Thursday, August 23, 2007

Of Parties and Shotgun Weddings

The top four US banks tapped the Fed's Discount window yesterday for $500 million each (what a coincidence, each wanted exactly the same amount!). In fact, the banks had absolutely no desire to borrow, so Citi, BofA, JPMorgan and Wachovia were frog marched to the window and told in no uncertain terms by Bernanke and Dodd to borrow on behalf of their customers facing insolvency, or else. The banks did the absolute minimum they could get away with and took their leave, saying the will come back...soon.

The Discount Window is open to banks, but the credit and liquidity problems currently reside mostly with their leveraged customers (mortgage originators, hedge funds, etc). The banks are supposed to take their customers' collateral (loans, ABS, CDO's, etc.) and back-to-back it with the Fed, thus becoming a "liquidity intermediary", since the Fed cannot deal directly with such riff-raff. In money broking this is called a "switch".

Problem is, the customers could decide (or be forced) to default on the bank loans, sticking them with the obligation to repay the Fed and to keep the collateral in exchange. But who wants that collateral...

The whole show was intended to exhibit the smooth co-operation between government, banks and the liquidity-challenged, but ended up looking like throwing a party where one showed up, forcing the organizers to rustle up four gents in rented tuxes to pose for the society photographers and make comments, like: "We are ever so pleased to be here, at such a wonderful bash. Oh, quick everyone, look over there - is that Clint Eastwood I spot over by the exit? Let me go and see..."

When I first commented on the Discount rate cut a few days ago, I pointed out that only around $200 million were outstanding on average, thus the rate cut was meaningless unless the amounts started going much higher, allowing the money to reach those that needed it. A couple of days passed and the big banks were not willing to do the necessary "switches", so phone calls were made, arms were twisted and...presto, the tuxes were rented. But $2 billion is a drop in the bucket, so we shall see what ensues.

More interesting as a move was BofA's decision yesterday to buy $2 billion worth of Countrywide convertible preferred shares with a yield of 7.25%, potentially giving them a 16% interest in the company, if/when they exercise the conversion. To accept such a lopsided deal, Countrywide must have been on the verge of drowning and desperate for a life preserver. The conversion price is set at $18/share, much below yesterday's closing level ($21.80). BofA said, with a straight face I presume, that the transaction would be immediately additive to earnings (no kidding, really?). Talk about shotgun weddings...


  1. Whatever the reasons were for these banks to go the Fed (solidarity, we can doubt, switch for their HF clients,oviously, or...) the only thing important is as the discount rate says, we have a window now for about 30 days to be more confortable. but thenafter what happens if the famous bank's clients beneficiating from the extra borrowings are not able to survive...october is going to be difficult !

  2. As someone else asked: Why didn't these banks loan their hard-pressed customers money? After all, that's what banks do, right? Loan money. Could it be they didn't like the collateral on offer?

    All of this seems to be such a big joke, yet it is really being pumped in the popular financial press, and is, ostensibly, what is driving a big rally.


  3. Miju wrote,

    "We have a window now for about 30 days to be more confortable."

    30 days? More like a week or two. The markets aren't going to wait 30 days to get wobbly. Around Labor Day things will get quite, uh, labored.

    Folks, the banks are looking at INSOLVENCY on a massive scale. A credit crunch would be a picnic by comparison.

  4. @1st anonymous.

    I've had two offers from BofA in the last week. The first was 0% interest for balance transfers AND line of credit with no fees on a CC with rewards for 12 months, I don't recall if there was a limit . The second was for a 35K CC with no balance transfer fees and 0% interest for 12 months.

    Who says BofA isn't taking care of their good customers?

    Too bad I don't have balances to transfer because our CC debt is zero. We suxxors because we were foolish enough to get rid of our CC debt 5 years ago.

    anon#1, so how much CC debt and mortgage debt do you have that causes you to castigate BofA for not giving you credit?

    No, we're not old farts, we just don't live an "I want more than I can afford right now" lifestyle. We're 35 and 37. So, maybe we are old farts if you're 23 and don't deserve/can't afford the credit you've been offered.

    Just 'cuz teh banks offer it, doesn't mean you have to accept it! Jeez.

  5. @anon1
    My bad. I missed the sarcasm in your post on my first reading. I agree with you 100%.

    :shakes head:

    If you have good credit, you can still get credit (but WTH would you bother?)

    If your credit sucked before, and sucks worse now that you're upside down in a home mortgage, why would anyone want to loan you even more money? Jeebus.

    I can hear the whining all the way from Comfortable St.

  6. this party is just at the front door, all this deciding which chair to sit in on the titanic...let's see how it looks in Dec-Mar when the "A" loans start going bad. (that is what the big boys are seeing in the looking glass)...if you hear anyone say subprime or a certain type of loan or borrower caused this, then walk away they don't know what is happening.....This is oversupply and no demand on homes, if the clean customers owe 40% more than their home is worth and they have to move, THEY WILL...that is why we put over 100 billion in the markets world-wide, the only fix is going to be if FHA wants to write 140% loans for everyone, that is the only fix........stock market and housing crash together this the past rich people would just move their money from stocks to bail housing....billions have evaporated......this is going to hurt...........