Saturday, August 18, 2007

The Wyle E. Coyote Acme Credit Loan

The Fed's over night discount rate cut of Friday has a lot of people wondering; "What is going on?" and "Why it was done?" I could be shot again for over simplification on this one. On the plus side, there are no complicated graphs, so read on.

Imagine a bunch of little stores that are about to open in the morning. Before they open, they go to the cash register and put in their transaction money for the day. This would be something like 5 20’s, 10 10’s, 20 5’s and 40 1’s and quarters, dimes nickels and pennies. This money is needed to open the store. The bigger the store, the more transaction money is needed.

Now let’s go one step further. Suppose the money is not there to open the store. Most businesses have an open credit line with their bank for such occasions. They can go down and borrow the money. What the heck, at the close of business, they can pay it back.

On to step three, the banks issue these lines of credit to businesses thinking that maybe only five to ten percent of their clients will call for such a loan at any one time. They were not counting on all of their clients lining up at the credit line window at the same time. The bank at this point has over contracted these lines of credit, and has to go to the Fed window for an overnight loan. Wasn’t it Countrywide that exercised their line of credit for 11.5 billion Thursday with 41 lenders?

So what is happening? New money is not flowing into the system. People are not borrowing, buying or what ever. The money supply is contracting. Lowering the discount rate, allows banks to make those loans to business so they can open with cash in the drawer ready for business. It’s no longer an over-nighter, hey pay us when you can. I think the Fed is stealing the same boiler plate previously used on home loans.

But why did the stock market go up? The increased access to liquidity allows the big traders to exercise their credit lines. After all buying and selling stocks is a business. You’ll notice that Bernanke picked an expiration Friday, (before the market opened) to drop the discount rate, which burned the short option players royally. Done like a true professional!

Halloween is early this year, the third Friday (Thursday if you're smart) in September, a Triple Witching Expiration. I guess I’ll mosey over for some cider and donuts at the 11.5 billion dollar bon(d)fire.

29 comments:

Anonymous said...

Love your blog, but you'll have to indulge me here -

Correct use is businesses, not business's.

['s] = possessive. "The car's tires were flat."

[s or es] is plural. "There were two cars in the driveway.

Love me , hate me, I am the apostrophe police.

Again great blog.

Jim in San Marcos said...

Hi Anon

Thanks, I corrected it. I can't blame this one on spell check.

Glad you enjoy it

Take care

Anonymous said...

How far can the FED go to easy CFC's pain?

Jim in San Marcos said...

Hi Anon 10:37

CFC is toast. They're so big that this credit line is just money to keep the cash register open and meet payroll. You can't force people to buy houses.

The problem lies with the banks. I don't have any statistics, but I would bet that the banks have written line of credit agreements with their business customers for twice of what they can actually deliver.

This in itself is not a problem, but when supply of an item declines, prices for it rise. Bernankes end run, is to thwart a bidding war for short term bridge loans.

The loan is taken on by the business in the hope that things will get better. But if things get worse, you have more time to go broke.

Anonymous said...

I`m new to all this, can you spare a minute and answer a few questions? 1. The third friday in September, is this the day that the fed will want it`s money back? 2. The gold bugs are all claiming that gold is going to (as they say) "go to the moon". Is there anyway that gold could be in a bubble itself, being as it has skyrocketed in the last couple of years? 3. Could this turn out to be a 1929 type of depression instead of an inflationary Germany type of meltdown? What I`m trying to say is, how can you have inflation if nobody has any money to buy anything? Won`t China ease up on the natural resources if the global economy tanks? 4. I`ve heard people say that the amount of paid off home mortgage`s in the U.S.A. is considerable. If this is so, how can the small amount of sub-prime mortgages affect the global economy so much? Is it a confidence issue?

Jim in San Marcos said...

Hi Anon 5:08

The Triple-witching day is the third Friday of the month that ends each quarter. It marks the simultaneous expiration, at the close, of stock options, index options and index futures. It's just a very volatile day for the stock market.

Normally the Fed Discount window has a next day settlement--they've extended it to 30 days and are accepting as collateral some rather questionable securities

The price of gold isn't going to the moon. Your currency could be going to zero. If gold was suddenly worth a million dollars an ounce it would still only purchase 200 gallons of gasoline or be the equivalent of one weeks wages. How much paper will you trade for an ounce of gold? Gold keeps its value paper money doesn't

If everyone is broke, the government receives no tax revenues. In Germany's case, the government tried to print their way out of a bad situation and it didn't work.

