By Ye Xie
Bloomberg.com
Friday 10 August 2007
The Federal Reserve added $38 billion in temporary funds to the banking system through the purchase of securities including mortgage-backed debt to meet demand for cash amid a rout in bonds backed by home loans to riskier borrowers.
The Fed's additions totaled the most since September 2001. They came in three weekend repurchase agreements, of $19 billion, $16 billion and $3 billion. Losses in U.S. subprime mortgages have been rippling through credit markets, driving interest rates higher and sinking stocks. The Fed added $24 billion yesterday.
The New York Fed's actions lowered the Federal funds rate to 5.25 percent, matching the central bank's benchmark overnight rate, according to ICAP Plc. The rate began trading today at 6 percent, the highest open since January 2001. Treasuries erased gains after the additions and stocks pared their losses.
"They've been very aggressive and they want to make sure there's sufficient liquidity in the financial market," said Ward McCarthy, principal at Stone & McCarthy Research in Skillman, New Jersey. "It looks like they succeeded."
The Fed accepted mortgage-backed debt issued or guaranteed by federal agencies, so-called agency debt and Treasuries as collateral for today's repos.
2001 Record
The Fed's benchmark was 6 percent the last time fed funds opened at today's level. On average, the Fed has added about $9 billion in temporary funds daily this year through yesterday.
In the week after the Sept. 11, 2001, terror attacks, the Fed added a daily average of $75.3 billion in reserves through repos. The record was $81.25 billion on Sept. 14, 2001.
Stocks dropped worldwide today on speculation losses in mortgage debt will hurt economic growth. European benchmark indexes fell 1 percent or more.
The European Central Bank today loaned 61.05 billion euros ($83.6 billion), pumping funds into the banking system for a second day. The ECB added an unprecedented 94.8 billion euros yesterday.
Some banks may experience "unusual funding needs," the Fed said in a statement from Washington. The Fed's discount window is open and the central bank pledges to provide liquidity, the Fed said.
As of yesterday, interest-rate futures for August showed investors saw more than a 50 percent chance the Fed will cut the key rate a quarter-point on any day from Aug. 16, Merrill Lynch & Co. said in a report yesterday. An August rate cut is a "genuine possibility," JPMorgan Chase & Co. said in a report today.
"Because of today's operations, the probability of an August cut has gone down," said Dominic Konstam, head of interest-rate strategy in New York at Credit Suisse Group. "The Fed is going out of its way not to cut rates to resolve the liquidity issue."
"Special Demand"
Countrywide Financial Corp., the biggest U.S. mortgage lender, said it faces "unprecedented disruptions" that may reduce profit, suggesting a credit crunch that started with the U.S. subprime market will spread. BNP Paribas SA, France's biggest bank, helped spark financial market turmoil yesterday by halting withdrawals from three investment funds because it couldn't value their holdings.
The central bank probably received only mortgage-backed debt in today's operations, said Louis Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. The central bank likely wanted to avoid taking Treasury debt at a time when government securities are in demand as a safe haven, he said.
"The Street has special demand for the highest-quality Treasury collateral right now, so the Fed chose to leave Treasury collateral," Crandall said. "It should not be taken as a sign that basic Fannie Mae and Freddie Mac mortgage pools are difficult to finance."
Overnight Rates
The Fed typically only accepts so-called agency mortgage- backed securities, such as those guaranteed by government- chartered Fannie Mae or Freddie Mac, rather than non-agency home- loan bonds from other financial institutions. Issuance and trading of non-agency bonds, including securities backed by subprime mortgages, has ground to a near-halt the past month.
Overnight euro rates again rose to as high as 4.27 percent today, compared with the ECB's benchmark rate of 4 percent.
Fed funds, the U.S. overnight interbank lending rate, closed at 4 15/16 percent yesterday, after trading between 4 3/4 percent and 5 3/4 percent, and averaging 5.38 percent, according to ICAP Plc, the world's largest inter-dealer broker.
In repos, the Fed buys U.S. Treasury, mortgage-backed and so-called agency debt from its 21 primary dealers for a set period, temporarily raising the amount of money available in the banking system. At maturity, the securities are returned to the dealers, and the cash to the Fed.
