The Weekly Report

By: Mick P | Sun, Apr 27, 2008
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Welcome to the Weekly Report. This week we look ahead to the new pricing system for Mortgage Backed Securities and Asset Backed Securities created by the Bank of England, developments in bonds and yields and why the Federal Reserve is central to current yield changes. We ask if the credible policies are leading to increased inflation expectations and look for global reaction. We update the long term trend update for the Dow, FTSE and Gold.

By now I doubt there is an investor or trader worldwide who isn't aware of the Federal Reserve, Bank of England, Bank of Canada, Royal Bank of Australia and the ECB have been doing in their efforts to infuse liquidity and arrange swaps or borrowings of AAA Government bonds to replace credit paper/notes affected by the loss of confidence in its ability to avoid default events.

This week Mr King at the Bank of England made it clear (how unusual is that!) that the Special Liquidity Scheme it has introduced will last for at least 3 years and if it is required to expand beyond the initial £50Bn then it will happen. The new facility is in addition to this, quoted from the B of E site (it is a large quote but contains some vital information):

What's so important or vital you may ask? Well, how about the pricing of AAA rated Mortgage and Credit card backed securities, valued at 70-90p on the Pound. Surely that sets a mark to market maximum price for the next 3 years. Borrowing using AAA mortgage and credit debt as collateral just got expensive. Borrowing using anything else as collateral is next to impossible. Borrowing using collateral "invented" after 31 Dec 2007 isn't allowed to be used in the Special Liquidity Scheme. It also means the best route to move losses off the books is to deal with the B of E and it's not free:

That though is not the most important point raised by the B of E. They have refused to take ANY securities backed by US mortgages. The US just got downgraded by the Old Lady. Now if the B of E won't deal in US mortgage securities, why would any UK bank buy them or accept them as collateral on their lending? Without the "King Put" the risk is just too great.

Can you smell contagion? It gets worse, not only has all US MBS been downgraded to junk but ANY derivative of ANY MBS or ABS is not acceptable as a swap for Gilts.

Here though is the clincher, US Asset Backed Securities backed by credit cards and rated AAA, are acceptable. US credit card debt is more valuable than US mortgage debt. So, who does the B of E rely on for the ratings criteria?

But the Old Lady has one more swift kick to deliver, it maybe the nastiest of all:

The haircuts can be considerable as seen by this table:

The US GSE is for conventional debt.

It looks to me that the use of the rating agencies in this matter is very limited. The Bank has decided to make a market on the assets swapped for Gilts, regardless of market conditions and not rely on ratings. Just when you thought it was safe to dump your toxic waste, you realize you could get margin called on it. Of course, if the B of E are marking to market, what's the reasoning for anyone else not to do so? In an attempt to get around a moral hazard that we know is troubling Mr King, the Bank may just have initiated the very scenario they were trying to avoid.

Sometime ago I said that the Facilities set up by the Federal Reserve had an inherent flaw, one that could be taken advantage of by speculators.

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Mick P

Author: Mick P

Mick P (Collection Agency)
About Collection Agency

An Occasional Letter From The Collection Agency in association with Live Charts UK.

For some years now I have written an ongoing letter, using macro-economics, to try and peer into the economic future 6 to 18 months ahead. The letter was posted on a financial bulletin board to allow others discuss its topic.The letter contains no recommendations to buy or sell, indeed I leave that to all the other letters out there and to the readers own judgement. The letter is designed to make us all think about what may be coming, what macro trends are occurring and how that will affect future trends and how those trends will filter down to everyday life and help spot weak or strong areas to focus on for trading or investing.

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