Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Junior Gold Miners: New Yearly Lows! Will We See a Further Drop? - 23rd Jul 21
Best Forex Strategy for Consistent Profits - 23rd Jul 21
Popular Forex Brokers That You Might Want to Check Out - 22nd Jul 21
Bitcoin Black Swan - Will Crypto Currencies Get Banned? - 22nd Jul 21
Bitcoin Price Enters Stage #4 Excess Phase Peak Breakdown – Where To Next? - 22nd Jul 21
Powell Gave Congress Dovish Signs. Will It Help Gold Price? - 22nd Jul 21
What’s Next For Gold Is Always About The US Dollar - 22nd Jul 21
URGENT! ALL Windows 10 Users Must Do this NOW! Windows Image Backup Before it is Too Late! - 22nd Jul 21
Bitcoin Price CRASH, How to SELL BTC at $40k! Real Analysis vs Shill Coin Pumper's and Clueless Newbs - 21st Jul 21
Emotional Stock Traders React To Recent Market Rotation – Are You Ready For What’s Next? - 21st Jul 21
Killing Driveway Weeds FAST with a Pressure Washer - 8 months Later - Did it work?- Block Paving Weeds - 21st Jul 21
Post-Covid Stimulus Payouts & The US Fed Push Global Investors Deeper Into US Value Bubble - 21st Jul 21
What is Social Trading - 21st Jul 21
Would Transparency Help Crypto? - 21st Jul 21
AI Predicts US Tech Stocks Price Valuations Three Years Ahead (ASVF) - 20th Jul 21
Gold Asks: Has Inflation Already Peaked? - 20th Jul 21
FREE PASS to Analysis and Trend forecasts of 50+ Global Markets by Elliott Wave International - 20th Jul 21
Nissan to Create 1000s of jobs with electric vehicle investment in UK - 20th Jul 21
Bitcoin Halvings Price Forecast and Stock to Flow Analysis - 18th Jul 21
Dell S3220DGF Unboxing and Stand Assembly - 32 Inch 165hz Curved Gaming Monitor Amazon Discount - 18th Jul 21
What Does The Fed Mean By “Transitory Inflation” And Why Is It Important To Understand? - 18th Jul 21
Will the US stock market’s worsening breadth matter? - 18th Jul 21
Bitcoin Halving's Price Projection Forecasts Trend Trajectory - 18th Jul 21
Dell S3220DGF Price CRASH to £305! 32 Inch 165hz Curved Gaming Monitor Amazon Bargain - 16th Jul 21
Google, Amazon and Netflix are Scrambling For This Rare Gas - 16th Jul 21
Sheffield Millhouses Park New Children's Play Area July 2021 Vs Old Play Area - Better or Worse? - 16th Jul 21
Inflation Soars, Powell Remains Unmoved. What about Gold? - 16th Jul 21
Goldrunner: Gold Could Jump To $1,900-$2,100 In Next 30 days – Here’s Why - 15th Jul 21
Tips For Finding The Right Influencers - 15th Jul 21
ECB Changed Monetary Strategy. Will It Alter Gold’s Course? - 15th Jul 21
NASA And Big Tech Are Facing Off Over This Rare Gas - 15th Jul 21
Will the U.S. Dollar Lose Momentum In the Second Half of 2021? - 15th Jul 21
Bitcoin Stock to Flow Model Forecasts Infinity and Beyond! - 14th Jul 21
Proteomics: The Next Truly Massive Investing Opportunity - 14th Jul 21
Massive Solar Storm to Hit Earth 2025, Coronal Mass Ejection (CME) Danger and Protection Solutions - 14th Jul 21
Is This The Best Way To Play The Coming Helium Boom? - 14th Jul 21
Meet SuperMania and its Ever-Present Sidekick, SuperMeltdown - 14th Jul 21
How NFTs Are Shaking Up Arts Trading - 14th Jul 21
Gold: High Time to Move Out of the Penthouse - 13th Jul 21
Climb Aboard! Silver Should Run Up To $38 In Next 30 Days - 13th Jul 21
How Will Remote Work Impact the U.K. economy? - 13th Jul 21
Why Helium Stocks Are Set To Soar in 2021 - 13th Jul 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Effect of Fed Liquidity Facilities on the Markets

Stock-Markets / Credit Crisis 2008 May 19, 2008 - 06:42 AM GMT

By: Mick_Phoenix

Stock-Markets Welcome to the weekly report. This week we look at inflation and deflation, the Dow, gold and FTSE but start with a look at a recent speech by William C. Dudley who is the executive vice president of the Markets Group at the Federal Reserve Bank of New York. He is also the manager of the System Open Market Account for the Federal Open Market Committee. The Markets Group oversees domestic open market and foreign exchange trading operations and the provisions of account services to foreign central banks.


