Fed Auction Money Found Its Way To Wall Street
by David Yu
I had to take the last couple of weeks off to attend to some pressing personal matters. It didn't seem like I'd missed much anyway. The trading volume had been thin and the price movement had been quite stagnant. I wouldn't place too much weight on recent market action. It's the time to relax and enjoy some time off. The market's back to where I'd left off on 12/13/2007. The S&P 500 barely moved from 1488.41 on 12/13/2007 to 1478.49 on Friday, 12/28/2007. The market probably would've gone down further had it not been for the liquidity injections from the European Central Bank and the Fed. Most of the money appeared to have found its way back to Wall Street.
More than 80% of the first $20 billion auction by the Fed went to institutions in the New York district, where the largest banks and brokerages headquartered (see Chart 1 below). This indicates that the biggest borrowers are near Wall Street. Banks in the Fed San Francisco district that covers most of the West, on the other hand, had only borrowed 3% of the auction money. The Chicago and the Richmond Fed districts had borrowed just 2.38% and 0.13% respectively.
Chart 1
Nonetheless, the Fed and the European Central Bank's term auctions seem to be working. The Fed Fund's Effective Rate, the interest rate that banks charge each other to borrow money, had tumbled to near 4%, the lowest level since December 2005 (see Chart 2, below). This indicates that banks are no longer as reluctant to lend to each other. All the liquidity wouldn't do much if the intermediaries, the banks, weren't willing to lend.
Chart 2
The London Interbank Offered Rate (LIBOR), the interest rate banks offered to lend to each other in the London wholesale money market, has also been dropping (see Chart 3 below).
Chart 3
These declining interbank lending rates indicate ample liquidity in the banking system for the time being (basic law of supply and demand), and they might've gotten the banks through the end of the year. The question is how much longer and how much more money the central banks are willing to keep in the system while exposing themselves to the hazard of holding potentially risky assets as collateral for loans to banks.
Since this whole mess started with the subprime loans, and the subprime loans' problems started with declining real estate value, further deterioration of the housing market could exacerbate the situation. Unfortunately, it could get worse before it gets better. And it could take a while before we see the bottom because current housing market debacle is more of a structural problem than just a bump in the road. And it takes time to resolve structural problems.
One of such structural problems facing California, for an example, is population migration (see Chart 4 below). California's population migration has been in decline since 2000, due to declining domestic migration during the same period as well as declining foreign migration since 2001 (911 terrorists attack). Increasing number of people moving out of California naturally dampens the demand for housing, rent or own. This long-term declining trend doesn't reverse itself overnight. It's going to be a time consuming process.
Chart 4
We'll check up on the language of the market once the market's operating in full capacity again. For now, I'm wishing all of you a Happy New Year. Make sure you take some time off to relax and enjoy...
email: dyuguard-2@yahoo.com