Fed Treads Moral Hazard

I am exceedingly late this morn, but I had to direct your attention to the front page article of the Money and Investing section of the WSJ:  Fed Treads Moral Hazard:

"Wall Street has a dream: that the Federal Reserve will rescue financial markets with a sharp cut in interest rates.

Behind that dream lurks a problem, something financial people call moral hazard.

Moral hazard is an old economic concept with its roots
in the insurance business. The idea goes like this: If you protect
someone too well against an unwanted outcome, that person may behave
recklessly. Someone who buys extensive liability insurance for his car
may drive too fast because he feels financially protected.

These days, investors and economists use the term to
refer to the market’s longing for Federal Reserve interest-rate cuts.
If investors believe the Fed will rescue them from their excesses,
people will take greater risks and, ultimately, suffer greater
consequences. Some grumble that the Fed created problems this way in
1998, 1999 and 2003

If the Fed were to cut rates now, it certainly could
help with the current market crisis. The cheaper money would reduce
pressure on stock and bond markets by making it easier to buy
beaten-down stocks, bonds and other securities world-wide. Wall Street
is a powerful lobby in Washington, and its bleating for help can be
hard to resist for politicians, whose campaigns often depend on
financial contributions from Wall Street figures.

But if the Fed were to ride to the rescue, the
skeptics worry, it would encourage people to speculate even more,
creating an even bigger bubble later.

"You don’t want to see the Fed bail out these guys who
have made a lot of money. They have made their bed and you want to see
them lie in it," says a veteran trader at a New York brokerage house.
"Then again, you don’t want to see the economy go into recession."

That, in a nutshell, is the choice the Fed’s policy makers face today.
(emphasis added)

Its a must read — and for you non-WSJ-subscribers, its free just for today.


graphic courtesy of WSJ


Fed Treads Moral Hazard   
Step In and Cut Rates Or Stand By and Watch: Whither Helicopter Ben?
WSJ, August 13, 2007; Page C1

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What's been said:

Discussions found on the web:
  1. mikeVA commented on Aug 13

    Hasn’t the Federal Reserve protected the “moral hazard” of energy dependence, tax-cut and spend fiscal policy, and balance of payments?

  2. scorpio commented on Aug 13

    we can outsource the working class and middle class in this country but god forbid we dont step in IMMEDIATELY when the ownership prospects of the top 1% look shaky. good work Ben. you are a worthy successor to Easy Al.

  3. Deborah commented on Aug 13

    The key word is the first sentence of the WSJ article: “Wall Street has a *dream*…” The problem is that dreams and reality are totally divergent. Postponing the inevitable only prolongs the pain.

  4. david foster commented on Aug 13

    It’s not just the moral hazard–a Fed easing would likely be immediately inflationary and would be a negative for the dollar. The effect on *fixed* mortgage rates might well be to take them higher.

  5. zero529 commented on Aug 13

    Does Congress have the ability to compel the Fed to reinstate M3 reporting?

  6. SPECTRE of Deflation commented on Aug 13

    Treads? The FED has been blowing bubbles for a very long while to keep the game going. What’s left is nothing. All of the money was spent, and now there is only the debt which must be paid back or forgiven.

    The market is still up for the year, yet they can’t allow a normal correction to occur because it brings down the Ponzi Scheme. Throw away any concept of market efficiency. This is all about window dressing for the common sheeple to keep them spending.

  7. michael schumacher commented on Aug 13

    Agree with Spectre….it’s already happening.
    People (and politicians) laugh about the instant creation of money over the last week or so……why just look at the last week??..it’s been going on since last year.

    Why have any moral ethics or do things by the rules when ber”hank”e will just fly in some cheap money and as long as they do more than 5% then it’s supposed to be good for all us “investors”.

    What a crock of shit….

    BTW the BOJ adding liquidity is the biggest joke going…….they’ve been basically fueling the treasurey trade for over a year now.


