Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

[flow5]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

Commercial paper (CP) is a unsecured promissory note. CP has a fixed maturity (typically 30 days). CP can be discounted from face value or interest-bearing. Ordinarily CP is issued by large companies, having back-up lines of credit, supported by high credit ratings.


Its dollar volume is the 2^nd largest of any money market instrument (second to U.S. government securities). It is used for short term working capital. It is similar to a line of credit but less expensive to float/issue. Due to CP’s short maturities, issuers must continually refinance (roll-over) a significant amount of maturing paper.
The liquidity crisis is making it expensive and hard to roll-over maturing obligations (availability, access to, convertibility). Some firms are using credit-enhancements, (1) letters of credit (LOC), (2) asset-backed pledges, and (3) revolving credit (variable payments) etc., as defenses.

Commercial paper is sensitive to the immediate economic outlook. Because of its short maturity, commercial paper is exempt from SEC regulations, i.e., their 270 days guideline..The volume of commercial paper outstanding was previously included in the definition of the M3 money supply figure. However only commercial bank financed paper was correctly reported/included in M3..

The current fall in the volume of commercial paper reflects both illiquidity and an upcoming contraction in gdp. It represents a decline in the supply of money as well as a decline in the velocity of money – a doppelganger.

[flow5]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak



Illiquidity.

[flow5]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak


Heavy Selling Spreads Across Asia; Yen Carry Trade Unwinds




Every Asian index fell Thursday, led by a 6.9% drop in Seoul, which had been one of the best performing countries in the region year-to-date. Highflying Shanghai finally took a hit, down 2.1%. Unwinding of the yen carry trade is gaining momentum, as the yen rose 2.4% against the US$ and 2.9% against the euro, to multi-month highs. "We are at a tipping point. Investors that had been short the yen for more than a year and a half have fully squared those positions. The question now is whether they are starting to build long positions," said the head of macro strategy at State Street Global Markets.

[flow5]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

Securities Holdings as of August 15, 2007 ($ thousands)

Summary T-Bills T-Notes & T-Bonds TIIS

Security Type Total Par Value US Treasury Bills (T-Bills) 277,018,806 US Treasury Notes and Bonds (Notes/Bonds) 472,142,049 US Treasury Inflation-Indexed Securities (TIIS)* 35,752,628 Total SOMA Holdings 784,913,483 Change From Prior Week -1,236,342 FRBNY's "trading desk" sold bonds. This helps explain the declining rates of change in the monetary aggregates.

[flow5]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

2. Federal Reserve's Expanded Discount Window Collateral Qualifications

2.1 General Collateral Requirements
Reserve Banks require collateral to secure all obligations owed by financial institutions under Operating Circular No. 10 All collateral pledged to a Reserve Bank must be free of any conflicting claims, liens, security interests or restrictions upon transfer or pledge to the Reserve Bank.

2.2 Obtaining a Security Interest - Filing a UCC-1 Financing Statement
When instruments, accounts, chattel paper or intangibles are pledged to secure Discount Window obligations, a Financing Statement (UCC-1) is filed with the appropriate authorities to perfect the Reserve Bank's interest in the collateral. Reserve Banks conduct lien searches to ensure that no other creditors have filed a UCC-1 covering the same collateral.

2.3 Unacceptable Types of Assets

In determining whether collateral is acceptable for the Discount Window, the Reserve Bank will consider assets that meet regulatory standards for sound asset quality and other associated risks. It will not accept assets that: (1) are subject to adverse regulatory classification; (2) are 30 days or more past due (60 days for mortgage notes and other consumer debt, including student loans); (3) are illegal investments for the pledging institution; or that (4) exhibit collateral and credit documentation deficiencies.

2.3.1 Assets Subject to Restrictions on Assignment

Some assets offered as collateral may be subject to restrictions on assignment. Such assets should be discussed with the Reserve Bank before being pledged.

