Congress passes the $700 BLN rescue package

September 26th, 2008  by Lou Muddaris

Closing Data

Dow Jones up 196 @ 11022	NASDAQ up 30 @ 2186	Gold down 13 @ 882
Oil up 4.7 @ 111.5	FTSE up 101 @ 5197	Silver down 0.16 @ 13.28
Copper down 90 @ 6905	Lead down 55 @ 6905	Zinc down 8.5 @ 1755
Aluminium down 30@ 2431	Nickel down 75 @ 16725	Tin down 245 @ 17455

SPI up 39 @ 5033

BREAKING NEWS: Congress passes the $700 BLN rescue package

The principal has been agreed its just needs to be detailed exactly who, how, what and where the money goes. Obviously, the credit markets are rescued but we need to know exactly which financial institutions benefit and by how much? Will overseas banks such as NAB be paid back their $800 million write down? Will judges be allowed to re-write the bankrupt mortgage deals? (that is key). The list is endless…watch this space as the devil is in the detail. What we do know is that the Government will prevent foreclosures and the excessive salary packages of executives will be under Government control; the days of the "Masters of the Universe" or "BSD's" are well and truly over…"alas poor Gekko I knew him well!". (BSD's?.... call in for an explanation!)

It's all about the money markets, stupid!

As I promised in yesterday's Market Fox Report I would explain in plain English how this foundation of capitalism works and how it, and not the stock markets, nearly caused the world's Armageddon!

The money markets transact billions of dollars of loans from Governments, Corporations, Sovereigns and Banks. They issue debt, (I.O.U's) with a coupon (interest rate payment) and a maturity date (when you get your money back) to raise money for financing everything from society and, public needs (governments) to building new factories (corporations). These loans vary both in time from short dated (overnight) to 30 years and vary enormously in terms of quality. The quality is important and is assessed by Standard & Poors and by the traders themselves, ranging from Triple AAA (Government and major Corporations) to junk!

The Government Treasury bonds (debt) have a lower yield as its 100% safe whilst the junk (certain corporations) have a higher yield as investors demand a higher return as that Corporation has a higher chance of going under! That is exactly what started to happen as the fancy mortgaged backed bonds failed on rate rises and caused a domino effect. Investors/traders sold those junk bonds causing yields to rise which simply escalated the problem and in turn they bought U.S. Government Treasury Bonds causing yields to fall to unreal levels. For example would you lend Uncle Sam your money for 10 years to get an annualized return of 3.8% with inflation at 5%?. It got worse yesterday when the U.S. Treasury 1 month bill paid a mere .10%! When the going gets tough the tough buy U.S. treasuries purely as a "flight to quality". They also in times of risk aversion borrow the Japanese Yen at .25% and lend it to U.S. at 20 times that rate! The net affect sees the Yen currency appreciate against the USD. Obviously the opposite is true when investors become more risk tolerant.

These investors have to park their daily billions somewhere so in times like these Uncle Sam benefits and consequently he has to pay out less interest to investors. The irony is the U.S. is technically bankrupt with a current deficit of over $11 Trillion yet still they borrow from them; they have to, as if Uncle Sam goes under then they all do along with rest of the world.

The final nail in the Capitalist coffin was the invention by the investment banks in the mid 1990's of "Default Swaps". These were bonds, $62 billion worth, which offered "protection" against company's going belly up. These turned out to be a disaster as investors/hedge funds got nervous of their counter party creditworthiness and bought them. Last week for example, sellers of these "Credit Default Swaps" demanded as much as $2.1 million up front plus $500,000 a year to "protect" $10 million in Morgan Stanley Bonds from defaulting. This, based on a JPMorgan model predicted there is a 65% chance of Morgan Stanley going bust within 5 years! These Investment banks had in effect cannabalised themselves…you've gotta love the irony!

But the central banks are helping, no?

By pumping squillions of dollars into the money markets it isn't doing very much as banks still won't lend to each other or corporations due to the high risk of their counter party defaulting. LIBOR rates flipped nearly 50bp as they simply kept the money on their books…thank you very much!

As this money market jungle is unregulated they can do as they please. The solution is very simple…REGULATE IT. Once that is done the money market rates will normalize so when a Central Bank cuts rates it will be passed on. That's exactly why even if the Federal reserve bank cut rates from the paltry 2% it won't do very much, its like pushing a piece of string. We need long term rates down, i.e. the 10 and 30 year rates which directly affect the consumer and housing market…and that will only happen when this $700 bilion package is swiftly followed up by regulating the money markets.

Here endeth the lesson!

Other news

Babcock and Brown screamed higher to $2.74 on take over talk, Deutche Bank rumoured to be offering $2.50 per share. On an ASX "please explain" BNB said "They are in talks with a lot of people about a lot of things". Nice repost!

No doubt the details of the U.S. rescue package will be released over the weekend so get ready for another "Manic Monday"!

Quote of the day: "Compromise is an agreement whereby both parties get what neither of them wanted"

Contact your Freeman Fox Stockbroker on 07 3031 9960 or 1800 003 369 Ext 7.

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