You have no doubt heard the term “Libor” mentioned on air much recently.   Here’s why.

Libor stands for the London interbank offered rate. It is the interest rate banks charge each other to make overnight loans.   Most loans that eventually find their way to you begin at the top with the 16 banks that set Libor.  And because banks are increasingly nervous about each others’ financial situation, last night something incredible happened: Libor surged the most ever.   It rose more than 4 percentage points to 6.88%.

Think about that.   The most basic interest rate banks charge each basically tripled.

If banks are going to charge each other nearly 7% for a one-day loan, it says two things.  First, they are scared and not willing to lend money unless they are compensated for the risk.  Second, credit is likely to tighten up at your level for cars and other loans.

The move in Libor is equivalent to the interest rate on your credit card soaring from 15% to 45%.   You may be willing to put that dinner or pair of Levi’s on the card at 15%, but you will be much less likely to use that credit if you have to pay 45% interest.  Banks think and act the same way.

Most consumer loans, including how many ARMs will reset, are tied to Libor in the long run.   Interest rates trickle down.   Libor can be dull to talk about, but the impact on you is anything but.

The folks in Bloomington and Kankakee, Illinois should be asking why their Congressman didn’t vote for the bailout bill.   Jerry Weller was the only member of the House who was a no-show.

Weller has said he will not seek re-election, but that’s no excuse on this historic vote.

While Washington debates, there may be a “shadow bailout” taking place and acting as a de facto rescue plan.

For the last several days the U.S. Fed and central banks around the world have been aggressively adding money and liquidity to the markets.   Yesterday the Fed announced a $150 billion dollar lending program for banks as well as an additional $330 billion dollar “swap line” with foreign central banks.   This is in addition to the $230 billion that the Fed borrowed last week and now brings the total to $620 billion dollars.

Additionally, the Fed is also increasing the size of a special auction known as the Term Auction Facility, or TAF.    Without drowning you in numbers, the point is the Fed has also made about $225 billion in short-term loans available.  It will also hold two other TAF sales in November totaling another $150 billion dollars.

This is also a global phenomenon.   Overnight, Ireland guaranteed the debt of its banks.    This was meant to restore confidence.    The market, especially in Europe, needs it.  In the past few days five European banks have been bailed out.   Coupled with the backing of the Irish banks whose debt was guaranteed it makes 13 European banks that were “rescued” in the past two days.

Politicians talk and the Fed, Treasury and global banks are acting.

Update: Asked former Fed official Vince Reinhart about this in an interview today:

Last night on FBN and again this morning I reiterated what I was hearing on the Hill; that this bill had a good chance of not passing.   Few others were discussing the possibility of failure because of the continued optimism of Democratic leaders.   But working the Congressional halls Sunday it was clear there was much opposition.   Those sources turned out to be correct.   All in all, it was a dramatic day as “bailout bill” fails and stocks sink.   Dow posting its biggest ever point loss (though not percentage drop, that was the 22% haircut in 1987).

Looking back does us no good.   Let’s look ahead.   A few quick takeaways from Washington and Wall Street:

1. The “Emergency Economic Stabilization Act of 2008″ is likely dead.   The failure to pass today cut it off at the knees.   If there is going to be another rescue package it will have to be an entirely new bill.   Basically, we start again.  As a source on the Hill told me, “it’s going to be another long weekend” coming up.    Tomorrow and Wednesday are Jewish holidays and Congress is not in session.   The next formal move will be Thursday.

2. There is likely to be a new, different bill forthcoming with different provisions and language, though similar goals.   There is too much riding on this politically now.  The theoretical “horse is out of the barn.”   Two Congressional sources told me today they expect another package to be put together.

3. Key concerns in the failed bill were not just ideological.   There were some last-minute changes to bankruptcy law provisions that angered a few Democrats.   Despite trying to put forth a united front, 95 Democrats voted against the bill.