About half the homeowners in the US have their home free and clear of a mortgage. The real estate market jumped in value from six trillion dollars to twelve trillion dollars. As the market comes back to realistic values, six trillion dollars of debt will vaporize. To aggravate things even worse, there is about 2 trillion in credit card debt.

There is a confidence issue. As long as people feel confident things will be OK. That warm and fuzzy feeling is fading fast.

Anonymous said...

Thank you Jim, you`ve cleared up a lot for me. Thanks for taking the time to explain something to a novice.

Anonymous said...

What would happen to the market if Countrywide does go bankrupt? It seems to have everybody's attention, including the Fed. How long do you think CFC has and will it leach off the bank depositors money?

Jim in San Marcos said...

Hi Anon 7:52

I don't think it would do much if Countrywide went bankrupt. It might just be the way to survive and stay in business. Just as a guesstimate, 61,000 employees at $20/hr comes out to a payroll of 2 billion a year. They went out and tapped their line of credit for a whopping 11.5 billion.

There is definite need for their service; the only catch is that the present market can't support an organization that big. They have to downsize by 75%.

I would guess that Countrywide's bridge loan lenders (considering the vast amount loaned) expect some sort of collateral to be secured with the funds advanced. It could be that Countrywide is forcing their current loans of good quality onto the banks using their credit line commitment from the banks.

I don't think that the banks would loan 11.5 billion to anyone to meet payroll especially if you have a bleed rate of 2 to 5 billion per year.

The thing that makes me believe that they may collapse is that it would be almost impossible to downsize and honor lease commitments for each business location and all of the advertising contracted out. I don't know how many offices they have, but you would have to figure anywhere from $2K to 5K per day to turn the key in the door. That might seem like a lot, but it was probably one half the commission on one of many mortgage loans that they wrote every day. I would give them three months before they file for BK

The bank's depositor's money is not at risk if in a FDIC insured account. Countrywide owns a bank and from what I have read 40% of the funds are not in FDIC bank deposits. Those funds could be at risk, but the bank should survive.

Anonymous said...

Hello Jim, this is Anon 5:08 again. If I could ask one more question... I`ve noticed some people using the 1929 and 1987 Dow charts to draw a relevance to what is happening now in our economy. Do you feel that this is "whackoism", or is there something to this kind of chart comparison? I`ve always heard that history repeats itself, but is this taking it a little too far? What is your opinion? I assume from your forum`s title, that you do think that we might be in trouble one day. (or maybe we are already in trouble but the general public doesn`t know it yet) Thanks, I`ll try not to wear out my welcome, but just finding out about all this stuff is pretty unnerving.

Jim in San Marcos said...

Hi Anon 5:08

Charts have their place. You can learn a lot from charts if you have had some basic economic courses. They will show you where we have been, but not where we are going. The charts for 1929 and 1987 would have to be similar, up to the top and down quick. 1987 would be considered a hic-up for what is to follow. Not much is mentioned about the June 1928 crash that ruined an awful lot of people. 1929 is all people remember.

The thing to realize is that a crash is a panic event. A significant number of people react the same way at the same time and create a group event. Reason and common sense will have little effect.

If you don't own a house, I would recommend a 10% investment in gold and silver to protect you from inflation. I would also recommend that you have a two year cushion of savings in cash, in case you get laid off.

The reality that is bothering me lately, is when my wife drages me to an Indian gambling casino, everyone is so old, very few young people. When I saw the a China exchange brokerage office on the news yesterday, I had to notice that everyone was so young.

You can't convince me that these 20 year old Chinese capitalists know what they are doing. It's going to be a real mess when it happens.

Anonymous said...

Once again, thanks Jim. You seem pretty levelheaded. This is a great site, I wish more people would stumble upon it as I have. Keep up the good work. I`m looking forward to your next post. Take care.

Tom said...

Jim,

Headline -
AP, Four Major Banks Borrow From Fed
Wednesday August 22, 6:22 pm ET
By Adam Schreck, AP Business Writer

Citi, JPMorgan Chase, Bank of America and Wachovia Say They Borrowed $500M Each From Fed

http://biz.yahoo.com/ap/070822/banks_fed_window.html?.v=8

I thought this article was relevant to this post… What are your thoughts on this article and impact (next couple of weeks) to the market?

These four banks are strong enough to cover the 30 day loan, with or without the credit crises. If other not-so-well-to-do banks generate even more upside down housing loans borrowing money from the FED (since there is a lack of investors willing to buy mortgage backed securities) with hopes of packaging and selling to investors does this not further compound the problem???

