The decision last week by the Federal Reserve to flow up to $200 billion into the credit market has done little to embolden market participants, many of whom believe the Fed's action did not go far enough to help the credit crunch.
"From one standpoint I think [Fed Chairman Ben Bernanke's] targeted response is certainly interesting from a wonky textbook point of view, but to a certain degree this is a lot bigger than certainly yesterday's action acknowledged," said Max Bublitz, chief strategist of SCM Advisors. "It's a little bit akin to coming to a knife fight with a cap gun. I think that's in essence what everyone's saying."
The Fed plans to hold auctions for Treasurys in exchange for mortgage-backed debt beginning on March 27. The action is a coordinated effort with Canadian and European banks, which plan to inject up to $45 billion into their banking systems.
While stocks surged on March 11 upon announcement of the Fed's move and the Dow jumped 417 points for its best day in five and a half years, many analysts were disappointed that the Fed did not agree to make outright purchases of mortgage debt.
"When you take a look at the dismantling of the shadow banking system, what we're seeing is that there's no buyer of last resort for this stuff," Bublitz said. "The Fed's trying to buy some of the quality stuff, but they don't want to junk up their portfolio."
Merrill Lynch analysts said in a research note released on March 11 that the Fed's move will not alleviate the credit crunch or economic recession. "The size of the auctions, while sizable in terms of the Fed's balance sheet, are actually fairly small in light of the overall credit situation and in no way does this solve - or is intended to solve - the massive write-downs and losses in the banking sector that are ongoing in this cycle," they wrote.
While Merrill Lynch called the Fed's initiative a "positive, innovative" step, the analysts argued that it is just not big enough to make a dent. The analysts noted that $200 billion is a small portion of the $6 trillion MBS market, which comprises $4.1 trillion in agency MBS and $1.9 trillion in non-agency MBS.
While Bear Stearns's economists were also less than hopeful that the Fed's action will be enough to reverse the looming recession, they believe it will at least ease the burden that monetary policy would have to play in bolstering the credit market. They called it "a brilliantly conceived addition to its lender-of-last-resort armory to ease funding pressures on mortgage-backed securities.
"The program might provide the needed circuit breaker to the adverse feedback loop in the mortgage market," Bear economists said.
Bublitz, however, believes the Fed has been too late in trying to bring relief to the credit markets.
"What you really want from policy makers is that they understand the problems that we're dealing with and it's not altogether clear to me that they got it," he said. "I think they are playing catch up and so they've been in a reactive mode." While this approach might work during good times, Bublitz added, "these are extraordinary times and I've yet to see the Fed be proactive."
Bublitz argued that it has not been fully understood how much the growth of the economy was propped up and supported by monetary policy after 9/11, by fiscal stimulus and by the unprecedented expansion of credit. All of this, he said, resulted in only 2.5% or 3.5% GDP.
"That doesn't say much about the underlying strength of the economy," he said. "One of those props is being kicked out as the federal banking system is being, frankly, dismantled and shoved back onto the regulated banking system's balance sheet, and obviously they're constrained."
Ultimately, Bublitz believes that it's not so much a price or yield correction that we need to go through, but a timing function.
"I think these people need to get slapped for another couple of months until they're totally bummed and walking with their chins on the ground," he said.
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