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Central Banks Flood Wall Street with Money With Little Effect

Interest-Rates / Credit Crunch Dec 21, 2007 - 10:08 AM GMT

By: Money_and_Markets


Best Financial Markets Analysis ArticleMike Larson writes: I spend my time analyzing and trading the markets now. But back in college, I double-majored in English and Journalism. So I'm familiar with many of the classics — those great works of literature that still have relevance to current events.

For instance, I can't get Samuel Taylor Coleridge's "Rime of the Ancient Mariner" out of my head. You've probably heard the classic lament:

"Water, water, every where,
And all the boards did shrink;
Water, water, every where,
Nor any drop to drink."

The passage comes as the poem's namesake sea captain, having shot an albatross that was following his ship out of the sky, finds himself trapped at sea.

The wind has died ... the ship has become trapped ... and the crew has been driven mad with thirst — surrounded by an ocean of water that, of course, they cannot drink.

Eventually the Mariner's crew dies and he is forced to wander the Earth telling his story as penance for killing the harmless bird. But it's the "ocean of useless water" image that I want to focus on today.

Reason: It's a perfect description of what's happening in the financial markets right now!

Central Banks Flood Wall Street with Money, but Investors Are Lost at Sea

The world's central banks are taking all kinds of paper off financial firms' hands — mortgage bonds, government bonds, a labyrinth of complex debt securities — and giving them boatloads of raw money in return.

The idea is that the banks will soak up all that liquidity, slaking their thirst to rebuild their balance sheets, then turn around and make a bunch of easy money loans again.

And we're not talking about a few drips and drabs of cash. We're talking about a veritable ocean of liquidity!

Earlier this week, the European Central Bank offered a mind-boggling $502 billion in two-week money to banks on the Continent. It said it would charge 4.21%, below the short-term rate on inter-bank loans at the time (around 4.94%).

To put this into perspective, $502 billion is enough to give $75 to every man, woman, and child on the planet ... it could buy about 3,300 Boeing 787 Dreamliner airplanes ... or more than 12.5 million of GM's top-of-the-line 2008 Hummer H3s!

The Bank of England is also offering special three-month loans, denominated in British pounds, to banks that are getting hammered there.

Central banks have been pouring money into the system ...

Meanwhile, the U.S. Federal Reserve conducted a $20 billion emergency auction on December 17 ... another $20 billion auction was held by the Fed yesterday ... and two more auctions are scheduled for early 2008.

These extraordinary measures are designed to channel liquidity to U.S. banks, which are reeling from massive mortgage write-offs.

The End Result Is a Bailout Of Epic Proportions!

Never before in the history of central banking have we seen so much money handed out so liberally to so many institutions that have only themselves to blame for the problems they're facing.

These are the same chowder-head financial institutions whose origination, bundling, sales, and trading of sliced-and-diced home mortgages — with lackluster due diligence and little regard for the ultimate performance of those loans — helped fuel the housing bubble in the first place.

These are the same guys whose clients and investment managers took huge risks by purchasing opaque securities — debt issued by so-called Special Investment Vehicles (SIVs), Collateralized Debt Obligations (CDOs), subprime Residential Mortgage Backed Securities (RMBS), and more.

They could have just as easily stuck with Treasuries, mind you. But they got greedy ... and now they're getting burned.

And these are the same companies that have been raking in tens of billions of dollars in profit for the past several years thanks to the global boom in easy credit.

Heck, it was just this summer that the former CEO of Citigroup, Chuck Prince, famously told the Financial Times in reference to easy-money fueled deals:

"As long as the music is playing, you've got to get up and dance. We're still dancing."

And now, these VERY SAME FIRMS are going hat in hand to the central banks of the world. They're begging for the biggest low-cost money bailout in history. And they're getting it!

Billions and billions of dollars have essentially been flushed down the toilet!

On top of everything I mentioned already, the so-called "Super SIV" or "M-LEC" program that's designed to help banks offload some of their crummiest debt securities is close to launching. It may ultimately buy up to $50 billion in securities to prevent them from being sold at fire-sale prices.

