TSLF

Last week the Fed announced yet another new measure to deal with the ongoing problems in credit markets in the form of a just-created
Term Securities Lending Facility
, which we’re apparently invited to refer to affectionately as a TSLF.

Hear the word of the Fed:

Under this new Term Securities Lending Facility (TSLF), the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. The TSLF is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally.

This is the logical next step in Bernanke’s vision of monetary policy using the asset side of the Fed’s balance sheet. This strategy shift began last September, when the Fed was simultaneously implementing two kinds of operations. On the one hand, the Fed was conducting repurchase agreements, in which it takes temporary possession of certain private sector assets (including possibly mortgage-backed securities) and gives cash to the recipient by creating new Federal Reserve deposits. Essentially a repo is a short-term collateralized loan from the Fed. On the other hand, the Fed was simultaneously conducting open market sales out of the Fed’s holdings of Treasury securities (or allowing existing holdings to expire through redemption), either of which by itself would absorb Federal Reserve deposits . The combined effect of the dual operations was to leave the Fed’s total assets (and therefore its total liabilities) unaffected. Since there was no change in total liabilities, it had no direct implications for the total volume of Federal Reserve deposits or the money supply, which is how we usually think of monetary policy affecting the economy. But by reducing the Fed’s holdings of Treasuries and increasing the Fed’s holdings of the procured collateral, the swap allowed banks temporarily to replace problem assets with good funds, at least for the term of the repo.



TAF actions and net outstanding balance as of indicated begin date, in billions of dollars. Gross amounts from FRB NY
begin end amount net outstanding

Dec 20 Jan 17 20 20

Dec 27 Jan 31 20 40

Jan 17 Feb 14 30 50

Jan 31 Feb 28 30 60

Feb 14 Mar 13 30 60

Feb 28 Mar 27 30 60

Mar 13 Apr 10 50 80



In December, the Fed introduced the term auction facility as a device for implementing such swaps on a bigger scale. In these operations, banks could offer a variety of assets as collateral, and receive loans of Federal Reserve deposits. Again these operations were offset by open market sales of Treasuries so as to keep the total volume of Fed assets and liabilities unchanged. By my calculations, the Fed is currently holding $80 billion in assets under this facility, almost identical to the amount by which it has reduced its holdings of Treasury securities, and amounting to about 10% of its previous total Treasury holdings.



Treasury securities held outright (from FRB Release H.4.1 as obtained from DRI/Webstract) and outstanding Fed TAF holdings, weekly averages as of Wednesdays, in billions of dollars.
taf_mar_08.gif



And the new TSLF will do the same thing on an even bigger scale– $200 billion has been announced as the first step. Under the TSLF, the Fed will temporarily swap more of its Treasury holdings for private sector troubled assets, and thereby eliminate the middle man required with repos or the TAF. No need to add reserves through the repo or TAF and then drain them out with open market sales. Instead we just swap the Treasuries directly for the target assets.

The Fed announced on Tuesday that it would increase its repos and TAF each to $100 billion, and the new TSLF is proposed as an additional separate $200 billion, which comes to a total of $400 billion, or about half of the quantity of Treasury securities that the Fed had been holding last summer.

What does the Fed hope to accomplish with all this? Steve Waldman draws a colorful analogy:

Until the current crisis is long past, I think it unlikely that any large bank will default and stiff the Fed with toxic collateral. Why not? Because for that to happen, the Fed would have to pull the trigger itself, by demanding payment on loans rather than offering to roll them over. Since TAF started last fall, on net, the Fed has not only rolled over its loans to the banking system, but has periodically increased banks’ line of credit as well. In an echo of the housing bubble, there’s no such thing as a bad loan as long as borrowers can always refinance to cover the last one.

The distinction between debt and equity is much murkier than many people like to believe. Arguably, debt whose timely repayment cannot be enforced should be viewed as equity. (Financial statement analysts perform this sort of reclassification all the time in order to try to tease the true condition of firms out of accounting statements.) If you think, as I do, that the Fed would not force repayment as long as doing so would create hardship for important borrowers, then perhaps these “term loans” are best viewed not as debt, but as very cheap preferred equity….

