Monday, March 17, 2008

Financial system is melting - Fed is trying to throw water on the fire

This is going to be a difficult day for the financial markets. From BBC News :
Markets from New York to Tokyo have recorded heavy losses in reaction to the emergency bailout of US investment bank Bear Stearns over the weekend.

In New York the Dow Jones Industrials tumbled 194 points, more than 1.5%, in early trading before recovering.

London's FTSE 100 index was down 2.7%, in Paris the Cac 40 slumped 2.9% and Frankfurt's Dax fell 4.1%.

European banks have been hit. UBS plunged 13.1%, Societe Generale fell 9.1% and Commerzbank was down 7.9%.

US banks were hammered in pre-market trading, with Lehman Brothers down 30%.
What happened? Also from BBC News:
JPMorgan Chase is to buy Wall Street's fifth-largest investment bank, Bear Stearns, for $2 a share - a fraction of its previous value.

The news has rattled investors worldwide, who fear that the credit crisis is deepening.

The bank got into trouble over its sub-prime mortgage debts, and other banks had stopped lending to it.

The rescue has been backed by the US Federal Reserve, who will lend $30bn and lower its discount rate to 3.25%.
But Bear Stearns' disappearance is just the top story in a series of bad news financial stories.
  • BBC News :
    US banking giant Citigroup has reported a $9.83bn (£5bn) net loss for the last three months of 2007.

    Chief executive Vikram Pandit said the loss had been caused by a $18.1bn exposure to bad mortgage debt and was "clearly unacceptable".

    The company, the largest banking group in the US, said revenues during the fourth quarter fell 70% from a year earlier to $7.2bn.
  • BBC News
    Merrill Lynch posts $7.8bn loss
    Wall Street banking giant Merrill Lynch has unveiled a huge loss for 2007, crippled by exposure to risky investments in the US housing market.

    It made a net loss of $7.8bn (£3.9bn) in the 12 months to the end of December from a net profit of $7.5bn in 2006.

    The loss includes a massive $14.1bn write-down on failed investments related to sub-prime mortgages.

    Merrill Lynch is the latest big bank to reveal losses related to the crisis in the US mortgage market.

    Earlier this week, Citigroup and JP Morgan also announced write-downs because of their exposure to the crisis in the sub-prime loan sector, which focused on consumers with poor or non-existent credit histories.

    JP Morgan Chase said its earnings for the last three months of 2007 fell 34%, while Citigroup reported a $9.83bn net loss for the last three months of 2007.
  • BBC News
    HSBC in $17bn credit crisis loss
    HSBC, the UK's largest bank, has said it has made a $17.2bn (£8.7bn) loss after the decline in the US housing market hit the value of its loans.

    But its annual profits still rose 10% to $24.2bn (£12.2bn), up from $22.08bn the year before.

    The write-down is the largest of the big-five UK banks because HSBC has large operations in the US.

    The bank said the global financial system had come under "extraordinary strain" in 2007.

    "The outlook for the rest of 2008 is uncertain," said HSBC chairman Stephen Green.

    "The economic slowdown and the credit outlook in the US may well get worse before they get better," he added.
  • Bloomberg financial news
    March 16 (Bloomberg) -- The Federal Reserve, in emergency decisions aimed at containing a crisis of confidence in the U.S. financial system, cut the rate on direct loans to commercial banks and opened up borrowing at the rate to securities firms.

    The moves, coming in an announcement timed for the start of trading on the Tokyo Stock Exchange, included commitments to encourage JPMorgan Chase & Co. to buy Bear Stearns Cos. after a run on the firm threatened the stability of global markets. The Fed also extended the maximum term of loans to commercial banks to 90 days from 30 days.

    The Fed's first weekend change in borrowing costs since 1979 is Chairman Ben S. Bernanke's latest step to alleviate a credit squeeze that's exacerbating the U.S. economic slowdown. The dollar tumbled to a 12-year low against the yen and Treasury notes rallied as traders increased bets that officials will reduce their main rate by 1 percentage point when they meet on March 18.

    ``Clearly, the Fed is trying to provide more liquidity to prevent a more vicious cycle and race to the bottom,'' said Gary Schlossberg, senior economist at Wells Capital Management in San Francisco, which oversees $200 billion. ``The problem is there's so much concern about credit quality that now there are solvency issues, and it's something the Fed has a more difficult time dealing with.''
So what is happening? Krugman told us last Friday:
Four years ago, an academic economist named Ben Bernanke co-authored a technical paper that could have been titled “Things the Federal Reserve Might Try if It’s Desperate” — although that may not have been obvious from its actual title, “Monetary Policy Alternatives at the Zero Bound: An Empirical Investigation.”

Today, the Fed is indeed desperate, and Mr. Bernanke, as its chairman, is putting some of the paper’s suggestions into effect. Unfortunately, however, the Bernanke Fed’s actions — even though they’re unprecedented in their scope — probably won’t be enough to halt the economy’s downward spiral. [Snip]

These days, it’s rare to get through a week without hearing about another financial disaster. Some of this is unavoidable: there’s nothing Mr. Bernanke can or should do to prevent people who bet on ever-rising house prices from losing money. But the Fed is trying to contain the damage from the collapse of the housing bubble, keeping it from causing a deep recession or wrecking financial markets that had nothing to do with housing.