3. Acceptable Collateral Types

3.1 U.S. Government and Agency Securities

U.S. Government and Agency Securities are recorded in the Federal Reserve's National Book-Entry System (NBES). They are not issued in certificated form. Acceptable categories of NBES-eligible securities include:

3.1.1 U.S. Treasury Obligations

U.S. Treasury Obligations are direct obligations of the U.S. government.

3.1.2 U.S. Government/Agency Obligations: Full Faith and Credit

Full Faith and Credit U.S. Government/Agency Obligations are obligations that are backed by the full faith and credit of the U.S. government.

3.1.3 U.S. Government Sponsored Enterprise Obligations

Government Sponsored Enterprise (GSE) Obligations are debt instruments issued by GSEs such as the Federal National Mortgage Association, Federal Farm Credit Bank, etc.

3.2 Foreign Sovereign Debt Obligations
Foreign Sovereign Debt Obligations are obligations of foreign governments, including development banks. Only certain foreign debt obligations and currencies are acceptable, and pledging such securities may also involve unique perfection issues. Therefore, an institution should contact its Reserve Bank for more specific information.

3.3 Municipal or Corporate Obligations

Municipal or Corporate Obligations are acceptable as collateral if they are of investment quality. These obligations are generally recorded on the books of the Depository Trust Company and include the following:

3.3.1 State and Local Government Obligations

State and Local Government Obligations are debt instruments that represent general debt or special project debt of state- or local-government entities.

3.3.2 Corporate Market Instruments

Corporate Market Instruments are debt instruments issued by corporate entities that may be publicly traded (e.g., asset-backed securities, corporate bonds and mortgage-backed instruments).

3.4 Commercial Paper
Commercial Paper is acceptable as collateral if it is of investment quality. These obligations are generally recorded on the books of the Depository Trust Company.

3.5 Bank Issued Assets
Bank issued assets include certificates of deposit, bank notes, and deposit notes. They are acceptable as collateral if they are issued by an institution in sound financial condition. The assets can not be issued by the pledging institution or its affiliate. These obligations may be recorded on the books of the Depository Trust Company.

3.6 Customer Obligations
Customer Obligations may be accepted as collateral if they meet the credit-quality standards set by an institution's local Reserve Bank. These obligations may include assets such as commercial loans, consumer loans and one-to-four-family mortgage loans.

[Jim Nickerson]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

If the 12 discount windows are properly administered, advances would only be made to meet emergency outflows of funds from the applicant banks. Advances by the reserve banks would be closely monitored to prevent the use of these funds for profit, that is, to finance an expansion of thee applicant bank’s earning assets. If legal reserves acquired through advances are used to finance bank credit expansion, then the fed is allowing the depository institutions to usurp a power that should be the exclusive province of the central bank.

For many years (before George Mitchell & some others) it was understood that discounting was a privilege, not a right. Banks should not borrow from the central bank except in an emergency. And an emergency does not extend to helping a banker meet obligations under lines of credit. Under this system bankers know they have to hold sufficient liquid assets to meet such contingencies, or meet their obligations through their “managed liabilities.” As it is, bankers can borrow to meet “seasonal needs.” Today, discount rules and administration are so lax, that borrowed funds can be resold in the federal fund’s market. By providing virtually free access to the discount window, the Fed relinquishes its power to control money creation.

It should be emphasized that one dollar of borrowed reserves provides the same legal-economic base for the expansion of money as one dollar of non-borrowed reserves. The fact that advances have to be repaid in one month or less is immaterial. A new advance can be obtained, or an old advance extended, or the borrowing bank replaced by other borrowing banks. The importance of controlling borrowed reserves is indicated by an excessive volume of free legal reserves/discounting.


Under proper conditions and surveillance, the increased volume of discounting can be easily offset by concurrent open market sales or through a smaller volume of purchases than would otherwise have been made. Discount window administration is necessarily concerned with the emergency needs of specific banks. Applications for secondary credit to meet short-term liquidity needs or to resolve deteriorating financial circumstances should be given priority. In this way the illiquidity needs of the problem banks can be addressed before they balloon.

