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Federal Reserve Chairman Ben S. Bernanke may need to step up his effort to unfreeze bank funding markets as a surge in borrowing costs blunts the impact of the cash auctions the central bank introduced in December.TAF Not Working As Expected
"There's clearly a need for the Fed to do more," said Charles Lieberman, a former New York Fed economist who's now chief investment officer of Advisors Capital Management LLC in Paramus, New Jersey. "The underlying problem" is that banks and other investors are "still nervous" about lending to each other, he said.
Increases in Libor and other rates are "a pretty clear indication that liquidity remains an issue or that term liquidity remains scarce," said Dean Maki, chief U.S. economist at Barclays in New York and a former Fed researcher. "The Fed's made pretty clear they're going to continue to attack those problems as needed."
The Fed auctions 28-day loans through the TAF, helping banks borrow funds that they might not obtain from counterparts. The Fed created the tool because of rising rates on one- to three-month loans among banks, Fed Governor Frederic Mishkin said in a February speech. The auctions may have had "significant beneficial effects on financial markets," he said at the time.
Another gauge of bank funding costs, the premium on Libor over the overnight indexed swap rate, a measure of what traders expect for the Fed's benchmark rate, reached 87 basis points on April 21. That was the highest since the Fed announced the TAF on Dec. 12.
Bigger TAF operations would probably slow or reverse the increase in borrowing costs, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. Originally $40 billion a month, the Fed raised the amount of the auctions to $60 billion in January and to $100 billion in March.
"Any substantial further increase would start moving the program to a level where" it is more than "just psychologically relevant," Crandall said.
A month after the Federal Reserve rescued Bear Stearns Cos. from bankruptcy, Chairman Ben S. Bernanke got an S.O.S. from Congress.My Comment: The TAF has worked so well at spurring bank to bank lending, I am sure "similar bold action" would work equally well for student loans.
There is "a potential crisis in the student-loan market" requiring "similar bold action," Chairman Christopher Dodd of Connecticut and six other Democrats wrote Bernanke. They want the Fed to swap Treasury notes for bonds backed by student loans.
Student loans are just the start. Former Fed officials and other Fed-watchers say that Bernanke's actions in saving Bear Stearns will expose the central bank to continuing pressure to use its $889 billion balance sheet to prop up companies or entire industries deemed important by politicians.My Comment: Appalling is right, but illegal is closer to what's happening.
"It is appalling where we are right now," former St. Louis Fed President William Poole, who retired in March, said in an interview. The Fed has introduced "a backstop for the entire financial system."
The Fed's loans to Bear Stearns were "a rogue operation,'' said Anna Schwartz, who co-wrote "A Monetary History of the United States'' with the late Nobel laureate Milton Friedman.My Comment: This is interesting. We have a Fed governor admitting the Fed has unleashed a genie that cannot be contained, but he supports the action anyway.
"To me, it is an open and shut case," she said in an interview from her office in New York. "The Fed had no business intervening there."
"There is no way to put the genie back in the bottle," Minneapolis Fed President Gary Stern said in an interview with Fox Business Network on April 18. "What worries me most about where we wind up is that we will have an expansion of the safety net without adequate incentives to contain it."
Stern noted that he supported the Fed's moves to restore financial stability.
Richmond Fed chief Jeffrey Lacker and policy adviser Marvin Goodfriend wrote in a 1999 paper that central bank lending creates ever-expanding expectations. "The rate of incidence of financial distress that calls for central bank lending should tend to increase over time," they wrote. That "creates a potentially severe moral-hazard problem."My Comment: There is nothing "potential" about this. The Fed is a moral hazard.
Bernanke rejected Dodd's request in an April 25 letter, saying it's up to Congress and the Bush administration to address diminishing profits on the loans.This S.O.S. was unanswered. Nonetheless, the expectations genie has been unleashed and it will not be long before more S.O.S. alarms are sounded.
The Labor Department reported Thursday that claims for unemployment benefits rose by 35,000 to 380,000. Private economists had expected claims would rise by a smaller 18,000.This is in contrast to a recent weekly report that was better than expected. I suggested then, and will continue to suggest that way better than expected numbers are more likely than not to be outliers.