  8. Fred commented on Aug 13

    I strongly disagree (shocker). This Freeze up was based on irrational fear which led to banks not trusting each other because ONE sub sector couldn’t get pricing on a rarely traded asset class, all the sudden under question.

    Subprime is, of course, a mess, and are being priced as such. That should not send alternate classes of PERFORMING assets into a bid vacume (which has happened thanks to the lock jaw fear).

    There is NOTHING MORALY wrong with providing short term liquididrty to banks which allow PERFOMING markets to continue. CONFIDENCE WILL ALLOW THE (EXISTING) LIQUIDIDTY TO RETURN TO ITS PROPPER path of investment.

    These arguements are the same ones used by the Armegeddans every time…helped along by levergage and punk/fear Blair Witch rumors.

  9. michael schumacher commented on Aug 13

    and as per usual Fred misses the point of the piece in the first place.

    The lack of understanding you continue to display just boggles the mind


  10. MikeW commented on Aug 13

    I’d like to suggest that we not
    take as a given that a Fed rate cut
    would “help with the current market crisis”.

    Our markets are very dependent on the
    choices of international investors. If
    a Fed cut makes the dollar less attractive,
    we could see longer-term interest
    rise, rather than fall, in response.
    New conundrum, anyone?

    No one wants a recession, but they are
    part of the natural economic order. Perhaps
    if we’d worked our way through the last one,
    more naturally, our American economy would be a lot stronger right now.

  11. johntron commented on Aug 13

    there will always be excessive speculation/boom and bust in some market, whether the Fed acts or not.

    The Fed is damned if it cuts, damned if it doesn’t.

  12. scorpio commented on Aug 13

    this Fed, just like under Greenspan, is a pussycat. according to recent disclosures Bernanke only has a couple $MM to his name. he, like Greenie, needs to bail out these 2-and-20 hedgies so they can pay for his retirement.

  13. Sven commented on Aug 13

    Spectre of Deflation…what no website? If you had one, I’d read it.

  14. Fred commented on Aug 13

    Great retort MS…thorough, granular discussion. lol

  15. techy2468 commented on Aug 13


    few questions to you:

    1. do you really believe we are going to be in a bull market in the coming years?
    2. consumer spending is going to drop down going forward, due to the fact that they are going deeper into debt (now they are using more credit cards than before). do you disagree with this?

    3. housing is going down, i hope you agree with this, which means not much home equity withdrawels

    business spending is not bad right now, so is the job market…..but they usually lag consumer spending.

    If the negative sentiment continues, it wont take long for business to go on defensive……your comments on this?

  16. michael schumacher commented on Aug 13


    as witness to the very “thorough, NON-granular” STATEMENTS that you continue to make.

    Don’t worry…a few more days like last week and you’ll be posting on the “hold and hope board”.


  17. Gary commented on Aug 13

    I think Fred’s grammar and spelling should be taken into account when weighing the significance of his opinion.

  18. Bob A commented on Aug 13

    …just like there “is nothing morally wrong” with providing clean needles to junkies Fred right? And condoms to hookers? I say we start giving cars to car thiefs so they don’t have to steal cars too.

  19. Sven commented on Aug 13

    Gary…You mean Liquidididididdity isn’t a word?

  20. Bonghiteric commented on Aug 13

    If, as you point out, the Fed has been juicing the markets with infusions for the last year or so, are you implying that LIBOR and the fed funds rate would/should be higher than than their stated targets? What “rules” are being broken by the Fed’s liquidity injections?

  21. michael schumacher commented on Aug 13

    we all make spelling and grammar mistakes….NBD.

    It’s the content (or lack of it) that matters.

    Providing cash to the system that has shown time and again that it can’t handle (responsibly) what it already has is just giving more crack to the junkie who is in rehab.

    At some point the cord needs to be cut and the cheap money floating around needs to be removed from the system as it’s already proven these people can’t handle it…

    let’s see how many more denials or “no comments” we can get from GS this week. Injecting $3 billion into a fund that was (just last week) in no trouble at all is not what most people call “no trouble”.


