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    Daily Digest – Apr 11

    by Davos

    Saturday, April 11, 2009, 3:56 PM

  • Fed Orders Banks Not to Release Stress Test Results
  • Lessons from the Past
  • Government Tries To Hold A Gun To The Head Of GM (GM) Creditors
  • Foreclosures in the pipe
  • Foreign currency swap lines for the Fed
  • Why did the Fed, the Bank of England, the ECB, the Bank of Japan and the Swiss National Bank announce a dubbel openslaande porte-brisée deur?
  • The Bernanke Revolution
  • Legacy Loans Program – Public Comments
  • The Alchemy of Finance
  • Budget Deficit Close to $1 Billion in First Six Months (Chart)
  • Same Store Sales (Chart)


Fed Orders Banks Not to Release Stress Test Results

From Bloomberg: Fed Said to Order Banks to Stay Mum on ‘Stress Test’ Results (ht Justin)

The U.S. Federal Reserve has told Goldman Sachs Group Inc., Citigroup Inc. and other banks to keep mum on the results of "stress tests" that will gauge their ability to weather the recession …

The Fed wants to ensure that the report cards don’t leak during earnings conference calls scheduled for this month. …

"If you allow banks to talk about it, people are just going to assume that the ones that don’t comment about it failed," said Paul Miller, an analyst at FBR Capital Markets in Arlington, Virginia.

What ever happened to transparency? This suggests the results are very ugly for some banks.

Lessons from the Past

In today’s world, it’s probably fair to say that a lot of people are hungry for ideas on how to cope and stay afloat. Although some of the items listed in the following post from BillShrink’s Shrinkage Is Good blog, "16 Depression Era Money Saving Tips," are somewhat self evident, I thought many visitors would find it to be a good source of inspiration.

We are often told that the current financial meltdown is the most serious since the Great Depression. And while that may be true, comparing today’s times to such an awful and demoralizing crisis has the effect of scaring people, thereby making the situation worse. This is the wrong way to react to the situation. Rather than passively absorbing fear and uncertainty, we would do well to remember that some people managed to stay afloat during the Great Depression – and to learn how they did it. In that vein, here are 16 Depression-era money saving tips and how they can be utilized today.

Government Tries To Hold A Gun To The Head Of GM (GM) Creditors

he Treasury is using all of its muscle in The Motor City. Bondholders in GM (GM) and Chrysler think they may do better if the companies go bankrupt than if they take the paltry offer of equity-for-debt exchanges that will bring them a few cents on each dollar of their investments.

The government does not have much of a case, but that is not keeping it from trying to strong-arm a restructuring of the two auto firms.

According to The Wall Street Journal, "At Chrysler, the U.S. wants banks and investors who control its bank debt to give up about 85% of the nearly $7 billion they are owed. In bankruptcies, such senior secured lenders typically get most of their money back." The debtor program being discussed for GM is probably not much better.

Foreclosures in the pipe

The bottom line is that there is a massive wave of actual foreclosures that will hit beginning in April that can’t be stopped without a national moratorium – this wave is so big I would not put it past them trying it.

Foreign currency swap lines for the Fed

Five central banks have agreed to currency swap lines that enable the Federal Reserve to provide foreign currencies to U.S. financial institutions.

Q: What does it mean?

A: So far the funding shortfall was thought to be largely a USD problem, the C.B.s are telling us loud and clear, it isn’t.

The fed is opening lines that could help American banks funds foreign capital flight from the United States. This is disturbing.

Why did the Fed, the Bank of England, the ECB, the Bank of Japan and the Swiss National Bank announce a dubbel openslaande porte-brisée deur?

A swap is a swap is a swap. The arrangement between the Fed and the Bank of England provides the Fed with sterling and the Bank of England with US dollars. The swap arrangement with the ECB provides the Fed with euros and the ECB with US dollars. Etc. Etc. You don’t have to make two announcements, one that the Fed is getting Swiss francs, euros, yen and sterling and one, a couple of months later, that the SNB, the ECB, the BoJ and the BoE are getting US dollars. So why the redundant announcement on April 6, 2009?

