Friday March 7, 2008 - 18:07:57 GMT
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Credit Goes Wylie Coyote, Fed Emergency Cut Today?
Road Runner just turned the corner on the mountain road and Wylie Coyote did not make itâ€¦credit markets are in free fall. It is no longer simply subprime or auction rate securities that are collapsing. â€śGoodâ€ť credit like AAA (what is that anymore) GSEs are being abandoned with bad credit. Margin calls for heretofore safe investments are sweeping through leveraged funds forcing more selling and very few brokers are quoting. Collateral seizure by banks is in evidence and unless these assets return to normal spreads over Treasuries, banks face more write downs. It will be interesting to see if and when the backbone of credit markets goes the way of GSEs â€“ swaps market is at risk. This is a world that is screaming counterparty risk. What is to keep a bank from cutting credit lines to all customers if they feel cash is king and may need it to provide against losses in other markets? Why not call in lines on customers who are even deep in the black on commodity or FX trades? We may not be there now but the nightmare in the mortgage and municipal markets in the last week suggest no market is immune to deleveraging.
What is the Fed to do? No amount of easing addresses the current fear of counterparty failure. Liquidity keeps banks flush with cash so depositors can get money at the ATM and write checks that clear. But lending is another story and pumping cash into banks does not make them ready lenders if they feel asset prices are collapsing and borrowers are exposed to collapsing asset prices.
The Fed will cut the funds rate nonetheless because if nothing else it steepens the yield curve and allows banks to recapitalize a la Bank of Japanâ€™s ZIRP days. But this does nothing for todayâ€™s asset prices and market nerves. Yes I think the Fed could cut 75 basis points today, and irrespective of the jobs report â€“ talk about policy by myopia. Will it cut today? Bernanke has said the Fed prefers to make rate changes at scheduled meetings. The bar is high, but markets are in need of defibrillation. I put it at 50-50 for today. The key motivation is disorderly credit markets and rapid tightening in credit conditions (yes the same thing). I am also assuming that the Fed has already held an emergency FOMC meeting to authorize a between-meeting rate cut.
As I have said before, the dollar is a sideshow to credit marketsâ€¦it is a concern for sure but it will not distract the Fed (or Treasury) from the much bigger problem.
B1 Ben is in the air and ready to bomb away and March 18 is a lifetime away in this credit market collapse.David Gilmore
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