  22. howard commented on Aug 13

    i too am not clear why a rate cut at this moment helps. the problem, as i understand it, is that there are no bids for certain securities; there are no bids because no one really understands the underlying performance characteristics given how many “phony” mortgages were issued the last couple of years and securitized.

    a lower fed funds rate doesn’t suddenly help people who shouldn’t have a mortgage pay their current costs, so why should it thaw the freeze up of a particular market?

    (my own belief is that if there was a fed rate cut, long rates would jump, but that’s a separate discussion.)

  23. michael schumacher commented on Aug 13


    It’s not that they do them it’s what is done with the money given to them by off-loading paper to the fed in exchange for cash to push the market up. FOr no other reason than total mismanagement by the very people who recieve these funds.

    There are two drops…Fed (done with acute regularity) and the Treasurey (decides that whatever $$$ is has lying around can be deemed “excess tax receipts” and then given to the broker/dealers to “work with”)

    As an aside since when does our gov’t have a total of almost $80 billion just lying around??? That’s the bullshit the Treasurey would like you to believe when it pushed that out to the market in the form of an “auction”.

    Again…..it’s not they they (FED. Treas.) do this….(it should be) but WHAT is done with this cash.


  24. David commented on Aug 13

    Unlatch the window (Fed)! What if I don’t have a window (ECB)?
    August 11, 2007

    It’s been quite a week. We will assume readers have closely followed the markets. Some observations are in order.

    The European Central Bank (ECB) shot first. On Thursday they injected 95 billion Euro ($130 billion). They called it “fine-tuning.” Right there, they missed a chance to establish world class transparency.

    We call it emergency action to stabilize the markets. It was their largest single intervention ever. It was distributed to 49 banks. They accepted 100% of the bids received. The single largest day intervention prior to Thursday was September 12, 2001 when the ECB allocated 69 billion Euro (100% acceptance for 63 banks). So much for the words “fine-tuning.”

    The ECB announced exactly what they were going to do. They executed flawlessly. Their strategy is designed because of their structure. The ECB does not have a direct discount window. For that purpose, Euro-zone banks would have to go directly to one of the 13 national central banks. That means the ECB would allow diffusion of an emergency response and place it in the hands of the 13 diverse central bank bureaucracies. By their decisive action with partial transparency, the ECB preempted that outcome.
    They followed with more transactions on Friday. They announced what they were doing. They did not explain why. They succeeded in calming the Euro market; however, their explanation was insufficient.
    They have given up nothing in their ability to set the policy making interest rate. They can easily hike a quarter point in September if their governing council wishes to do it.

    The ECB is created by a treaty. Its mandate does not explicitly direct it to calm financial markets. The treaty makes the structure of the ECB extremely difficult to change. The ECB governing council includes the governors of many central banks who are still charged with the lender of last resort function. Clearly, the ECB’s action validates the ECB’s decision to preempt the action involving each country’s central bank. We agree with their concept. The problem is they didn’t explain it. They used the business-as-usual term “fine-tuning” which was the mistake; that diminished their transparency. That is the “why” element they failed to explain to the markets.

    Let’s go to our Federal Reserve.

    We regrettably say that in our view the Federal Reserve (Fed) started out by playing it too “cutesy.” Their first action on Thursday was an unusually large 12 billion repo. They issued no statement and declined to comment when asked. They announced it with their normal Thursday morning notification. It seems they wanted to make it look like business-as-usual.

    There was nothing usual about Thursday morning. Banks were paying three-quarters of a point above the Fed’s policy rate. The Fed must have realized the inadequacy of their first transaction and heard the markets’ complaints. A second repo round was done on Thursday. But the Fed, again, failed to explain its actions to the markets.

    On Friday they announced the discount window invitation. The message to the markets was that the Fed got serious. On Friday they infused liquidity three separate times.

    They also did something which seems peculiar. All we know are reports that there were 19 billion in 3-day Repo transactions involving mortgage paper of some sort. We don’t know what paper; we don’t know exactly why.

