by Calculated Risk on 10/04/2008 05:18:00 PM

The next Fed meeting is more than three weeks away (a two day meeting on October 28th and 29th) and the economic data suggests the economy is deteriorating rapidly. And the TARP will not start buying assets for several weeks, maybe not until mid-November. This suggests the possibility of an intermeeting Fed rate cut.

Fed Chairman Bernanke released a statement on Friday:

We will continue to use all of the powers at our disposal to mitigate credit market disruptions and to foster a strong, vibrant economy.

The Financial Times notes: Declining economy could force Fed to act

The last time the macro-economic data deteriorated rapidly – around the turn of the year – the Fed reacted decisively with big rate cuts, including an intermeeting move. In the eyes of many the latest data also adds up to an open-and-shut case for further Fed rate cuts.
...
If the Fed does decide to cut, the case for cutting at the meeting is that a new set of economic forecasts could win over doubters. But if the Fed wants to maximise the impact of the cut it could move intermeeting in the hope of shocking the credit markets back to life.
emphasis added

And here are the latest Fed Fund probabilities from the Cleveland Fed.

Click on graph for larger image in new window.

Until a couple of weeks ago, market participants anticipated no change in the Fed Funds rate in October.

Now, because of recent events, there is a strong consensus for a rate cut by the October meeting.

But if you are going to lower rates at the end of October, why wait?

Back in 2004, Bernanke wrote a paper (with NBER economist Kenneth Kuttner) What Explains the Stock Market’s Reaction to Federal Reserve Policy?

The most direct and immediate effects of monetary policy actions, such as changes in the federal funds rate, are on the financial markets; by affecting asset prices and returns, policymakers try to modify economic behavior in ways that will help to achieve their ultimate objectives.
...
The unexpected 50-basis-point intermeeting rate reductions on 3 January [2001] and 18 April [2001] were both greeted euphorically, with one-day returns of 5.3% and 4.0% respectively. The 50-basis-point rate cut on 20 March [2001] was received less enthusiastically, however. Even though the cut was more or less what the futures market had been anticipating, financial press reported that many equity market participants were “disappointed” the rate cut hadn’t been an even larger 75 basis point action. Consequently, the market lost more than 2%.
...
Another unusually vehement reaction to a Fed action is associated with the 25-basis-point intermeeting rate cut on 15 October 1998, which was taken in response to unsettled conditions in the financial markets — specifically, the deteriorating situations in Asia and Russia. For whatever reason, the unexpected intermeeting cut lifted equities over 4%.
...
This study has documented a relatively strong and consistent response of the stock market to unexpected monetary policy actions, using federal funds futures data to gauge policy expectations.

To surprise the market, the Fed might need to cut by at least 50 bps - maybe 75 bps - and announce the action before the market opens on Monday.

by Calculated Risk on 10/04/2008 03:29:00 PM

From Bloomberg: Hypo Real Estate Says Banks Withdrew Support for Rescue Package (hat tip Ryan)

Hypo Real Estate Holding AG, the troubled German property lender, said private banks withdrew their support for a 35 billion-euro ($49 billion) rescue package.

``The intended rescue package involved a liquidity line to be provided by a consortium of several financial institutions,'' Hypo Real Estate said in a statement on the DBF newswire today. ``The consortium has now declined to provide the line. The Group is now in the process of determining the consequences of this'' and ``alternative measures are being investigated.'

Hypo mostly lends to commercial and public projects internationally.

by Calculated Risk on 10/04/2008 08:43:00 AM

This is interesting ... from The Times: Homeowners steer clear of equity release loans

Fearful homeowners have finally called a halt to a decade-long spree of cashing-in on the value of their properties to pay for big-ticket consumer spending and paying off debt, the Bank of England revealed yesterday.

The Bank’s latest figures show that Britons have abruptly abandoned the habit of borrowing against their houses and flats through mortgage equity withdrawal, bringing to an end a decade-long era of the nation using its homes as cash machines.

Second-quarter figures for equity withdrawal showed that, rather than raising borrowed cash against their properties, homeowners injected a net £2.8 billion of new equity.
...
In practice, this means that homeowners collectively invested more capital in properties during the second quarter, either through paying down mortgages or cash payments to buy, than they raised through home loans.

The news marks a big turnaround.

