Fed Day Taking Second Place to AIG Worries

Jeez-Louise! What a ride we're having!!!! Last week it was Fannie & Freddie. Yesterday it was Merrill & Lehman. Today...it could be AIG. These are watershed changes of seismic proportion. Really, really amazing stuff. In the turmoil, though, there is opportunity. From 2 weeks ago through today, we've seen certain loan programs provide an interest rate drop of nearly 1 full percentage point. That is HUGE for people looking to buy a house or refinance their current home. That change hasn't been without incident, though. It's been a very volatile ride down in the bond markets and it continues to be today (read on).

So, what's going on today? Well, today it's supposed to be Fed Day...but that isn't the big story at the moment. Right now, all eyes are on insurance giant AIG, which is in very serious trouble. The company is in desperate need of around $75 Billion and it has until today to shore up this capital, otherwise it could face bankruptcy. This story is far reaching as AIG is a worldwide company, with $1 Trillion in assets and operating in 130 countries. Think about this - AIG provides insurance in all facets of life, from car to life insurance - and should AIG go bankrupt, claims around the world would not get paid - that is scary to imagine. We will all see what happens in the next several hours as this story develops.

At 2:15pm ET, the Fed will release its interest rate decision and policy statement. Up until the last few days, there wasn't much of a chance for a Fed Cut - but as of this morning, the Fed Funds Futures are saying there is a 100% chance of a .25% cut and a 50% chance of a .50% cut. This is really amazing. We won't know for sure what will happen until later today - but with mounting issues in the financial sector, the Fed may just cut in an attempt to restore a sense of calm in the global financial markets. Should the Fed cut, Mortgage Bonds probably won't like this action because of its inflationary effects. Mortgage Bonds have already traded in a fairly wide 35bps range. The volatility in the market continues.

The headline Consumer Price Index for August was reported at -0.1%, meeting expectations and representing the first monthly decline since October 2006. When stripping out volatile food and energy, the Core CPI rose 0.2%, also meeting expectations. The Overall CPI year over year increased 5.4% and the Core CPI year over year rose 2.5%. With the report meeting expectations, the Fed may be feeling better about inflationary threats and this could help them justify a rate cut later this afternoon....again, probably not good for mortgage rates.

I really hope the Fed doesn't cut, as they did when they panicked in January. We are just starting to see signs of inflation moderating, oil prices receding and the US Dollar strengthening. A Fed Cut would likely disrupt those nice trends. Should the Fed not cut - Mortgage Bonds may likely move another leg higher, but should they cut - we could see prices give up some of their recent gains. I do expect mortgage bond prices to move higher in the longer-term, but a Fed Cut today could provide a speed bump and possible retracement in prices.

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Rich

Lehman Fails, Merrill Sold, Fannie & Freddie Rescued - How Can This Be Good?

The headlines certainly portend a very dicey time for the world economic system. However, at a very personal level, these watershed events can be good (in the end) for you and me - the average consumer. How, do you ask, can seismic disruptions to the world financial market benefit you?

Let's take a look at the bigger picture. You and I live our daily lives in what we can call "The Real Economy." That is to say, we spend the money in our wallets to buy tangible "stuff" every day like food, clothes, gas, etc. We operate our finances in a pretty simple way, too. It's basic, spend less than you make so that your have more than you need at the end of each day. Otherwise, you go into debt. Either you can service (pay for) that debt, or you can not. If you can not, you go bankrupt. It's really that simple. Large financial institutions operate in more of an economy of the ether (air). In that they buy and sell futures, derrivatives, futures on bets on what the federal reserve will do, long term bonds, short term bonds, corporate bonds, government bonds, municipal bonds, school bonds, etc., etc., etc. Some of these things are real what I would call "real" like stocks, real estate and bonds. Other instruments, though, are more "in the ether" and where this all comes unwound. Instruments like derrivatives, futures and the like are bets on what things "should" do - and by their nature - contain much more risk. Now, I'm watering this down a LOT - so, those of you reading who will take issue, your objection is duely noted.

All that said, we will see more banks and brokerages fail. As taxpayers, we will feel some pain from this as the US Government will (and already has) participated in the mop-up that ensues watershed events such as these. The bankruptcy filing by Lehman Brothers comes in at a whopping $613,000,000,000.00 (BILLION with a B). That dwarfs the previous filing of Worldcom in 2002, Enron in 2001 and Drexel Burnham Lambert in 1986. How can this be good? When these events unwind, the initial period is often akin to a REALLY bad case of the flu. You feel sick to your stomach, there's no end in sight, you can't sleep...there's just nothing that good about it. When the dust settles, there are fewer players in the game. The rules have typically been reset in such a way that new controls are in place to keep some of the bad things from happening again in the future. And, some unexpected good things will happen. For instance, mortgage rates will come down as a result of this as investors - both individual and institutional - seek the relative security of long-term bond investments vs. riskier hybrid and stock investments.

Along with that, the fall of one or two more big players in the financial services sector will be good for the larger economy in time. Sometimes you can have too much of a good thing. Too many players doing the same thing in the same space with the same money leads to a house of cards being built up....which has to fall. Today, we see the fall of two giants in the form of Merrill Lynch and Lehman Brothers. Stay tuned, it's just going to get more interesting from here. As Neil Peart says..."Adventures Suck When You're Going Through Them!"

We will look back at these times as an adventure - perhaps not an enjoyable one - but, an adventure none-the-less. Look for rates to move lower this week...which could actually spur positive activity for the housing market....which, is good for the broader US Market....see, a silver lining!