    To us the transaction is a puzzle. If the Fed bought GNMAs, they could have infused the same liquidity with a treasury note. If they bought FNMAs, they would be reversing earlier decisions not to do that. If they bought any other mortgage paper (whether AAA or as low as sub-prime) they would be subject to valid criticism of attempting to prop up the mortgage market.

    The Fed’s actions did lower the Federal Funds Rate. No question about that. Unlike the ECB, the Fed was not transparent and some of its operational implementation remains an enigma. This is especially true for the first transactions on Thursday morning.

    I am confident that the Federal Open Market Committee (FOMC) member conference calls and the ECB governing council conference calls reflected members of each who were concerned about functioning markets and systemic risk. The members of each organization are skilled and well intended. The two organizations confront different operating structures. Each had to work within their unique constraints.

    In the Fed’s case, there appears to be minor but important operational glitches in implementation and in achieving transparency under very pressured circumstances. In the ECB’s case, the operational execution was flawless. The explanation to the markets was incomplete. Both banks could improve their transparency. The Fed needs to examine its execution as well.

    For last week we would give the ECB an A minus. Regrettably, the Fed only earns a B.

  25. Fred commented on Aug 13

    Techy…thanks for the civil questions, and MS for the snarky drivel.

    1) Do I think it’s a Bull Market? YES, as do the COT Commercial Traders (aka: Smart Money), as well as massive number of INSIDERS that are buying their stocks right now — the most since 2002. (Granular enough MS?)

    2) I’ve been hearing the death of the consumer since 9/11, the duct tape bottom (‘o3) etc.

    3) business spending shows no sign of retreating….neither do EARNINGS. (How many quarters now have we hear “peak earnings?)

  26. stormrunner commented on Aug 13

    Just my 2c
    I see others here bashing those that defend the system, given the mechanics of the system, Repo’s regardless of the collateral used are not inflationary, they must be paid back in a short time frame. I agree however, tampering with the discount rate again lets Pandora out of her box. The problem is systemic many here agree but very few comment on the merits of an alternative such as chartilism. If we are willing to accept the Debt-Based monetary system, we must also then accept that all money is created in debt and that ever increasing amounts of debt will need to be issued to service the previous debt along with accommadating the natural expansion of the market. Once all debts are repaid money – these “Bills of Credit” or Debt-Notes cease to exist. This is ponzi, no finite system can expand into perpetuity. Once extension of new credit is restrained, given the model of no permanent money supply, servicing existing debt becomes a serious challenge, hence deflation of the existing over inflated assett class and the rudimentary basis for a transfer of wealth from the credit strapped to the flush with cash. Given that this is so easily manipulated and the frequency of the complaints, I have trouble understanding why people would even expect the owners to play nicely. We have given them the tools through ignorance of the mechanics to allow this charade.

  27. michael schumacher commented on Aug 13

    >>3) business spending shows no sign of retreating….neither do EARNINGS. (How many quarters now have we hear “peak earnings?)>>

    Earnings have basically sucked this qtr. Enough people here will call you out on that alone.

    Talk about Drivel


  28. Fred commented on Aug 13

    Really Michelle?

    From Zachs Aug 6th 2007:

    A total of 404 companies in the S&P 500 have reported, or 80.8% of the total. As in recent quarters, positive surprises dominate disappointments, currently by a ratio of 3.6:1, roughly in line with a week ago. The median surprise is a very healthy and continues to climb as the season wears on, currently at 3.33%, up from 2.78% last week, and up from 2.36% two weeks ago. The median growth rate among those that have already reported also continues to rise. It is now at 13.73%, up from 12.78% last week and up from 9.38% two weeks ago. It now looks clear that we will have yet another quarter of double-digit median year-over-year growth (20 in a row).

    Don’t let the facts get in the way of your “story”.

  29. michael schumacher commented on Aug 13

    not my story…..it’s the story of reality. Something that your “facts and figures” somehow disregard.

