Can the Fed seduce investors to think all is fine while derivatives unravel and deficits prevail?
*Barron's, by Alan Abelson, February 18, 2008
“The latest casualty of the virulent and spreading credit collapse is, as you may have heard, the auction-rate securities market. That’s another of those fairly obscure contrivances, custom-made by Wall Street to satisfy the ravenous hunger among large repositories of capital, ranging from student-loan organizations to the Port Authority of New York and New Jersey, in every part of the good old U.S.A.
Like most of the new-fangled contraptions designed to enrich Wall Street (and, after all these years, we’re still fruitlessly searching for the customers’ yachts), the auction-rate securities market was built on fantasy — specifically, the idea that borrowers could raise long-term money, while paying the lower costs of borrowing short. And the magic that would enable them to perform that neat trick was to turn over the obligation via an auction, at intervals varying from a week to over a month.
The market was supposed to be extremely liquid, so the borrower would be able to sell whenever it chose to. And so it was. Should an auction fail, the borrower’s interest rate on the loan shot up, typically quite dramatically, sometimes quadrupling or more. But the possibility of that happening was not worth talking or even thinking about.
As last week’s brutal headlines made clear, the auction-rate-securities market was, as advertised, highly liquid — until suddenly it wasn’t. And also, as advertised, the penalty clause on those borrowings, mandating quantum leaps in interest rates, was the rare exception, almost never invoked — until, out of nowhere, it became the rule.
We find it still bemusing that Mr. Bernanke and his cohorts, with the strident urgings of untold legions of professional kibitzers in and out of government and on Wall Street, are so devoted to slashing interest rates — inflation and the dollar be damned — in a kind of robotic effort to inject life into the failing economy.
Again, as we’ve said many a time and oft, it most evidently isn’t the cost of credit that’s the problem, but its availability, or lack of it. That’s why the industrial-strength reductions of rates by the Fed have proved so unavailing and why further major cuts are odds on to be just as unrewarding.
And we’re constrained to repeat also that only righting our horribly askew accounts, both with the rest of the world and ourselves, will lay the groundwork for a solid and extended recovery.
Investors still are suffering from the illusion that the Fed’s snake oil will cure what ails the economy and furnish the sustenance for a new bull market. All we can say is — dream on.”
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