Fed Rally on Garbage Paper!

5 Day Dow Jones Industrials, 3 minute chart
Dow_5_day_3_minute_chart

~~~

Perfect timing by the Fed in their surprise, $200B lending:

As we have noted recently, markets have been moderately oversold, with
negative sentiment high, and  disbelief in the economic recession still
surprisingly widespread (Some are even claiming that the credit crunch is a myth).

The Fed action came at a time when the markets were ripe for an oversold bounce.

Before we continue, let’sd understand what the Fed actually did: Rather than merely expanding the existing Term Auction Facility (TAF), they went several steps further. They created a new credit facility, the Term Securities Lending Facility (TSLF).

Then, they empowered the TSLF to accept a broad range of private collateral — "AAA" private mortgages in addition to those that are agency paper.

Note the quality of the paper the Fed is accepting, via a recent Bloomberg report:

"Even after downgrading almost 10,000 subprime-mortgage bonds, Standard
& Poor’s and Moody’s Investors Service haven’t cut the ones that
matter most: AAA securities that are the mainstays of bank and
insurance company investments
.

 

None of the 80 AAA securities in ABX indexes that track subprime bonds
meet the criteria S&P had even before it toughened ratings
standards in February, according to data compiled by Bloomberg. A bond
sold by Deutsche Bank AG in May 2006 is AAA at both companies even
though 43 percent of the underlying mortgages are delinquent.

 

Sticking to the rules would strip at least $120 billion in bonds of
their AAA status, extending the pain of a mortgage crisis that’s
triggered $188 billion in writedowns for the world’s largest financial
firms. AAA debt fell as low as 61 cents on the dollar after record home
foreclosures and a decline to AA may push the value of the debt to 26
cents, according to Credit Suisse Group." (emphasis added)

If I read the Fed release correctly, this is the junky paper the Fed will be accepting as collateral.

Why did they do this?

-New pressures on ALL agency spreads;
-Rising mortgage rates despite FOMC rate cuts;
-Ongoing limited credit availablility;
-Dramatic widening spreads between mortgage-backed paper and US Treasuries

The good news is this will help brokers and banks; the bad news is  it will do nothing to help the Housing market, or stop the decline in House prices. Nor will it help resolve the inverted pyramid of derivatives that sits atop Housing. And, one has to believe it will only add to inflationary pressures.

No recession at any cost seems to be the
Feds’ philosophy in light of the
latest massive cash infusion to Banks…

~~~

Watch this rally towards the end of the day. If it fades, it will be time to get crazy short . . .

20 Day Dow Jones Industrials, 3 minute chart
20_day_3_minute_dow

>

Sources:
Fed to Lend $200 Billion, Take on Mortgage Securities
Scott Lanman
Bloomberg, March 11 2008
http://www.bloomberg.com/apps/news?pid=20601087&sid=aMxbCGWcY5J0&

Moody’s, S&P Defer Cuts on AAA Subprime, Hiding Loss
Mark Pittman
Bloomberg, March 11 2008
http://www.bloomberg.com/apps/news?pid=20601109&sid=aRLWzHsF16lY&

Portfolio Strategy | Crunch Mythology
Ken Fisher
Forbes 03.24.08, 12:00 AM ET
http://www.forbes.com/home/columnists/forbes/2008/0324/168.html

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