November 20, 2008 8:50AM
The Biggest Obstacle We Still Face: The Credit Markets
By Alexis Glick
-
Share:
At the close of the market yesterday, after a 5-6% drop across the board, I called a good friend in the credit markets to see what was going on. He said the cause of the sell off was the credit markets. Does it help to have the car company executives testifying on Capitol Hill about how dire their situation is? No. Does it help to have Bernanke, Paulson and Bair testify before Congress about the use of the TARP funds and why they are not working? While we want answers and accountability, my guess is it’s a lousy time to grandstand.
The biggest issue we face at this juncture is what we have done to the credit markets.
Let’s be perfectly clear about this. The Treasury Department and the Federal Reserve Bank instituted two key programs in the wake of this financial meltdown. Both programs are NOT working as well as they wanted them to. They may have worked initially or temporarily, but they’re beginning to fail. Who knows…in six months we may look back and say the programs worked or that they prevented an even bigger collapse. But, at the moment it’s ugly.
The two programs I am talking about are the initiation and use of the TARP fund or Troubled Asset Relief Program and the Federal Reserve Bank’s Commercial Paper Funding Facility, otherwise known as CPFF. These acronyms are killing me!
The TARP fund has not lived up to anyone’s expectations. Its original purpose to purchase troubled assets failed. That idea has been scrapped all together. Many people in the industry said it was a failed concept from the very beginning because there was no way to figure out how to sell troubled assets in the open marketplace through multiple reverse auctions. Not only did they not know how to price them, they didn’t know if the private sector would participate, who would manage those assets if the government was the final and only purchaser and how those managers and the government would be compensated. It was a mess. Great idea. Poor planning. Many fund managers and economists were happier to see the Treasury Department follow Europe’s lead by pumping cash into financial institutions through large capital injections. So what happened?
In order to sell the idea, Paulson had to tell the biggest and most powerful players to participate in order to prove that tapping into the TARP for smaller banks wasn’t a sign of weakness. Not only did it anger many of those top executives who said they didn’t need the money or want the strings attached to it but it created the biggest problem we face today, the too big to fail concept. By carving out which banks get the larger sums of money and by allowing the Treasury to give money to some banks and decline to fund others, it forced the strong to get stronger and the weak to either fail, get weaker or to step into a cheap deal with little upside because they had no other choice. National City Corp, NCC, is the classic example when it was taken under by PNC Bank.
The CPFF or Commercial Paper Funding Facility that the Federal Reserve Bank started on October 27th has done terrific things for the companies that can get access to that type of funding. The companies that the Federal Reserve Bank is willing to purchase U.S. commercial paper from through the SPV, Special Purpose Vehicle, are the best and brightest, companies with A1/P1/F1 ratings. What about the companies that fall below that rating? They are suffering big time.
Yes, LIBOR, the London Interbank Offered Rate, kind of the equivalent to our Federal Funds rate but arguably more important because it is calculated including 10 currencies and is the primary rate used for banks to lend to one another in many countries, the standard rate by which short-term interest rates and interest rate swaps are marked, and variable rate mortgages are priced. While that rate has improved substantially, implying an easing of credit and lending, it is now slowly beginning to turn back in the wrong direction.
Think about it this way. If you are a major commercial bank and the Fed says they want you to lend to corporations and consumers but you know you can either lend to a company whose debt the Federal Reserve Bank is not willing to purchase through short-term funding or who may be at risk of default or take your money keep it in cash or even better yet, invest it in high yield corporate bonds, the debt by which these companies are funding their paper, for yields as high as 30%, why would you give the money away? On the other side, if you are a corporation that doesn’t meet the Federal Reserve Banks requirements trying to get access to short-term funding and the bank says they’ll lend you the money but for that money you, the corporation, have to pay 3, 4, maybe 5 x what top tier corporations are paying for that cash, would you be willing to do that? In some cases those corporations have no choice but what is the lesser of two evils if you are the bank?
So what has the CPFF and TARP fund done?
1. Protected us, the taxpayer, by making sure that any securities or collateral that they take is high quality and that they are only lending to the institutions that they think are either too big to fail or safe enough to get through this storm.
2. Anyone who falls below that line, even if they are a very good company, is getting screwed. The cost of funding exploded and is not easing because no one wants to buy their paper and banks that are willing to lend them money are asking for outrageous rates of return, all time highs.