Repos help maintain enough money in the system to keep overnight interest rates close to the central bank's target. They don't signal a policy shift.
Impact of Mortgage Crisis Spreads
By Gregory Zuckerman, James R. Hagerty, and David Gauthier-Villars
The Wall Street Journal
Friday 10 August 2007
Dow tumbles 2.8 percent as fallout intensifies; moves by central banks.
Fallout from the intensifying credit crisis stretched from a French bank to the largest home-mortgage lender in the U.S., triggering unusual central-bank interventions and driving the Dow Jones Industrial Average to its second-worst drop this year.
The troubles demonstrated both the global reach of the crisis and its impact on a widening circle of markets and companies. The first jolt came from French bank BNP Paribas, which said early in the day that it was freezing three investment funds once worth a combined $2.17 billion because of losses related to U.S. housing loans. That prompted the U.S. and European central banks to inject cash into money markets to keep interest rates down. (See related article.)
The unease accelerated in the U.S. with news that several hedge funds were in the red and selling off assets. Apartment and condominium builder Tarragon Corp. raised doubts about its ability to remain in business amid weak demand and an inability to raise new financing. After markets closed, mortgage-lender Countrywide Financial Corp. said "unprecedented disruptions" in credit markets could affect its financial condition.
The stock market, which on Wednesday had risen sharply on hopes credit problems were being contained, swooned as hedge funds, many of which borrowed increasing amounts of money in recent years to boost returns amid placid markets, scrambled to sell holdings and cut their borrowings. The Dow Jones Industrial Average ended down 387.18 points, or 2.8%, at 13270.68. (See related article.)
After the close of trading, Renaissance Technologies Corp., a hedge-fund company with one of the best records in recent years, told investors that a key fund has lost 8.7% so far in August and is down 7.4% in 2007. Another big fund company, Highbridge Capital Management, told investors its Highbridge Statistical Opportunities Fund was down 18% as of the 8th of the month, and was down 16% for the year. The $1.8 billion publicly traded Highbridge Statistical Market Neutral Fund was down 5.2% for the month as of Wednesday.
Meanwhile, Countrywide, of Calabasas, Calif., said in a Securities and Exchange Commission filing that it was shoring up its finances and had "adequate funding liquidity." (SEC filing) But the company, the nation's largest home-mortgage lender in terms of volume, warned that "the situation is rapidly evolving and the impact on the company is unknown." Reduced demand from investors is prompting Countrywide to retain more of its loans rather than selling them.
The statement could send shivers through financial markets today. It came just a week after Bear Stearns Cos., the Wall Street trading giant, had to reassure investors that it had ample cash on hand amid concern that it faced funding problems because of deteriorating credit-market conditions and the implosion of two of its hedge funds.
On Friday, markets in Asia tumbled in early trading. (See related article.) After the Nikkei 225 index fell more than 2%, Japan's central bank injected $8.39 billion into money markets. That followed actions Thursday by the European Central Bank, which provided more than $130 billion to money markets, and the U.S. Federal Reserve, which added $24 billion in reserves to the U.S. banking system.
What started late last year as worry over a sharp rise in defaults on subprime mortgages has mushroomed into a crisis for the entire home-loan industry and investors world-wide. By March, late payments were reaching worrisome levels on Alt-A mortgages, a category between prime and subprime that includes many loans for which borrowers "state" rather than verify their incomes. Most prime loans continue to perform well, but Countrywide has reported a rapid rise in delinquent payments on certain prime home-equity loans that were used by people stretching themselves to buy homes with little or no money down.
Payments were at least 30 days late on about 20% of "nonprime" mortgages serviced by Countrywide as of June 30, up from 14% a year earlier, the company said. Nonprime includes loans to people with weak credit records and high debt in relation to their income, as well as to people who don't document their income or assets. On prime home-equity loans, the delinquency rate was 3.7%, up from 1.5% a year before. For all loans, the rate was 5%, up from 3.9%.
In a sign of the growing difficulty in selling loans, Countrywide said that it transferred $1 billion of nonprime mortgages from its "held for sale" category to "held for investment" in the first half - meaning they will stay on the books instead of being sold. Countrywide marked the value of those loans down to $800 million. Despite its current woes, the company argues that it is well-placed to gain market share from weaker rivals.
