Wrong Again

For a long time, stock market types dismissed the ominous implications of falling house prices, rising foreclosures, tightening lending standards, and widening spreads in a growing array of fixed-income markets.

When these facts were brought up, they were dismissed as irrelevant to what was happening in the "real" economy.

When it became clear that they were having a deleterious effect on the fortunes of homebuilders and other long-time beneficiaries of the boom in housing, "strategists," "analysts," and other so-called experts repeatedly argued that the problems would remain "contained."

When makers of consumer discretionary goods, auto producers, and retailers like Wal-Mart then said that their customers were hurting and so were they, the "smart money" said relax, because the Fed would soon ease policy and then share prices would rise, somehow aiding the economy in the process.

As it happens, they were wrong each time.

And now, it seems, they are wrong again. Instead of seeing Friday's Fed move for what it was -- a panic response to a fast-expanding credit crisis -- many of Wall Street's delusionals interpreted it as a sort of magical moment. As they saw it, the monetary fairy would soon be sprinkling lots of interest rate pixie dust around Wall Street and, in the end, all would be well.

Well, it didn't take very long for one group at least, money market traders, to see that the happy ending scenario wasn't quite working out according to plan. In "Fed Fails to Calm Money Markets," the Financial Times details today's dramatic developments.

Money market investors staged a dramatic flight to safety on Monday, knocking down yields on short-term US government debt, as top Treasury and Federal Reserve officials continued behind-the-scenes efforts to maintain confidence in the credit markets.

The yield on the three-month Treasury bill fell 66 basis points to 3.09 per cent after being down by 125 basis points during the day – a greater plunge than during the October 1987 stock market crash. The yield on the one-month Treasury bill fell 62 basis points to 2.33 per cent after being down 175 points. US equities closed mixed following gains in European and Asian stock prices.

The frantic scramble to obtain short-term government paper at almost any price suggests the Fed’s move on Friday to make credit available to banks on more attractive terms has yet to stabilise the markets.

This in turn encouraged speculation the central bank would have to cut the federal funds rate, its main interest rate. In a sign of growing political attention to the crisis, Ben Bernanke, Fed chairman, and Hank Paulson, Treasury secretary, were to meet on Tuesday with Senator Christopher Dodd, the Senate banking committee chairman.

Analysts said the plunge in T-bill yields was driven by money market funds, which hold $2,700bn in assets, shifting away from asset-backed commercial paper, which promises investors the cash flows from mortgages and other loans.

In response to investors’ pressure, funds that previously had sought to boost returns with more aggressive strategies have been selling asset-backed commercial paper and raising their holdings of government securities. At the same time, money is piling into traditional funds that only buy government debt.

“We had clients asking to be pulled out of money market funds and wanting to get into Treasuries,” said Henley Smith, fixed-income manager at Castleton Partners. “People are buying T-bills because you know exactly what’s in it.”

Data from Dealogic showed companies in Europe failed to refinance more than 80 per cent of asset-backed commercial paper that matured on Monday.

Separately, people close to the situation said Deutsche Bank had taken advantage of new terms offered by the Fed on Friday by borrowing at the “discount window”. They said the move was taken to show support for the Fed’s actions.

Mr Paulson and senior Fed officials were talking to large institutional investors and banks in an effort to calm markets, but policymakers denied they were trying to talk up prices.

One investor said he had been called over the weekend by a senior Fed official seeking to “explain” Friday’s decision to lower the discount rate.

Maybe equity traders are just a bit slower on the uptake when it comes to the complexities of credit markets. Let's see what happens tomorrow.

Comments

[Bruce Allen]

Mike,

The irony of this whole thing is so thick you can cut with a ladle. Cannot people see what is REALLY going on here? Or maybe it's because reality is just too unpleasant to deal with, so we like to delude ourselves into believing that everything is OK, life is "good", and there's no need whatsoever to worry because our wonderful "feds" have everything under control? You tell me. What they're essentially doing is creating more debt to solve debt! I simply can't comprehend why the majority of people today don't understand that! Keep up the good work.

[daveDave]

the problem with analysts is that they dont get paid when the people pull their money from their funds
so you will find it a difficult task if not impossible task to find one that will tell the truth
the fact that we are in a time where real inflation is
10-15% and T bills are paying just under 5%
everything is broken many lost their shirts and the only people getting bailed out are the top tier loan institutions which is to say socialism is fine for the rich but for the unwashed masses 100% capitalism at its greediest only
they want your pension and they will get it too
they want it all and you will be left in the street as the cold wind howls
everyone knows the finacial pundits are shills for a broken economy and trust me the economy is borken beyond repair thats the whole world economy not just ours when central banks around the world pump in 400 billion to keep it afloat and the common man cant even get a loan to save his house
when Red China is carrying enough of our debt to wipe the American economy off the map for good over night
then we need to get back to common sense men not shills that prop up confidence when every man woman and child with common sense knows the ponzi game is over and has been for sometime
perhaps it is time to reach for the gold standard to back the currency perhaps the banks ought to be left to rot on the vine they are corrput to the core
I made my money by not listening to the shills and in most cases did the opposite of what they preached
I wouldnt touch the markets today with a ten foot pole