3. The municipalities that are running growing state budget deficits have no access to the CPFF. So imagine what that means when your city, your state, your schools, your buses, your police stations, your neighborhood can’t get funding unless they are willing to pay historically high rates of return.
To be clear about this, short-term commercial paper funding historically has been offered to only the highest rated companies. High yield or weaker rated companies have not been able to access liquidity through these means. The problem is that some of the companies with less than A1 ratings are paying the highest rates they have ever had to pay to get access to liquidity in the secondary market. The concept of even getting a 3 or a 5 year loan is out the door. Do companies still have revolving lines of credit? Yes. That’s the good news. They can tap into those lines to meet some of their short-term demand. Have a lot of companies filed for bankruptcy? No. The problem the bigger financial institutions and hedge funds face is that without a purchase of troubled assets, no floor is put on the value of those assets. In addition, if you’re one of those financial institutions you now know Paulson is not giving out any more money in the wake of this announcement and at the same time the hedge funds that invested in these exotic instruments are forced to deleverage at bargain basement prices because they have no other option. It’s becoming a vicious cycle. It’s called forced selling!
One has to wonder, might these two programs put more companies, more municipalities and more banks out of business or will it intentionally force a record number of MNA (merger and acquisition) deals in 2009?
-
Share:
If the banks won’t lend and unfreeze the credit markets…….why doesn’t the Treasury just set up a direct lending facility?…Let the Treasury make loans to businesses and consumers for autos and mortgages…….In my opinion…if we unfreeze the credit markets I think lots of other problems may start to self correct…
The excuse for not helping the automotive industry is the Big 3 can’t compete with foreign car makers. They need to retool and rethink how they do business or no money for them. So called TV business wonder boys and girls wonder why not and on the other hand they want to know when will Citi get some TARP money.
I say NO, they can’t compete with other banks. There are a lot of small banks and mid size banks that are doing just fine. They need to rethink how they do business and show congress a detailed plan of what they will change and how will they use the money before getting any help.
Also I want to see the executives of these Big financial institutions before congress explaining why they need the money and showing there plan of action. CitiGroup does
not need help, it needs to reorganize. Sell some of its assets. These institutions are
too big.
Right now this is not a level playing field and I as a citizen and tax payer do not like what I hear and see on television.
Hello Alexis,
I was on your show this morning, and you asked me to read and comment on your post above. Some comments:
TARP may have had good intentions of putting a floor on certain debt instruments, but the mechanics of the purchase were going to be nearly impossible to execute. Reverse auctions would have set a low price that a nearly-failing institution was willing to take, which would have resulted in another round of mark-to-market writedowns for the institutions that DIDN’T sell at that distressed price. Regardless, markets had assumed Treasury was going to use TARP to purchase RMBS securities, which is why RMBS markets were up, yes up, during September and October while everything else was getting smashed. When Paulson said last week TARP would not purchase securities, RMBS got hit hard, and the BKX index crashed through its July 15 lows.
On CPFF, I have a more optimistic view than you on its eventual outcome. The Fed is purchasing hundreds of billions of top-rated CP so it doesn’t have to do any/much credit analysis. Therefore, banks do not have to use their balance sheets buying that CP or extending back-up lines of credit to those top-rated corporates. Instead, banks can use their balance sheets to lend to smaller companies, at least in theory. Everything is frozen at this juncture, but I would guess this will pan out eventually.
Tomorrow, I’ll address the point I was making this morning about how inaccurate application of bond ratings are destroying capital in the banking system, making the whole credit crisis worse than it should be. Right now, I’m going to go get some sleep!
ONLY seeking here to put forth what I think are decent ideas. No need to publish I even.
But I will say- it JUST occurred to me.
If Gasoline costs more to make than you can charge for it ? right now ?
AND ? Gas refineries are handling this the way they always have ? lower output ?
I hate to say it, but THAT does have one dark side.
LESS oil demand, for less gas production.
So, here is gasoline being crimped on production to bump up the price, make less, charge more, and here is oil doing the same - OPEC that is.
so, Gasoline production goes down, so will oil production, but oil will try and cut down production to make oil go up, in turn, gasoline goes back up.
This summer - gas went up as if on a roller coaster so much that consumers now second guess spending on x-mas I think. tight wallets.
I see a terrible cycle of abuse here.
And yes, if it’s IP matched as well - that’s fine.
Point is - journalism is journalism.
Hope you or someone explores just how factored in or fair it is to say 11 and 1/2 years low for DJIA.
7000 in 2000 etc, isn’t fair to compare to 7000 today.
