Since August of last year, the Fed has been behaving much of the time like the last car on the roller coaster, following the trends downhill as they pick up speed. The Fed should have been taking pre-emptive action months ago. However, it keeps responding to panics rather than heading them off. The Fed’s desultory pace of interest rate reductions, and its lack of anticipatory action to stave off panic in the Fannie Mae and Freddie Mac markets are but two examples. The NYT:

The latest signs of panic in the markets came last week. Banks began calling in loans they had made to hedge funds, mortgage companies and others, forcing them to sell billions of bonds. The moves prompted concern about securities backed by Fannie Mae and Freddie Mac, the large government-chartered buyers of mortgages that many investors believe have the implicit backing of the federal government. When big investors are forced to quickly dump billions of dollars in securities, trading can seize up, especially when buyers are scarce, as they are now. Just a few weeks earlier, a similar bout of forced selling drove down the prices of municipal bonds issued by states and cities.

And now a trader’s perspective from Jim Cramer on the same subject of the implicit guarantees of agency paper:

# 1. The Treasury and the President saw fit not to endorse the “implicit” guarantee for Fannie Mae and Freddie Mac paper. For those of us who have bought and sold this paper for most of our lives, this was the signal that almost everything could be worthless. Their refusal to acknowledge the problems was so in the Hoover playbook that it was shameful.

# 2. We always figured that you should be able to lever up if you are in the bond market, with nine to one being an acceptable level for rock solid collateral like Fannie Mae mortgage paper, which was presumed to pay off at par with the only question being when. Now, because the question is no longer “when,” but “if” that level of leverage is going to be obliterated. Maybe three or four times is all we will get. There have to be trillions of dollars at risk in loans right now because of that loss of implicit guarantees.

The Fed should have had a plan for this. We have had sequential runs on markets for months now, and it was only a matter of time before the “implicit” government guarantee of certain mortgage paper was tested. But what is to be expected from a Fed that has allowed itself to get far behind the curve in cutting interest rates — so far indeed, that little cuts were followed by huge market declines, and big cuts were enacted as explicit responses to market panics (the two 25bp rate cuts were followed by serious market deterioration, while the 75+50bp cuts that occurred close together were a reaction to world panic in the markets):

The Fed has twin self-inflicted problems, in our view. First, it has lagged far behind what was necessary in cutting rates. That has exacerbated the housing market decline, created an ideal environment for shorting the dollar (eg, oil price speculation), and provided the perverse incentive to real estate buyers to put off buying until the pokey Fed gets around to providing its lowest Fed Funds rate, maybe in late 2008, thus further prolonging the real estate downturn. Second, the Fed’s (and Treasury’s) silence on AAA securities thought by market participants to have a government guarantee is deeply troubling, amplifying uncertainty when credit markets are already precarious. All in all, a questionable performance.

Question: how will it be possible for troubled Carlyle Capital to “stretch out” its debts secured by agency paper if the value of that paper is currently unknowable?

This entry was posted on Sunday, March 9th, 2008 at 3:45 pm and is filed under Democrats, General, Republicans, business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.