The Federal Reserve is injecting equity into failing banks while calling it debt. Citibank is paying 11% to Abu Dhabi for ADIA’s small preferred equity stake, while the US Fed gets under 3% now for the “collateralized 28-day loans” it makes to Citi…. I still think this all amounts to a gigantic bail-out.


Douglas Elmendorf
defends the Fed from Waldman’s charge:

Taking agency MBS as collateral does not meaningfully increase the risk faced by the federal government. First, the Fed will presumably require a significant “haircut” on the value of the collateral. Second, if the federal government would ultimately prevent a default by Fannie and Freddie anyway, absorbing some of that commitment now does not add to the overall risk. Taking private MBS as collateral does increase risk, unless an adequate haircut is taken, because the government is otherwise unlikely to stand behind the truly private lenders.

Whether one takes comfort in Elmendorf’s argument depends entirely on the size of the haircut, about which I know only the following (from WSJ):

Fed officials decline to be specific except to say [the haircut] will seem conservative for ordinary times and liberal for tumultuous times. (One starting point may be the haircuts imposed on MBS collateral at the discount window: They range from 2% to 15% depending on the maturity and the availability of market pricing).

James Hymas is another defender of the Fed’s actions:

there are many players with indigestible lumps of sub-prime paper on their books. These are, I’ll bet a nickel, on their books at marked-to-disfunctional-market prices well below ultimate recovery, but so what? They can’t sell them to hot money– hot money’s got its own problems…. They can’t sell them to real money– real money read in the paper just last week that it’s all worthless junk. So the paper has to sit on the books for a while and be financed in the interim.

One measure economists sometimes use for the liquidity of an asset is the bid-ask spread. By that definition, one might be justified in referring to the present problems as a problem of liquidity– the gap between the price at which owners would like to sell these assets and the price that counterparties are willing to pay is so big that the assets don’t move. That illiquidity itself has proven to be a paralyzing force on the financial system. By creating a value for these assets– the ability to pledge them as collateral for purposes of temporarily acquiring good funds– the Fed is creating a market where none existed, thereby tackling the problem of liquidity head on.

OK, but if we agree to use that framework to describe the current difficulties as a liquidity (as opposed to a solvency) problem, which is closer to the “true” valuation, the bid or the ask price? If it’s not far from the asking price, then the Fed is taking a bold step that may help cure a profoundly serious problem. If it’s nearer the bid price, then the Fed has just agreed to absorb a huge chunk of what was formerly private-sector risk. To evaluate the magnitude of that risk absorption, we’d need to know the specific assets pledged as collateral, the specific terms, and the specific borrowers, none of which the Fed appears to have any intention of making public.

It appears to me that the Fed’s unconventional new measures surely involve at least some absorption of risk by the Federal Reserve itself. It therefore seems appropriate to try to think through the implications of what will happen if indeed the Fed is not repaid on some of these loans and gets stuck holding the inferior collateral.

It strikes me that the immediate accounting implications of such a default would be nil– the Fed now holds the collateral as an asset, can claim its value equals that of the original loan, and can carry it on that basis at least for several years, with no changes in its other assets or liabilities necessitated by the fact that the collateral is, in fact, not worth what it’s being carried at. The main cash flow implication that I can see is the following. When those Treasury securities were held by the Fed, the interest that the U.S. Treasury owed on the securities was a line entry for the U.S. Treasury (gross interest expense) that was exactly canceled by another entry (receipts returned from the Fed) to determine the “net interest” that the Treasury had to pay. With those Treasury securities now owned by the private sector instead of by the Fed, the Treasury’s going to have to make those payments with actual cash, and if the collateral is nonperforming, the Fed doesn’t have any receipts to return to the Treasury. The net cash flow consequences for the Treasury of a default would therefore be identical to those if the Treasury were simply to have borrowed up front a sum equal to the difference between the amount that the Fed lends and the amount that it is repaid.