I think people would like to get that value in real proportion.
Factoring in the condition of the dollar, say 11.5 years ago.
I’d start there.
SEEMS most people want a thermometer on the market meats - especially this holiday season.
X-mas shopping could ride on the coat tails of a DRY turkey if people let it bake too long (as I do).
I’m not sure what they are baking over at the Treasury ovens.
Let’s just hope they don’t start shovelling money into furnaces to hedge against deflation !
Most US consumers would not able or willing to grasp that.
ALMOST like when we destroy food to anchor stability on futures.
You had someone on recently, I think it was you, stating that gasoline right now costs more to make than you can charge, alas refineries as seeking to cut back.
OPEC is doing this.
I wonder if there will be a backlash from this.
Petro IS the magma underneath the tectonic plates of our global economy.
Alexis,
Something to consider looking into.
When I read THIS ? at MarketWatch headline ?
“Late dive drives Dow down 444 points; S&P is at an 11½-year low”
Why not look into whether inflation and the dollar have been factored into this.
I suspect it’s more than 11.
I’m not a smart financial person, just an ordinary, hard-working, tax-paying American who is now retired. I lived the way my parents taught us, within our means, on a budget. My husband & I owned three houses over the course of a lifetime - we always paid the mortgage on time, didn’t go into debt over our heads and always maintained savings for emergencies. We put 4 kids thru college. We are solvent, not rich, but not poor either. We are proud of how we’ve handled our finances…responsibly, that’s the American way (or so we thought.)
As I see it, when people were given mortgages they didn’t qualify for because corrupt politicians used and abused the banking system for their own finincial gains and to secure votes, that’s when the problem started. The people who got the homes they didn’t have to work for are the same ones who are unable to pay their credit card bills, too.
For what it’s worth, I just wanted to say that I am a member of the large group of hard-working tax-paying Americans who recognize that it is our tax money — earned by our honest labors — that is going to fund the corruption, the welfare (because that’s exactly what those subprime mortgages were)and the huge social programs that are coming with the next president.
My husband & I are grateful to have grown up in the best of times — the 40’s & 50’s –when this country was the America our founding fathers envisioned, where we still could claim life, liberty & the pursuit of happiness…when more of our money could be used for ourselves and didn’t have to be given to the govenment. Unfortunately, our children & grandchildren will have to adjust to a new and different America where the values they were taught in our home are not prized nor are they respected. Where their dreams may go unfulfilled as more of the fruits of their labors go to the government.
We need to learn from history. The Federal Reserve System was created in 1913 to fix two main weaknesses: an “inelastic” currency and a lack of liquidity. It evolved from a series of panics starting in 1907, when unemployment reached 20%. Starting from New York City, rural farmers eventually couldn’t get the loans to run their farms. At the time, J.P. Morgan stepped up to the plate and personally made temporary loans to key New York banks and other financial institutions. He went to the clergy to calm public’s fears. The Federal Reserve System was created to take the role of J.P. Morgan in the future. Unfortunately, there is no substitute for a J.P. Morgan.
As we now know, the “liquidity” problem requires a personal touch. Unfortunately, I just continue hearing to “keep the financial institutions intact”. There is really no personal touch here.
Good job Gary! For 3 years I have alienated friends and family by predicting this. I am not as well versed as yourself to be able to pen that. It does not take a rocket scientist to do simple math and what bothers me the most is that people much closer to all of this than us have known and done nothing but collect their bonuses for a long time. This is the first time in my life that I have been scared about our future. I have no faith in our leaders what so ever. Not in business,not in government, or any where else for that matter. Greed and instant gratification have killed us.
Eric
I just wanna know what color this tarp is. Is it like the blue ones you see on roofs after a hurricane? And how would a piece of plastic sheeting save the economy?
Until we stop the fore-closures, this market will continue to spiral downward. SOMEONE NEEDS TO ACCELERATE THE RE-TERMING OF ALL THE MORTGAGES THAT ARE ARM’S AND THOSE WHO ARE IN DELINQUENCY!!! This will get the economy back up and running in the right direction.
And if we think things are bad with housing….. just let one of the Big 3 go into bankrupcty and the domino effect will be deafening. THE BIG CRASH will put us all in jeapardy. WE CANNOT CONTINUE TO EXPECT THE BIG 3 COMPANIES TO COMPETE WITH COUNTRIES. WE NEED A 21ST CENTURY MANUFACTURING STRATEGY!!