So Mr. Bernanke and his colleagues have been doing the usual thing: printing up green paper and using it to buy bonds. Unfortunately, the policy isn’t having much effect on the things that matter. Interest rates on government bonds are down — but financial chaos has made banks unwilling to take risks, and it’s getting harder, not easier, for businesses to borrow money.

As a result, the Fed’s attempt to avert a recession has almost certainly failed. And each new piece of economic data — like the news that retail sales fell last month — adds to fears that the recession will be both deep and long.

So now the Fed is following one of the options suggested in that 2004 paper, which was about things to do when conventional monetary policy isn’t getting any traction. Instead of following its usual practice of buying only safe U.S. government debt, the Fed announced this week that it would put $400 billion — almost half its available funds — into other stuff, including bonds backed by, yes, home mortgages. The hope is that this will stabilize markets and end the panic.

Officially, the Fed won’t be buying mortgage-backed securities outright: it’s only accepting them as collateral in return for loans. But it’s definitely taking on some mortgage risk. Is this, to some extent, a bailout for banks? Yes.

Still, that’s not what has me worried. I’m more concerned that despite the extraordinary scale of Mr. Bernanke’s action — to my knowledge, no advanced-country’s central bank has ever exposed itself to this much market risk — the Fed still won’t manage to get a grip on the economy. You see, $400 billion sounds like a lot, but it’s still small compared with the problem. [Snip]

...there’s only so much the Fed — whose resources are limited, and whose mandate doesn’t extend to rescuing the whole financial system — can do when faced with what looks increasingly like one of history’s great financial crises.

The next steps will be up to the politicians.
The most certain predictor of which party wins the Presidency over the last half century has been the economy. An economic downturn has been sufficient to change the incumbent party to the outside one. We are now clearly in a recession, and it is getting worse.

The Republican Party in Congress has shown remarkable discipline in being totally obstructionist, using House and especially Senate rules over the last year to prevent any useful Congressional actions. They show no evidence of changing their ways. As a result, any significant political response to the economic conditions is unlikely to come from Congress before the election in November 2008.

Meanwhile, George Bush is performing a reprise of Herbert Hoover speeches as he stated
WASHINGTON -- President Bush said Saturday that the government must guard against going too far in trying to fix the troubled economy and that "one of the worst things you can do is overcorrect." Democrats said Bush is relying on inaction to solve the problem.

Bush said in his weekly radio address that the recently adopted program of tax rebates for families and businesses should begin to lift the economy in the second quarter and have a stronger impact in the third quarter. But he urged caution about doing more, particularly about the crisis in the housing market, where prices are tumbling and home foreclosures have soared to an all-time high.

"If we were to pursue some of the sweeping government solutions that we hear about in Washington, we would make a complicated problem even worse -- and end up hurting far more homeowners than we help," the president said.
So the problem has gone beyond what can be handled by purely economic means and become one that requires political changes. Bush, being conservative, is going to apply the Herbert Hoover solution and Congressional Republicans are working hard towards the same goal of government inaction. In 1929 the Republican solution to economic distress was to leave the problem to the economy and not take any political actions. They are at it again. They aren't called "conservatives" for nothing. The policies that failed in the past during the Depression are good enough for them again today.

So that's where the economic problems stand this morning. The set of problems has gotten sufficiently severe so that radical action is needed just to keep them from getting a lot worse, yet the Republican Party thinks they can make political gains (or stem their losses in November) by preventing any political actions from being used.

In the meantime, BBC News reports this morning that
At one stage on Monday morning it took $1.5904 to buy a euro.
and also from BBC News
The prices of oil and gold have hit records as investors have switched money into commodities to escape turmoil in other financial markets.

The main contract for US light sweet crude hit $111.80 a barrel on Monday, before slipping back.

The spot price for gold also briefly hit a record above $1,030 an ounce.

Commodity prices have been boosted by the falling dollar which hit a record low against the euro and fell to a 12-year low against the yen.

Oil prices have risen about 16% this year, gold is up 23%.

That's where things stand. America - and the world - is in the worst financial situation since the Depression, and the Republican Party is committed to preventing any effective reaction to keep things from getting worse. Even if the Republicans were not on an obstructionist binge, there isn't a lot that can be done to provide short term improvement. We're just going to have to ride this out wearing conservative shackles, like trying to swim in a flood while carrying lead weights.

Addendum 3:17 PM CDT
If you want a sense of how severe the financial crisis is from the point of view of the professionals, go read Total BS on Wall Street by Jared Bernstein, then read the comments to his post.

The Carlyle Capitals calls scared the sh*t out of me and now BS... . I just heard a rumor that my firm has(d) $500M in BS stock.
I thought we could lose a big bank this year. I didn't think it would be this soon, and I didn't think it would be Bear. But there you have it, and now the markets are only betting on who's next.
the subprime infection has spread to AAA instruments. So now even safe mortgage-backs are no longer safe. It's no longer the case that we can let bad-loans burn off without impacting good ones
Hate to join today's chorus, but we're screwed. Not even cheap Fed money is satisfying this beast.

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