We now return to regularly scheduled credit crunch

Despite what you see in the mainstream financial media, hear from Treasury, or what you're financial advisor tells you, it ain't nowhere near over yet. Remember that these assurances are coming from the same people that said last year "the sub-prime issue is contained", "problems in the sub-prime market will not affect the greater economy", "Bear Sterns is solidly capitalized", "this should be the last of the write downs",and my favorite "we don't need to raise additional capital". I personally had begun to doubt my own thesis based on the recent performance of markets particularly financials but the following information points, most current as of the past couple of days have me thinking the worst is yet to come. We've only been at halftime or in the eye of the storm depending on which metaphor you prefer.

Bank of America May Not Guarantee Countrywide's Debt (Update6)

May 2 (Bloomberg) -- Bank of America Corp., the second- biggest U.S. bank, said it may not guarantee $38.1 billion of Countrywide Financial Corp.'s debt after taking over the mortgage lender, increasing the likelihood of a default.

``If bondholders get stiffed by Bank of America, it will scare the hell out of everyone,'' Whalen said. ``This is called thinking the unthinkable.''

While the market was rallying over the past month, basically since the JPM/Bear deal, it appears that central bankers worldwide have been busy trying to figure out how to unwind this massive credit bubble and avoid actual price discovery on all different types of bonds currently untradeable that are stinking up balance sheets worldwide. Guess what the next idea is? Expand the types of collateral acceptable to swap for Treasuries at the recently created FED facilities to include bonds backed by credit card and auto-loan debt!!!

Fed expands auction, accepts wider collateral

NEW YORK (MarketWatch) -- The Federal Reserve, along with other central banks, said Friday that it was increasing the funding it is providing to banks and announced that, for the first time, it was willing to accept bonds backed by auto loans and credit cards.

They've got some type of swaparoo arrangement going with various Central Banks in Europe.

"In view of the persistent liquidity pressures in some term funding markets, the European Central Bank, the Federal Reserve and the Swiss National Bank are announcing an expansion of their liquidity measures," the Fed said in a statement.

Meanwhile Standar & Poors, a major if not the largest, credit rating agency has given up on rating a particular type of Residential Mortgage Backed Security (RMBS).

S&P Stops Rating Home Equity RMBS; Cites “Anomalous” Borrower Behavior

Standard & Poor’s Rating Services on Thursday did something that very few market participants expected: the agency said it would stop rating RMBS backed by so-called closed-end seconds altogether, whether prime or subprime.

S&P said that an “unprecedented level of loan performance deterioration” has essentially made it impossible to rate second-lien RMBS going forward.

This does not bode well for the still struggling housing market particularly in "Bubble Areas" where piggy-backing a HELOC or second has been standard practice in buying overpriced housing.

So what does it all mean put together? IMHO it's bad, it's really bad, it's scary bad. Central Bankers, Treasury folks, Investment Banks, Commercial Banks, and Politicians are scared. The contaminated paper is most likely sitting in Level 3 assets on the banks side, being swapped for Treasuries in the recent fed "liquidity" instruments (TAF, TSLF, etc....) therefore being hidden in the Fed's balance sheet, and scariest of all most, likely polluting working peoples pensions, 401ks, and money market funds. (BTW several money markets have had to be made whole by the institutions that run them to bring them to the $1=1share level over the past 6 months). CALPERS (the California pension fund for public employees) has had an exodus of high level officers very recently along with a blowup of some real estate deal they were involved in.

Much like the housing problem was never a "contained sub-prime" issue, and is actually an affordabillity issue where even good credit borrowers are walking away from home they have a negative equity position in. The "liquidity crisis" is actually a crisis of the two things that our modern banking system cannot survive without- SOLVENCY and TRUST. The "liquidity crisis" is a result of the lack of those two things. Banks know what they have hidden in the deepest darkest reaches of their Level 3 assetts and assume naturally that other institutions have the same garbage in their's, hence the lack of liquidity or the willingness to lend.

Anyone who has a 401k, mutual fund, or money market fund should pay carefull attention to the prospectus to see if they are holding anything remotely related to the toxic bonds floating around (ABS Assett Backed Securities which include CDO's, RMBS,CMBS, and a multitude of other acronymed securities), and react in your best interest. With the FED accepting auto debt and CREDIT CARD DEBT as acceptable collateral the safety of long dated Treasuries is questionable IMHO.

In the interest of disclosure (I'm trying not to talk my book, but hard not to when you trade what you believe), I have a couple of positions open that though not major, should be noted. They actually are more of lotto ticket plays on a TSHTF scenario. I have long calls on the Vix for a return of volatillity, long dated long puts against TLT(Lehman Treasury Index ETF) for a bond market disruption, and opened a tiny front month long put position against the XLF (Spyder Financial ETF) in case things go to hell in the near term.





[edit on 2-5-2008 by jefwane]