The Fed and LIBOR

watch that TED spread widen to levels NEVER seen before……..

The Fed knows what they have to do however they will behave like most children when told what they HAVE to do.

Freddie sees losses upwards of $12 billion but GS,HSBC are seeing the HOD.

What garbage

Ciao
MS

From an excellent Sanford Bernstein piece today. Guy was former Treasurer of MS.

The reason that funding tightens at calendar year-end is that as December 31 approaches, commercial banks begin to reduce their discretionary lending activities in order to “window dress” their balance sheets for year
end. And as this large funding source disappears, the cost of funding over that short period near December 31 rises rapidly. For the fixed income divisions of the institutional brokerage firms, because their year end is November 301, this presents an earnings opportunity. The US brokerage firms increase their balance sheets and purchase assets that have been shed as part of this year-end window dressing by the commercial
banks and provide funding at highly attractive rates2 through financing trades.

For the short-term funding desks of the brokers, this means that December 31 is typically the worst day of the year. A day that starts in Tokyo and Hong Kong with funding desks drawing down all available Asian currency lines of credit, followed by similar actions in Milan, Frankfurt and London and ending the day in New York with the US funding desks borrowing from all the regional banks until the Fed Wire closes, then calling the banks in New York City to draw on their lines. Finally, when the NY Clearinghouse closes at around 8:30 pm, the Corporate Treasurer would then call the major clearing bank such as BONY or Chase
and literally beg for that final $100 to $200 million dollars needed to cover the last hole in the balance sheet.

This bit of Wall Street trivia is important because the 2007 year end is going be much, MUCH more ‘exciting’ than normal because major commercial banks around the world, which have suffered losses in Q3 2007, are now in challenging capital positions. To shore up their Tier 1 capital ratios and to appear both liquid and financially strong when they print their 2007 year-end balance sheets, the only available solution is to reduce discretionary loans and shed assets prior to year end.

However, for brokerage firms, the funding and liquidity challenges of August have not been forgotten. Commercial paper issuers have reduced the tenure of their maturities and a significant portion of the brokers’ balance sheets have become less liquid as conditions have worsened in the structured product and MBS marketplace. As such, it appears that the Street is attempting to remain very liquid at year end in the
face of much more attentive rating agencies and very concerned counterparties. Morgan Stanley has publicly stated that it “is husbanding” liquidity. So this year, the major capital markets brokers appear to be
passing on the opportunity to peak their balance sheet.

As we near year end, the bond market (or at least Agency paper), Alt-A and Sub-Prime MBS sectors as well as all of the structured product sectors of the bond market are being starved for financing. With limited
funding available, one-month LIBOR (which now matures after the year-end) has gapped out to over two percentage points higher than the federal-funds target. The total U.S. commercial paper market (a source of
short-term funding for daily operations at many companies) has declined and, not surprisingly, the U.S. asset-backed commercial paper sector, which has contracted by about a third since August, continues to shrink.

FedIn a rare instance, investors may be looking at the Fed meeting with greater interest in the changes in the discount rate, rather than the federal-funds rate.

It’s anticipated that the Federal Reserve will lower the federal-funds target by 0.25 percentage point at today’s rate-setting meeting, but the market is watching to see if the Fed narrows the difference between that rate and the discount rate — the rate at which banks can borrow from the Federal Reserve’s discount window.

That rate currently sits at 5%, or a half-point difference, down from the full percentage point difference back in the summer. And economists are hoping the Fed takes further action here, perhaps even eliminating the premium the discount rate holds over the funds rate, to stimulate more lending.
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