What's Going On?

COF closes Greenpoint Mortgage Unit, which was the creator of the Alt-A loan. That business was valued at about $6 billion a few years ago. That's fitting.

KKR Financial can't roll its $5 billion commercial paper ("CP"). Its creators, "the" KKR say they'll put in $100 million as part of a $500 million stock offering. Hmm. That's "equity". So the unit was undercapitalized? Could it be that a firm set up by LBO-types had too much debt? lolol. The WSJ story says the units sold asset-backed CP to fund ... mortgage securities.

Uh ... where are the back-up bank lines of credit for the CP? I guess the cupidity of KKR Financial knew no bounds as they wouldn't pay for them, risking the entire company. How did the CP get rated? I wonder if the rating agencies relaxed conditions? In my day - many moons ago - any asset backed CP programs needs back-up bank lines of credit. Maybe that went the way of the 20% down payment.

WSJ from yesterday has an interesting story about many German banks having severe problems and a story on Babblevision this AM early by Sylvia said several more have failed. Apparently those banks created off-balance sheet conduits that sold asset-backed CP and invested in securities. D'uh? Isn't that just an off-balance sheet bank? Didn't Enron go under through off-balance sheet financing? It seems those asset-backed CP programs had no back-up bank lines, either.

Does no one do risk analysis anymore? Or is the infatuation with derivatives so intoxicating that the modern masters of the universes don't bother?

If an entity issues CP to buy mortgage securities, there is a miss-match in (a) maturities, (b) fixed-floating rates (e. g., LIBOR vs. a fixed rate index like Treasuries), (c) basis (e. g. Treasuries vs. the securities market yield), and (d) default risk in the securities. Not all can be hedged. In fact, only (b) can be hedged. Hedging (d) with a "credit swap derivative index" is just a fiction as that introduces another factor of basis risk. That's why "EQUITY" is needed! That's why back-up bank lines are needed! Sheesh! We knew and did this 20 years ago. What the hell is going on?

CP is a very touchy security - like an unexploded bomb. When it becomes due, it's DUE! No questions, PAY ME! Issuers of CP need armor protection or risk instant bankruptcy.

German ZEW August business confidence index was very low this AM - way below expectations and way below July. The German bank problems must be impacting that.

Here's why the Fed MUST cut the overnight rate. The discount rate cut simply will not work as the overnight rate is too high forcing the discount rate to be too high. Think about it! The discount rate is 5.75%. You've got a bunch of high grade securities yielding ... 5.25%. That was a pretty good rate a few months ago. How can you finance those thru the discount window and lose money every minute? So you can't. So you have to discount them further. That means more liquidations. Which is what the Fed "says" it wants to prevent.

The Fed is causing more liquidations by keeping the overnight rate unnaturally high. Look at the Treasury Bill rates! Money market funds are scooping up T-bills and cutting CP investments. Why? They are worried they can't sell CP holdings if they get redemptions. Why? The discount rate is simply TOO HIGH!!! Financing that CP thru the discount window at 5.75% creates LOSSES and then they risk "breaking the buck" and failing.

Everyone patting the Fed on the back for a "brilliant" move are mostly wrong. That discount rate policy change would work IF AND ONLY IF the Fed cut rates simultaneously - a lot.

The Fed must cut the overnight rate to 4% and the discount rate to 4.5% so the yield permits funding of the CP and other collateral at a positive spread.

Heck, the Fed is effectively raising rates! Issuers of CP used to get 5.25%. Now they must pay at least 6% to issue the paper and then have it financed by the discount window at 5.75% as a positive spread is essential for a bank to do this.

These dolts in DC really need smacked in the face. A functioning CP market is a primary reason the Fed was created. Are they just stupid or insular or what? What the heck are they worried about? Their inflation fighting image! Phooey! Fools!

PS: A Babblevision guest is making the point tht non-bank entities acting like ... banks are a cause of this situation. The non-bank "banks" depress margins and hurt the banks; they get better margins by avoiding bank regulations, but forego access to the discount window and other safety nets. Uh, I've been ranting about entities like hedge funds acting like banks for ... many moons. Other non-bank banks are the mortgage "bankers" like Thornburg, which are really just finance companies.

PPS: this also shows that once these non-bank banks get wiped out, the banks will make good money. That's part of the logic for my big bank play: BAC, C, JPM - more in BAC than other two.