    I can tell ANY story I want with statistics…….it’s not worth much when it disregards reality. AS those do…..

    I guess you did’nt know that.


  30. Fred commented on Aug 13

    MS…Please educate us mere mortals…

    How and why (specifically) does this current quarter’s earning “suck”?

    I’m sure the record numbers of insiders buying their own company’s stock want to know why they’re so dumb.

  31. michael schumacher commented on Aug 13

    educate you??? I don’t have that much time Frederique….

    Stock buybacks as an indicator of economic health??? Wow… you are more clueless than I originally thought. WHy don’t you look at the little box BELOW where you get the purchase information from. You’ll see quite a difference in those.

    Does the term dilution mean anything to you?
    Probably not.

    Good luck with the ostrich view.



  32. wunsacon commented on Aug 13

    stormrunner, so is Weimerica your vision? Should we just play along on the long side because that’s the direction the federal government is pushing everything? Or is the federal government going to keep rates where they are (or increase them) to fight inflation and force the cash-strapped to sell to those with cash?

  33. Fred commented on Aug 13

    How and why (specifically) does this current quarter’s earning “suck”?

    PS…there’s a difference between buybacks, and insider buying. Lol

  34. techy2468 commented on Aug 13

    Fred. i heartfully wish that you are right and the consumer and business are not going to cut down.

    but if i am not wrong, consumers got a good reprieve dut to the housing boom of 2003-2005, and they took out a ton of money from home equity to continue the shopping and to pay all their credit card bills.

    so if this data about consumer debt is right…..we will see some serious damage in next 4-5 months. and cutdown in business spending will immediately follow the consumers.

    and if the below graph on calculated risk is right….retail sales have been falling since a year…



  35. michael schumacher commented on Aug 13


    When you answer the many questions that you’ve left hanging over the last few weeks you can then be able to get upon the soap box and ask questions…Unitl then STFU

    or would you like to answer the other issues that have been brought up to you and you continue to ignore??

    I’ll start with the wage question you have dodged for more than a month…..
    I know you remember……

    did’nt think so.


  36. techy2468 commented on Aug 13

    sorry for too many comments.


    one more thing, just because everyone thinks this is a bull market….we dont have to follow, right?

    i means was not the smart money buying tech stocks in 2000??

    right now everyone is having a record profits….does that mean they will have a great time going forward. I am sorry but it only means they had a good time in the past.

    i do not believe in the doom gloom theory too, because people are just stretching the data towards the extreme scenario….

    but the data currently points to a slowdown….which we cannot escape unless we inflate everything by a big amount (since debt is the problem, which can be reduced by inflation) everyone gets a 50% pay hike….and we can continue the binge for few more years.

  37. stormrunner commented on Aug 13

    wunsacon said:
    “stormrunner, so is Weimerica your vision?”

    Wow you either have not completely read my posts or do not understand the point. This Debt-Based Monetary system is designed to do exactly what is doing

    —If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks…will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered…. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs. -Thomas Jefferson

    If we end up in “Weimerica” slowly inflating and monetizing our way along it is because the system is fatally flawed and can not be repaired other wise short of a serious recession or depression to purge the system. This is the fate of all Debt-Based fiat currencies. I am screaming for reform.

    ….The problem is systemic many here agree but very few comment on the merits of an alternative such as chartilism.

    ….This is ponzi, no finite system can expand into perpetuity

    You either missed these sentences or do not know what a chartilist is.

    To summarize chartilists believe in debt-free permanent money spent into the economy as opposed to Debt-Based “Bills of Credit” which disappear as the debts are serviced. This design is nefariously a form of debt slavery at the Big Picture level

    Insinuating a lack of understanding on my part as if I’m advocating inflation is counter intuitive.

    Please educate yourself as to the pit falls of this I repeat “Debt-Based Monetary system”
    “Money as Debt” 47 min you’ll have entirely new perspective on the second most important aspect of any society behind the rule of law.

