Monday, September 15, 2008

Using more of our money… Bail Baby, Bail!

On April Fools day of this year, I wrote about a money spigot opened up by the Fed that allowed investment banks on Wall Street to drive by and borrow any amount that they wished from the Feds sans rigorous oversight or regulation. The rate of drawing from the spigot was about $33 billion a day then – I do not have the numbers for now. The ostensible reason for this largesse was to preserve 'financial liquidity' and make sure that the major players on the Street have enough money to perform their complex dalliances and ensuring year end bonuses.

This weekend, we witnessed multiple events that almost looks like an automatic structural re-adjustment of the financial industry. The spectacularly predictable failure of Lehman. Merrill rushing into the waiting hands of its suitor, Bank of America and AIG (the biggest insurance company in the world) gasping for air as it asks the Fed for $40 billion in restructuring costs.

Well, the common sense would dictate the following: Hey, these companies played poker with the money entrusted to them and during the process of carving up mortgages into complex financial instruments that no-one understood, they were setting themselves for failure. Let the structural adjustment happen, let the financially unsound institutions fail, as soon as the bad apples amongst the lot is weeded out and we should see the bottom of this thing - Or so, one might think.

Well, the Fed thinks otherwise. In a sign of continuing largesse and misfired blanks from Paulson’s bazooka, the Fed has opened up newer spigots of money to Wall Street banks.

From here:

In an obscure but highly important announcement late Sunday evening, the Fed said it would let Wall Street firms post as collateral much riskier assets — including equities, junk bonds, subprime mortgage-backed securities and even whole mortgages — in exchange for emergency loans through the Primary Dealer Credit Facility.

But with the new announcement, the Fed will accept stocks and some debt that has junk-bond status and some securities that may have few real buyers.

Well, now they are ready to accept junk bonds from distressed companies on Wall Street. Wonder what is next.

What amazes me is that we have just peeled some preliminary skin off the mortgage mess. We are only witnessing the fallout from a type of mortgage called 'sub-prime'. Mortgages of lesser toxicity sit waiting for their turn to wreck havoc – an example of such a mortgage is called 'Alt-A'.

From here:
Homeowners lured by low introductory rates to Alt-A mortgages, which typically require little or no proof of a borrower's income, may fuel the next wave of foreclosures and further delay a recovery from the worst housing decline since the 1930s. Almost 16 percent of securitized Alt-A loans issued since January 2006 are at least 60 days late, data compiled by Bloomberg show. Defaults will accelerate next year and continue through 2011 as these loans hit their three- and five-year reset periods

About 3 million U.S. borrowers have Alt-A mortgages totaling $1 trillion, compared with $855 billion of subprime loans outstanding, according to Inside Mortgage Finance, a trade publication in Bethesda, Maryland. Of the Alt-A borrowers, 70 percent may have exaggerated their income, said David Olson, president of mortgage research firm Wholesale Access in Columbia, Maryland

Wonder what the Fed will do when the bottom on the Alt-A mortgage market fall out. I guess we all have a simple enough answer: Use more of our money… Bail Baby, Bail!

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