The report on jobless claims came a day ahead of a report on unemployment for April. Economists expect that report will show that the unemployment rate edged up to 5.2 percent in April, from 5.1 percent in March. The economy is expected to lose 70,000 jobs, the fourth straight month of job losses.
Treasury Secretary Henry Paulson said the credit crisis probably is more than half over and retained his forecast for the U.S. economy to keep growing.Questions For Paulson
"We are closer to the end of this problem than we are to the beginning," Paulson said in a Bloomberg Television interview today in Washington. Even with "headwinds and despite some of the things that we're going through, this economy is still growing, albeit modestly," he said.
Federal Deposit Insurance Committee Chairman Sheila Bair today said Congress should authorize the Treasury to make home loans to help pay down as much as 20 percent of the principal on mortgages.
Paulson said he will "look carefully" at the FDIC plan, while emphasizing his confidence in the Hope Now Alliance of lenders spearheading a private effort to modify home loans.
Process Vs. Event: Consumer Spending CutbacksThe key point is the process. A structural shift in consumption to savings or at least reduced consumption, is in store for boomers. Meanwhile job prospects are looking pretty grim for some time to come across the entire economic spectrum. Walk-aways are increasing and so are credit card defaults. Peak oil suggests gasoline prices will be at least somewhat sticky.
One thing to keep in mind is that what we believe is a long-term shift in consumer spending habits is part of an ongoing process, not an event. As a result, the behavior shifts will be incremental, carried out over time as opposed to appearing as a single data point in corporate earnings report.
Some of the better-managed companies out there have been anticipating this shift and reducing the impact of consumer discretionary to their earnings. Take, for example, CVS (CVS).
During the company's call today, David B. Rickard, Chief Financial Officer, noted how the front-store business at CVS, the retail item business, now makes up only 15% of revenues and even of that only 20% is considered discretionary. Even so, the company said it has yet to see any truly meaningful impact in slowing discretionary sales.
"I can report that we recently looked at the discretionary versus non-discretionary categories to evaluate whether there was any change in trend," Rickard said. "Our data shows no evidence of a consumer slowdown based on this analysis." However, Rickard added: "My interpretation is that consumers are making tough choices on big ticket purchases but they aren't yet focused on Snickers bars."
That will come as good news for Warren Buffett and Berkshire Hathaway. Mars manufactures the Snickers bar.
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(new from Wacom!) Economy for everyone.
The Bank of England has warned that banks' fears of a financial meltdown may become a self-fulfilling prophecy. Banks previously over-willing to lend are now too reluctant, even with credit-worthy borrowers, it suggests.My Comment: The psychology of deflation sets in. Banks are unwilling or unable to lend.
This increased fear of risk has itself undermined confidence in financial institutions and made them reluctant to lend to each other, the Bank adds.My Comment: This is what happens when banks have a bloated balance sheet and deteriorating assets.
Its financial stability report suggests the credit exposure not declared by UK banks may be near to �100bn. The quarterly report says that there is a "significant increase" in the risk that a major bank collapse or reluctance to lend will disrupt the financial system.My Comment: That suggests that banks may have insufficient capital to lend whether someone is a good credit risk or not.
In its quarterly Financial Stability Report, the Bank of England warns that there are potentially large exposures that have still not been declared by financial institutions.
However, the Bank points out that the freezing up of markets has meant that these estimated losses may be inflated because of the difficulty of pricing the complex securities which are now very difficult to value.My Comment: Market conditions may not return to "normal" for decades, if "normal" means anything like we have seen for the past 5 years. Otherwise, normal is likely to be years. Whatever "normal" means, talk of reduced loan losses is fantasy.
It says that "credit losses from the turmoil are unlikely ever to rise to levels implied by current market prices unless there is a significant deterioration in fundamentals."
And it estimates that total sub-prime losses could be reduced from $400bn to $200bn once market conditions return to normal.
The Bank of England judges that there is a risk that "the currently elevated risk premia in some markets will persist".My Comment: The risk is the BOE and the Fed manages to encourage more foolish lending. The more banks lend now, the bigger the defaults will be later. In a world awash in overcapacity, I fail to see the need for massive amounts of lending.