    For a greater understanding of these concepts see “Money as Debt”
    Also refer to the posts were I already stated some of these points in answer to your question @. helicopter-drop

    and again @ the greenspan kaput

    Then return and please slam me with rational reasons why I am incorrect. Believe me I would like nothing more than to be delusional about this. I could then sleep easy, confident that the world my son inherits will be better than the one passed down to us.

  38. stormrunner commented on Aug 13


    You know I think I’m too passionate and misinterpreted your question by “vision” you probably meant prediction as opposed to prefered outcome, my apologies. At any rate I’m know expert just a reading a lot of experts. I make no assumptions about the near term other than that this is one hell of a mess that the FED can not absolve themselves of.

  39. wunsacon commented on Aug 13

    Hi stormrunner. Yes, I meant “prediction” and not “what you hope comes to pass”! ;-)

  40. bastiat commented on Aug 13

    The Big Picture: The Motion Picture

    Fred: Current corp profits are not bad.

    M “Ciao”S: Earnings suck. Everybody knows that.

    Fred: Current data says they’re fine.

    M “Ciao”S: Pshaw! Statistics is for wimps.

    Fred: Then why do earnings “suck?”

    M “Ciao”S: Shut up, that’s why.

  41. SPECTRE of Deflation commented on Aug 13

    Fred, when it’s all said and done, let’s just say that they swapped junk for junk. We have $50 Trillion Dollars in unfunded liabilites as a country. We can never pay it back or make good on all the promises we have made.

    Let me also say that the FED will be unsuccessful in propping up the credit market with it’s puny infusions. We have $545 Trillion in Derivatives out there that people are having more and more of a hard time putting a value on [It’s a real be-atch when you can’t catch a bid]. It’s gotten to the point where it’s infecting the ABCP credit market so check your MM account for problems Bro.

  42. SPECTRE of Deflation commented on Aug 13

    If, as you point out, the Fed has been juicing the markets with infusions for the last year or so, are you implying that LIBOR and the fed funds rate would/should be higher than than their stated targets? What “rules” are being broken by the Fed’s liquidity injections?

    Posted by: Bonghiteric | Aug 13, 2007 11:49:04 AM

    Firstly, it’s not a year or so. The velocity of money, actually credit, is about to enter a hotrod in NASCAR. 14% M3 growth equals a doubling of the supply of money/credit every 5.25 years.

    In fact , if I’m not mistaken, we exceeded our legal debt ceiling last week after beiing told weeks ago by Paulson that that problem wouldn’t occur until Oct. 2007.

  43. mhm commented on Aug 13

    bastiat, thanks for the executive summary.

    The plot might get better if we all stop feeding the troll.

  44. stormrunner commented on Aug 13

    Even though I am completely unqualified to predict the future, I am a firm believer in mean reversion. Being that the whole debacle seems to have originated at loose monetary policy followed by unrealistic price appreciation of residential housing, whose paper was then packaged, sold and re-leveraged. Mean reversion especially an over shoot is likely to occur resulting in housing related asset depreciation. Even if the FED tries to inflate out of this it’s not likely that employers would be willing to pay the wages, or consumers willing to pay the prices necessary to sustain these leveraged positions, at any level from the people who took the loans to the people who bought them leading to default. It is more likely some balance will occur between the two. There should end up some divergence where notable depreciation > 20% occurs in housing and unknown price reductions in consumer durable goods due to lack of interest. While financing, due to risk aversion, consumables food, fuel etc rise in cost as the FED too late to the party inflates to dampen the carnage. Eventually, I don’t know when, wages will catch back up to falling asset prices for what will be the new scaled down middle class. I expect the asset deflation part to be less than 18-24 months followed by a return to asset inflation shortly after, simply because that’s the nature of the system. Assets get more expensive as time progresses baring some event in this case FED intervention to 1%(swing from median first up then down then back up). This would be my vision FWIW

  45. tt commented on Aug 13

    MS is a TROLL

  46. Eclectic commented on Aug 13


    Add together your:


    Currently Underfunded Nominal Trauched Securities, and then… add my newly defined:

    Syndicated LAyered Participation Notes…

    And we can come up with a very good definition of moral hazard.

