Last week some $75 million of "fed funds" (that is, interbank overnight credit) was transacted at a rate of 15%, and "a bunch" went through in the low to mid 7s.
No, I didn't mistype that. You can find the actual data at this link.
Originally I, and everyone else, assumed that the "high" was an error. A bad print. That there was no chance this was "real".
Yes, "EFF" (effective fedfunds) was right where "it should be" according to The Fed - across all transactions.
Now let's think about this one for a minute here folks.
"Someone" transacted a $75 million overnight loan that they needed to meet reserve requirements at an absolutely outrageous interest rate - about what you pay for credit card money. A bunch of "someone else's" transacted a bunch at 7-7.5%.
They had the discount window available to them at 50 bips of penalty to EFF, which is a direct overnight loan from The Fed, but didn't use it.
Are you going to try to tell me that some banks actually paid nearly 10% more as an interest rate than they had to?
On what planet are we having this discussion?
There is only one possible explanation for this particular behavior - The Fed would not take the alleged "collateral" these institutions tried to put up, and the market didn't think it was worth much either, even on an overnight basis, and as such "the market" priced the interest rate similar to how Guido would for your "short-term" loan!
This raises the spectre of something truly terrifying in the credit markets -
The Fed may be inches away from losing control over the FF Rate entirely!
Indeed, for those transactions, they already have!
The implications of this, if it spreads, are truly terrifying. We are not talking about a three sigma event, a four sigma, or a five sigma.
We are talking about the equivalent of Financial Armageddon in the credit markets.
Sensing this possibility, a whole bunch of someones put on a bunch of options on the FF Futures contracts that are so far out of the "mainstream" of conventional thinking that they have zero chance of paying off unless a major dislocation event occurs.
These weren't just "idle speculators" either - they were risk management desks, repo desks and, of course, once they started to get bought hard, speculators who piled in behind them.
This sort of trade is so far out of the realm of "normal" that it deserves notice.
Unlike the options trades on the SPY (and other markets) - aka the "Bin Laden" trades that I wrote about - this is not some wild "unnamed" person putting these on.
These are the risk managers and repo desks that handle transactions in the credit markets every single day.
When they start freaking out like this, you goddamn well better sit up and take notice!
Note that back in August we didn't see shit like this. Yeah, that was bad. But even in the worst moments of August, nobody got such a wild hair up their ass that they thought The Fed would lose control of the overnight lending rate!
The little press that this did get put it out there as a "no ease" play. Uh uh.
That is a dislocation play guys and gals.
Think about this for a minute. If you think the Fed is going to cut rates, you wouldn't want to be on that side of the trade. It doesn't pay well enough. You want to be on the other side. So if the belief here is simply that someone is in big trouble and "Ben will ride to the rescue", you take the opposite position.
This bet is more akin to "The Fed loses control entirely and Effective Fed Funds trades radically higher irrespective of what Bernanke does, because nobody trusts anyone anymore - not even overnight."
In other words, this bet is one that the credit markets will go supercritical.
And it wasn't made by just one firm, one speculator, or one guy.
A few months ago I pointed out that every big equity market dump - every last one of them - has started in the credit markets. It always starts there, simply because of the volume of business transacted and the sensitivity to problems. In the equity markets one company can go "boom" and it doesn't mean much. But in the credit markets "systemic risk" - that is, a refusal to trust people as a foundational principle - once it takes hold is very, very difficult to tamp back down.
There is only one way to fix this in the credit world, and that is to force ALL of the off-balance sheet bullshit back ON balance sheets, to force ALL credit derivatives and structured credit to trade through public exchanges and to force ALL marks to be to market - anything less simply must be recorded as a "zero" until you can get an actual transaction to mark against!
That, by the way, is what I've been calling for - in the petition, in my letter to Bush, in my writings for months.
Unfortunately Hank Paulson, Ben Bernanke, The Fed as an institution and everyone else are going in exactly the opposite direction - more obfuscation, more mendacity, more myth.
We are at extreme risk here.
I do not have a way to assign a potential time, day, or event to an impending supercritical dislocation.
All I can do is note that there are market participants out there who are deathly afraid that it is going to happen and soon; they have placed their bets and spent a goodly amount of money doing it.
