Slow Motion Train Wreck

How long the Fed can keep the train on the tracks remains to be seen but I agree with Sedacca that it might not be too long. Capital impairments are simply too high, and the combination of rising unemployment, imploding commercial real estate, and homeowners walking away will be too much for lenders to handle. One or more major banks and broker dealers in addition to Bear Stearns will not survive the coming train wreck.

Citigroup, Merrill, Morgan Stanley, Lehman?

Existing Home Sales & Supply

Existing-home sales – including single-family, townhomes, condominiums and co-ops – rose 2.9 percent to a seasonally adjusted annual rate (1) of 5.03 million units in February from a pace of 4.89 million in January, but remain 23.8 percent below the 6.60 million-unit level in February 2007. The sales pace has been in a fairly narrow range since last September.

The national median existing-home price for all housing types was $195,900 in February, down 8.2 percent from a year earlier when the median was $213,500.

Also in the NAR sales report is the following:

Home prices within metropolitan areas are more telling. The most recent data shows roughly half of the metro areas in the U.S. with price increases, with healthy gains in markets such as Oklahoma City and Trenton, N.J.

What is conveniently left out of this bit of optimistic drivel is that the "most recent data" is from the third quarter of 2007, before all the bad stuff started happening. Some time ago, the NAR cited these statistics and they claimed price increases in two-thirds of metro areas - that was for data through June of 2007.

Look for these claims to disappear as soon as the fourth quarter data is available.

S&P Flags Goldman, Lehman

Standard & Poor's, in a continuing sign of loss of confidence in investment banks' profitability, Friday put Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc. on negative outlook, lowering them from stable.

Although S&P didn't change the senior-debt ratings from AA-minus for Goldman and A-plus for Lehman Brothers, it brought its view of the likelihood of a precipitous decline in profits at the Wall Street firms during the next two years to the same negative levels it previously assigned to Merrill Lynch & Co. and Morgan Stanley.

The changes in the ratings outlooks are appropriate despite the fact that recent actions by the Federal Reserve have instilled confidence in the capital markets, S&P added.

"We believe that negative rating outlooks are broadly appropriate for the independent securities firms, reflecting the potential for a more substantial decline in profitability from capital-market activities," S&P said in a report whose principal authors are managing director Scott Sprinzen and analyst Diane Hinton. "Our current expectation is that net revenues could decline 20%-30% year-on-year" after write-downs.

The Fed becomes a Subprime Lender

The Federal Reserve may be a central bank with special rights and obligations, but in the end it, too, is a bank and has to be very careful who it lends to and what kind of collateral it accepts in exchange.

From a bank analyst perspective, during the last few months the Fed has become increasingly more lax in its lending practices. It is financing highly leveraged investment banks and brokers and accepting a wide range of illiquid securities as collateral, particularly MBSs.

As of March 12, 2008 the Fed had almost $891 billion in assets, of which $660 billion were in Treasury bills and notes and $170 billion in an assortment of repos, the TAF facility, etc. The most recently announced programs like the TSLF ($200 billion), the open-ended discount window facility for investment banks/brokers and the $30 billion loan to Morgan (i.e. Bear's toxic assets) are not shown yet.

Like any other bank, the Fed does not have an unlimited amount of money to lend - all it has is about $660 billion in Treasuries that it can exchange for other, less marketable securities (and it has already announced programs for a big part of that). In contrast, US home mortgages alone amount to $10.5 trillion; if things keep unraveling, the Fed's balance sheet will prove very small for the role it has now chosen for itself.

As for the liability side, the Fed has issued about $781 billion of its own Federal Reserve Notes, i.e. dollars. Our currency is thus increasingly going to be backed by lower quality, riskier assets that no one else wishes to buy or lend against, instead of Treasurys. In effect, Mr. Bernanke is betting the farm on a quick real estate/mortgage turnaround and a very shallow recession. Worse still, instead of charging a higher interest rate for the loans made against the riskier collateral, the Fed keeps cutting rates.

Let's summarize: riskier borrowers, low quality collateral concentrated on real estate, questionable appraisals for market prices and "low, low rates". Is the Fed turning itself into a sub-prime lender? If I were a bank examiner, I would want to have a quiet word with Mr. Chairman about his lending practices.

And if I were a shareholder or creditor of the Federal Reserve Bank (remember what its liabilities are), I would be worried. As, indeed, so many already are - they are those who are exchanging their dollars for other currencies and commodities.

Foreign investors veto Fed rescue

Asian, Mid East and European investors stood aside at last week's auction of 10-year US Treasury notes. "It was a disaster," said Ray Attrill from 4castweb. "We may be close to the point where the uglier consequences of benign neglect towards the currency are revealed."

The share of foreign buyers ("indirect bidders") plummeted to 5.8pc, from an average 25pc over the last eight weeks. On the Richter Scale of unfolding dramas, this matches the death of Bear Stearns.

Goldman & Lehman Earnings

Those were not good earnings. Those were horrid earnings. However, the end of the world that many were expecting did not come. It's hard to say for sure but the realization the world is not ending today is likely what's behind this rally. The Fed's rate cut today that everyone is yapping about on CNBC likely has nothing to do with it.

Lehman may not be Bear Stearns but it is still leveraged 30.7 to 1. Citigroup and many financials are hugely leveraged as well. Eventually the market will have to face a deleveraging of those assets. Huge additional writeoffs are coming. Furthermore, many homebuilders are going to go bankrupt and today does not change that. But that is not today's business.

Today's business is simple: The much anticipated end of world did not come. Looking forward however, the underlying economic fundamentals have not changed.

Are the Fed & Financial Institutions Runing Low on Ammo as Projected Losses Escalate?

Housing Value = $20 Trillion

Outstanding Mortgages = $11 Trillion

Fannie Mae & Freddie Mac Share = $1.5 Trillion portfolio + $3.4 Trillion guaranteed

Household Equity = $9 Trillion ($3 Trillion > 30% decline)

Estimated Loss on All Credit = $1 to $2.7 Trillion

Capital of All Banks, Savings,
      Credit Unions, Hedge Funds, GSEs = $1.7 Trillion

Fed Capital Remaining = $400 Billion