The following graph shows home equity extraction in the U.S. through Q1 2008 (NSA - not seasonally adjusted) provided by Federal Reserve economist Jim Kennedy based on the mortgage system presented in "Estimates of Home Mortgage Originations, Repayments, and Debt On One-to-Four-Family Residences," Alan Greenspan and James Kennedy, Federal Reserve Board FEDS working paper no. 2005-41.

Click on graph for larger image in new window.

Just like in the UK, there was a surge of equity extraction in recent years. And just like in the UK, equity extraction has fallen off a cliff.

I've contacted Dr. Kennedy's office, but unfortunately data isn't available yet for Q2. However the US data probably looks very similar to UK data.

Here is what I wrote last year:

As homeowner equity continues to decline sharply in the coming quarters, combined with tighter lending standards, equity extraction should decline significantly and impact consumer spending.

As of Q1 homeowner equity had declined sharply, lending standards had tightened, and equity extraction had declined significantly. And now, based on the recent monthly data from the BEA on Personal Consumption Expenditures (PCE), it appears consumer spending has slowed sharply. My recent comment was: "[T]this will be the first decline in PCE since Q4 1991. This is strong evidence that the indefatigable U.S. consumer is finally throwing in the towel."

It appears that less equity extraction is finally having a significant impact on consumer spending. Of course consumer spending is also being impact by job losses and the recession.

by Calculated Risk on 10/03/2008 10:58:00 PM

From the Financial Times: Dutch government takes over Fortis units

The Dutch government on Friday re-negotiated last weekend’s bail-out of Fortis in order to buy all of Fortis’s Dutch operations for €16.8bn, including its Dutch insurance operations and the Dutch operations of ABN Amro.
...
Wouter Bos, Dutch finance minister, said the Dutch state took the decision after seeing how Fortis faced greater liquidity problems this week following the rescue.
...
The Dutch government will privatise the Fortis and ABN Amro operations after calm returns to the markets, it said.

Nationalize. Then privatize. That is a proven approach. It will be interesting to see if the Dutch approach works better or worse than the Paulson plan.

by Calculated Risk on 10/03/2008 07:40:00 PM

From Rex Nutting at MarketWatch: More severe recession now forecast by Goldman Sachs

The U.S. recession will be "significantly deeper" than they previously thought, Goldman Sachs economists predicted Friday in a research note. ... The unemployment rate will likely rise to 8% by the end of next year from 6.1% currently.

Goldman is now forecasting Q3 2008 real GDP growth at 0.0%, with PCE at minus 2.5% (annualized as reported by BEA). This is similar to my two month estimate for PCE, see Estimating PCE Growth for Q3 2008. Both PCE and investment will be negative in Q3, but net exports, private inventories and government spending will probably all show positive growth in Q3. So GDP may be close to zero.

A major change in the Goldman outlook is the increase in the unemployment rate to 8% in 2009 (their previous forecast was for unemployment reaching 7% in 2009).

One of the features of recent recessions is that the unemployment rate kept rising for 18 months to two years after the recession officially ended. This suggests that the peak unemployment rate (for this cycle) might not happen until 2011, even if the recession ends in late 2009 - scary. I'll have some more thoughts on unemployment soon.

Note that this is the headline unemployment number. Other measures of unemployment are much higher: See Krugman: The track record

by Calculated Risk on 10/03/2008 04:12:00 PM

IRS Notice:

For purposes of Code Sec. 382(h), any deduction properly allowed after an ownership change of a corporation that is a bank with respect to losses on loans or bad debts, including any deduction for a reasonable addition to a reserve for bad debts, shall not be treated as a built-in loss or a deduction attributable to periods before the change date. This guidance does not affect the application of any provision of the IRC except Code Sec. 382. Banks may rely on this guidance until further guidance is issued.

This new rule apparently allows Wells Fargo to accelerate the use of Wachovia's huge write-downs as an offset to their own income, saving Wells Fargo a substantial amount in taxes over the next several years.

In an email memo sent yesteryday, the law firm Wachtell, Lipton, Rosen & Katz noted:

As part of the federal government’s ongoing comprehensive response to the current credit crisis, the Treasury Department and the Internal Revenue Service have acted decisively to ameliorate the impact of Section 382 of the Internal Revenue Code in the context of bank mergers and acquisitions and capital raising by banks and others. In an environment where asset quality concerns are giving potential bank acquirors and investors pause about engaging in acquisitions or supplying badly needed equity capital, these steps are likely to significantly enhance the risk/reward calculus by facilitating the deductibility of losses.

This IRS change probably motivated Wells Fargo to acquire Wachovia. This is another way to help recapitalize the banking system.