Rattled by a constant stream of bad news, investors in recent days have been shunning nearly all mortgages except for those that can be sold to Fannie Mae and Freddie Mac, the government-sponsored investors that guarantee payments on loans that "conform" to their standards. That has prompted lenders to boost rates on prime "jumbo" loans - those totaling $417,000 or more, too big to be guaranteed by Fannie or Freddie - to as much as 7.25% or 8%. Usually, such loans cost only about a quarter percentage point more than "conforming" mortgages, but the gap has ballooned to as much as 0.8 point during the past week.
In financial markets, several entities thought to be insulated from the subprime meltdown now turn out to be affected, leading investors to wonder who might be next. For instance, BNP just last week had said the three funds were conducting business as usual. But Europe's sixth-largest bank by stock-market value said yesterday that it had been forced to suspend the funds on Tuesday because of a sudden and unexpected dearth of buyers and sellers.
"The market for the assets has just disappeared," said Alain Papiasse, head of BNP Paribas's asset-management-services division. "Since the start of this week, there are no prices for instruments that carry, directly or indirectly, some types of U.S. assets."
In the U.S. the latest crop of hedge funds to be hit hard by the market's turmoil includes those that focus on "market-neutral" strategies, or strategies that seek to do as well in both falling and rising markets. The strategy has been embraced by some of the biggest names in hedge funds, in part because it's popular with institutional investors who hunger for gains in any kind of market.
Many market-neutral funds have been wagering on high-quality stocks, or stocks that trade at low valuations based on various metrics, and betting against stocks that look expensive. Because this stance is seen as relatively conservative, the funds felt comfortable borrowing money to boost returns.
But as banks began getting worried about their hedge-fund clients in recent weeks, some hedge funds were asked to put up more collateral to back the loans, or anticipated these requests. The funds sold some of their holdings of high-quality stocks to raise the cash, and closed out "short" trades, or bets against companies, by buying back shares of companies seen as expensive. Others sold positions simply to become more conservative, in a rocky market.
Since market-neutral funds often are guided by similar computer models and share similar holdings, the actions magnified moves in asset prices. The last week has been the worst on record for many large hedge funds focusing on this strategy, worrying traders across Wall Street, many of whom look to these firms for signs of stability in difficult markets.
AQR Capital Management LLC, a $38 billion fund based in Greenwich, Conn., has seen losses in recent days in investments employing market-neutral strategies, although the firm's other strategies, which represent the majority of its assets under management, are holding up, according to a person close to the matter.
Other big funds also are hurting. A Goldman Sachs Group Inc. fund, known as GS North American Equity Opportunities, saw the value of its holdings fall more than 15% between the beginning of the year and July 27, according to investors familiar with the fund. The Equity Opportunities fund lost more than 11% between July 1 and 27, according to the investors, some of whom are current and former Goldman partners.
News of that fund's problems came just a day after word that Goldman's most widely known internal fund, the $9 billion Global Alpha, has liquidated certain positions to curb its risk profile. That fund was rumored to be facing liquidation - a notion a Goldman spokesman has called "categorically untrue." Yesterday Goldman also dismissed published report that the Equity Opportunities hedge fund is liquidating.
Those developments shook the market in part because Goldman is renowned for trading prowess. The sales at Goldman's two funds follow bigger losses at rivals such as Bear Stearns Cos., which has been forced to shut down two hedge funds in recent weeks after crippling losses on securities tied to subprime loans.
Tykhe Capital LLC - a New York-based quantitative, or computer-driven, hedge-fund firm that manages about $1.8 billion - has suffered losses of about 20% in its largest hedge fund so far this month, and is moving quickly to trim its investment positions, according to an investor in the firm briefed by Tykhe executives. Tykhe isn't closing down, according to the investor. Calls to Tykhe seeking comment weren't returned.
During the past several days, a number of other quantitative funds have also been hard-hit. These funds generally operate by building computer models of market behavior and then allowing computer programs to dictate trading. With the recent trouble in financial markets, many lenders, funds and brokerages were following statistical models that grossly underestimated how risky the environment had become.
Kate Kelly, Alex Frangos, Henny Sender, Anita Raghavan and Ian McDonald contributed to this article.
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