Monday, April 27, 2009

Is the Federal Reserve the next Lehman/Bear Sterns?

It's interesting to note that while the Federal Reserve has been preventing the banks from falling off the cliff they seemed to have neglected their own balance sheet.

As first pointed out on istockanalyst.com there has been a seismic shift in the "assets" and liabilities of the Federal Reserve. According to the Fed's own reports in April 2007, the bulk of the Fed's assets ($787 billion out of $850 billion of total assets - or 89% of assets) consisted of relatively high quality US Government debt - treasuries, t-bills, notes, etc.

Two years later? Assets - to use the term loosely - have exploded to over $2.1 TRILLION. Almost $700 billion of new assets include Mortgage Backed securities and term auction credit. Central Bank swaps and commercial paper funding adds another $500 billion. These are shocking numbers. Remember the good old fashioned US treasuries that represented almost 90% of the banks assets? They now represent just 24% of the Fed's assets.

Now I know most of your eyes are glazing over so I'll bring in home by focusing in what this all means. Remember the questionable assets that brought down the banks because the banks took out too much debt against too few assets. Well, many of those assets are now on the balance sheet of our central bank.

Again, via istockanalyst.com

"And the Fed banks are holding total capital of just $45.7 billion against the sum total of $2.19 trillion in assets, meaning the Fed is leveraging its capital 48-to-1. That compares to only 27-to-1 two years ago.

What’s the Risk?

The answer is that it all comes down to the reaction of the capital markets …

Do investors continue to aggressively bid on U.S. Treasuries at our debt auctions?

Do foreign creditors, who hold more than 53 percent of the privately held Treasury debt outstanding, start balking at supporting our profligacy?

Does the U.S.’s AAA credit rating come under closer scrutiny?

And does the dollar start to reflect the fact that the Fed is throwing money around like a drunken sailor — and taking on any and all kinds of crummy assets? "

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GM seems to want to file for Chapter 11

I didn't spend much time this morning reviewing the GM news because there were many other stories moving the markets. I was extremely puzzled by the 20% move UP in GM's stock today. If anyone took their restructuring plan seriously I think you could argue that it means the current stock trading at around $2 per share is virtually worthless.

I guess maybe people just read the headlines - job cuts, dealer cutbacks, Pontiac shutdown - and thought, Yeah!! GM will live to fight another day. Perhaps, but it doesn't mean that the stock has any value. Today GM has roughly 610 million shares outstanding, but if their proposed restructuring went through they'd issue 60 billion + shares to bondholders, the US government and the employee benefit fund. That's 100 TIMES the current number of shares outstanding which should in theory make each share of GM worth 1/100th it's current price or $0.02/share.

However, since the proposal requires 90% approval from the bondholders I think this plan has zero chance of success. If you were a bondholder would you like to own 10% of GM's stock or take your chances in bankruptcy court? There's a high probability that this plan will lead to bankruptcy filing for GM before the end of June.

Cheers!

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