What are Paulson and Bernanke Saying?

Bernanke and Paulson are testifying before the House Financial Services Committee and these are their comments (this list will be growing as they speak, so check back often)

Bernanke’s Comments
– Some Signs Credit Market Are Improving
– Credit Conditions Still Far From Normal
– Injection of TARP Capital Critical to Confidence
– Banks Should Review Compensation to Curb Risk Taking
– Says Banks Should Set Appropriate Dividend Policies
10:26am ET Additions
– Revealing Borrowers is Counterproductive
10:56am ET Additions
– Overwhelming Amount of Fed Lending Quite Safe
– Fed Needs to Do What’s Needed to Keep System Viable
– Sees No Significant Credit Risk in Fed Policy
– We Need to Do A lot More to Prevent Foreclosure
11:21am ET Additions
– FDIC Foreclosure Effort Very Promising
– AIG Rescue is to Avoid Contagion of Losses
– Dollar Remains the Premier Currency
– Current Account Imbalances Very Serious Issue
– Foreclosures a Symptom and a Cause of Crisis
12:07pm ET Additions
Crisis Not a Failure of Capitalism

My Take: Nothing meaningful from Bernanke. He’ll be staying on as Fed Chairman so he has more of an interest in doing what is needed at this time than Paulson. He still thinks that there is a long road ahead to stabilizing the credit markets and confidence. No surprises there.

Paulson’s Comments
– TARP Not Panacea for All Our Economic Difficulties
– Rescue Package Wasn’t an Economy Stimulus Program
– Credit Recovery to Determine Speed of Economy Rebound
– No TARP Firepower Left to Buy Distressed Assets
– Economic Slowdown May Prolong Housing Slump
– No Plans for Using Remainder of TARP Funds
– See Modest TARP Funds Aiding a Fed ABS Facility
– Fed Facility Can Help Consumer Credit
– Best Emphasis for TARP is Capital Injections
10:26am ET Additions
– Financial Market Stress Hurts the Economy
– Economy Has Continued to Get Worse
– Our Purpose for TARP Was Protecting Capital Market
– AIG would have failed without Fed Stepping in
– Will Keep Looking for Ways to Ease Foreclosures
– We’ve Turned a Corner Stabilizing Markets
– Will Take A lot of Work to Revive the Economy
10:56am ET Additions
– When Facts Changed, We Changed the Strategy
– TARP Was Aimed at Financial System
– Not a Good Thing Having US Automaker Fail
– Automaker Solution Needs to Have Viability
– There are Other ways to Help Automakers
– TARP has Broad Definition of Financial Firms
– Auto Companies Fall Outside that Definition
– I Have Not Said No To Mortgage Help in TARP
– Working Hard to Prevent Windfall for Banks
– TARP in Process Developing Insurance Program
– No Decisions Made on Other Uses for TARP
– Definitely Capital Available for Some Firms
– Premature to Start Another TARP Capital Program
11:21am ET Additions
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TIC Report Explains Dollar Rally – Top 5 Owners of US Treasuries

Despite the turmoil in the US financial markets, foreign demand for US securities remain robust, particularly since the Treasury’s International Capital flow report was for September, the month that Lehman collapsed.

TIC Report Explains Dollar Rally

Demand was particularly strong for US Treasuries and equities but foreigners dumped corporate bonds on the fear of default risk. As a testament to China’s rising economic power, they have now surpassed Japan as the largest holder of US debt. In September, increased repatriation led to a net sale of US securities by the Japanese while China accumulated a growing amount of US securities for the third consecutive month. The increase in foreign holdings of US debt helps to explains the dollar’s recent rally because despite higher issuance, demand for US Treasuries remains voracious.

Top 5 Owners of US Treasury Securities

Watch out for Paulson and Bernanke

The strong TIC report and the positive news from the tech sector is helping to fuel a recovery in Dow futures, which is driving the US dollar and Japanese Yen lower. We could see a recovery in carry trades today as long as Bernanke and Paulson don’t rain on the party when they testify on the government’s implementation of the $700B bailout plan before the House Financial Services Committee. This is a big risk since Paulson indicated yesterday that he will be leaving the clean up job for the new Administration. He does not plan on requesting the second half of the $700B bailout plan to leave firepower for Obama’s team. If Paulson continues to wash his hands of this mess, the market may begin to sell off once again, driving carry trades lower on the fear that nothing new will be implemented until Obama takes office. With 8 weeks to go before Bush leaves office, the current Administration is more focused on wrapping things up than starting new initiatives.