4. Politicians up for tough re-election races went with the populist sentiment.   Congressional Quarterly notes that of the races deemed “competitive,” 85% of the incumbents voted against the bill.

5. Congressional sources tell me Nancy Pelosi’s pre-vote speech attacking the President’s policies and a new ad by left-leaning group MoveOn.org blaming McCain set off many Republicans who may have been on the fence and they voted against the bill in protest.

6. The dollar continues to strengthen, posting its biggest gain in 15 years.   As tough as it may be in the U.S., most on Wall Street agree that things are much worse in Europe.   Five European banks have failed in past few days and the fear is that the European Central Bank does not have the flexibility of our Federal Reserve to deal with the problem.    America has problems, but its believed Europe’s are more severe.   The downside is that this issue is growing globally.   The dollar’s gain is also negative for one of the few sectors of the American economy that has been performing, the exporters.   More expensive dollars make our goods less competitive around the world.

7. The dollar’s gain and fears of a global slowdown hurt oil and commodities today, minus the haven of gold.   It’s one of the few upsides of today’s market reaction.  Lower oil and commodity prices mean you will pay less for a gallon of gas and a gallon of milk.

8. For stock investors and mutual fund owners it was a rough day.   It’s been a rough year.   Confidence in the stock market is low.   But thankfully the always rational David Winters reminds us that often the best long-term opportunities appear in the worst of times.

9. Next big story is likely to be pension fund problems.  Many pension plans have faced funding issues in the past few years.   This problem may reappear because of negative real returns on treasuries and stocks taking a hit this year.  Watch pension funds closely.

The JP Morgan/Washington Mutual and Citigroup/Wachovia deals may provide some valuable insight into the illness of the loan market.

JP Morgan said it will write down about $31 billion from the $176 billion in loans it acquired from Washington Mutual.   That’s about 1/8th of the loan book.

Citigroup said it will “absorb” up to $42 billion in losses (basically what it thinks it may write down) on Wachovia’s $312 billion in loans.   That’s just under 1/8th of the loan book.   Granted, the FDIC will take on any additional problems above the $42 billion, but I guarantee that the $42 billion figure wasn’t reached by accident.  It was no doubt the end result of negotiations between the parties.

These deals may provide some valuable insight.   If you average the two together you get roughly 1/7th.    The signal these banks may be sending is that they expect roughly 1 out of every 7 loans they bought to go sour. 

Whatever you think of these deals, at the minimum we may be gaining some important insight into the real state of the U.S. loan market…that about 15% is simply DOA.  

Having been in Washington since Thursday it’s been interesting watching the “rescue package” bill - now officially called the “Emergency Economic Stabilization Act of 2008” (full text of Act) - take shape.    When not on-air, I’ve spent much of the weekend on Capitol Hill and trolling Congressional offices.   Having obtained a copy of the proposed bill, a few things stick out:

1. Power of SEC to suspect “mark-to-market” accounting.    If SEC acts on this power, it would be very good for banks.   Under “mark-to-market” rules banks must value assets on their balance sheets based on current market price.  This is part of the problem.   The market price is very, very low (if it exists at all) for many of the worst subprime-related mortgage assets.  This forces banks to write them down and then raise capital if the cutting the price on these assets drops the banks below the minimum acceptable capital levels. 

2. Private money would be allowed to bid on assets.   Under the proposed bill, private firms such as hedge funds, investment companies and other potential buyers would be allowed to bid on distressed assets.   This means that the Treasury and taxpayer may not be on the hook for some of the bad debts in question.   The issues with this are that 1) private money has been able to buy these already (it’s called “the market”) and buyers haven’t wanted to touch this stuff, and 2) private buyers could come in, buy the “best of the worst,” and leave the nastiest goods for the Treasury to buy. 