In contrast, the FRBNY’s “trading desk” deals with a network of 21 established primary dealers which participate in the Fed’s open market operations and submit bids or offers as well as trade using the automated U.S.Treasury securities auction system when bonds, bills, & notes are originally sold. It follows that “primary dealers must be in compliance with Tier I and Tier II capital standards under the Basel Capital Accord, with at least $100 million of Tier I capital” and thus by observance are not encountering the same kind liquidity problems experienced . Instead the primary security dealers are reaping a windfall through large repurchase agreements executed by the Manager of the Open Market Account. A responsible central banking policy will not permit the determination of the volume of legal reserves of depository institutions to be dictated, even in a small way, by the profit proclivities of commercial bankers.

flow5,

I suspect you know a lot about what you are writing, but to me being so low on the totem pole (the bottom of the part buried in the ground) when it comes to serious knowledge of banking and Federal Reserve maneuvering, everything you write is way, way over my head, and I suspect this may be true for more than a few others who try to follow all new posts.

I once was a doctor and early on I talked to patients as though they were doctors--which rarely was the case. It finally dawned on me that if I could not talk "patient talk" rather than "doctor talk," then all I might be trying to communicate were wasted words.

I see your posts as the same. If you have something that is worth your time to write or research, the essence of which is rather erudite, is it possible that you could "dumb it down" to being understandable by those who might profit from what you know or believe to be the case but who do not share your level of expertise. I hope that isn't aksing too much.

[flow5]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

My Two Cents
Andy Sutton
8/17/2007
Occasionally, on dark, secluded back streets, adolescents and other not so tightly wrapped folks engage in a classic American rite of passage known as 'Chicken'. The idea behind the game is for two cars to drive directly towards each other at a high rate of speed and see who swerves first. That person is dubbed the chicken. Obviously, it is easy to envision what happens if neither driver blinks.
For approximately the past two weeks financial commentators and observers have been watching a variant of this classic game. The markets, roiled in certainly the biggest blow-off since the end of the tech bubble, and perhaps of all time were screaming madly for the Fed to step in and open the discount window. CNBC host and industry shill Jim Cramer almost brought on a stroke screaming that Bernanke "doesn't know how bad it is out there!" On the other side was the Fed, stalwart, poised and resolute. Something had to give...
Tough Talk and Wobbly Legs...
Ben Bernanke and his fellow Fed governors have been talking tough. St. Louis Fed President William Poole made several references to the crisis and warned the markets that the Fed would not come to the rescue unless it became obvious that the risk to the financial system was severe. The Fed began backpedaling last week by injecting funds into the financial system in an effort to maintain the target for the Fed Funds Rate at 5.25%.
This morning, the Fed went into full swerve mode cutting the Discount Rate 50 basis to 5.75% from 6.25% This threw a floor under the markets which responded by opening nearly 300 points higher. This came after a suspiciously miraculous rescue from a 343 point intraday drop yesterday. Immediately, the market cheerleaders went into full pom-pom mode, calling a bottom and predicting new records by the end of the year.
Not so Fast...
So I have to ask - what has changed? We know that there are a couple main reasons for the recent bout of volatility:
1) Complacency with regards to risk and the proper pricing thereof;
2) All but absent lending standards on mortgages;
3) Inflationary monetary policies by world governments
Unfortunately, you don't just 'undo' the bad policies of the past seven years and expect everything to be better. Not without a price; things just don't work that way. Sure, banks have tightened their lending standards. Sure risk is being repriced. All things left equal, in time, things would correct nastily, but they would correct. But that is not politically acceptable, nor is individual responsibility. We all knew that eventually the Fed would give in and respond with large infusions of fresh money. There are certain institutions that have been deemed 'too big to fail' and need to be bailed out. However, this now goes well beyond the money center banks as the Fed's first injections never got the intended recipients. Putting cash in the hands of big money center banks was a lousy idea since they just hoarded it. Putting money directly in the hands of ailing hedge funds and lenders might be the next step. Today just made it cheaper for those who ail to borrow more. The Fed's logic being that a problem that was caused by too much easy money can somehow be fixed by more of the same.
We know that the mortgage market is nowhere near out of the woods. Resets will continue (and accelerate) through the end of this year and well into next. The glut of homes coming onto the market through foreclosure and forced selling will cause home prices to deteriorate even further eroding consumer confidence.