"This could lead to a self-fulfilling adverse cycle in which persistent market illiquidity and falling asset prices further undermine confidence in banks and results in a sharper tightening of credit conditions."
Lending drying upMy Comment: Tightening credit is the smart thing to do. Banks that tighten the most will lose the least.
The Bank's quarterly survey of credit conditions shows that lenders are tightening up credit sharply not just on home loans, but also on household lending and commercial loans to companies.
And the sources of future loans in wholesale money markets have also contracted sharply.
The market for "asset-backed securities" such as sub-prime and other mortgages has collapsed - with the value of such assets issued going from $700bn a quarter in the middle of 2007 to just $100bn in the first quarter of 2008.
The Bank of England argues that to rebuild financial confidence, it will continue to allow UK banks to swap illiquid assets with safe UK government securities.My Comment: Swaps accomplish nothing. What is swapped today has to be swapped back later. Except in some make believe pretend world, virtually nothing is accomplished by swapping.
Argentine bonds show growing speculation that the country will default for the second time this decade as inflation and anti-government protests swell.Wheels Fly Off Eurozone Economy
The nation's $10.8 billion of floating-rate dollar bonds due in 2012 yielded 7.20 percentage points more than Treasuries of similar maturity at 5:43 p.m. in New York. That implies an almost 20 percent chance of Argentina halting payments in the next two years, according to Credit Suisse Group. No other emerging-market government securities have as high a probability of default.
"Argentina has serious problems," said Igor Arsenin, an emerging-markets strategist at Credit Suisse in New York. "There's a lack of investor confidence. They are concerned lenders won't be willing to extend credit if this continues."
Spain's business federation warned that Spanish unemployment will rise by 500,000 by the summer unless the government takes "valiant measures" to offset the housing and construction crash. "For every dwelling not built, two workers will lose their jobs," said the group's president, Gerardo Diaz Ferran.My Comment: That qualifies for the clown statement of the day. Is Spain supposed to do keep building houses no one needs just to keep people employed? Then again, perhaps there is a place for talent like that on Bush's team of economic advisers.
The country's credit group ASNEF said the volume of personal loans had dropped 30pc in the first quarter, the worst performance since the country's financial crisis in the early 1990s.Avalanche Of Redundancies In the UK
David Owen, an economist at Dresdner Kleinwort, said Europe would soon be engulfed by the twin effects of a "collapse in export volumes" and a slow motion credit squeeze. "The wheels are coming off the eurozone economy," he said.
BNP Paribas warned clients yesterday that the "decoupling story" was no longer credible. "We see Europe in the early stage of a credit crunch, and if we are right credit supply will shut down," it said. Key governors of the European Central Bank began to back away from their hawkish stance of recent weeks, clearly disturbed by the market perception that they are mulling a rate rise to choke off price rises.
France is succumbing to the slowdown. Insee business climate index fell harder than expected in April to 106, from 108 in March.
Eric Chaney, Europe strategist at Morgan Stanley, said the April survey by French corporate treasurers was "alarming", pointing to distress in the financial system. "Let's call a spade a spade, some sort of credit crunch is unfolding in the funding of French companies," he said.
Britain could be heading for an "avalanche of redundancies" in the coming months as economic reality finally catches up with the jobs market, a leading expert has warned.The global economy is clearly slowing. Increased bank lending makes little economic sense in this environment, and even less when one considers the precarious capital positions at most banks.
John Philpott, of the Chartered Institute of Personnel and Development, said that the labour market was now close to its peak, and that the rise in unemployment could be more sudden and sharp than in previous economic downturns.
At 5.2pc, the unemployment rate is currently the lowest in many years. The warning comes amid growing fears that, having enjoyed some of its best months on record, the jobs market is set for an imminent deterioration.
He said: "I don't believe the labour market can defy gravity. It would be a miracle if there weren't some softening. We probably have peaked and unemployment will go up a little bit. "The conditions are building for an avalanche - the question is whether there will be a trigger point. I suspect the housing market will hold the key. If you get a bigger shock than people are anticipating that will have a knock-on effect, which could cause jobs to tumble."