3. Direct mortgage purchasing.   The government could become the “bad neighbor next door.”   The Washington Post reported (password required) this morning that Fannie Mae currently owns more than 54,000 actual mortgages.   The Democrats have been pushing for more direct mortgage relief in the bill and it looks like they are getting it.   This means that the empty foreclosed house on the street could become owned by the Government.   In that case, basic questions arise.   Who takes care of the home?  Does the Federal Government call someone to come mow the overgrown lawn?   One Congressman I spoke with today on Capitol Hill (who is against the bill) joked that he was waiting for phone calls from angry voters/neighbors asking him to come cut the grass and paint the house because it was bringing down values on the street.   Banks who end up owning foreclosed properties have more incentive and local capability to manage those properties.  Does the Government start bidding out on property management firms across the country?

4. European and Asian banks would be eligible for the bailout.     Angry taxpayers are about to get angrier.   The language of the bill allows for any firm ”licensed” or with “significant operations” in the United States to participate in asset sales.   Legally those standards are very easy to meet.   This means that European and other global banks who purchased some of the ”toxic” U.S. mortgage related assets may be able to sell them back to our Treasury.   The concept of “caveat emptor” appears to be dying a fast, global death.   Meantime, many European banks are facing their own crisis.   There is chatter that European regulators may be discussing a similar plan to ours.   If that happens, I hope our lobbyists in Europe are as active in getting into their plan as theirs have been in sliding into ours.

Comparing big, bad ole SUVs to big, bad ole mortgage assets is the best I can do in helping convey the key sticking point in the debate over the “Trouble Asset Relief Plan”, or TARP (though I am considering calling it just “The Plan,” or “TP” for short).

First things first.  The debate about whether we will have a financial rescue plan is over.   Listening to Sen. Chuck Schumer’s opening remarks in front of the Joint Economic Committee hearing happening now, it’s clear that some type of massive bailout package is coming.   The primary debate now will be centered around exactly how such a plan will work.   And the single biggest question inside that debate is what price the fund will pay for the assets its meant to buy.

In talking about this pricing issue, Paulson and Bernanke are throwing around terms such as “market to market,” “hold to maturity” and “fire sale price” with PhD ease.  Dont’ get lost in the language.  What Paulson is saying, and what Congress must figure out, is simply: do we buy the toxic assets from the banks at extremely depressed prices just to get them off the books, or do we buy the assets at a price that we think the assets may be worth down the road?

Back to Hummers.

You own a large SUV and want to sell it.   You paid $30,000 for it a few years ago.   The blue book value of the truck is $20,000 and you owe just under that amount.  Unfortunately, because of the weak economy and high gas prices there are many other similar SUVs on the market and few buyers.   You take it to a local dealer who offers you just $10,000 for it, saying he can’t pay more because the market for SUVs has collapsed and he can’t sell it for higher than that.    You now are faced with just two choices: 1) sell the SUV at a loss to the dealer because at least you can get rid of the gas-guzzler (”fire-sale price”) or 2) hold on to the SUV and hope that gas prices fall and the market for big vehicles comes back (”hold to maturity” price).

These toxic mortgage assets are the SUV.   Once loved and with high resale values, both have become outcasts with no pricing power.

Like everything else on Wall Street, you can make an argument for both sides of the “fire sale price” and “hold to maturity” price debate.   And believe me, the argument is being made for both sides.    Forget poltical parties, we now have two economic parties, FSPs and HTMs.  Here are the brief arguments each are making:

Fire Sale pricing: Get rid of that SUV at all costs, because the cost of ownership is too damaging.  That’s the idea behind this concept.   Raise the $700 billion, force sales at severely distressed prices, and cleanse the balance sheets.   Supporters argue that this method, while perhaps not getting as much value as possible, is better because it will open the banks up to more lending.   RIght now credit is still very tight, and opening up lending in our credit-based economy will benefit all.  Critics say this method will limit participation by banks, who will want more money and thus keep credit tight by not cleaning their balance sheets.