    It’s when you buy the securities and then you get either: 1) – F’ed, or 2) – bitch slapped.


  47. Clyde commented on Aug 13


    I have a theory that the injections are a tacit admission by the Fed that Countrywide, Bear & Goldman are “too big to fail”. Countrywide because of its mortgage leadership and the others because of the havoc it would create with counterparty credit across all derivatives.

    And one more thing, I would read your blog a lot more often if you would exercise discretion in removing posters that engage in repetitive boorish behavior.

    Other than that, I like the way you roll.

  48. jules commented on Aug 13

    Barry…can you muzzle the MS “ciao” troll?
    He is extremely annoying, and omnipresent.

  49. Eclectic commented on Aug 13

    Ciao’s got a voice… Let him speak.

  50. Jack McHugh commented on Aug 13

    Good Afternoon: Rather than with expectations of glee over M&A announcements, investors are now opening their Monday morning newspapers gingerly and with trepidation that another financial player is somehow in trouble. A peek at the headlines in this morning’s Wall Street Journal revealed that not only were no big LBOs consummated over the weekend, but also that more than one quantitatively driven hedge fund has landed in the financial equivalent of knee-deep rough. Two of the more prominent funds to admit to hefty losses recently were Goldman’s Global Equity Opportunities Fund and its Global Alpha Fund (see story below). The former offers investors the ability to redeem on a monthly basis, so it is no surprise that Goldman ponied up $ 2 billion of its own capital to help see the fund through this period of turbulence. That outside investors, including Maurice Greenberg, were successfully recruited to toss in another billion to the fund is a testament to the marketing ability of Goldman Sachs. Since Global Alpha only offers quarterly redemptions, Goldman decided not to infuse this fund with shareholder capital — at least not yet.

    For stock market participants, however, the news that Goldman was stepping in to help at least one of their troubled funds was deemed bullish. That retail sales figures for July came in a hair above lowered expectations also helped, but equities started the day on a distinctly positive note. The major averages were up almost 1% at the open. As it turned out, however, those prices represented the highs for the day. The Fed apparently intervened again in the money markets, but the size of their open market operations were deemed too small by many to represent a true helping hand. After sliding off the morning highs, the major stock indexes rallied by 0.5% or more on three occasions, only to fall back each time. By day’s end, most of the averages finished slightly in the red, though it’s worth noting that the Russell 2000 did fall more than 1%. Bonds turned in a solid day. Treasury yields dropped anywhere between 3 bps and 5 bps. The dollar had a mixed day, as it rose against the euro and resumed dropping against the yen. Like stocks, commodities were also 1% higher in the early going before slipping back as the day wore on. Higher prices for crude oil and its products enabled the CRB index to hold on to a gain of approximately 0.2%.

    The other two stories you see below came out during while the markets were open and no doubt contributed to the pullback in share prices. A Canadian firm, Coventree, came forth to admit that it couldn’t roll its Asset Backed Commercial Paper (ABCP – see story below). It extended the maturity date for its existing paper and is trying hard to line up temporary (read: emergency) funding. Anything that threatens the viability of the money markets is serious, and Coventree apparently is not tiny. The other story of note is that private equity firm, KKR, announced that its funding costs for LBO transactions had “increased significantly”. In a filing with the SEC, KKR summed it up the difficulties facing the entire PE fraternity:

    “More costly and restrictive financing may adversely impact the returns of our leveraged-buyout transactions and, therefore, adversely affect our results of operations and financial condition,” KKR said in its filing. (source: Bloomberg article below).

