(From BARRON'S)
By Randall W. Forsyth
The 21st century version of a bank run encircled the globe, but by week's end it seemed to be contained by central bankers using tried-and-true 20th century methods.
But the real question is how, and whether, the damage from the subprime mortgage meltdown can be contained. The good news is that the positives of a strong global economy should mute the repercussions from this financial debacle. The bad news is that mortgage crisis still is in its early innings.
Central banks around the globe injected $290 billion of liquidity Thursday and Friday after money markets in Europe and the U.S. suddenly tightened. It followed BNP Paribas' halt in withdrawals from two of its funds with big chunks of U.S. subprime paper, the firm citing the inability to value its assets during the market's collapse.
Thursday's efforts, totaling $154 billion with $130 billion coming from the European Central Bank, did little to relieve the distress. But Friday, the Federal Reserve was able to restore a semblance of normalcy, if only by taking extraordinary actions. First, like the mythical Chicago voter, it entered the market early and often. It arranged three rounds of repurchase agreements, which is unusual, for a total of $38 billion, up from $24 billion on Thursday, and the most since the days following Sept. 11, 2001. The Fed also accepted mortgage-backed securities as collateral in the first round to bolster that beleaguered sector instead of the more usual Treasuries.
And just to make sure nobody missed the message of these open-market operations, the Fed issued a press release saying it would provide liquidity to keep the financial markets functioning and to keep the federal-funds rate close to its target of 5 1/4% after the cost of overnight money had climbed as high as 6%. The Fed added that the discount window was open to banks and other depository institutions experiencing "unusual funding needs."
Bernanke & Co.'s words and actions had the desired effect Friday, and nowhere was their impact more evident than in the action of Countrywide Financial (ticker:CFC). Shares of the big mortgage lender were slammed with a 13% loss at the open after it said in an SEC filing that it and other lenders faced "unprecedented disruptions" in the credit markets that resulted in Countrywide having to hold $1 billion in mortgages on its books that it had planned to sell into the secondary markets. By Friday's close, Countrywide was off less than 3%, a huge recovery that extended to the overall stock market.
Not since 1966 -- when the term "credit crunch" was coined after the Fed pushed market interest rates above the legal limits banks and thrifts then could pay on deposits and thus stopped lending in its tracks -- has the nation's mortgage apparatus been so close to breaking down.
The current crisis arguably has the potential for more economic disruption than the celebrated 1998 Long Term Capital Management meltdown. Then, as Northern Trust economist Asha Bangalore points out, the economy cruising along -- in contrast to the past four quarters, which have seen below-potential growth on average.
Moreover, mortgage borrowers perversely benefited from the LTCM fiasco. Not only did the Greenspan Fed lower rates, sparking a huge bond rally, but, also, the government-sponsored enterprises Fannie Mae (FNM) and Freddie Mac (FRE) went on virtual buying sprees. As a result, the biggest part of the credit mar- ket -- mortgages -- remained flush. Now, Fannie is looking to expand its portfolio beyond the $727 billion limit imposed on it after its accounting and governance scandals -- a move viewed skeptically by the White House but supported by some congressional Democrats.
Indeed, the full impact of the mortgage crisis still lies ahead. From the beginning of 2007 through mid 2008, interest rates on over $1 trillion of adjustable-rate mortgages are slated to be reset, many from low "teaser" rates.
The subprime mess also recalls another crisis -- the virtual collapse of the commercial-paper market in the wake of the Penn Central bankruptcy of 1970. Back then, the paper market consisted of relatively simple short-term corporate IOUs. Now, so-called asset-backed commercial paper is backed by all manner of things, from credit cards and auto loans to collateralized debt obligations, and comprises over half the CP outstanding. Moreover, notes MacroMavens' Stephanie Pomboy, money-market funds own 27% of CP outstanding.
While the Fed managed to soothe the financial markets' nerves by week's end, the potential for future upheavals remains. As a result, the futures market is looking for the central bank to ride to the rescue with rate cuts. Fed-funds contracts are fully discounting a quarter-point cut, to 5%, at the Sept. 18 Federal Open Market Committee meeting, and a further reduction to 4 3/4% in December.
As the chart here shows, financial crises have tended to coincide with peaks in the fed-funds rate and subsequent Fed easing. The subsequent rate relief would be hailed by the markets as the start of a new bull run.(see accompanying illustratione -- Barron's August 13, 2007)
There is a new wrinkle -- the precarious state of the dollar. No longer is the greenback viewed as a safe haven in the world, contends Barclay Capital's currency team.
Indeed, as MacroMavens' Pomboy has posited, a Fed rate cut that sends the dollar tumbling could have a perverse effect. The influx of foreign capital has kept U.S. interest rates low and provided a flood of credit for everything from leveraged buyouts to, of course, subprime mortgages. If there's an exodus of foreign capital fleeing a declining dollar, credit could tighten even as the Fed eases. Be careful of what you wish for.
