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

United States Treasury promises to pay the Fed for Bear Stearns losses

This is us folks.  The US government, i.e. taxpayers, guarantees the NY Federal Reserve loan of $29,000,000,000 to JPMorgan/Bear Stearns.  Call and write your congressional representatives if you disagree.  Otherwise, you need not do anything.  Click to read the letter →  treasuryletter0308.pdf

 Jim Rogers’ reaction to Fed moves on Bloomberg  

Bear Stearns worth $2.00 / share

And now…..it’s down to $2.00 (sold to JP Morgan and ….the US taxpayers via Fed’s guarantee of BSC liabilities as part of the deal).  This is a 3 month chart.  Wondering how an investment bank worth almost $100 3 months ago is suddenly worth $30 last Friday, and $2 today?  Answer:  reality. 

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:

Central banks cannot prevent unraveling of global economy?

Satyajit Das opines that the tools available to central banks are inadequate to address the scope of the global economic problems we face.  The black box or shadow economy may involve the unwinding of “innovative” financial products/derivatives such that monetary and fiscal policy simply will not work this time. 

http://www.boston.com/bostonglobe/ideas/articles/2008/01/27/the_black_box_economy/

Deja vu – Bernanke will prevent (cure?) deflation with a copy machine

Way back when he was “just” a Fed Governor, in 2002, Bernanke gave an amazing speech detailing what he would do to prevent or cure deflation.  I read him as saying that he doesn’t think the U.S. will go into deflation because our financial system (banks and household balance sheets) are so healthy (forget that now!).  The other reason he gives is that the Federal Reserve can itself prevent or cure deflation.  Bernanke gives a list of the steps he would take — and it looks as if he’s already several steps down on the list with the TAF auctions.  But never fear, as a bottom line Bernanke thinks we should all be comforted by the fact that if all else fails, he’s got a printing press (oops, a copy machine) to print lots of dollar bills and reinflate the economy. 

It’s true, and worth another close read: 

http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/#f8

What would Milton Friedman say to Ben Bernanke?

Milton Friedman died in 2006.  If he were living, what would he say about the current economic situation?

It may be instructive to review what he said about the dot.com bubble in 2000.  Friedman believed that in the event of an equities bubble burst, the Federal Reserve should pour in money to cushion the economy – but not indefinitely.  For example, using the Great Depression as an example, when the bubble burst in 1929, from peak to trough, the equities market lost about 80% of its value over about 3 years.  Friedman believed that had the Federal Reserve followed “correct” policy, the market would have bottomed sooner and not fallen so far.  Friedman was quick to point out that precisely how much and how long to “pour money in” is tricky to figure out, and that the Fed should not pour money in for so long that it creates another bubble. 

Here is part of the transcript from a Hoover Institution (by Peter Robinson) interview with Milton Friedman recorded March 10, 2000:

Bernanke, looking jittery and haunted, testifies – open comment

Watching this testimony live, without benefit of transcript, Bernanke incredibly is saying there will NOT be a recession!  Forecasting slower growth picking up in late 2008.  Some decent questions from Congresspeople re: why would a rebate actually improve economy?  Shift from pro-savings economy to pro-debt, etc.

Comments? 

Why is Bernanke talking so optimistically (yet looking terrible)?

What will Congress do on fiscal side?

Will Bernanke lower rates on 1/30 and if so why?

Cheers!