    Gee, no wonder the newspapers and airwaves have been so quiet about LBOs lately. They’re getting more costly to complete and thus make less economic sense than when lenders were blithely handing over funds earlier this year. Private equity firms have two unappetizing choices. They can either forge ahead under the current financing regime and make less money for themselves and their investors, or they can step back and buy companies at lower prices than on offer today. As painful as this episode has been for some, the major averages still have yet to drop by even 10% (the lone exception is the Russell 2000, which is right now 10% off its peak). So the so-called LBO put is alive, if not well, and, in options parlance, is definitely “out of the money”. If the stock market drops 20%, we’ll once again see some deals hitting the left hand column of the Wall Street Journal. It’s my guess, though, that investors won’t be looking forward to M&A Mondays like they have in days gone by.

    Goldman Global Equity Fund Gets $3 Billion in Capital

    KKR Says Financing Costs `Increased Significantly’

    Coventree Fails to Sell Asset-Backed Commercial Paper

  51. stormrunner commented on Aug 13

    On a different note there is an interesting article over at financial sense attempting to define the magnitude of the recent debacle. It sites methods of deception akin to Enron fame.


    What now appears to be ‘systemic problems’ in the Financial System all began with revelations by Bear Stearns.

    Interestingly, in Bear Stearns latest 10-K filing with the SEC, they self-describe [at the top of page 54 if you want to play along at home] their activities conducted in off-balance-sheet-arrangements are described as follows:

    In the normal course of business, the Company enters into arrangements with special purpose entities (“SPEs”), also known as variable interest entities (“VIEs”). SPEs are corporations, trusts or partnerships that are established for a limited purpose. SPEs, by their nature, are generally not controlled by their equity owners…..

    …make mention of the use of SPE’s – where the use of derivatives is concerned – because this term has a familiar “ring” to it. SPE’s were the very same accounting structures which Enron used to hide a quagmire of fraudulent OTC derivatives transactions.
    The Whitewing SPE is only one of the thousands of Special Purpose Entities set up by Enron CFO Andy Fastow with the assistance of its auditor, Andersen, and its law firm. The SPE appears to be almost hopelessly complex to hide risk as well as hide the trail of the millions of dollars Andy Fastow was making in double dealing at Enron.

    So, Bear Stearns – with a current VaR of 28.7 – appears to have lost perhaps as much as 3 billion dollars:……
    To lose 3 billion on this amount of aggregate business implies a “virtual write-off” of the whole business segment.

    Here, we can see that Citigroup [Citibank] has VaR of $121 compared to Bear Stearns at $28.7, and Bear Stearns lost HOW MUCH?

    Interesting read.

  52. Barry Ritholtz commented on Aug 13

    I don’t think Beat Stearns is too big to fail — Goldman, or Citibank or even JPM, maybe.

    But Bear? Nah . . .

  53. mhm commented on Aug 13

    Every other investment bank wants to see the Bear skin hanging dry since the LTCM affair…

  54. angryinch commented on Aug 13

    Oh Fred, such a kidder!

    Insiders bought a lot of stock in 2002. Correct. They bought ALL THE WAY DOWN. They also bought a lot in late 2001. Patriotism, don’tcha know.

    Some rocket scientist on Realmonkey.com made the same point as you. He was jizzy with delite that insiders at financial companies had bought over $45 million worth of shares since June.

    Is that a lot? Better than nothing, I guess.

    But for comparison’s sake, note that Angelo Mozilo of Countrywide SOLD over $45 million worth of CFC (or is it KFC?) since June.

    So the insiders at other financial outfits had better step up their buying to keep up with Tan Angelo. Nobody sells stock quite like the Tan Man can.

  55. SPECTRE of Deflation commented on Aug 13

    Spectre of Deflation…what no website? If you had one, I’d read it.

    Posted by: Sven | Aug 13, 2007 10:43:15 AM

    Thanks very much for the complement. I have given some thought regarding doing a blog, but know very little of the mechanics of actually setting a blog up. It might be fun. Anyone with sites that would be helpful in that endeavour would be much appreciated.

  56. Eclectic commented on Aug 14

    Merle Hazard,

    Too funny! Thanks.

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