If you want to know the effect of the Fed facilities on the markets, Mr Dudley is the man to ask. In a follow up to a speech he gave back in October '07, Mr D looked at the effects that the various Fed facilities had on the LIBOR/OIS spread and whether the facilities had done the job they were designed to do, i.e. introduce liquidity for assets. The speech covers a lot that my readers already know so I'll reproduce the salient paragraphs and charts and then add my comments afterwards. This is the problem as W C Dudley sees it:

  • "Let me first define the underlying problem. The diagnosis is important both in influencing the design of the liquidity tools and in assessing how they are likely to influence market conditions.

    As I see it, this period of market turmoil has been driven mainly by two developments. First, there has been significant reintermediation of financial flows back through the commercial banking system. The collapse of large parts of the structured finance market means that banks can no longer securitize many types of loans and other assets. Also, banks have found that off-balance-sheet exposures-such as structured investment vehicles (SIVs) or backstop lines of credit that are now being drawn upon-are adding to the demands on their balance sheets.

    Second, deleveraging has occurred throughout the financial system, driven by two fundamental shifts in perception. On one side, actual risks-due to changes in the macroeconomic outlook, an increase in price volatility, and a reduction in liquidity-and perceptions about risks-due to the potential consequences of this risk for highly leveraged institutions and structures-have shifted. Many assets are now viewed as having more credit risk, price risk, and/or illiquidity risk than earlier anticipated. Leverage is being reduced in response to this increase in risk.

    On the other side, the balance sheet pressures on banks have caused them to pull back in terms of their willingness to finance positions held by non-bank financial intermediaries. Thus, some of the deleveraging is forced, rather than voluntary."

Mr Dudley then goes on to explain the reinforcing (viscous circle) that has occurred because of these pressures, culminating in the Bear Stearns episode. After looking at the effects of intermediation and deleveraging, the LIBOR cheating and subsequent reset higher, FX swap prices and increased counter party risk W C Dudley still feels these areas may explain some but not all of the reasoning behind the funding pressures.

So Mr Dudley digs a little deeper (they may move slowly at the Fed but the analysis can be good) and pinpoints what he sees as the real problem:

  • "So what has been driving the recent widening in term funding spreads? In my view, the rise in funding pressures is mainly the consequence of increased balance sheet pressure on banks. This balance sheet pressure is an important consequence of the reinter - mediation process. Although banks have raised a lot of capital, this capital raising has only recently caught up with the offsetting mark-to-market losses and the increase in loan loss provisions. At the same time, the capital ratios that senior bank managements are targeting may have risen as the macroeconomic outlook has deteriorated and funding pressures have increased.

    The argument that balance sheet pressure is the main driver behind the recent rise in term funding spreads is supported by what has been happening to the relationship between other asset prices-especially the comparison of yields for those assets that have to be held on the balance sheet versus those that can be easily sold or securitized."

Here comes the good bit, central to Mr Dudley's speech:

  • "Why is this noteworthy? Jumbo mortgages can no longer be securitized, the market is closed. Thus, if banks originate such mortgages, they have to be willing to hold them on their balance sheets. In contrast, conforming mortgages can be sold to Fannie Mae or Freddie Mac. Because the credit risk of jumbo mortgages is likely to be comparable to the credit risk of conforming mortgages, the increase in the spread between these two assets is likely to mainly reflect an increase in the shadow price of bank balance sheet capacity.

    If this is true, then the same balance sheet capacity issue is likely to be an important factor behind the widening in term funding spreads. After all, a bank has a choice. It can use its scarce balance sheet capacity to fund a jumbo mortgage or to make a 3-month term loan to another bank.

    If balance sheet capacity is the main driver of the widening in spreads, this suggests that there are limits to what the Federal Reserve can accomplish in terms of narrowing such funding spreads. After all, the Fed's actions cannot create bank capital or ease balance sheet constraints materially. "

Now for my readers, myself and a few other writers and bloggers out there, most of the above is "old news". We recognised the effect that a re-pricing of assets would have on bank balance sheets, especially when Basel 2 kicked in quite some time ago. Whether Basel 2 caused the re-pricing or not is now mute (in the US B2 only applies to the top 10 international banks). It happened and we have to live with it.

By concentrating on bank balance sheets and the repairs required to capital ratios, investors have an important anchor point for fundamental analysis. For instance (and this is why you love me) in the FTSE 100 we have a large bank sector which has and is being battered, except for

To read the rest of the Weekly Report sign up for the 14 day free trial at www.caletters.com

By Mick Phoenix
www.caletters.com

An Occasional Letter in association with Livecharts.co.uk

To contact Michael or discuss the letters topic E Mail mickp@livecharts.co.uk .

Copyright © 2008 by Mick Phoenix - All rights reserved.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Do your own due diligence.

Mick Phoenix  Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in