Never mind that those prices are what the market is dictating — an inconvenient fact the "free marketers" on Wall Street conveniently ignore when asset prices decline.

Can These Colossal Efforts Offset the Worst Housing and Mortgage Downturn in Decades?

There's no doubt that a lot of efforts are going toward helping troubled financial firms. But there's plenty of doubt about the effectiveness of the approach.

After all, the latest news in the housing sector is grim ...

  • Existing home sales have collapsed 31% from their 2005 peak. New home sales are down even more — 48%.
  • Home prices dropped 4.5% from a year ago in the third quarter, according to S&P/Case-Shiller, the biggest drop on record (the data goes back to 1988). New home prices, for their part, plunged 13% in October, the sharpest decline in 37 years.
  • Single family home starts have cratered 55% from their January 2006 peak. Meanwhile, the issuance of building permits for future construction has dropped to its lowest level since 1991.
  • An index that measures home builder optimism, buyer traffic, and expected sales sits at record lows — 19 compared with readings in the 70s during the boom.
  • The nationwide home vacancy rate is running at a near-record of 2.7%, a testament to the dramatic glut of empty, unproductive homes piling up on the market.
  • About 5.6% of the nation's homeowners have fallen behind on their mortgage payments — the most since 1986.
  • The percentage of homes in some stage of foreclosure has surged to 1.7%, the highest rate the Mortgage Bankers Association has ever found (its data goes back to 1972).

The financial hits keep on coming, too. Morgan Stanley just reported the company's first quarterly loss in history thanks to $9.4 billion in write-downs on mortgage-linked investments. It was the exact same story at Bear Stearns — first quarterly loss ever. And Merrill Lynch recently took an $8.4 billion hit, with another $8 billion plus in additional write-downs reportedly in the offing.

Your local retail banks aren't doing any better:

 Fifth Third Bancorp announced a fourth-quarter loan loss provision of $275 million, double what it reported just three months earlier.

 National City said it would take a $200 million charge for its mortgage exposure.

 Wachovia announced it would double its fourth-quarter provision to around $1 billion.

 PNC Financial Services whiffed badly on its earnings targets, blaming problems with commercial real estate development financing and mortgage loans.

Result: Virtually the entire financial industry is begging for more bailout money. At the first Fed auction I referenced earlier, 93 firms submitted bids for $61.5 billion in funds. Since the rules allowed only $20 billion to be awarded, that means there was more than three times as much demand as there was supply.

Banks are reaching out to private investors around the globe, too. Morgan Stanley sought, and received, a $5 billion infusion from China Investment Corp., the investment fund run by that country's government. Citigroup scored $7.5 billion from Abu Dhabi. And UBS managed to wrangle $11.5 billion from the Government of Singapore Investment Corp. and unidentified Middle Eastern investors.

Here's my take ...

The Bailout Efforts Are Big, but Financial Ships Have Taken on Massive Amounts of Water!

There's an ocean of money on offer. But it remains to be seen whether it will save all the financial institutions trapped in the credit market doldrums.

I think we'll see many more lenders, both small and not-so-small, fail. We'll see delinquencies and foreclosures continue to pile up. And yes, home prices will fall further in 2008, thanks to tighter mortgage credit and extremely high levels of for-sale inventory.

At the same time, you'll see even more aggressive bailout proposals. Candidates and lawmakers on both sides of the aisle will throw money at the problem, while the Fed will continue to shoot from the hip, searching eagerly for something ... anything ... to "reliquify" the credit markets.

Ultimately, home prices will find a floor and the housing market will turn. And ultimately, the cumulative effects of all these fiscal and policy measures will turn the tide in the mortgage and banking markets.

The mere anticipation of that will cause certain stocks to reverse recent losses and take off. That's why I've been saying that some selective, bottom-fishing finally makes sense in financial firms that have little or no mortgage risk and that can survive the credit storm.

But first, there will be more pain. So you have to make sure you've purged your portfolio of the vulnerable firms — the ones that, like the ancient Mariner's crew, will perish before the financial winds pick up again.

Until next time,


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