Source: Wall Street Journal

Source: Wall Street Journal

Higher Core Prices Will Not Stop the Fed From Easing Rates in December
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Leaving the Mess for Obama

There are increasing signs that the Bush Administration wants to leave the clean up job to Barack Obama.

According to Treasury Secretary Paulson, even though the first half of the $700 billion bailout package is being used up quickly, the Bush Administration will not be asking Congress for the remaining $350 billion.

With 8 weeks to go before Bush leaves office, the current Administration is more focused on wrapping things up than starting new initiatives.

Paulson said it best:

“I’m going to do what we need to do to keep the system strong but I’m not going to be looking to start up new things unless they’re necessary, unless they make great sense” and “I want to preserve the firepower, the flexibility we have now and those that come after us will have.”

This was the same spirit that Bush took at this weekend’s emergency meeting of G20 nations that I talked about this morning. The meeting was a big disappointment as the Group failed to deliver any specific solutions. Instead, they set an action plan for March 31 and another meeting for April 30th. The G20 is clearly waiting for the new Administration to take charge before putting the pedal to the medal. The only question is, will the global economy be able to wait that long.

Stocks Rally and Currencies Recover: Is this the Bottom?

The case for a bounce in equities this week was strong following the Lehman CDS Auction and the possibility of new measures from the G7 and G20 nations in Washington this weekend. New guarantees and a host of other announcements have helped to stabilize the financial markets and ease the credit crisis, but is this enough or are we simply seeing a light volume Columbus Day rally in US equities?

Banks and money markets are closed today, which means that we have yet to see the full reaction to this weekend’s announcements, but there is a good chance that this is a near term bottom that could lead to a move back above 9500 in the Dow as investors come in to scoop up stocks at fire sale prices.

Many of the liquidity problems in the financial markets have been addressed by the unified response from the G7 nations. The timing is also right because equities and carry trades have become so oversold leading investors to look for a reason to buy. Sentiment is extremely important these days and we have seen market sentiment shift from skepticism to hope, which should lead to a reversal in the strength in the US dollar and Japanese Yen. From the unlimited dollar funding to interbank loan guarantees, the efforts of nations around the world may be finally working.

In order for this to be the long term bottom in equities, two important hurdles need to be overcome – the Oct 21 settlement of Lehman’s Credit Default Swaps and the Nov 7 settlement of WaMu’s CDS. As counterparty A forks up payment to counterparty B for the protection of a Lehman default, bankruptcies is a strong possibility as those who fall into the counterparty A group fail to come up with the money. If there are no major bankruptcies that forces the US government to come up with another $100B to recapitalize an ailing financial institution, then the worst may be over (Here a great article on Who’s on the hook for the Lehman CDS mess).

Eventually everyone does the right thing and this is the step in the right direction for all of the major world economies. For the currency market, this means a correction in the US dollar and the Japanese Yen, but a recovery for carry trades and the Euro.

Now let’s get a little bit more specific on who announced what this weekend:
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US Dollar: Don’t Trust This Rally

It is now confirmed that the US housing and labor market is in serious trouble. New home sales broke below the 500k make or break mark for the first time in 17 years. The last time we saw new home sales at these levels was during Bush Senior’s Administration. Jobless claims also climbed to 493k, the highest since 2001. To add salt to the wound, durable goods orders dropped 4.5 percent last month.

However these depression like numbers failed to put a dent into the US dollar as investors hold their breath for the approval of Paulson’s Troubled Asset Relief Program. With Congress going on recess at the end of next week, something needs to happen over the next few days. The euphoria in the markets could be short lived since the stock and currency markets have been very fickle.

Gold prices are higher and everyone is hungry for US Treasuries, driving the TED spread and the LIBOR/OIS spread near historic highs. This tells us one thing – which is that lending between banks have frozen and big investors are still risk averse. Therefore I would not trust the USD/JPY and carry trade rally.

Paulson’s Plan Could be a Lose-Lose for the US Dollar

Paulson’s plan is ultimately a lose-lose situation for the US dollar. If it is approved, it would cause a destruction of the US balance sheet by increasing the nation’s debt ceiling by 6.6 percent to $11.315 trillion. If it is not approved or if Paulson and Bernanke only get a trimmed down version of the plan, they would have to go back to the drawing board to come up with other solutions to unclog the mess. If we end up being between rescue plans, the uncertainty would weigh on the US dollar. Therefore I still believe that the US dollar could fall another 5 percent over the next few months.

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