Note: according to the WSJ Law blog, Wells Fargo was advised by Wachtell, Lipton, Rosen & Katz in the Wachovia deal.

by Calculated Risk on 10/03/2008 02:24:00 PM

Paulson Statement on Emergency Economic Stabilization Act:

By acting this week, Congress has proven that our Nation’s leaders are capable of coming together at a time of crisis, even at a critical stage of the political calendar, to do what is necessary to stabilize our financial system and protect the economic security of all Americans.

The American people will appreciate the leadership of their elected representatives and senators who took bold action to help stem a severe credit crunch that threatens to cost many jobs and undermine access to credit for working Americans.

This bill contains a broad set of tools that can be deployed to strengthen financial institutions, large and small, that serve businesses and families. Our financial institutions are varied – from large banks headquartered in New York, to regional banks that serve multi-state areas, to community banks and credit unions that are vital to the lives of our citizens and their towns and communities. Each institution has its own unique benefits, and their collective strength makes our financial system more resilient, and more innovative. The challenges our institutions face are just as varied – from holding illiquid mortgage backed securities, to illiquid whole loans, to raising needed capital, to simply facing a crisis of confidence. This diversity of institutions and challenges requires that we deploy the tools in this rescue package, in combination with the tools the Fed, the Treasury, the FDIC and other bank regulators already have, in a variety of ways that addresses each of these needs and restores the ability of our financial system to fuel our broader economy.

There is no one-size-fits-all solution to alleviating the stress in our financial system. Each situation will be different and we must implement these new programs with a strategy that allows us to adapt to changing circumstances and conditions, and attract private capital. The broad authorities in this legislation, when combined with existing regulatory authorities and resources, gives us the ability to protect and recapitalize our financial system as we work through the stresses in our credit markets.

We will move rapidly to implement the new authorities, but we will also move methodically. In the coming days we will work with the Federal Reserve and the FDIC to develop strategies that deploy these tools in an expedited and methodical way to maximize effectiveness in strengthening the financial system, so it can continue to play its necessary and vital role supporting the U.S. economy and American jobs. Transparency throughout this process will be important, and I look forward to providing regular updates as we move ahead to implement this strategy.
Emphasis added

Other than helping attract private capital by cleaning up the institutions' balance sheets, I'm not sure how this plan helps the financial system recapitalize. Hopefully Mr. Paulson doesn't intend to pay a premium, not just to the current market value, but to current book value, for the toxic assets. But how else could the plan help the financial system recapitalize?

by Calculated Risk on 10/03/2008 01:22:00 PM

Vote: 263 Yes to 171 No

Fed Chairman Bernanke statement:

I applaud the action taken by the Congress. It demonstrates the government's commitment to do what it takes to support and strengthen our economy. The legislation is a critical step toward stabilizing our financial markets and ensuring an uninterrupted flow of credit to households and businesses.

The Federal Reserve will continue to work closely with the Treasury as it undertakes these new initiatives. We will continue to use all of the powers at our disposal to mitigate credit market disruptions and to foster a strong, vibrant economy.

The TED spread (from Bloomberg) is at 3.83.

by Calculated Risk on 10/03/2008 11:43:00 AM

Here is the live feed from C-SPAN.

Here is the CNBC feed.

by Calculated Risk on 10/03/2008 11:02:00 AM

From Bloomberg: Citigroup Demands Wachovia, Wells Fargo Terminate Merger Deal

Citigroup Inc. demanded that Wells Fargo & Co. and Wachovia Corp. terminate a $15.1 billion takeover agreement announced today, saying it breached an exclusive deal the New York-based company reached earlier this week.
...
``Citi has substantial legal rights regarding Wachovia and this transaction,'' the New York-based company said in a statement. ``Wachovia's agreement to a transaction with Wells Fargo is in clear breach of an exclusivity agreement between Citi and Wachovia.''

From the FDIC: FDIC Chairman Sheila Bair Comments on Agreement to Merge by Wells Fargo and Wachovia

"Since the close of our bidding process, Wells has apparently re-assessed its position and come forth with this new offer that does not require FDIC assistance. ...

"The FDIC stands behind its previously announced agreement with Citigroup. The FDIC will be reviewing all proposals and working with the primary regulators of all three institutions to pursue a resolution that serves the public interest."

The Wells Fargo deal seems to make more sense, and appears better for Wachovia stakeholders and U.S. taxpayers. Maybe there will be some sort of breakup fee for Citi.