Hold to Maturity pricing:  Buy the SUV at the price it may be worth down the road.  This is what Paulson and Bernake favor.    The Treasury Secretary believes that this approach is best because it will maximize the amount of banks participating in the plan as they wil likely get more than they could for the assets in the current market.    Critics point to this as the primary downside; politcally it looks like even more of a “Wall Street bailout” this way, as banks dump assets at prices more favorable to them.

Based on the Wall Street dialogue I’m reading, it’s likely the latter is going to be the method used.  Paulson holds enormous sway, and despite the grandstanding and questioning of him in these hearings, it’s likely Congress will defer to him with regard to the deep details of pricing.

Either way, we should know by the end of the week just how the Hummer will be sold.

The blame-game surrounding the current housing & financial crisis has elevated to new heights in the last few weeks. Daily now we hear Republicans and Senators from both parties express their outrage - outrage! - about the state of affairs. The finger pointing primarily is headed from Washington right up I-95 to Wall Street. Congress is demanding to know what happened.

Maybe Congress should revisit some of its previous proposals before wagging a finger northward. Even as major cracks were appearing in the housing market, there were governmental efforts to loosen credit and lending by permitting no down payment loans and allowing loans to be made that could reflect 100% of the average price of a home sold in a given area.

The following press release was taken from Barney Frank’s Web site after the House passed H.R. 1852: Expanding American Homeownership Act. I have highlighted some of the key takeways.

You can access original release here:

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September 18, 2007

House Passes Comprehensive FHA Reform

Washington, DC – The U.S. House of Representatives today overwhelmingly passed H.R. 1852, the “Expanding American Homeownership Act of 2007,” which will revitalize the Federal Housing Administration (FHA), a federally insured loan program that for over 60 years has been a reliable source of affordable fixed rate mortgage loans, especially for first-time homebuyers. The measure, originally introduced by Representative Maxine Waters, Chairwoman of the Subcommittee on Housing and Community Opportunity, and Barney Frank, Chairman of the Financial Services Committee, will enable FHA to serve more subprime borrowers at affordable rates and terms, recapture borrowers that have turned to predatory loans in recent years, and offer refinancing loan opportunities to borrowers struggling to meet their mortgage payments in the midst of the current turbulent mortgage markets.

“There is an affordable housing crisis in America. In recent months, that crisis has exploded beyond the poorest renters and homeowners, to threaten the domestic economy. H.R. 1852 is a necessary step in walking us back from the brink and in the direction of meeting the housing needs of all Americans,” said Chairwoman Waters.

“A revitalized FHA program will help future homeowners realize the dream of home ownership, and will prevent many first time and inexperienced home buyers from being pushed into loans that are unaffordable or difficult to understand,” said Chairman Frank. “The bill we passed today will help people all across America because we have enacted provisions to allow the FHA to insure loans in high cost areas.”

Specifically, the bill includes the following important provisions:

- Lower Down Payments. Authorizes zero and lower down payment loans for borrowers that can afford mortgage payments, but lack the cash for a required down payment.

- Subprime borrowers. Directs FHA to provide mortgage loans to higher risk (but qualified) borrowers, without authorizing unnecessary fee hikes on such borrowers.

- Multifamily Loans. Raises FHA multifamily loan limits, so these loans can fully fund construction costs in high cost areas, and enhances sale of foreclosed FHA rental housing loans to localities, so that affordable housing can be maintained in local communities.

- Affordable Housing Fund. Authorizes up to $300 million a year from the bill’s excess profits for affordable housing, instead of returning such funds to the General Treasury.

- Higher Loan Limits. Adopts the Frank/Miller/Cardoza amendment that would raise FHA single family loan limits, which now bar loans above 95% of the median home price in each local area and shut FHA out of higher cost home markets. The amendment raises the FHA loan limit in each area to the lower of (a) 125% of the local area median home price or (b) 175% of the national GSE conforming loan limit. The amendment also retains the bill’s provision for a nationwide FHA loan floor of 65% of the GSE conforming loan limit, and gives HUD authority to raise these loan limit amounts by up to $100,000 “if market conditions warrant.”

