How to End the Fear?

[twaddle]

Good blog article on our current meltdown:

Economist's View: How to End the Fear?

We live in interesting times. We have the usual recessionary slowdown. The usual asset bubble popping. The usual insolvencies and bankrupties. But an unusual widespread liquidity problem that the fed hasn't been able to fix.

What do you think of the idea of the fed providing liquidity to all comers? The pawnbroker of last resort?

I kind of like the idea. And I can't think of anything better. I don't especially like the idea of watching the banking system and "shadow" banking system melt down and take the real economy with it....

[DblDoc]

Interesting read. I don't profess to know enough about the inner workings of the banking/shadow banking system to know if his suggestion is viable or not.

It might be easier to just shoot this Mr Margin guy.

DD

[ladelfina]

"ring ring"!

If it is only a problem of liquidity, fine. I am afraid that it is a problem of solvency.
Can a problem of solvency "go away" with whatever tricks the government has in its magic bag?

I'm going to do a separate post on bank balance sheets and see what you geniuses have to say.

[twaddle]

Quote:

Originally Posted by ladelfina If it is only a problem of liquidity, fine.

Which is worse, a few "bad" companies going bankrupt due to insolvency, or a bunch of good companies going bankrupt due to lack of liquidity?

TMA is viewed as a good company with solid assets. When they ran out of liquidity, they were forced to sell good assets at a discount. Same thing is happening with hedge funds holding muni bonds, etc. The next asset sold at a discount may be one that you're holding.

Here's Larry Summers (former Sect of Treasury) on the potential fallout:

Calculated Risk: Video of Larry Summers at Stanford

Bottom-line: we'll probably see the fed pull a rabbit out of their hat. It won't be a simple cut of the fed funds rate. If it works, the markets will party hard. If it doesn't, we'll be in for some interesting times.

[ladelfina]

Quote:

Which is worse, a few "bad" companies going bankrupt due to insolvency, or a bunch of good companies going bankrupt due to lack of liquidity?

I didn't say it shouldn't be done to help liquidity; I just was speculating that that may not be all of the problem.. in which case, yes, it will be "interesting".

[twaddle]

Oh, it's definately not the only problem. We have "normal" problems too. The liquidity thing is potentially one of those unpredictable black swans that we always hear about. I prefer normal problems.

[chinaco]

There will almost always be some group of people who attempt to push the limits to make an inordinate profit from any given situation that looks like opportunity.

This was the case with the tech bubble... which was pushed and cheered on by the investment banks. The same thing with the sub-prime debacle.

There are always a few snakes in the woodpile. No different this time.

I think the best thing to do is to send them to prison. There were a few large organizations that fueled much of this. Now all they have to do is go after the JP Morgans and the like for bundling and selling the trash.

I think a couple of 25-30 year prison sentences will send the message. Plus go after everything they own... make them disgorge.

Jail does not seem to deter these people. This is where regulatory bodies need to step in. There is something missing from the accounting system and accounting for risk in the banking system. Deregulation of banks seems to have allowed them to take on more risk. Probably not a good thing since we depend on it for stabilty.

BBC NEWS | Business | Countrywide in US sub-prime probe

[Milton]

Quote:

Originally Posted by chinaco Jail does not seem to deter these people.

Perhaps because they haven't broken any laws. They may have been foolish/negligent/reckless, and perhaps they should be fired (or at least have their large bonuses elminated). But jail?

It is easy to rant about sending people to prison, but greed is not a crime. Indeed, it's the whole foundation of the American way of life.

[laurence]

So the Fed is trading good assets with bad:

Stocks rebound sharply after Fed move - Stocks & economy - MSNBC.com

And the market is up 300+ points. Taking these bundled mortgages off banks hands and giving them T-bills looks....o.k., but that doesn't make the investments any safer, I guess the bad ones will just be added to the national debt?

[brewer12345]

Quote:

Originally Posted by laurencewill So the Fed is trading good assets with bad

Point of correction. The collteral the Fed will accept in this game is limited to two things:

1) Agency MBS (i.e. Fannie, Freddie & Ginnie paper)
2) Non-agency MBS that is AAA rated

The first category is stuff that the feddle gummint explicitly or implicitly is on the hook for anyway, so its hard to see how there is any risk whatsoever in that stuff. The second category is the most lilly-white private label paper with the creamiest rating. I think there is just about zero risk in that.

This is about injecting liquidity into the market without having to drop the fed funds rate too far to do it. IMO, the Fed isn't assuming any actual risk of loss on these assets.

[ziggy29]

Quote:

Originally Posted by laurencewill So the Fed is trading good assets with bad: Stocks rebound sharply after Fed move - Stocks & economy - MSNBC.com And the market is up 300+ points. Taking these bundled mortgages off banks hands and giving them T-bills looks....o.k., but that doesn't make the investments any safer, I guess the bad ones will just be added to the national debt?