The above chart depicts in dollars and by category the mortgages resetting going forward from January 2007. Right now, we are in the early stages of the spike with the bulk of those mortgages being of the subprime flavor. Throw in the alt-a's and option-ARM's and you're looking at the vast majority of these resets being of the type that sport the highest incidence of foreclosure. We still have a long, long way to go in this regard.

The repricing of risk has already led to the failure of 2 Bear Stearns hedge funds and the near-failure of a number of others. The downgrading in subprime mortgage tranches has only begun. Unless a good deal of illegal financial chicanery is used, more losses will occur going forward. More defaults and foreclosures in the mortgage arena will only exacerbate that problem. Clearly, nothing has changed.

The biggest problem I continue to see with this entire situation is that it is now very obvious that the tough love I spoke about in a recent commentary will only apply to those parties deemed insignificant and unimportant. The big boys now know they will be protected. The Bernanke Put is in full play. Such a statement will undoubtedly cause many investors to exclaim 'That's great! They should be protecting my money!' But at what cost will this protection come? Who will bear the expense? I have a sneaking suspicion those same investors will not like my answer. To get it all they have to do is find the nearest mirror.

"My Two Cents" (Andy Sutton) aims at my same point about the discount window.

[c1ue]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

Jim,

Flow is just talking about how the spirit of what the Fed normally considers as collateral is technically being violated by accepting MBS', also that normal use of the discounting window should not be for something like expanding credit due to overly aggressive lending policies.

I posted something similar which was written by John Paul Koning as mises.org - go check it out.

[Rajiv]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

Here is the link for those who want to read it "The Fed Bought What?"

What is significant about Friday's repurchase agreements is not so much their size, but the securities that the Fed exchanged for money: mortgage-backed securities (MBS). Indeed, the entire $38 billion dollar injection went to MBS purchases, the largest open market purchase of this asset type ever conducted by the Fed, smashing the previous record of $8.6 billion set back in September of 2005. See chart, above

[Guest]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

Flow5 - some of your posts on this thread have pointed out some elements of austerity with which in your view the Fed has conducted policy during this administration.

How would that reconcile itself with now pointing out a potential moral hazard by the Fed, in the event of an outright eventual repurchase of mortgage backed securities?

Do you interpret such an eventual repurchase as an imperative the Fed is bound to, in order to be the responsible player of last resort - in the absence of any other buyer, as their not stepping in will destabilize markets to a far greater extent than any moral hazard which may be incurred? That might be an argument.

Granted they have not actually yet purchased these securities yet, but a moral hazard question given the size of such an operation seems entirely legitimate to ask.

[flow5]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

The same mentality (abuse in laxity) exists today as was prevalent during the S&L crisis.

This administration has moral hazard confused with moral suasion.

We live in a predatory society. Depository institutions operate with negligble exess reserves. They will always take advantage of an opportunity to remain fully lent-up.

The volume of total reserves of depository institutions currently exceeds the FOMC's target (policy-rule). Based on past liquidity crisis's these excess reserves will eventually be "washed out" (see H.3 release).

[flow5]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

There is a 4% carry over for deficiencies and excesses which are applied to the next maintenance period (every 2 weeks) for the computation of legal reserves.

[Guest]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

Flow5 -

As I've conceded to you there are legitimate doubts about the depth of Peter Schiff's market insights, perhaps in counterpart you can help me better understand the following ? :

I understand from your reply to the Moral Hazard / Fed as last resort CDO bidder question, that in your view it is the depository institutions which are primary culprits of moral hazard, and not the CB's? To your view it seems it is the intermediary banks which are not acting with the same degree of responsibility as the Fed, whereas if they conformed more strictly to Fed guidelines then distortions would not be as exacerbated?