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The popular buzz phrase in the media - particularly the non-financial media - about the $700-plus billion dollar rescue plan is “Wall Street bailout.”

Certainly the plan, which will most likely top $1 trillion dollars, is primarily designed to buy bad mortgage-related assets from the books of Wall Street firms.   That may ease up on the pressure which exists in the remaining large-cap investment firms who bought, sold and traded this garbage.  But upon inspection there is much more to the “bailout” than just Wall Street.   It may turn to be much more of a Washington and American consumer bailout than Wall Street one.

This may be an unpopular view, but examine the following:

First, the primary asset that’s meant to be purchased with this massive fund is toxic mortgage debt.   Nasty stuff that’s rotting and infecting banks’ balance sheets.   Not just investment banks mind you, but many mortgage-centric and regional banks around the country.  Names such as Seattle-based Washington Mutual (WM), Charlotte, NC-based Wachovia (WB) and a host of others nationwide.  According to reports there are nearly $500 billion worth of ARM resets hitting this year, about 80% of that subprime.  These were loans applied for by consumers, approved by lenders, and entered into contracts by both parties across the country.   At its heart, a mortgage is a deal between borrower and lender.  Both sides must agree.  The majority of the problem not surprisingly rests in the states where the housing frenzy hit its crescendo,  California, Arizona and Florida.   That’s not Wall Street.

Second, it was two Washington, D.C. firms that helped enabled this debacle.   The unfettered growth of Fannie Mae and Freddie Mac allowed lenders all over the country to transfer the risk of non-payment and make bad mortgage loans.   No one was minding the store, and lenders got sticky fingers, signing up many for loans with fancy names and bad results such as the ARM, option-ARM, neg-am hybrid option ARM and the now-infamous “ninja” loans (no income, no job, no assets).   Getting the most attention in the crisis are names such as Countrywide and IndyMac, both based in California (at least IndyMac was based in California before it went bust).   But many of the 8,000-plus local banks and countless mortgage brokers also agreed to lend money.   I’m quite certain Wachovia wishes it never bought San Francisco-based Golden West Financial.   None of those “big three” are based on Wall Street.

Third, many borrowers across America sitting on underwater loans may end up benefitting from this plan.   Democrats are insisting that part of any package includes help for homeowners facing foreclosure.   If the government buys up these bad mortgages, what are the chances vote-seeking politicians will really push foreclosure?   As Josh Rosner of Graham Fisher said on the show today, it’s possible many homeowners who don’t pay their mortgages will face no repercussions.  Private companies are more likely to seek some value from their loan in the form of the property.  They have an incentive to do so, the government does not.  It’s bad politics, and their money is essentially free.   Don’t pay the mortgage, just squat.  And that’s what the government may be left with, squat.   That’s not Wall Street.

Fourth, Treasury Secretary Hank Paulson is reportedly seeking authority to use this giant piggy bank to buy up all manner of bad debt.   Anything from credit card receivables to bad auto loans.   Don’t you think Rye, New York-based Mastercard (MA), San Francisco-based Visa (V) or General Motors (GM) and Ford (F) wouldn’t like that?    Of course, the automakers are also seeking their own seat at the bailout table.   In a research note today, BNP Paribas’ Paul Mortimer-Lee said the draft of the plan gives the Treasury the “power to buy what it wants, when it wants and at any price it wants.”

Fifth, it’s difficult to bail out those that are already dead.   Bear, Lehman and Merrill are gone.   Yes, Merrill was bought by Bank of America (based in Charlotte) but the consensus is that this was a preemptive strike by Merrill dealmakers to do what Lehman should’ve done: sell.   Most employees at Bear and Lehman have lost all their wealth.  Remember Wall Streeters are paid primarily in company stock.  If the stock is at zero, they are paid zero.   In some ways this is the end of a big part of Wall Street, not a bailout.