With the original swap arrangements, the rationale for the arrangements was clearly a US dollar scarcity among financial institutions outside the US. Even with the extension of the September 18, 2008 arrangements announced on February 3, 2009, US dollar scarcity outside the US was given as the reason by the Bank of England: "To address continued pressures in global U.S. dollar funding markets, the temporary reciprocal currency arrangements (swap lines) between the Federal Reserve and other central banks have been extended to October 30, 2009."

But on April 6, 2009, the statement by the Fed is not about the Fed supplying US dollars to foreign central banks to meet an excess demand for US dollars by banks outside the US. The statement is all about foreign central banks supplying the Fed with euros, sterling, yen and Swiss francs to accommodate a US thirst for these foreign currencies: "The Bank of England, the European Central Bank (ECB), the Federal Reserve, the Bank of Japan, and the Swiss National Bank are announcing swap arrangements that would enable the provision of foreign currency liquidity by the Federal Reserve to U.S. financial institutions. Should the need arise, euro, yen, sterling and Swiss francs would be provided to the Federal Reserve via these additional swap agreements with the relevant central banks. Central banks continue to work together and are taking steps as appropriate to foster stability in global financial markets."

It may well be that in a swap arrangement between central banks, one party is the supplicant and the other party the bestower of favours. When Iceland tried to arrange swap arrangements with the ECB and the Fed in the spring of 2008, there certainly was very little appetite for Icelandic kroner in the ECB and the Fed – so little in fact, that Iceland failed in its attempt to arrange the swaps.

Two things are very weird about the April 6, 2009 announcement. The first is that it was redundant. It provided no new information beyond the extension of the old swap arrangements of September 18, 2008, that had been announced on February 3, 2009. The February 3, 2009 announcement extended the swap arrangements to October 30, 2009. The April 6, 2009 announcement did not change that. And the April 6, 2009 announcement did not change the size of the swap materially (the Bank of England can probably draw up to $44 bn or so under the latest swap arrangement).

It is conceivable – the statements are worded quite clumsily – that the April 6, 2009 announcement is about swap arrangements additional to the swaps previously announced (on February 3, 2009). In that case, the size of the swap arrangements has effectively been doubled. The redundancy objection disappears, but the misleading framing objection continues to apply in spades. If this is indeed the case, my concerns (explained below) about the fate of the US dollars provided by the Fed in the original swaps are strengthened.

The second strange feature is that the April 6, 2009 statement by the Fed is misleading. It is clearly phrased to convey a sense of the Fed needing foreign exchange (euros, yen, Swiss francs and sterling) to provide this foreign currency liquidity to US financial institutions. That is rhubarb. The US dollar shortage abroad continues today in much the same way as on February 3, 2009 or on September 18, 2008. Financial institutions in the US can get foreign exchange liquidity quite readily from the US subsidiaries of Euro Area, British, Swiss and Japanese banks. They don’t need the Fed for that.

On April 6, 2009 as on September 18, 2008, the non-US central banks were the beggars in the swap arrangements and the Fed the chooser. So why pretend that the opposite is the case? Why make a redundant and misleading announcement about the swap arrangements? The answer "beats me", comes to mind. So does: "a collective central bank screw-up". Finally there is the possible explanation that by re-framing an existing swap arrangements as the reflection of a Fed need for foreign exchange rather than as a non-US central bank need for US dollars, attention is diverted from foreign exchange shortages outside the US.

I can certainly make a quite convincing case that the UK is woefully short of foreign exchange reserves. At the end of March 2009, UK official foreign exchange reserveswere $49.3 bn gross and $28.3 bn net. The Bank of England’s net foreign currency assets are negligible ($6 mn at the end of 2008)

Clearly, the UK swap facility with the Fed is large relative to the size of UK Government Foreign Currency Assets. Gross foreign exchange reserves exceed the size of the swap facility ($44 bn, say) by less than $5 bn and net foreign exchange reserves are more than $15 bn lower than the size of the swap facility.