Can you help me better understand then why Mr. Ty Andros is fixating on the central banks as the principal agents in these unfolding events? His exposition is very clear and easy to follow, which is I suppose why it's so easy to be misled by it?

___________

(COMMENT: don't intermediary banks actions seem to be the rational ones here?)

This week a fire emerged across the banking systems of the G7, as CMO/CDO's markets started to implode. Approximately 300 billion dollars was PRINTED during the week to rescue the banks and the prime brokers from "ARM"ageddon.

The overnight lending windows froze as banks REFUSED to lend to other banks as the value of their counterparties collateral suddenly was in question.

The overnight commercial paper market suffered many disruptions as well. So the authorities did as they must to keep the game going: they printed the money and said "COME and GET IT" to supply the short term liquidity requirements of the G7 financial systems.

... These episodes are set to continue as the financial authorities DO NOT know where the problems are, and on whose balance sheets they reside so they must wait for them to emerge then address them one at a time ...

... The important event is that the US "FEDERAL RESERVE" went to the heart of the problem on Friday and took the "MORTGAGE BACKED SECURITIES" as collateral. They took over 20 billion dollars worth of them into inventory. ...

... NEVER has any central bank taken these over the counter derivatives as collateral. By putting a price on them now they can mark the models to the market, and the G7 central banks have the purchasing power to dictate the bid price, therefore now the balance sheets can be defined.

... Another shoe just dropped as we go to press, banks are WITHDRAWING their credit lines to hedge funds that hold this paper, and they are revoking credit lines predicated on this type of collateral. ...

... To effectively address this problem the G7 central banks must wait for bank after bank, institution after institution, hedge fund after hedge fund, pension fund after pension fund to try and exit their positions ...

... The cockroaches must be identified as they as are flushed out by the mob of investors in PANIC liquidation mode. LOL. Some will be allowed to survive and others will be allowed to die as a lesson to others. ...

The G7 central banks will HAVE TO be the market maker of last resort. To not do so spells doom for the G7 financial system as the "ALWAYS" inflating value of the assets are the underpinnings of their financial systems.

... But there is one containment strategy you can bank on: "THEY WILL PRINT THE MONEY"! Otherwise this is the big Kahuna for the G7 financial systems, and I don't believe they are ready to throw in the towel! ...

[flow5]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

"I understand from your reply to the Moral Hazard / Fed as last resort CDO bidder question, that in your view it is the depository institutions which are primary culprits of moral hazard, and not the CB's? To your view it seems it is the intermediary banks which are not acting with the same degree of responsibility as the Fed, whereas if they conformed more strictly to Fed guidelines then distortions would not be as exacerbated?

Can you help me better understand then why Mr. Ty Andros is fixating on the central banks as the principal agents in these unfolding events? His exposition is very clear and easy to follow, which is I suppose why it's so easy to be misled by it?"
================================================== ======

All lending institutions were given the opportunity to make bad loans. And to some extent all lending institutions exploited Greenspan's conundrum (& his extremely flawed monetary policy). The existing legislation was an invitation to disaster. But greed, incompetence, abuse of power, fraud, & reckless financial practices are not just unique to the lending industry. Since 1958, the basic flaw has been institutional...

Contrary to Milton Friedman & Alan Greenspan, depository institutions should be subject to more intense, not less, regulation. In re-organizing our financial institutions the first requirement is to recognize that the competitive freedoms of the mercantile marketplace cannot be applied to the institutions that create our money, or protect our savings.

[Rajiv]

Re: Inflation Peaks/Real-gdp Peaks/Interest Rates Peak

Contrary to Milton Friedman & Alan Greenspan, depository institutions should be subject to more intense, not less, regulation. In re-organizing our financial institutions the first requirement is to recognize that the competitive freedoms of the mercantile marketplace cannot be applied to the institutions that create our money, or protect our savings.

Well said!