They smell it, and they're the ones that are close enough to the action to know about it.
What you do, with your own risk exposure, given the upcoming Fed Meeting, is up to you.
Still, there is always (gallows) humour....
Junk Debt Crisis: “Lake Tahoe Housewife To Blame”
June 27 – Following months of housing crisis, delinquency, default, foreclosure, rising bond yields, widening credit spreads and freak atmospheric conditions, Wall Street has finally announced the identity of the culprit responsible: Mrs. Margaralene Wozniak of Maple Terrace, Lake Tahoe. Mrs. Wozniak, 87, lies at the heart of the once profitable partnership between subprime lenders and Wall Street brokerage firms that is now toboganning crazily toward a frenzied charnel-house of blood-letting horror. Since the beginning of 2006, almost all US mortgage companies have closed or declared bankruptcy – and Mrs. Wozniak is to blame, according to industry experts.
The manic slaughter-orgy has only just begun. As home prices collapse, mortgage defaults and overripe newspaper headlines portending imminent disaster shoot into the stratosphere, bond investors who financed the housing boom stand to lose as much as $480 quadrillion in CDOs backed solely by a mortgage on Mrs. Wozniak’s trailer. A number of large investment banks and hedge funds have already quite literally imploded after gambling – unprofitably, as it turns out – on claims on Mrs. Wozniak’s Placerville residence.
The subprime industry – and investor losses – would never have become quite so huge without 320 million independent mortgage brokers in California and a regulatory regime that has been described by some as mildly sub-optimal.
“Even with explanations, Mrs. Wozniak never really understood what type of loans she was getting,” says Lavinia Twonk, formerly with Toxique Funding of Pasadena. “She thought she’d won a Zimmer frame.”
The sales job was made easier with exotic mortgages such as so-called no-doc docs, which enable borrowers to get multi-billion dollar loans without having to supply evidence of income or savings, or for that matter even documents. Verbal agreements on the part of the mortgage salesman, at which the borrower is not actually required to be present, are sufficient in California law.
Californian lenders subsequently sold the loans to major brokerage firms, who in turn packaged them into CDOs and sold them to eager pension funds, normally whilst laughing uproariously. The role of the rating agencies has now been called into question.
Leading industry analysts suggest that the agencies have failed to disclose the true risk of CDOs, which are a type of sub-strain of the Ebola Zaire virus. A typical CDO causes an investor’s internal parts to liquefy – typically during a broader-based market crisis - and then detonate violently. Holders of the investment grade portion of CDOs, rated ‘Super Lovely’ by agency Duff and ‘Angel Delight’ by rival Substandard and Poor, are deemed only moderately likely to have their major organs forcibly removed by anonymous surgeons. Holders of second-tier ‘Mezzanine’ tranches, rated ‘Ocean breeze’ by Duff and ‘Fields of soft, waving grass’ by Poor, run a slightly higher risk of holders being tossed over a cliff onto jagged rocks. The ‘Equity’ tranches, hitherto variously rated ‘Piquant’ and ‘Saucy’ carry a fairly high risk of holders having their body parts crushed with small hammers and then being ripped apart by choreographed attack dogs. Jeff Venal of ratings agency Happytime No Clouds Gorgeous Summerbuns, speaking on condition of anonymity, said he wasn’t concerned about accusations of graft and conflict of interest, not least because he had a ‘First Lien’ claim against Mrs. Wozniak’s kidneys.
Independent consultants suggest that institutional buyers may have repeated the errors of previous eras and been sold virulent rubbish by overzealous Wall Street brokers. Twyla Verbinsky, fixed-income portfolio manager of the Carson City Retirement Programme, says she decided to buy equity tranches after a free sample fell out of her breakfast cereal. “I got even more interested because a broker told me they would be absolutely delightful. From that point on, I was hooked.” She says the investment is worth the risk because the Retirement Programme may be able to get higher returns than from the zero coupon perpetual bonds it was sold last year. The fund is relying on advice from bankers selling the CDOs, says Ms. Verbinsky. “As a fiduciary investor, I obviously have to trust everybody, and particularly Wall Street salespeople.”
http://thepriceofeverything.typepad.com ... crisi.html