Is It Busted?

We spend our lives living in a narrative, actually multiple narratives. We live in the narrative of a constitutional republic, while at the same time the process has become anything but constitutional. We trade in markets which are built on scaffolds we don’t even begin to understand, because we substitute a narrative in place of actual knowledge.

Narratives are easy morsalized bites which may or may not have any basis in reality. Recently the FED has started to expand it’s balance sheet yet again, through the Repo market. In September liquidity froze, ballooning overnight lending rates from the FED’s preferred 2% to 10%. In order to stay solvent companies need to have their liabilities covered, i.e. they need to be able to point to some cash in the bank when the regulator and the market comes calling. If corporations, like insurance or brokerage houses are short on cash they borrow some over night from banks. Banks charge interest for the privileged and the interest they charge is independent. Banks accept collateral for the use of their money. So I may own 1M in US treasuries and I may need 1M to look solvent so I can borrow 1M in cash and put up my 1M in treasuries as collateral. The next day I expect some money to come in say 1,020,000. So I pay back the 1M plus the 2% interest and get my treasuries back. It’s a market.

What happened in Sept was interest to lend 1M ballooned to 10%, meaning suddenly banks saw a much bigger risk in the system and wanted 5 x the interest to lend the 1M for the same collateral that had been used as collateral the week before. The spike in interest also called a lack of liquidity was blamed on “quarterly income tax payments”. The narrative raises it’s ugly head. Taxes are more regular than sunrises. There is no business that is not aware of its quarterly obligation. It’s like numero uno on the calendar of up coming events in the life of a business. The idea that businesses somehow forgot to budget enough to pay taxes to the extent that it caused interest to balloon to 10% is simply ridiculous. I ran a business for 30 years and somehow always managed to remember to pay my taxes.

So what happened? A change in risk happened. No longer was the collateral adequate. In fact the collateral had been discounted 5X. Suddenly my 1M in treasuries or whatever was actually viewed as 200K when it came to getting a loan. Guess what happened in 2008 to Bear Sterns and later Lehman. “Sorry boys no more money for your crappy collateralize debt obligations (CDO’s) because they aren’t worth the paper they are printed on. We no longer believe the cabby who bought a 1M McMansion and then took out a 500K line of credit to buy a 2 new cars and a boat will be able to pay his obligation and so your paper that contains his loan is pretty worthless. We’ll loan you 3 cents on the dollar, take it or leave it. From our perspective It’s more likely the cabby will just plop the keys in the mailbox and walk away”

I ran across this video and it’s worth watching. It explains the FED funds market and how the government is having to inject money into the process to paper over the obvious excessive risk in the system. Guard your children and your wives, the narrative will not protect you. Only a clear understanding of reality will.

Leave a Reply

Your email address will not be published.