Monday, October 19, 2009

How The Federal Reserve Bailed Out The World

From Zero Hedge, further reading to this mornings post on Analyze This       
Banks Doubled Down: Super Long Assets /Short USD
"What pushed the system to the brink was not cross-currency funding er se, but rather too many large banks employing funding strategies in the same direction, the funding equivalent of a “crowded trade”."..the Bank of International Settlements, "The US dollar shortage in global banking and the international policy response"
Why is this critical? We are now back at a time when the only gains in the stock market are at the expense of dollar destruction, with a concomittant funding for dollar denominated assets. In one short year since the collapse of Lehman we have gone back to the same dollar funding risk exposure as was on the books in these days before Dick Fuld's empire unravelled. While whether or not the Federal Reserve stepped beyond its bounds in practically bailing out not just Goldman Sachs, but as this paper has proven, virtually the entire world, is not up to us to decide. However, a critical topic is: have we learned anything from the implications of an unprecedented dollar funding gap, which is likely back to record levels once again? What is obvious is that the Fed's current policy of a weak dollar, contrary to its repeated lies otherwise, is simply enhancing the dollar funding moral hazard: and the breaking point will come sooner or later with disastrous consequences.
As the H.4.1 discloses weekly, the Fed's liquidity swaps are now back to almost zero. This means that foreign Central Banks believe they have the FX swap and dollar maturity situation under control. They thought the same before Lehman blew up. And they were wrong. As the DXY continues tumbling ever lower to fresh 2009 lows, the trade de jour is once again the dollar funding one, although unlike before when the Yen was the carry currency of choice, this time it is the dollar itself, positioning banks for the double whammy of not just a dollar funding shock, but one coupled with a potential massive and historic short squeeze. If and when an exogenous event occurs, not even $6.5 trillion in Fed swap lines will be sufficient to bail out the world economy. It is time someone in Congress asks the Chairman all the pertinent questions that evolve from this analysis and how he is prepared to handle its next, much more vicious, and likely terminal, iteration.
Full BIS paper.

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