Countdown 97 days

FED’S NEXT MOVE?

In mid-March when markets crashed the Federal Reserve met to develop a strategy to avoid a total meltdown of the financial markets. The normal Fed tool used to stimulate the economy is a lowering of the prime interest rate. This tool had already been exploited by Trump demanding the Fed lower the rate during a good economy in 2018. Trump used this as a tool to continue to stimulate the economy.

Lessons had been learned during the great recession 11 years ago. The recession was as a result of a lack of Republican oversight on the banking and hedge fund industry. The melt down 11 years ago led to the lack of liquidity in the financial markets. Lending was frozen and foreclosures were at a high.  This led to the Dodd-Frank legislation dealing with banking and loss reserves and rules governing risk.  The term “too big to fail” was the rationale for the bank and hedge fund bailouts. 

The Dodd-Frank legislation fixed the risk and reserve problems with federal backed banks under the Federal Deposit Insurance Corp. (FDIC) umbrella. Banks like Chase, JP Morgan, and Bank of America have all thus far are in no immediate distress. The tougher regulations on the banks pushed the risky investments into the hedge funds. This comfort with the current status will change soon with foreclosures. The virus and its uncertainty has frozen the banks that are now uneasy to take on any risk and thus lending is curtailed as in 2008. 

Dodd-Frank left alone the shady hedge fund markets. This market sucked off taxpayer money with the “too big to fail” mantra in 2008. Republicans balked initially and insisted that if you bail out the high-risk takers once they will do it again and again. So here we are again. The powers to reign in the potential vulnerabilities have been undermined by the Trump Administration. The weakening of regulations has been led by the Treasury Secretary Stephen Mnuchin. There was an Obama-era working group that had the task of looking into the inherent risks of hedge funds, but was abandoned by Mnuchin. On November 16, 2016 the working group warned that hedge funds could be a source of instability in turbulent times.

At this time it should be known that Steve Mnuchin is an investment banker who comes from the obscure hedge fund markets. He led a panel set up by Dodd-Frank to identify risks in the markets and has consistently moved to release firms from oversight. 

The risk takers rake in the money in good times and force the government bailout in the hard times or have the economy suffer with no liquidity. No funds are willing to take risks during the pandemic where the future is so uncertain. Janet Yellin former Federal Reserve chairman said, “It’s very dangerous to have a regime in which you know this (bailout) can happen”….”The Fed did unbelievable things this time.”  The problem comes when relying on the central bank is no long-term solution. What happens when the Treasury Department is no longer as aggressive in the markets?

The problem comes with thin margin future trades by the hedge funds buying government backed securities. With the pandemic, the market collapsed and no one was buying the securities held by the hedge funds when the security delivery was due. The funding necessary to make these types of  trades suddenly dried up. Hedge funds were left holding the paper and some hedge funds were forced to sell with a market that had broken down. Banks were saturated with the government debt and as a result were unwilling to take on any more. 

The problem was a shock to the international markets as government securities are at the core of all global financial markets and had ground to a standstill. The Bank for International Settlements, the bank to all central banks said of the meltdown in their annual report in June, “The severe dislocation in one of the world’s most liquid and important markets is startling.” 

In comes the Federal Reserve buying up the securities and bailing out the hedge fund before it went belly up trying to offload without a market and suffering tremendous losses. This action of buying up government backed securities, provided the necessary cash infusion and liquidity that went straight to the only places where a profit or safety was available. The stock market for no rational reason other than providing a haven in the short term for all that liquidity has almost fully recovered. This is crazy during a pandemic with all the market uncertainties looming on the horizon. When the foreclosures hit the market will they cling on to the high risk paper and want another bailout?

It is not clear if the hedge funds had anything to do with the meltdown. There are few requirements for hedge funds to disclose detailed information on the size of their wagers (yes hedge funds bet on the economy). There is a group that thinks the hedge funds were not in any financial difficulty and were able to continue providing liquidity in the markets, even when the banks were pulling back. The Fed provided preemptive actions to buy the government-backed debt that, if put on the open market, the markets without buyers would tank.

What will be the Fed’s next move? The housing and mortgage market will be the next shoe to drop in this pandemic economy. This will impact banks and mortgage holders. Banks were the beneficiaries of the last bailout at the expense of the homeowner.  Will it be different this time allowing the homeowner to remain in their residence and push back payments during the pandemic or until a vaccine is universally available? It’s obvious the economy will not be in full stride for at least another year and until that time adjustments to the economy will be necessary.

Real Estate Investment Trusts REIT’s and mortgage hedge funds being flush with cash and low interest rates have managed to gobble up underwater and foreclosed properties. The impending mortgage meltdown and foreclosures are looming.  The wealthy investors are again going to make their bets. With the President as a real estate investor you can imagine he and his friends will be taken care of. When the mortgage lending markets dry up and banks are not taking any pandemic risks, will the RIET’s and the hedge funds step in again and take on risky mortgages.

This action delays the foreclosure pain to the future and the impact will not occur until after the election. When REIT’s and hedge funds fail, will they be bailed out at taxpayer expense once again?  The impending mortgage and other economic problems have been kicked down the road by the Fed and will eventually hit the economy like a sludge hammer. I just wonder when? Indications are the Fed is doing all it can to reduce any economic pain until after November. The underlying economic conditions can be hidden for only so long. Unemployment will remain stagnant until the virus is tamed with a vaccine or reduced significantly and instant tests are available.

UPDATE:

Two vaccines were entering valid phase 3 trials using 30,000 volunteers. Phase 3 takes at least 6 months for the results. This puts the first availability at best January 2021. Any vaccine announcements prior to January would be given prior to the approval, by the FDA. This discounts the compilations of the data, obtaining side effects and reactions, FDA approval process, the manufacture and distribution initial distribution to medical professionals and care workers that will make it mid-year for general public availability.

151,000 total dead and 1,300 died today of the virus and Trump said last week his administration was working on a plan for the virus. But his biggest concern is that the people like Fauci better than him.