reuters’ report:

“One of the biggest changes the Fed made was to accept equities as collateral for cash loans at one of its special credit facilities, the first time that the Fed has done so in its nearly 95-year history. 

One of the most striking new Fed action was its decision to accept equities as collateral for cash loans under its Primary Dealer Credit Facility for investment banks. Until now, collateral was limited to investment-grade debt securities.”

What does this mean?  Essentially, that the quality of the collateral held by the Federal Reserve is continuing to deteriorate.  Long gone are the days of AAA rated collateral requirements.  The Federal Reserve is now potentially the largest player in the stock market.  At the very least, it will be subjected to stock market risk, a scary thought.  Is this the role of a Central Bank? 

The action is summarized by Nouriel Roubini as follows:

[T]he Fed is accepting even more toxic collateral for the TSLF and PDCF, including even equities; so now after having nationalized the mortgage market via the takeover of Fannie and Freddie the government is also starting to manipulate directly the stock market (a step that started with the SEC restrictions on naked short sales of the primary dealers; so the process of turning the US market system in a socialist system controlled by the government is now in full swing. And the Fed takes massive credit and now market risks by its effective purchase of equities.”  http://www.rgemonitor.com/roubini-monitor/253567/if_lehman_collapses_expect_a_run_on_all_of_the_other_broker_dealers_and_the_collapse_of_the_shadow_banking_system

British bank Lloyds TSB’s profits plunge 70%

http://www.thisislondon.co.uk/standard/article-23523323-details/Profit+crash+rocks+banks/article.do

The news hit London on July 30th that one of the most conservative of the British major banking institutions saw its profits plunge by 70%.  “The result was far worse than a pessimistic City was expecting and raised fears for high street rivals. HBOS, which owns Halifax, reports tomorrow and Alliance & Leicester the day after.  Lloyds TSB blamed the global credit crunch and losses in its insurance business. The figures will heighten government fears that more small banks could collapse such as Northern Rock. Lloyds was regarded as the most conservative of the big banks and had won praise for resisting the temptation to make risky loans during the boom years.”

Banking crisis – money IVs

No, we’re not out of the woods.  B&B in  the UK and now Lehman on Wall Street are showing that when the tide goes out, we see who’s swimming naked.  Simply put, it’s not a good sign when investment banks and banks have to use credit to survive.  As observed so well today, what goes up must come down harder:

“Lehman is in serious trouble on Wall Street. But that’s nothing compared to Bradford & Bingley in the UK, which may be wiped out in a matter of days. As you can see below, they were very close a few days ago. A bank run has been avoided so far because of an alleged government guarantee for every first £35.000 in deposits. What that is truly worth remains to be seen if bank failures come fast and furious in the UK.

That scenario is not that far out in left field; most large UK banks are caught up in rights issues. That over-supply means that to get any new capital, they’ll have to sell themselves dirt cheap. Which in turn will provoke enormous anger among shareholders. It could happen very soon. But yes, it’s still possible that Gordon Brown sells the future of his people to save the banking system.

Not that Lehman is looking good, mind you, they’re going “money intravenous” for the third time in a few months, and they lost over 50% of their values at the same time. If that trend doesn’t stop, there is no way out of failure or a fire-sale. And following tight on the Lehman heels, Wachovia is lined up for the emergency room, and perhaps the last rites. Or, you guessed it, a fire-sale.

People are often asking for “the” moment, and “the” writing on the wall. How about this: “Sales of [US] commercial properties were down 71 per cent in the first quarter compared with a year earlier.[..] Commercial property prices in the US in February saw their sharpest decline since records began nearly 15 years ago.”

http://theautomaticearth.blogspot.com/2008/06/debt-rattle-june-3-2008-what-goes-up.html

This is not business as usual

For curiosity’s sake, take a look at the historical dollar amount of borrowing by depository institutions (banks) from the Federal Reserve.  It is hard not to notice that what we have here is unprecedented over the last 100 years.  When you hear someone say the credit crisis is almost over, check this chart and think again.

Total Borrowings of Depository Institutions from Fed. Reserve 1910 – present (Billions $US)

Scary chart: British banks undercapitalized

Fed chart shows current borrowing schemes

Click through to see New York Federal Reserve Bank’s March 2008 chart explaining TAF, TSLF, among many others including acceptable collateral for each type of lending:

forms_of_fed_lending.pdf

 Jim Rogers’ reaction to Fed moves on Bloomberg  

The Fed running low on ammunition?

The Federal Reserve has certain assets — about $800 Billion in Treasuries.  Once it lends away the additional $200 Billion announced today, and counting the TAFs (Term Auction Facilities), about one-half of the Fed’s reserve of Treasuries will be gone.  This chart shows the Fed’s reserves before this additional $200 billion is given out, so you’ll have to continue that line downwards to imagine what it’ll look like by the end of March:

Banks’ nonborrowed reserves go below zero into negative territory

Click on the thumbnail and weep.  This chart is the latest, and was updated as of 2/22/08.  It’s dramatic. ↓

Now click on this thumbnail to see latest (as of 2/15/08) Fed chart for banks’ total borrowings from the Federal Reserve -  without precedent it would seem.  ↓

                      For an excellent discussion of the meaning of all of this, check out “Borrowed Reserves and Tinfoil Hats” from Mish’s blog:  http://globaleconomicanalysis.blogspot.com/2008/02/borrowed-reserves-and-tin-foil-hats.html

Nationalized losses/private profit: Gov’t forgets to nationalize 40 billion pounds sterling of Northern Rock’s best assets

http://www.guardian.co.uk/business/2008/feb/21/northernrock.banking

Those who are suspicious of bank nationalization schemes have more to work with.  While sticking UK taxpayers with the bill for Northern Rock’s bad money management, the government cannot explain why an offshore group of the bank’s highest higher quality mortgages worth£40 billion was left out of the nationalization. ”Yesterday, senior peers, including the former chancellor Lord Lawson, expressed astonishment that ministers were at a loss to explain at the outset of the Lords debate the contractual relationship between Granite and the Rock. In the Commons David Cameron accused Gordon Brown of showing “less openness than Fidel Castro.”  

Ron Sandler, new chairman of Northern Rock