Small net or gross foreign exchange reserves don’t matter as long as the solvency of the government and the nation are beyond doubt, because in that case the authorities will always be able to borrow whatever foreign exchange reserves they require. This is arguably no longer the case anywhere. The massive prospective government deficits of the UK and the impressive size of the nation’s short-term foreign currency-denominated liabilities are such that one can without too much effort visualise a scenario where both the government and the private sector are rationed out of the foreign exchange markets and debt markets. When a ‘sudden stop’ is a non-negligible risk, foreign exchange reserves matter. Ask the Asian and South American countries that went through the 1997-1998 crises.

Recently, interest in the Bank of England’s US dollar repos has petered out, but at the beginning of the programme, amounts close to the $40 bn limit were taken up. If those US dollars were borrowed by banks like RBS and HBOS, both insolvent except for past, current and anticipated future government financial support, they may well have been lost. These banks (and other UK banks that are still standing more or less on their own two feet) had (and continue to have) very large US dollar exposures on which they made massive losses – well in excess of $40 bn. These banks also have few liquid foreign currency assets.

Assume one or more banks that borrowed US dollars from the Bank of England cannot pay them back. The Bank of England takes the collateral that secured these US dollar loans. Eligible collateral for these loans consists of those securities that are routinely eligible in the Bank’s short-term repo open market operations and Standing Facilities, as published on the Bank’s website, together with conventional US Treasury securities. Assume that little if any of the collateral offered for the US dollar loans from the Bank of England consisted of US Treasury securities. So the Bank gets a mitt full of sterling securities back in lieu of the US dollars it has lost. Nice, but not good enough. When the swap arrangements expires, the Bank of England has to repay the Fed in US dollars, not in sterling securities. So unless the swap arrangement is extended, or extended and expanded, the Bank of England would have to send the Fed an ‘Oops’ note.

If the full swap line was lost ($40 bn), the UK would be completely out of (net) foreign exchange reserves – if we consolidate the foreign exchange assets and liabilities of the government and the US dollar swap exposure of the Bank of England. Not a good place to be. Of course, the beauty of swaps if that they are off-balance sheet items.

I haven’t checked the details about the official foreign exchange reserves of Switzerland and the Euro Area nations, nor do I know much about the foreign exchange losses of Swiss and Eurozone banks, although I expect that these losses are vast. It is possible that the earlier use of the swap lines by the ECB and the SNB has also made a rather large dent in the net foreign exchange reserves of Switzerland and the Eurozone nations.

In any case, the Machiavallian interpretation of the redundant second announcement of the central bank swaps is that it was intended to divert attention from the dire condition of the official foreign exchange reserves of a number of European countries, especially the UK. Extending the duration of the swaps delays the moment that the loss of the US dollars will have to be recognised. If this was indeed the case, it is bound to fail. Markets can be stupid, but not that stupid. This will not reduce the risk that Reijkjavik-on-Thames will have to seek IMF assistance at some point.

The Bernanke Revolution

"From those relatively modest monetary and fiscal powers, the Federal Reserve has evolved into something that would be unrecognizable to its founders. Under the guise of economic expediency, the Fed has grabbed power, dramatically widening the areas of its responsibility. Since the 1990s, the Federal Reserve System, a private corporation registered in the State of Delaware, has behaved as though it were in charge of anything economic-moderating the swings of the business cycle, maintaining interest rates, supporting the value of depreciating assets, even intervening in the stock market.

Legacy Loans Program – Public Comments 

The FDIC and the Treasury recently announced that they will establish the Legacy Loans Program to remove troubled loans and other assets from banks. This program is necessary because uncertainty about the value of these assets makes it difficult for banks to raise capital and secure stable funding to support lending to households and businesses. All FDIC-insured depository institutions will be eligible to participate in the program.

The Alchemy of Finance

George Soros says the "formative experience" of spending his childhood in Nazi-occupied Hungary taught him "there are times where normal rules don’t apply." That, in turn, helped him develop a framework of viewing financial markets that runs counter to the efficient market hypothesis, which had dominated economic circles prior to the current crisis. As detailed in his investing classic ‘The Alchemy of Finance’ and revisited in his latest book ‘The Crash of 2008 and What It Means’, Soros’ theory of reflexivity is based on a two-way relationship between the markets and market participants. In sum:

Budget Deficit Close to $1 Billion in First Six Months (Chart)

Same Store Sales (Chart)

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