Sixth, much of the blame on the drop in bank stocks was blamed on short-sellers.  Those who make money when stocks fall.   To solve this “crisis,” the Administration hastily crafted an anti-short selling rule for many financial stocks.   Judging by today’s action, it hasn’t worked.   Even the most die-hard short sellers will tell you the government should make it more difficult to short a stock by bringing back the “uptick rule,” which for some reason the SEC killed as “obsolete” last year.  By the way, Pakistan unsuccessfully tried the same thing after rock-throwing investors expressed shock when they learned stocks can actually go down.  Karachi is definitely not Wall Street.

And let’s not leave out that beltway brigade of regulators.   For years Washington not only turned its collective eye away from the growing problem of bad mortgage debt, it has been encouraging it.   As the Journal smartly reminds us, Congress has been working to expand home ownership for years.   The Community Reinvestment Act compelled banks to open up lending standards.   It was passed in 1977, substantially expanded in 1995 and amended in 2005.  This isn’t all.   Even as late as last year Congress was voting on (and the House approved 348 to 72) other pieces of legislation such as the “Expanding Home Ownership Act” to facilitate home lending.

No one is arguing the importance of home ownership.  It’s the American dream and generally good for communities and economies.  The problem is when legislators become so eager to “help” that they decide to continue to ease up on regulation to do so.    Other non-governmental groups also stood ready to help with the cause.   The National Association of Realtors testified before Congress that part of the bill should be to eliminate the 3% down payment requirement for some FHA-backed loans.   The N.A.R. somehow managed to tie allowing no down payment to actually helping solve the housing crisis.   Of course, this is the same group whose former Chief Economist said in 2005 that the housing boom was “far from over” and that the 21st century would bring a new “golden age” of real estate.   This organization is based, by the way, in Chicago.  That’s not Wall Street.

To top it off stocks tumbled again Monday as the short-lived relief rally proved to be just that.   The benchmark Dow is now down 17% this year, further eroding investor assets and knocking confidence.   Banks such as Citigroup are down much more.   Citi’s holders have seen their investment go from $55 to $20 in just a year, wiping out huge sums.   And keep in mind that many of the biggest holders of names such as Citigroup aren’t big banks or “greedy” hedge funds.  Rather, they are retail investors, pension plans and index fund companies such as Vanguard.   It’s painful for many, not just those on Wall Street.

I concede the AIG loan was a Wall Street event.  That firm, literally based two blocks from the NYSE, sunk its hooks into obscure instruments called credit default swaps that guarantee bonds.   Purely the invention of some mad-scientist PhD math major, these “swaps” were incredibly profitable for AIG for years.   Until they weren’t.   In a big way.   An “$85 billion dollar loan” of weren’t.   But calling its a “bailout” may still be wrong.  It may be Wall Street, but a bailout would imply the problem is solved.   The company’s new CEO says he plans to pay back the loan, though the high interest rate may make that challenging.

My point is that it’s very easy for others - especially those seeking to divert negative attention away from themselves (such as regulation-soft politicians) - to make a bogeyman out of Wall Street.   The story is much easier to tell - and sell - when there is just one, convenient villain.

Noted economist and newsletter editor Dennis Gartman advised his readers today that we may be in for a new period of reflation.   Certainly looks like Dennis was right.   Many of the ‘hard’ commodities like oil and gold are soaring today.

The reasons range from fear of a devalued dollar from higher deficits to a push into ‘real’ assets as stocks resume their fall from Fridays likely-short covering rally.   It may also be that while there are so many questions around how this trillion-dollar rescue package will ultimately play out - and cost - that the short term money is moving into what’s working and showing momentum.

The other aspect to watch: contract months are changing.   There is a chance according to Fox Business’ Eric Bolling that many hedge funds were caught on the wrong side of some trades and are rolling positions over.

We will know tomorrow.  If the move higher continues, it may be more of a longer rally than just a covering and contract moving position change.