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Friday, June 19, 2009


the state of marginal systemic funding

i've added a sidebar link to the slosh report, which monitors treasury open market operations (TOMO), TIO and TAF management operations done by the federal reserve. this is one way one might gauge the fed management of bank liquidity. as one can readily see, after ramping up liquidity into the march lows in equities, the fed began withdrawing support from the market. while this amounted only to taking back the first quarter surge until mid-may, the fed has since may 21 overseen a fairly dramatic reduction in this liquidity profile -- most of it a reduction in the TAF.

while the S&P 500 peaked in early june, its may 20 high was 924.60 -- and, whether by causation or coincidence, it is trading at 924.90 as i write.

pragmatic capitalist further highlights the ongoing crash in another important source of marginal systemic funding, the commercial paper market.

The deceleration in commercial paper has had a very high correlation with economic activity in the last two years. The recent cliff dive in commercial paper represents how weak near-term business activity has been across the economy. I would expect to see a substantial acceleration in the ABCP market before we see any sharp acceleration in economic activity. As of now, the commercial paper market is nothing more than a sure sign that the so called “recovery” is beyond weak and is perhaps even weaker than many “green shoot” theorists assume. A double dip recession is looking more and more possible as we move into the second half of the year….

pragcap ties this move to a reduces need for working capital in industry, but i'm not so sure. i discussed this some last month. while non-financial paper -- the kind that amounts to flotation for working capital -- is indeed declining at a punishing rate and has continued to do so (latest figures here), the vast majority of the collapse in CP has been the unwinding of the off-balance sheet financing vehicles which were at the heart of the shadow banking system. asset-backed commercial paper has vaporized down from a seasonally-adjusted $717bn at the open of 2009 to $503bn through june 17, a (-29%) collapse. from its 2007 peak of nearly $1200bn, this is a spectacular unwind and exactly what is meant by the run on the shadow financial system that, per james kwak, has been a source of some debate recently. over this is, to my understanding, largely a function of the relentless unwinding of special-purpose vehicles (SIVs and conduits) which were funded by ABCP. the size of the unwind since the last two weeks, ending june 10 and 17, is particularly notable -- $54.7bn in total.

further, financial paper has been vanishing at a remarkable rate as well -- from $569bn at year open to $441bn today, down (-22%).

that's not to say there's no meat to pragcap's argument. domestic non-financial CP has deteriorated just as rapidly, from $202bn at 2009 open to $153bn today, a (-24%) drop. though much of this non-financial paper may have been in fact quasi-financial (thinking particularly about GE here) i think he's right to say:

While the market rallied a bit in the after hours market on this news I believe the market is overlooking a much larger problem. While it is a good sign that companies aren’t reaching out for short-term government funding it is also alarming that commercial paper issuance continues to fall off a cliff.

the reduction of dependence on short-term and fed-intermediated funding is a necessary part of the correction that must take place in the american financial and corporate system. but no one should pretend that these banks and companies are now healthy, aggressive and levering up using private finance. a massive amount of equity issuance combined with balance sheet downsizing/deleveraging is the underlying dynamic, and however necessary that is not a symptom of rude health -- nor is it a positive for equities.

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