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Tuesday September 9, 2008 - 19:11:20 GMT
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FX Blog - US Treasury Takes GSEs off Table, Plenty Else To Worry About

The weekend takeover of Fannie Mae and Freddie Mac was long overdue and based on how markets traded Friday, including rumors we reported of an imminent announcement from Secretary Paulson, one of the worst kept secrets.  So it is not surprising to look at asset prices and the financial sector, the most closely linked to the health of the mortgage market, and things still look radically bad.  US stocks have reversed about a third of Monday’s rally (DJIA – NASDAQ never participated).  Lehman, a security house most closely associated with the mortgage market, is rapidly seeing its market cap slip away as the press reports it is at the capital raising dance and no one wants to extend a hand.  Citigroup today was surpassed by Wells Fargo as the third largest US bank by market capital (wonder what the comparison would be on a per-employee basis?).  And a development that I think says a lot about the state of markets (Bill Gross’s mayday call is still relevant) is the surge in the yen…margin calls galore this week in the carry trade ripping out Mrs. Watanabe’s eyeballs (retail FX traders in Japan). 


If banks can't get capital in private market, which is the Lehman story, where is it going to come from?  Can the US gvt open its balance sheet to large US banks to lift capital maybe for preferred shares?  Maybe the shares go up over time maybe not.  Lehman today and who tomorrow?  SWFs are saying no thank you.  Private equity is saying no thank you.  What are Paulson and Bernanke saying…banks need to raise capital.  What was wrong with Fannie and Freddie?  Weak capital bases and no ability to raise new capital in private markets.


Now we see the auto companies getting access to the government’s balance sheet via the back door of a Congressional stimulus bill for $25bln in government guaranteed (and subsidized at below market rates) loans.  I wonder what access I would have to the Fed’s or Treasury’s balance sheet of I could not make ends meet?  Maybe I could assert I am too connected to fail and qualify for access to the discount window where I could post my flat panel TV and boat as collateral. 


Capital markets are still broken after Sunday’s historic if only temporary takeover of two of the largest publicly traded firms in US history.  The takeover helps the mortgage market function with adequate financing and keeps GSE debt holders whole (like much needed foreign central banks and state run banks), but it also is another signal of just how bad things have gotten.  Paulson said Sunday this was an action he never wanted to take, but was forced to and one even forced upon the CEOs of Fannie and Freddie (who at first resisted the takeover offer and then caved when said they had no choice – since reports have Syron and Mudd describing the meeting Saturday as a mugging). 


In terms of FX the message I get from markets is not in the popular narrative which goes like this…the capital markets are reacting to signs of slower global growth and slower European growth to be exact.  Sorry but this all about running from risk and running from leverage and a hell of a lot less about expectations of Fed tightening when Fed officials aside from a few malcontents are worried about the economy slowing more (Yellen said can’t rule out more easing) and expectations of ECB easing when ECB officials are uniformly worried about higher inflation and not worried enough about weak growth to rule out more rate hikes. 


I don’t have any confidence that at least half of the knock-your-socks-off dollar rally is anything more than a massive deleveraging and risk aversion trade…real money long European equities (and Asian equities) getting around to repatriating.  If anything this is not unlike what happened in the early throes of the start of the credit crisis which saw the dollar surge versus the euro and the yen explode higher.  I am not suggesting that once the market is out of risk it will be a return to a record dollar low versus the euro, but I do think we are due to see a healthy retracement of the 20cent move from 1.60 to 1.40 in 8 weeks (wow). 


And like a giant domino knockdown game, CDS, HELOC, Alt-A, Option ARM, credit cards. CMBS, auto loans and student loans all stand waiting in turn to be knocked down.  This could take months to unfold and no amount of government intervention can prevent these credit segments from suffering a severe repricing.  Yes a bottoming in housing would help.  But how can the housing market bottom with the US labor market not in an asymptotic retreat? 


Where is their a market for capital ahead?  In safety – cash, gold, resource companies on the cheap, AAA govies (more foreign AAA govies than US in light of opening of the balance sheet of the gvt) and now agencies. 


David Gilmore


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