The problem is that most of these "bad assets" aren't bad (they're very highly rated paper AND Freddies and Fannies) -- it's just that they are currently suffering illiquidity because no one wants them relative to the number these banks need to dump. And when these assets get repriced downward, it can force margin calls that require an attempt to sell even more illiquid securities, and rinse, lather, repeat. The Fed doesn't have to respond to margin calls, and this gives the banks a chance to breathe in the hopes that the market for these securities stabilizes, at which point (presumably) the banks could unwind the swap and take their securities again.

If this works -- AND if these "traded" mortgage securities don't go bad on the Fed -- it will look like a brilliant move. The main thing it does is get a LOT of these securities -- for which buyers are demanding huge discounts that trigger the balance sheet problems and margin calls -- off the trading block.

[Edit to add: I think Brewer's analysis was pretty much dead-on.]

[haha]

Quote:

Originally Posted by twaddle Oh, it's definately not the only problem. We have "normal" problems too. The liquidity thing is potentially one of those unpredictable black swans that we always hear about. I prefer normal problems.

Also, as the Summers video you linked shows, severe liquidity constraints can create insolvency.

TMA was likely on its way to failure, even though it possessed good assets in the sense that their cash flows were either minimally or not all compromised. But the mark-to-market discipline hit their colateral value. Since they were financed with debt TMA was forced to try to get new debt and/or liquidate assets.

Ha

[twaddle]

Yup, they decided to play the pawnbroker-as-last-resort role. But only for the banks. It'll be interesting to see if that helps guys like TMA. (Hey, they are up 120% since yesterday, so I guess it helped!)

[TeeRuh]

So brewer, I'm pretty uneducated (well totally uneducated) in these sort of things. Today I see the Fed injected some liquidity and the market goes up 400 points. Another head fake by people like myself that don't really understand? Good move by the fed? Short term fix with long term problems? Or what? (And once again, I'm asking because I haven't a clue; not trying to set anyone up ...)

Thanks,
t.r.

[Oldbabe]

Quote:

Originally Posted by TeeRuh Today I see the Fed injected some liquidity and the market goes up 400 points. t.r.

Is that what happened? The market got its fix and suddenly got its mojo back? But nothing fundamentally has really changed in the wider economic sense. I am a little disturbed by these market gyrations. What the heck is going to happen next?

[ziggy29]

Quote:

Originally Posted by Oldbabe Is that what happened? The market got its fix and suddenly got its mojo back? But nothing fundamentally has really changed in the wider economic sense. I am a little disturbed by these market gyrations. What the heck is going to happen next?

I don't think the market believes this is "the fix," but I think the market is convinced that the Fed is not about to allow an apocalypse in the secondary mortgage markets to take down one bank after another, which was a meltdown scenario the market had been fearing.

[Oldbabe]

Quote:

Originally Posted by ziggy29 I don't think the market believes this is "the fix," but I think the market is convinced that the Fed is not about to allow an apocalypse in the secondary mortgage markets to take down one bank after another, which was a meltdown scenario the market had been fearing.

But I don't understand why the market believes this is true. From what I've been reading the insolvency is so widespread that our government cannot save all these private banks and many believe that the government (i.e. taxpaper) should not do so. It seems like these liquidity infusions are stop gap measures and there's more difficulty down the road.

[brewer12345]

Quote:

Originally Posted by Oldbabe But I don't understand why the market believes this is true. From what I've been reading the insolvency is so widespread that our government cannot save all these private banks and many believe that the government (i.e. taxpaper) should not do so. It seems like these liquidity infusions are stop gap measures and there's more difficulty down the road.

You should shut off CNBC/start ignoring the financial press, if that is what you have gleaned from their sorry excuse for reporting.

The problem is primarily liquidity, not insolvency. Yes, there are some insolvent balance sheets out there (fewer, since a number have already imploded). But the bigger issue is a lack of market liquidity. Heck, I have heard that some hedge funds are getting margin calls on their leveraged treasury bond positions. Care to argue there is something wrong with that asset?

[DblDoc]

Quote:

Originally Posted by Oldbabe Is that what happened? The market got its fix and suddenly got its mojo back? But nothing fundamentally has really changed in the wider economic sense. I am a little disturbed by these market gyrations. What the heck is going to happen next?

I predict.....more gyrations. Until the musical chairs ends and everyone knows what they have and more importantly what its worth the volatility will continue. Next up: Will the fed cut rates as much as expected? And if not how will the market respond.

DD

[lsbcal]

Quote:

Originally Posted by Oldbabe ...I am a little disturbed by these market gyrations. What the heck is going to happen next?

I feel more then a *little* disturbed. These gyrations over recent months make me feel like the economic equivalent of Frankenstein is brewing. It feels like we could be heading into something far worse ... or not.

Probably the dollar will recover a little ... or not. Probably oil will stop reaching new inflation adjusted highs ... or not. Probably real interest rates will get back to more normal levels ... or not.

Maybe I'll sleep better tonight ... or not :confused:.