Morning Observation

Earthside Comments: We have been watching on television the financial channels: Bloomberg, CNBC and Fox Business Channel (that means about ten people are watching).

Almost every single guest on these programs -- fund managers, financial advisors, TV economics pundits, etc. -- are trying to tell us that we really are, this time for sure and they really mean it ... near a bottom. Their words are attempting to sell positive, but their eyes are hysterical.

If there is one sure signal that this is not a "bottom", it is when the speculators and stock dealers are desperate for you to believe that it is.

Furthermore, when Bush comes out and tells you that everything is going to be okay -- bury your money in the backyard.

Finally, take stock of what is going on when you see the Federal Reserve bailing out a failed investment bank (Bear Stearns), when the Fed takes on bad mortgage debt as collateral for treasury bond lending for corporations like ... Bear Stearns, when the central government goes deeper into debt just to send you 'free' money -- it means that the U.S. economy is almost completely being taken over by politicians in Washington with taxpayers bearing all the downside losses.

So, what all this means is that for the insider elites, for Bush's transnational corporate cronies, for the 'big time' securities dealers, well, YOU are rescuing them. You know that, don't you?

Link: Credit Crisis Tests Depth of Federal Reserve's Pockets | The Age

The big question now is not about bank balance sheets, it is about the central bank balance sheet, that is the US Federal Reserve. Is it running out of assets to prop up Wall Street?

Over the past few weeks the Fed has lent $US400 billion ($A415 billion) of treasuries to support the US banking system. At its last statement in January, it held just shy of $US800 billion in the bonds.

There are a similar number of greenbacks outstanding. Bear in mind that the balance sheet of a central bank is unique in that cash is booked as a liability and treasuries are counted as assets. That $20 note you have in your pocket is a liability of the Reserve Bank

The bailout of Bear Stearns is no one-off. The Fed said it would continue to bail out Wall Street, though not in those words. Neither did the governors spook the market by admitting they had invoked Depression-era law to grease the wheels of liquidity.

The cred of the Fed is now on the line, you might say. It has about $US800 billion in greenbacks outstanding. It cannot print another $US400 billion without seriously letting inflation go. It has no choice but to lend treasuries.

The Fed is providing the liquidity through "term auction facilities". This allows the banks to bid to borrow treasuries, straight from the Fed's vault, secured by mortgages and the like. The press releases show they are providing treasuries for 28 days , anticipating rolling the securities loans for up to six months. Banks such as Bear Stearns that get the treasuries immediately short them to provide funding. But if the Fed runs out of treasuries, the system is in dire straits. It could print money but inflation would spiral out of control.

Another possibility — the one everyone is hoping for — is that we are near the bottom and things recover. Or, as some are mooting, the US Congress could get involved and issue more treasuries, effectively buying mortgages.

While bailing out investment banks looks like an act of gross corporate welfare, the ramifications of letting Bear Stearns go would have been cataclysmic for financial markets. The bank is one of the top three "prime brokers" in the world. A prime broker provides loans and processes trades for hedge funds. But the fund relationship is far more critical than a service provider.

Hedge fund clients of Bear Sterns, as with other prime brokers such as Goldman Sachs, Morgan Stanley and Lehman, pledge their collateral — that is their investments — 100% to their prime broker. That means the broker can repledge them.

For instance, if you are holding a treasury then Bear Stearns can repledge it. The first thing it might do, after the prime brokerage contract is struck with the hedge fund, is to short that bond. If it does that, then it is effectively borrowing at the treasury rate. In the case of the hedge fund client, not only is its cash pledge unsecured to the prime broker but so are its assets.

Under many contracts, the fund lends 100% of its cash and assets unsecured to its prime broker, which means that if the broker goes bust, its fund clients wind up as unsecured creditors.

The collapse of Bear Stearns demonstrates just how critically interlocking are the relationships in global financial markets. In the case of Bear Stearns, the prime brokerage business was probably OK, but at the parent level there was about $US400 billion of assets sitting on just $US13 billion of equity.

Locally, there has been heat on failed retail brokerage Tricom for getting its small clients to pledge their assets, assets that would then be shorted, some argue, against their clients' interests.

This is how it works at the professional prime brokerage level. And since the sheer volume of business through the equity market from prime brokers, both short and long, contributes such a high proportion of ASX revenue, it makes it hard for the stock exchange to take seriously the Australian Securities and Investments Commission's latest initiative to chase hedge funds, rumour-mongers and short-sellers.