Billy Manders

From the Fed press release:

Release Date: September 14, 2008

For immediate release

The Federal Reserve Board on Sunday announced several initiatives to provide additional support to financial markets, including enhancements to its existing liquidity facilities.

"In close collaboration with the Treasury and the Securities and Exchange Commission, we have been in ongoing discussions with market participants, including through the weekend, to identify potential market vulnerabilities in the wake of an unwinding of a major financial institution and to consider appropriate official sector and private sector responses," said Federal Reserve Board Chairman Ben S. Bernanke. "The steps we are announcing today, along with significant commitments from the private sector, are intended to mitigate the potential risks and disruptions to markets."

"We have been and remain in close contact with other U.S. and international regulators, supervisory authorities, and central banks to monitor and share information on conditions in financial markets and firms around the world," Chairman Bernanke said.

The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.

The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.

These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally.

Also, Schedule 2 TSLF auctions will be conducted each week; previously, Schedule 2 auctions had been conducted every two weeks. In addition, the amounts offered under Schedule 2 auctions will be increased to a total of $150 billion, from a total of $125 billion. Amounts offered in Schedule 1 auctions will remain at a total of $50 billion. Thus, the total amount offered in the TSLF program will rise to $200 billion from $175 billion.

The Board also adopted an interim final rule that provides a temporary exception to the limitations in section 23A of the Federal Reserve Act. It allows all insured depository institutions to provide liquidity to their affiliates for assets typically funded in the tri-party repo market. This exception expires on January 30, 2009, unless extended by the Board, and is subject to various conditions to promote safety and soundness.

After the Lehman bankruptcy news, it now looks like Bank of America is close to a deal to buy Merril Lynch. This, after the Countrywide takeover, is huge news for BOA. The financial markets may continue this buyout/bankruptcy waltz for a little while...

From theNew York Times' Dealbook:

Bank of America is in advanced talks to buy Merrill Lynch for at least $38.25 billion in stock, people briefed on the negotiations said on Sunday, as a means to preserve that investment bank while Lehman Brothers looks likely to collapse.

The move suggests a desperate effort at triage on Wall Street, as Bank of America works to shore up the likely next victim of the credit crunch. A deal, valued at between $25 a share to $30 a share, could be announced as soon as Sunday night, these people said. Merrill shares closed at $17.05 on Friday.

This shouldn't surprise anyone who has been watching closely. The government can't bail out everyone and Lehman had ample time to find a suitor...which proved to be impossible in this credit and capital starved market.

From the NY Times Deal Book Blog:

Lehman will seek to place its parent company, Lehman Brothers Holdings, into bankruptcy protection, while its subsidiaries will remain solvent while the firm liquidates its holdings, these people said. A consortium of banks will provide a financial backstop to help provide an orderly winding down of the 158-year-old investment bank. And the Federal Reserve has agreed to accept lower-quality assets in return for loans from the government.

But Lehman's filing is unlikely to resemble those of other companies that seek bankruptcy protection. Because of the harsher treatment that federal bankruptcy law applies to financial-services firm, Lehman cannot hope to reorganize and survive as a going concern. It will instead liquidate its holdings.

To read the entire blog click here http://dealbook.blogs.nytimes.com/2008/09/14/lehman-to-file-for-bankruptcy-protection/

The Treasury is attemtping to broker a deal for Lehman without having to use any more government money. Thid may help stabilize the jittery financial markets...

From Bloomberg:

U.S. Treasury Secretary Henry Paulson and New York Federal Reserve Bank President Timothy Geithner urged the heads of Wall Street's biggest firms to find a solution to the plight of Lehman Brothers Holdings Inc., signaling their reluctance to use government funds to bail out the investment bank, people familiar with the talks said.

Talks between the government and the banks continued today, New York Fed spokesman Andrew Williamssaid. Yesterday's meeting, convened by Geithner, began at 6 p.m. with Kendrick Wilson, a former Goldman Sachs Group Inc. executive whom Paulson tapped last month as an adviser, helping lead discussions. An agreement may be reached as early as tonight, the Wall Street Journal reported today, citing unidentified people with knowledge of the discussions.

To read the entire article go here: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aHqQpSJ5E.I0

A credit default swap (CDS) is a credit derivative contract between two counterparties, whereby the "buyer" or "fixed rate payer" pays periodic payments to the "seller" or "floating rate payer" in exchange for the right to a payoff if there is a default or "credit event" in respect of a third party or "reference entity".

If a credit event occurs, the typical contract either settles by delivery by the buyer to the seller of a (usually defaulted) debt obligation of the reference entity against a payment by the seller of the par value ("physical settlement") or the seller pays the buyer the difference between the par value and the market price of a specified debt obligation, typically determined in an auction ("cash settlement").

A credit default swap resembles an insurance policy, as it can be used by a debt holder to hedge, or insure against a default under the debt instrument. However, because there is no requirement to actually hold any asset or suffer a loss, a credit default swap can also be used for speculative purposes and is not generally considered insurance for regulatory purposes.

from Pension Pulse:

Credit default swaps typically start trading on an upfront basis when concerns grow that a default is more likely, as sellers of protection grow nervous that a default could happen before they receive the quarterly premiums for the insurance.

Lehman's one-year default swaps closed on Wednesday at 1,156 basis points, according to data by Markit.

Five-year credit default swaps on Lehman, which are the most liquidly traded contracts, widened to around 650 basis points on Thursday after earlier jumping near 800 basis points.

These swaps imply that there is a 35 percent to 40 percent chance Lehman will default over the next five years, Backshall said. Read the entire arfticle here http://pensionpulse.blogspot.com/2008/09/is-counterparty-risk-set-to-explode.html

In these turbulent times, it makes sense to learn about these derivatives as a way to monitor the health of our financial institutions...