Global Credit Crisis U.S. Style

Bloomberg is reporting Commercial Paper Market in U.S. Shrinks for Seventh Week in Row, Fed Says.

The U.S. commercial paper market shrank for the seventh straight week as the Federal Reserve's interest rate cut fails to improve conditions for short-term credit.

Debt maturing in 270 days or less continued its biggest slump in seven years, falling $13.6 billion in the week ended yesterday to a seasonally adjusted $1.855 trillion, including a $17.3 billion decline in asset-backed commercial paper, according to the Federal Reserve in Washington. The week's decline is smaller than the previous week's drop of $48.1 billion, a sign that buyers are starting to return to the market after the Fed's half-point reduction Sept. 18 in its benchmark interest rate

You have to love the absurd positive spin with this statement: "The week's decline is smaller than the previous week's drop of $48.1 billion, a sign that buyers are starting to return to the market". Since when is a decline a sign buyers are returning?

Minyanville's Mr. Practical had this to say:

The Federal Reserve executed a whopping $38 billion in repos this morning. Apart from the size, the most amazing thing is that they took $22 billion in mortgages as collateral.

Perhaps I was wrong when I said the Federal Reserve would not wreck its balance sheet in attempting to reflate the economy. This is truly stuff of a Banana Republic.

The implied Fed Funds rate is now trading at 4.88% which is over the desired rate. The Fed is having to force more and more credit into the system to keep rates low. Banks just don't want to lend.

This is truly stuff for the history books. As stocks blindly stumble to new highs, the risk is almost unimaginable as to what happens if/when this fails.

Mortgage Restructure Free-For-All

Reuters is reporting Countrywide sees modifying 25,000 mortgages in '07.

Countrywide Financial Corp (CFC), the largest U.S. mortgage lender, said on Monday it expects to modify terms on nearly 25,000 home loans this year to help people avoid foreclosures.

The company said it has already modified more than 17,000 home loans this year, and provided assistance on about 35,000 mortgages, including through repayment plans, postponements of payments and refinancings.

Yesterday Mr. Practical talked about Countrywide in Mortgage Restructure Free-For-All in response to a question from Minyan J. about that restructuring. Here is a portion of his reply:

Minyan J,

That's the issue. It is merely an attempt to delay the inevitable; restructuring can take many forms, and from CFC's perspective what it is attempting to do is essentially extend a life line to higher risk borrowers.

This of course has consequences, such as immediate cash flow/earnings impact, and the associated impact on ABX pools and CDOs as outlined below.

Further, it introduces perhaps the unintended consequences that the writer puts forth--that is a deliberate attempt to get one's mortgage restructured at terms favorable to the borrower; in a sense, by having a restructuring go through, it is another point of price discovery, and leads to mark downs of all assets associated with that price discovery, which necessitates secondary actions on the part of other financial market participants.

That is, as price discovery increasingly occurs, and assets are marked down, it widens the asset/liability gap and necessitates further asset liquidation and or reversions of credit extensions in order to manage one's balance sheet.

It is this issue of price discovery which the Fed probably seeks to forestall as long as possible, as it is a ticking time bomb. For example, when Hovnanian (HOV) recently held its big weekend home sales event, the homes that were sold at a 20% "discount" to original levels essentially marked down the entire neighborhood by levels approaching 20%, and hence an individual's asset side is suddenly worth a lot less, necessitating adjustments in spending habits to reflect such a price discovery in order to maintain similar asset/liability ratios prevailing prior to the sale.

...

for a host of reasons, such as the stigma attached with such a negative credit event on your record and the likelihood that CFC is attaching several pre-requisites to the pool of people they are willing to do this for, among others.

That said, the people that do get through the filter and are willing to restructure their mortgages are likely far worse credits – meaning that CFC’s restructuring is likely to make matters worse by dragging out the inevitable (foreclosure) while providing the incentive (as you mentioned) for borrowers on the cusp to get better terms.

This is, like the Fed’s 50 bps rate cut, an attempt to forestall the inevitable price discovery that will affect these pools of mortgages. In the banking business, it is always preferable (from a cash flow and profits standpoint) to take your medicine all at once rather than delay it, unless, as an institution, you are so close to actual bankruptcy/bank run conditions that you are forced to put off the medicine taking.

Sadly, almost the entirety of the banking industry forestalls anyway.

Commercial Paper is still falling, it's taking more pressure from the Fed to keep rates low, the economic underpinnings of the economy get weaker by the day, and banks still do not want to lend. For now, the equity markets are ignoring all this.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/