The markets seem to have shrugged off some of the fears on the back of the Feds recent unprecedented policy changes: the granting of access for non-banks and primary dealers to the Feds lender of last resort borrowing window and last weeks announcement of a swap of up to USD 400 Bn of Treasuries for illiquid and sharply marked down MBS securities and other non-bankable structured product.
In addition the policy measures also include the ultimate hypocrisy of announcing that the GSE’s (Fannie Mae, Freddie Mac etc) will soak up another USD 200 Bn or so of mortgage risk through a relaxation of capital requirements on these institutions. Nothing illustrates more clearly that Fed is running out of rabbits than the fact that these institutions are now viewed as part of the solution to the mortgage mess in spite of their widely publicized risk management and accounting problems and their reluctance to so far recognize their mark to market losses on their mortgage portfolios. A proper investigation of this situation may one day reveal that senior US policymakers and the management of these organisations knowingly allowed these firms to “trade while insolvent” in the vain hope that they could contribute to the bailout “plan”.
Therefore it is not surprising that the markets are not aggressively biting on the pill. The Fed’s actions, while spectacular have done little to change behaviour. The flight to safety and hoarding of cash has seen the short end of the Treasury curve bought to down to a point where yield levels for certain maturities are at levels below that of Japan. The yields of TIPs are actually negative. The Ted spread has spiked again, the Treasury repo market is experienced a significant incidence of failed settlements. Ten-day historical volatility, has spiked up to a 52-week high of 37.89 on the SPX indicating greater market uncertainty and the potential for higher VIX readings. These conditions are wreaking havoc on banks and non-banks heavily laden with structured products and on hedge funds who run strategies that are dependant on high leverage and friendly markets.
The reality is that while the Fed can pump out liquidity in humungous amounts, it can do little to make market participants relend these dollars, and more importantly, because of that it can do even less to alter what is rapidly turning into a solvency crisis of massive proportions.
It is not too farfetched to say that we have only seen the beginning of what will likely be several further rounds of loss realization and the failure of additional Financial Houses and Hedge Funds.
The slumping U.S. economy has already hit Canada’s manufacturing sector hard since demand has been squeezed for Canadian shipments of everything from cement and auto parts to lumber, industrial products and roofing supplies, which come mainly from the industrial provinces of Ontario and Quebec. But an even greater drop in economic activity south of the border will eventually spread to all provinces and cut growth projections for all parts of Canada. Loan losses are set to rise further.