15 September 2008

The Paradigm Shift: “Too Big to Bail Out.”

Is anyone really set for this? A friend, Bill Fleckenstein, told me ”to win this game, all you have to do is recognize when other people finally ‘get it’.”

From what I have seen tonight from .gov and heard in the past couple of weeks from clients and the financial press, perhaps the proverbial ‘light bulb’ just went on. Is it possible? Does everyone finally get it? For example, do people finally understand this is not so much a liquidity crisis but a capital issue?

A paradigm shift back to ‘normal’ maybe occurring. Tonight sure looked like .gov is viewing these events as ’too big to bail out’. That is more than a shift, that is a full 180.

‘Maybe its different this time’ was perhaps the past two decades of free money and ultimate leverage. Now, its time for some harsh reality.

It looks like tonight that .gov decided to protect its balance sheet just like the banks have done for the past year. It is every bank for themselves. The Gov’t threw its balance sheet at the GSE’s just two weeks ago and here we sit. Nobody, and I mean nobody is prepared for this. And Nobody, and I mean nobody may be able to stop it.

Step back a minute and just think about it. All the pieces fit including the $70bb bank consortium that will mimic a Fed facility used by member banks to fill each others balance sheet holes. In addition, the new Fed rule changes accepting stock and short-term notes at the various Fed facilities sure seems like a way of temporarily slowing failures with less risk to the tax payer. This, on the surface, looks in no way is as significant as the TAF when it was created.

However, this little ditty that comes along with the loosened rules brings in some questions. Basically, this sets up for commercial banks to take out broker dealers. So, now money from from insured naive depositors can go to fund speculative brokerage operations.

“In a third step, the Fed said it would temporarily allow insured depository institutions to extend liquid funds to their affiliates for assets that would normally be accepted in tri-party repurchase agreements.”

Tomorrow’s AIG story will shed some more light on these thoughts. AIG asked for an unprecidented ’bridge loan’ from the Fed before tomorrow. We will see if .gov stands up. -Best Mr Mortgage

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