I also read an article that BofA made an equity investment of $2B into Countrywide on Wednesday. From the article “If Bank of America were to convert its shares under Countrywide's current share count, it would hold between 16 percent to 17 percent of Countrywide shares, said Robert Stickler, a Bank of America spokesman.” Article also states that "Bank of America's investment in Countrywide represents a vote of confidence and strengthens our balance sheet.” Maybe that’s what the folks at BofA want Countywide to believe, but could this be BofA staging a move for acquisition?

http://biz.yahoo.com/ap/070822/countrywide_bank_of_america.html?.v=14

Tom

Jim in San Marcos said...

Hi Tom

I read that news release, and the important part to me was

"The banks paid higher interest rates for the loans than if they'd borrowed the money elsewhere. Experts said they did that to try to reduce the stigma of tapping the discount window. In the past, if a bank used this source of borrowing, investors and depositors assumed the institution couldn't get a loan anywhere else. That, in turn, often made things worse by triggering runs on the bank and cutting off what market access the firm had left."
http://www.marketwatch.com/news/story/us-banking-giants-borrow-2/story.aspx?guid=%7B512F004F%2D5A40%2D4F59%2DA20C%2D1F07D1F2395F%7D

My son can come up with better excuses than that--it sounds like a snow job.

4 banks each went to the discount window and borrowed a half billion at the same time for more than it would cost them if they had borrowed the money else where???

They obviously had to be talking to each other. No Martha Stewart jail time here, no matter how suspicious. Its rather peculiar that the total amount borrowed is also the amount that Countrywide got from B of A.

"Bank of America's investment involved Countrywide nonvoting convertible preferred stock yielding 7.25% annually. The preferred can be converted into common stock, subject to restrictions on trading for 18 months. A full conversion would give Bank of America a 16% to 17% stake in Countrywide's common shares."
http://online.wsj.com/article/SB118781794985005692.html

Country Wide doesn't have access to the Fed's discount window. So from my interpretation, it looks like someone in Treasury asked the 4 banks to loan Country Wide two billion from the Fed discount window and as a risk premium, they get to keep the difference between the spread (7.25%-4.75%. It smells like a Fed bailout to me.

I could be wrong, but if the 4 big named banks really needed the money that info alone could make the private sector money run like the wind.

Anonymous said...

Now that is quite a coincidence! Four banks borrow $500million each and Countrywide gets an investment of $2billion from one of them? I see a shellgame here. I didn't put the two pieces of info together before. Why aren't the financial sites pondering this peculiar event?

Jim in San Marcos said...

Hi Anon 6:23

I think they have figured it out and are trading on the info. If you see a five dollar bill on the floor, you don't point it out to everyone present, you reach for it.

Anonymous said...

Analysts from Crédit Suisse are warning that the banks are having great difficulties in selling new bonds—if they can't do this, the credit lines to the hedge funds and other market participants must be cut off, which must lead again to a cascade of liquidations.

Hello Jim, this is Anon 5:08. The above paragraph is from an article I found today titled 'The Global House of Cards Is Collapsing' by Helga Zepp-LaRouche. Would the above paragraph be an accurate description of what you are talking about when you said in your latest post "I guess I`ll mosey on down with my cider & donuts to watch the bon(d)fire" on the 3rd Friday of September, I assume? This was on the Executive Intelligence Report website. I wish I knew how to make a link to it, but being a novice to computors also, I don`t. Thanks.

Jim in San Marcos said...

Hi Anon 5:08

It was kind of a vague joke. At halloween we use to have cider and donuts and have a big bonfire. Third Friday in September is refered to a a Triple Witching event, hence the reference to halloween. Plus I was alluding to the 11.5 billion that Country Wide exercised from their credit line.

The other thing I was suggesting was that if Bernanke pulled the same thing on the coming expiration Friday, a lot of traders will execute on Thursday before he makes his move.

Bernanke screwed the shorts, and the shorts are useful, they keep the market from hitting airpockets by buying to cover their shorts.

Thanks for the link, I googled it and found it.

Anonymous said...

Hello Jim, this is Anon 5:08 (again). Today (8-24-07), I heard on the radio that housing sales were up 2.8% for the month of July. Everybody was acting like the sub-prime mess is over and it`s time to celebrate. Is this just blatant propaganda from the media, or is there something to this? Has the fundamentals of the situation changed just because the housing was up 2.8% in July?

Jim in San Marcos said...

Hi Anon 5:08

Buying a house takes about 60 to 90 days so there is a lot of lag time. You might want to go back to my August 4 blog on "Doomed October Real Estate Figures."

