Defenestrating Thoughts from the Bivouac

The latest Fed action to inject “liquidity” of $200 billion via a Term Auction Facility (TAF) is really, really stupid. And the fact that the market went up is a sign that stock investors are not just irrational, they really don’t think for themselves.

Basically, the Fed is lending the banks US Treasuries, and taking some of the banks’ assets as a collateral. Given all the bond rating mess that’s happening, it shouldn’t be a surprise that the bank assets the Fed is picking up are at least partially bad. It’s possible that most of the assets are bad.

So two important things follow from this:

1. The banks are in big trouble. The bank couldn’t use its own assets to get liquidity on the open market. Or in other words, the open market wouldn’t touch their assets, because they are over-valued and possibly worthless. So the Fed has to “buy it”.
2. If the banks owe the Fed this much money ($200 billion is a lot), the Fed now owns a significant amount of the banks. This is like a home loan: the bank owns the home until you pay off the debt. Basically now, the Fed is nationalizing the banks.

So if the banks can’t repay the loan, the Fed has to eat the cost. And that means the taxpayers have to eat it. Basically, we’re looking at a taxpayer bailout of the banks.

But yesterday the market shot straight up. How is the Fed action good news? If the headline read, “$200 billion taxpayer bailout for the banks”, would the market go up? Probably not. Even the dumbest investor wouldn’t say, “Woohoo! The taxpayers had to give the banks $200 billion to kept them solvent temporarily! Buy, buy, buy!”

Keep in mind, this $200 billion is inflationary. The Fed just printed this money out of thin air. That’s massive inflationary pressure.

Unfortunately, this is a losing battle. The problem isn’t liquidity. It’s much more fundamental than that. The banks struggling to remain solvent. They don’t have the assets to cover their liabilities. Liquidity is a short term fix, but only delays the inevitable.

Keep in mind, the average recession has a 30% decrease in equities. So far, we’ll only seen 15%. You think that this recession will be “easier” than the rest? I doubt it.

Update

I just realized that isn’t a TAF, but something new: Term Securities Lending Facility (TSLF). This is an exchange program with a holding period of 28 days. It’s not strictly a cash influsion; rather the banks can take the treasuries that the Fed gives them and then sell them on the open market.

And in 28 days, this action will be repeated. And again and again. And so the banks never have to repay their loans, until they have the assets to do it. This could only work if the banks’ mortgage backed securities become worth their face value again. This seems unlikely. I think we’re just delaying the inevitable. At some point the banks are going to have to face the music.