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Daily Market Commentary

Yesterday, the minutes to the Federal Reserve's meeting were released.  It was very interesting to note that the overall Fed concern was certainly the economy.  They noted that declines in housing prices and equity prices simultaneously (and sharply) would lead to reductions in household wealth and dampen consumer spending.  Most have been banging on this drum for some time, but as we know, the Fed was behind the times a little (which caused their drastic 125 bp action last month).  Now, we know they acknowledge the risks.  While there is still mention of inflation pressures in the meeting, most Fed "participants generally expect inflation to moderate somewhat in coming quarters".



  This is not making flashy headlines, but is important nevertheless.  Dresdner Bank of Germany (owned by Allianz) is committing $19 bln to bail out its SIV "K2".  This follows a long line of similar bank actions around the world (including BMO yesterday), and is the third largest SIV rescue operation after Citigroup and HSBC.  While they tried to re-assure investors by telling them there is no subprime exposure in the portfolio, the results were the same.  The SIV, which was structured on paying short term funding rates to finance long term higher yielding assets, could no longer roll over the financing.  This is beyond a subprime problem.  For anyone who thinks everything above subprime is fine, there will be more shocks to come.


  The most worrying aspects of all these SIV and fund bailouts is the effect it will have on future earnings.  Because these banks are committing so much capital to support these existing pools of loans, their profit margins will be seriously squeezed.  Furthermore, they will be very unlikely to want to create MORE of these types of loans while they are sitting on a barely profitable multi-billion dollar pool of old ones (most of which are consumer level loans like mortgages, auto loans and credit cards).  We are seeing major tightening of lending standards.  While this may not have serious implications in economies with huge amounts of personal savings, we live in an economy where borrowing is a way of life.



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