I almost did a 30 day escrow once. So these people that bought, probably signed before Bear Stearns hit the wall June 21st. Plus remember the whole thing was "contained" for another 3 weeks.

Anonymous said...

Jim, this is Anon 5:08 again. The market has closed already and it was up around 130-140 (I forgot the exact number) on the news about the July housing figures according to CNBC. I went back and read your Aug.4th post and the one
comment attached to it. It would seem to me that if I can look at what you are saying about the lag time on housing (which makes perfect sense to me), then the MSM and traders on Wall Street would probably know this also, which leads me to this question: Why are they acting like this is the greatest thing since sliced bread, when in all likelihood they know that in Sept. & Oct. the truth will be plain to see? I just don`t understand, they have to know that this is going down the crapper, If somebody as simple-minded as I am can see that, then surely they can too? Either that, or I`m just wrong about everything concerning the current situation in finances.

Tom said...

Jim,

Good to see the activity is increasing at your site. Keep up the great work and looking forward to your next post.

I don't know much about the market, but learning more each day. I had read on another website (can’t remember the one) that during the GD, only about 3 percent of the population was stock trading during that time. I’m sure that number has increases substantially. How do I find out (if possible) what group of people are buying/selling in the markets? For example, is it mostly stock brokers and firms or individuals day trading through online trading or jockeying with their 401k's at work?

Retired now, but with my last employer (LMT), I screwed around with my 401k all the time, so I know how easy it is to move blocks of holdings around. I knew nothing of what I was doing and wonder how many others out there are currently doing this and to what extent it has an effect on the market.

Thanks,
Tom

Jim in San Marcos said...

Hi Anon 5:08

I hate to send you to a previous post again, but it's worth reading. The DOW stocks only went up $18 even though you saw the average go up 143 points read my previous post:
The Stock Market Game from April 25th.

If you originally bought the Dow stocks in 1910, and held on to everything including the splits, the 130 points up today would have some meaning.

The Dow divisor was at .1248 when I wrote that. So if you multiply the 143 points today by .1248 you get 17.84. The average Dow stock went up 50 cents.

Anonymous said...

Hello Jim, This is Anon 5:08. I read your Stock Market article, very enlighting. When I have time I will go back and read all of your posts, You`ve got a treasure chest full of info for a novice here. Thanks for all the work you have put into this site. I`ve learned more here in the last couple of days than I did in all of my (public) schooling. THANKS!

Jim in San Marcos said...

Hi Tom

It looks like just about everyone is playing the market. 90% of those in the market shouldn't be in it. Since the market has been very kind to everyone for the last 25 years, nothing I say will make anyone get out.

My wife and I each have a 401K and we can read whether or not the plan made money or not. But you really can't tell what your money is invested in. There is too much structure with words like "high yield, growth income fund, low yield bond funds, etc"

Three percent in the market during the GD sounds low, but commissions weren't cheap. You were not buying to sell tomorrow.

Here is a blog link that shows the evolution of today's market

Jim in San Marcos said...

Hi Anon 5:08

Maybe I'll meet you half way and start reposting some of my previous articles. It's hard for me to write on more than two topics a week. So I'll reach back a year and grab an extra one each week that I hope you like.

Take care

Tom said...

Jim,

Nothing better to do, so I added the total units and value of the list prices of CW's REO property from their website:

http://www.countrywide.com/purchase/f_reo.asp

Total REO - 11,313 units
Total baggage - $2,298,503,569.00

That’s 2.3B dollars! I checked a few county records where I could and it looks like CW discounted 25-35% in most cases in their list prices. Taking the number above, adding back in the estimated original loan values, there is instant evaporation of 800M. This 800M loss also assumes that all the properties sell for the listed price.

Many predict this as just the beginning. With CW the largest lender in the US and currently holding 2.3B in REO, I sure don't know how things get better for them from here???

Tom

Jim in San Marcos said...

Tom

It doens't look good. The last real estate slump was several years long. This one can't be more than a year old, so we have a ways to go.

If that total you got is the tip of the iceberg, their going to have some real fun in the coming year. Thanks for the calcs.

zgirl said...

Actually, according to mortgagebankers.org, 34% of homes are owned free and clear. Check my blog for data and links, as I'm currently researching hard facts on how big this problem could be (in specific numbers). Even if my conclusions end up being wrong, the blog will be a smorgasbord of data sources. I'm using it as my sort of "scratch pad" while figuring out where (whether?) to invest and what to do about our itch for a new house. The market's too inflated to buy right now, but, if things get really ugly, I don't want to be in a suburban tract home, ticking off the natives by bringing groceries home every week.