By Randall W. Forsyth
The 21st century version of a bank run encircled the globe, but by week's end it seemed to be contained by central bankers using tried-and-true 20th century methods.
But the real question is how, and whether, the damage from the subprime mortgage meltdown can be contained. The good news is that the positives of a strong global economy should mute the repercussions from this financial debacle. The bad news is that mortgage crisis still is in its early innings.
Central banks around the globe injected $290 billion of liquidity Thursday and Friday after money markets in Europe and the U.S. suddenly tightened. It followed BNP Paribas' halt in withdrawals from two of its funds with big chunks of U.S. subprime paper, the firm citing the inability to value its assets during the market's collapse.
Thursday's efforts, totaling $154 billion with $130 billion coming from the European Central Bank, did little to relieve the distress. But Friday, the Federal Reserve was able to restore a semblance of normalcy, if only by taking extraordinary actions. First, like the mythical Chicago voter, it entered the market early and often. It arranged three rounds of repurchase agreements, which is unusual, for a total of $38 billion, up from $24 billion on Thursday, and the most since the days following Sept. 11, 2001. The Fed also accepted mortgage-backed securities as collateral in the first round to bolster that beleaguered sector instead of the more usual Treasuries.
And just to make sure nobody missed the message of these open-market operations, the Fed issued a press release saying it would provide liquidity to keep the financial markets functioning and to keep the federal-funds rate close to its target of 5 1/4% after the cost of overnight money had climbed as high as 6%. The Fed added that the discount window was open to banks and other depository institutions experiencing "unusual funding needs."
Bernanke & Co.'s words and actions had the desired effect Friday, and nowhere was their impact more evident than in the action of Countrywide Financial (ticker:CFC). Shares of the big mortgage lender were slammed with a 13% loss at the open after it said in an SEC filing that it and other lenders faced "unprecedented disruptions" in the credit markets that resulted in Countrywide having to hold $1 billion in mortgages on its books that it had planned to sell into the secondary markets. By Friday's close, Countrywide was off less than 3%, a huge recovery that extended to the overall stock market.
Not since 1966 -- when the term "credit crunch" was coined after the Fed pushed market interest rates above the legal limits banks and thrifts then could pay on deposits and thus stopped lending in its tracks -- has the nation's mortgage apparatus been so close to breaking down.
The current crisis arguably has the potential for more economic disruption than the celebrated 1998 Long Term Capital Management meltdown. Then, as Northern Trust economist Asha Bangalore points out, the economy cruising along -- in contrast to the past four quarters, which have seen below-potential growth on average.
Moreover, mortgage borrowers perversely benefited from the LTCM fiasco. Not only did the Greenspan Fed lower rates, sparking a huge bond rally, but, also, the government-sponsored enterprises Fannie Mae (FNM) and Freddie Mac (FRE) went on virtual buying sprees. As a result, the biggest part of the credit mar- ket -- mortgages -- remained flush. Now, Fannie is looking to expand its portfolio beyond the $727 billion limit imposed on it after its accounting and governance scandals -- a move viewed skeptically by the White House but supported by some congressional Democrats.
Indeed, the full impact of the mortgage crisis still lies ahead. From the beginning of 2007 through mid 2008, interest rates on over $1 trillion of adjustable-rate mortgages are slated to be reset, many from low "teaser" rates.
The subprime mess also recalls another crisis -- the virtual collapse of the commercial-paper market in the wake of the Penn Central bankruptcy of 1970. Back then, the paper market consisted of relatively simple short-term corporate IOUs. Now, so-called asset-backed commercial paper is backed by all manner of things, from credit cards and auto loans to collateralized debt obligations, and comprises over half the CP outstanding. Moreover, notes MacroMavens' Stephanie Pomboy, money-market funds own 27% of CP outstanding.
While the Fed managed to soothe the financial markets' nerves by week's end, the potential for future upheavals remains. As a result, the futures market is looking for the central bank to ride to the rescue with rate cuts. Fed-funds contracts are fully discounting a quarter-point cut, to 5%, at the Sept. 18 Federal Open Market Committee meeting, and a further reduction to 4 3/4% in December.
As the chart here shows, financial crises have tended to coincide with peaks in the fed-funds rate and subsequent Fed easing. The subsequent rate relief would be hailed by the markets as the start of a new bull run.(see accompanying illustratione -- Barron's August 13, 2007)
There is a new wrinkle -- the precarious state of the dollar. No longer is the greenback viewed as a safe haven in the world, contends Barclay Capital's currency team.
Indeed, as MacroMavens' Pomboy has posited, a Fed rate cut that sends the dollar tumbling could have a perverse effect. The influx of foreign capital has kept U.S. interest rates low and provided a flood of credit for everything from leveraged buyouts to, of course, subprime mortgages. If there's an exodus of foreign capital fleeing a declining dollar, credit could tighten even as the Fed eases. Be careful of what you wish for.
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