Posted by: John Gilmore | September 16, 2006

Crisis Reverberates in Credit & Stock Markets

We’re now beginning to see all of these ‘unintended’ consequences of the recent bailouts. Here’s a question you should be asking yourself – what if they’re not ‘unintended’? What if the ‘problems’ (mentioned in the article below) developing daily are part of a plan? Let’s summarize some of these unintended consequences.

1. Investors are selling Fannie and Freddie bonds and buying bonds issued by large U.S. banks since the banks are now backed by the U.S. government. No one should be surprised that investors would take higher yields with implied government guarantees in this chaotic environment. So – we see investors flocking to big bank bonds and out of the bonds that are not backed by the government. No Surprise. What long term effects will this have on Fannie and Freddie? Will the government continue to back them and how will they back them? What happens to the housing market if it doesn’t?

2. The U.S. government will be forced to issue new debt (Treasuries) to pay for these bailouts. This will drive up interest rates – including mortgages. What will happen to the crippled housing market when you throw in much higher interest rates? Nothing good. As the article below mentions – we’re already starting to see this. Last week the 30 yr mortgage rate increased to 6.75% from 6.05%.

3. Last month the Federal Reserve moved to support short-term commercial paper since this market was frozen. What happened? Investors are not dumb. Not surprisingly, they invested in the commercial paper backed by the Fed and pulled away from short-term debt not backed by the Fed. Who is getting hurt by this? Corporations and European Banks.

4. The Fed’s efforts to unfreeze the short-term debt markets coupled with the FDIC’s efforts to stop bank withdrawals (increased insured amount to $250K from $100K) has led many money market fund managers to stay out of the short term debt markets – especially commercial paper. They are worried that Americans and corporations will favor simple bank accounts over their funds. Money market funds have historically contributed vast amounts of money to the commercial paper market – without them, the commercial paper market will remain largely frozen – where many companies and banks finance short-term obligations. Soon after these efforts, you’ll notice the Fed began offering money directly to corporations (they have not done this since the Great Depression).

So, if we again strip away all of the government/Federal Reserve rhetoric we see what is really happening. On the surface, it appears that our leaders are doing whatever they can to help the situation. If we take a close look at what is really happening, we see something else. We see these ‘bailouts’ increasing the U.S. debt by enormous amounts, we see interest rates rising significantly and we see normal short-term funding drying up. Do these efforts actually help or hurt the housing market? Higher interest rates will certainly hurt the housing market. Can the U.S. support trillions more debt? As you’ve seen me explain before – the answer is no. Sooner or later this is going to get very, very bad. Is it good for corporations and banks to borrow directly from the Fed? They are providing ‘solutions’ that are causing our government, corporations and banks to borrow even more from them. Do we really need to be even more indebted to a cartel of international bankers? As I’ve said before, we will not be able to get out of their grip until our monetary system changes.

The truth is that central banks the world over are negatively impacting the world’s economy. Their ‘solutions’ are simply accelerating the problems. As I’ve said before, I believe that a plan is at work here – and it certainly doesn’t benefit us.

jg – October 16, 2008

___________________________
October 16, 2008

Crisis Reverberates in Credit, Stock Markets

U.S. Efforts to Aid Debt Arena Cause Unintended Upshots
By LIZ RAPPAPORT and SERENA NG
Wall St. Journal

Government efforts to heal the credit markets are having unintended consequences that are roiling different sectors of the market and adding to anxiety among investors, who already are worried about the impact of a possible recession on U.S. companies.

Barely two days after the Treasury announced plans to buy stakes in U.S. banks and the Federal Deposit Insurance Corp. said it would provide guarantees on bank debt for three years, investors are making unexpected shifts.

Wednesday, bonds issued by mortgage providers Fannie Mae and Freddie Mac sold off sharply, even though these companies have government backing behind their debt. Traders said hedge funds were forced to sell as they deleverage, and investors were selling some Fannie and Freddie bonds — known as agency debt — and shifting money into bonds issued by large U.S. banks. These bank bonds boast higher yields and also would benefit from implied government guarantees, making them appear relatively safe in the eyes of risk-averse investors, for now.

The difference between yields on two-year Fannie Mae bonds and Treasury notes rose 0.25 percentage point Wednesday to 1.5 percentage points. That gap was less than a single percentage point when the government said in early September that it would place Fannie and Freddie under conservatorship.

The bonds issued by Citigroup Inc., Goldman Sachs Group Inc. and Bank of America Corp. gained over the last two days.

Investors have begun “to realize how potent the new FDIC-backed bank paper could be,” said Jim Vogel, an analyst at FTN Financial, who recently noted that there is some debate over how explicit the government’s guarantee of Fannie Mae- and Freddie Mac-backed debt is.

The agency debt’s selloff is the latest unexpected market response to Federal Reserve and Treasury attempts over the past few weeks to plug the financial system’s holes. The bailout plans may force the U.S. to issue new government debt that could drive up interest rates on mortgages, undermining efforts to rescue the housing market, the very problem that started it all.

Also, last month, the Fed moved to backstop short-term debt called asset-backed commercial paper, which led investors to pull away from the other half of the short-term debt market because it had no government guarantee. This debt was issued largely by corporations and European banks.

Not long after, the government’s move to provide more insurance for bank deposits caused some money managers to change the way they allocate their funds.
“Things are moving so fast, it’s hard for anyone to know what is going on,” said Jim Goulding, manager at Chicago trading firm GH Traders LLC.

While Treasurys remain popular now, because of a flight-to-quality trend that feeds off their safety, another unintended impact may be in the wings. The bailout plans will result in massive new issuance of U.S. Treasurys, sold to pay for it all. This likely would dilute the Treasury bond market, drive down prices, push up yields and cause mortgage rates to rise.

A miniature version of this happened this week. The average 30-year mortgage rate, which is based off of the 10-year Treasury rate, rose to 6.75% Wednesday from 6.05% Oct. 6, as the 10-year Treasury yield rose, according to HSH Associates.
“You have unintended consequences that spark government actions, that create other unintended consequences,” said David Kotok, chairman at money managers Cumberland Advisors.

The Fed’s efforts to unlock the short-term markets also have had meddlesome effects. The FDIC may have stopped the flood of withdrawals from banks when it agreed to insure deposits in accounts up to $250,000, up from $100,000, but this has led many money-market fund managers to stay out of the short-term debt markets, particularly for commercial paper. They worry that cash-strapped Americans and corporate treasurers will favor simple bank accounts over their funds even though they pay slightly higher returns.

Money-market fund managers are traditionally large participants in the commercial-paper market, where companies and banks finance near-term obligations.
The managers remain uncomfortable investing in debt that matures in more than a day. They still are holding on to large cash positions in case they are hit with redemption requests from investors.

The government’s plan isn’t a “panacea for money markets,” said Alex Roever, fixed-income strategist at J.P. Morgan Chase & Co.
In mid-September, when the Fed agreed to lend to U.S. banks with asset-backed commercial paper as collateral, the move was intended to unlock the market and help mutual funds sell the debt to banks in order to meet investor redemptions.
In the weeks following the Fed move, some commercial-paper brokers lamented that the Fed’s implied backstop for the asset-backed commercial-paper market caused investors to favor the higher yielding asset-backed debt over unsecured commercial paper issued by many corporations and European banks.

The imbalance squeezed European banks already having trouble funding themselves, and the Fed ultimately had to step in again to offer short-term loans directly to companies and banks.

Write to Liz Rappaport at liz.rappaport@wsj.com and Serena Ng at serena.ng@wsj.com

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