[NTBKtrader]

By Peter Eavis, Fortune writer
August 24 2007: 5:09 PM EDT

NEW YORK (Fortune) -- In a clear sign that the credit crunch is still affecting the nation's largest financial institutions, the Federal Reserve agreed this week to bend key banking regulations to help out Citigroup (Charts, Fortune 500) and Bank of America (Charts, Fortune 500), according to documents posted Friday on the Fed's web site.

The Aug. 20 letters from the Fed to Citigroup and Bank of America state that the Fed, which regulates large parts of the U.S. financial system, has agreed to exempt both banks from rules that effectively limit the amount of lending that their federally-insured banks can do with their brokerage affiliates. The exemption, which is temporary, means, for example, that Citigroup's Citibank entity can substantially increase funding to Citigroup Global Markets, its brokerage subsidiary. Citigroup and Bank of America requested the exemptions, according to the letters, to provide liquidity to those holding mortgage loans, mortgage-backed securities, and other securities.

This unusual move by the Fed shows that the largest Wall Street firms are continuing to have problems funding operations during the current market difficulties, according to banking industry skeptics. The Fed's move appears to support the view that even the biggest brokerages have been caught off guard by the credit crunch and don't have financing to deal with the resulting dislocation in the markets. The opposing, less negative view is that the Fed has taken this step merely to increase the speed with which the funds recently borrowed at the Fed's discount window can flow through to the bond markets, where the mortgage mess has caused a drying up of liquidity.

http://money.cnn.com/2007/08/24/magazin ... 2007082417

ps this Fed move has happened before, once in January of this year but I don't think it was to this extent.

[NTBKtrader]

copy and paste of a blunt post on another forum that I think is accurate

This gamble depends entirely on the idea the market will start eating the shit-sandwiches again. What happens if the broker buys these securities with the new bank loans, but then they can't get rid of them, at least not for anything they paid for them? The bank now has a loan on their books backed by an asset that is not worth the purchase price. That's where the real danger is.

The Fed can ALWAYS bail out the banks by simply turning on the printing presses (literally) and filling up bank vaults with new cash, through it's permanent open market operations. That sort of massive increase in the monetary base would not go unpunished, however. The dollar would roach immediately, and inflation would be back in a BIG way. It would ruin whatever credibility Bernanke has as an inflation-fighter.

I don't think this gamble will pay off in the long term because the issue is of asset quality, not liquidity. People will buy these things, just not for what the sellers are demanding. The ratings agencies have gotten off their asses and are downgrading the shit-sandwiches, which will make their values go down. So, somebody is going to have to eat the losses (toxic loans) here. Who is it gonna be? The CP sellers? Hedge funds? Brokers? Money market funds? Or the big banks?

[NTBKtrader]

Looking at this dispassionately and unemotionally, did the FED really have any other choice? (rhetorical question only).

The following is a list of observations, assumptions, and suspicions. (Sorry in advance if this seems overly long, but I am laying this out to make sure that I understand the situation, and possibly as an explanation if these assumptions are correct). I realize this is severe and that the "containment" has come to a crossroads. Wiley may still be close enough to edge to get back, although it is beginning to seem more unlikely.

1. There is a severe liquidity crisis in all (most?) AB-type paper, whether short term or long term, likely due to the fact that the underlying is either toxic, or suspected of being toxic in the absence of evidence to the contrary. As well, there is a high degree of suspicion as to the condition of "everyone's" balance sheets because no one really knows what is on them.

2. The problem may not be at the "bank" level, but at the "investment" level (brokerages, funds etc). I'm not sure of this, but I suspect that the banks themselves have (had) relatively clean balance sheets due to regulatory requirements.

3. Loans have have to get to this "investment" level to replace funding (often CP that cannot be rolled over, but also revolvers that may be called) that has disppeared due to the perception of risk (lenders are scared of what may be beneath the surface of the borrowers).

4. Banks have been taken by the hand by the FED to the discount window. Money has been borrowed - but due to regulatory constraints, and other factors, the banks may not be able to lend directly (and without some form of security?) to the ultimate parties who are "in trouble" (can't roll over existing financing, or borrow more as needed).

5. For BofA, Citi, and Wachovia, the problem seems to be concentrated at the broker level. Their clients are in trouble and need new loans. The broker does not have the funds to do this and cannot go to any "window" to get it. Because of the ongoing fear, no one who can is lending to anyone who wants to borrow (within the confines of the liquidity crunch. There may be normal "business" lending still going on - but "financial" lending appears to have become petrified)

6. To get the money into the brokers, the banks have to get exemptions from existing regulations, and that is what this is all about.

[NTBKtrader]

New York Fed Accepts Asset-Backed Paper as Collateral (Update3)

By Craig Torres and Mark Pittman

Aug. 24 (Bloomberg) -- The Federal Reserve Bank of New York targeted investor gridlock in the asset-backed commercial paper market today, giving banks new information on how they can use such securities as collateral in exchange for central bank loans.

``In response to specific inquiries, the Federal Reserve Bank of New York has affirmed its policy to consider accepting as collateral investment quality asset-backed commercial paper'' for discount-window loans, Andrew Williams, a spokesman for the bank in New York, said in an interview.

The clarification is the latest effort by central bankers to lubricate credit markets, which have shut out some companies after a slide in the value of securities backed by subprime mortgages. The Fed a week ago cut the so-called discount rate on direct loans to banks and encouraged lenders to use the resource. The four largest U.S. banks borrowed $2 billion this week.

http://www.bloomberg.com/apps/news?pid= ... refer=home

[NTBKtrader]

Some of the liability ``falls on the banks, some of it forces the unwind of these assets to potentials buyers,'' said Bill Gross, manager of the $103 billion Pimco Total Return Fund, the world's biggest bond fund, at Pacific Investment Management Co. in Newport Beach, California. ``There is no doubt that banks have been forced to assume liabilities that they had not assumed before.''

The $1.1 trillion market for commercial paper used to buy mortgages, aircraft cars has seized up just as more than half of that amount comes due in the next 90 days, according to the Federal Reserve. Unless they find new buyers, hundreds of hedge funds and home-loan companies will be forced to sell $75 billion of debt, according to Zurich-based UBS AG, Europe's largest bank.

Already Lost

Those sales would drive down prices in a market where investors have already lost $57 billion, based on Merrill Lynch & Co.'s broadest index of floating-rate securities backed by home- equity loans. That may hurt the 38.4 million individual and institutional investors in money market funds, the biggest owners of commercial paper. Top-rated commercial paper is one of the world's safest assets.

``When there's concern in an area that has so far been without concern, investors are going to behave cautiously until it's proven that the area doesn't have the element that the markets is concerned about,'' Fitch's James Moss, managing director of North American Financial Institutions, said on the conference call.

http://www.bloomberg.com/apps/news?pid= ... fer=canada