What became of TARP was not really a surprise when you look at it from a different angle. Let’s forget about what we know and create an imaginary, really bad made-for-TV movie script.
We follow the life of the CEO of an investment bank who finds himself offered the job of Secretary of the Treasury. Though he has half a billion in stock, he takes the government job for two reasons; 1) he gets to liquidate his stock for cash TAX FREE (one of the perks of the job is a one-time capital gains exemption under section 1043 of the Ir code - enacted by GHW Bush). and 2) because he gets his hands on the Treasury.
Because of the collapse of the subprime market, all of the lowest level tranches of the mortgage-backed securities that were financed by investment banks has instantly become ‘toxic’. The investment banks are hopelessly over-leveraged, and cannot meet their cash obligations.
He takes this to Congress and the Senate with an immediate urgency. In a scene reminiscent of when General Powell addressed the UN with evidence of weapons of mass destruction in Iraq, this Secretary Treasury presents a terrifying powerpoint presentation as to the state of the markets.
He has the built-in clout of a treasury secretary. Kind of like the Secretary of State. People tend to listen to high-ranking officials, and - to believe them.
The bill passes. And the immediate actions taken are so bold-faced and obvious that it reminds us of the time when O.J. Simpson said that he would spend the rest of his life trying to find the killers of his wife and Ron Goldman. As soon as he’s out, he’s on the back nine.
Taxpayer money is being handed out not to spur lending, not to purchase ‘toxic’ debt… oh no. In fact, this Treasury Secretary boldly announces that he has no intention of purchasing toxic debt. He then buys billions of dollars worth of preferred (non-voting) stock in major banks, including Wells Fargo. $25 billion to Wells Fargo. Wells Fargo is in fine shape - didn’t need the money. Why did they get it? Because they took over Wachovia. And Wachovia ‘was’ in trouble, so let’s bail out the new owner. These are not open market rules.
The first $350 billion is gone, mostly used to buy stock in banks. Did the taxpayer say this was ok? Was the House and Senate told that this money was going to buy shares in financials? Most of all, how are banking stocks doing?
While this matter is going on, simultaneously $2 trillion of taxpayer money vanished to recipients unknown. $2 trillion is 1/7th of the GDP of the country. When asked who got the money, this Treasury Secretary said, “I’m not saying”.
In a bad made-for TV movie, the plot would be that this Treasury Secretary knew all along he was going to take taxpayer dollars and bail out his friends by propping up the value of their financial shares. Simple plot isn’t it?
Then it makes sense what a failure TARP was in achieving the proposed objective. But in my bad movie, TARP was a spectacular success - in replenishing capital in collapsing markets by taking it from the taxpayer. Tada! TARP should be renamed, TADA.
There are two things that keep markets moving - whether it’s credit markets, real estate markets, credit default swaps, etc. The first one is sustainability - is this market viable? Does it stand on a foundation of real value? If not, then #2 is - “belief”. In the absence of sustainability, is there a widespread belief (maybe whipped by euphoria at times) that there is sustainability?
In the case of the credit markets, LIBOR loosened up because there was a belief that it would! Now that TARP went down in a ridiculous flop, credit markets are freezing and they are freezing because the cat is out of the bag.
Not only is the cat out of the bag, but can the country do another TARP? Nope! The big wahoo that McCain suspended his campaign for, the one that prompted our President to take to the airwaves to warn of the dire consequences if the bill didn’t pass would have the ‘cry wolf’ potency if we could even afford it.
We can’t, so there’s no more hail mary passes. This is the larger problem. If the ratings of U.S. Treasuries goes down (I predict it would go to junk, myself and am planning accordingly) then there goes the U.S. Dollar.
I am as sure as I am sitting here that it’s going to happen, and this terrifies me.
One problem as I see it is that we have made our future economic stability much weaker by creating more large “to big to fail” banking institutions by picking winners and loosers (forcing banks to merge or close doors). We have lost alot of “diversification” in the banking business. In my humble opinion (granted I am an atlanta mover not harvard mba) we need more smaller banks rather then a few very large banks. If we have many regional banks with focus on the local market and bank like activities (not these CDO’s and other wiz bang products of Mass Financial Destruction) then if we have losses and or issues they will be more limited in scope. We a few very very large banks are very interconnected if one has a serious problem then they are all going to be in trouble.
I have become addicted to your articles and morning program. You are great!
BTW: I recommand you get a wardrobe consultant… what you are wearing today is horrible!!