Loan Shark

You mention the time we were together
So long ago, well I don't remember
All I know is that it makes me feel good now
It's like I told you, only the lonely can play
--The Motels

Over the past year, the Fed has opened many special credit facilities to permit financial institutions to borrow cheaply from the central bank. The idea is that by borrowing extra cheap, institutions could then buy higher yielding securities and make money on the spread. Thus, banks could shore up their balance sheets by generating capital from the carry trade.

Problem is that, due to the sheer volume of underperforming assets on financial firms' balance sheets--assets that are highly leveraged and that continue to decline in value--there is no way this carry trade will be able to reliquify bank balance sheets in any reasonable period of time.

Insolvency looms.

Thus, we see an array of firms such as Lehman (LEH), Wells Fargo (WFC), Nat City (NCC), and Washington Mutual (WM) seeking to tap debt markets to raise capital. The effective interest rates required by creditors, however, are much higher (e.g., 9%+) than the levels where banks can make money, thus producing a negative cost of carry.

What's this tell us? Firms are desperate for capital. They're not thinking about ROI; they're thinking about survival.

Like Minyan Peter, I sense that a wave of bank failures and an overstressed FDIC are pending.

no positions