In other words, the Fed seems to be committing the Treasury to cover any losses that may be incurred.

Even in the worst possible outcome, the ultimate increase in outstanding Treasury debt would be substantially less than $400 billion, because the collateral is far from worthless. And I would trust the Fed to be taking a smaller risk on behalf of the Treasury than I would expect to be associated, for example, with congressionally mandated expansion of FHA insurance, or the unclear implicit Treasury liability that results from increasing the assets and guarantees from Fannie or Freddie. Nevertheless, the doubters seem to me to be correct that the risks currently being absorbed by the Federal Reserve are substantially greater than zero.

You don’t get something for nothing.



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27 thoughts on “TSLF

  1. anonymous

    i don’t think you quite understand the fundamental force that is driving the wide bid-ask spread in non-agency mortgage bonds.
    non-agency AAA’s were originally created with coupons in the L+50 range. effective durations in an environment of high prepayment speeds (CPR > 35%) were 2.5-3yrs. subordination levels were originally in the 27-30% range, and this grows over time as prepayments (or defaults) work their way through the pool.
    now, it only made sense to pay L+50 for these securities if you were able to apply a lot of leverage to them. no one in their right mind ever would have bought these bonds if all they thought they were receiving was a 6% yield to maturity. the yield is not commensurate with the fundamental risk profile of the borrower pool.
    we are now in a world where (a) risk premia have increased dramatically; (b) leverage is well nigh impossible to obtain for new entrants; and (c) the entire mortgage community can see that there are distressed sellers getting margined called who need to sell the bonds. therefore, the marginal buyer of non-agency AAA’s is not interested in buying the bonds at L+50. we want equity-like returns. so we are demanding L+750.
    the spread widening is being complicated by the fact that prepayment speeds have slowed dramatically. CPR’s are now around 15% or lower for many non-agency pools. effective durations are now in the 5-7 year range. ouch! negative convexity strikes again.
    so, what happens to the price of a bond with a coupon rate of L+50 if spreads widen 700bps and the duration extends to 6 years? you got it – the market price of the bond must decline by 42% due to basic bond math (chg price = chg in spread x duration). hence why non-agency AAA’s are now quoted on the secondary market at 50-70 cents on the dollar.
    the final issue that is complicating everything is the fact that most of the non-agency AAA’s that were created the past 3 years were sold to leveraged investors (SIV’s, conduits, hedge funds, insurance companies, banks, etc). dealer haircuts for AAA MBS typically ranged in the 2-3% range. the spread widening is forcing dealers to raise haircuts and many of the leveraged investors are refusing to post more collateral. so the brokers are taking bonds back on their books at 98 cents on the dollar, when the market bid is 50-70.
    now, roughly $1.5T of non-agency AAA’s were created from 05-07. the equity base that originally supported these bonds was ~ $30B. that equity base has been wiped out and the market value of the bonds has dropped to $1T. the dealer community never wanted nor intended to be long-term mortgage investors; they don’t have the capital structure for it, or the ability to dynamically hedge the duration risk. they are “moving companies” not “storage companies”. but at the same time, they don’t want to sell money good bonds at 50 cents on the dollar when they are on the books for 98. it would destroy the equity base of their firm.
    hence, you have what alan greenspan would call a conundrum: how do we find >$1T of new capital that is willing to invest in non-agency AAA’s in the middle of a housing collapse and credit crisis? because if we can’t get the capital into the non-agency market very quickly, the broker dealer community will be unable to fulfill its financial intermediation function in an effective fashion.
    instead, they will mini-GSE’s, with retained mortgage portfolios earning very narrow spreads.
    that’s the problem that’s unfolding in the market. it’s a huge technical overhang for anyone who wants to buy non-agency AAA’s in size. the other problem is that most of the expertise on how to value non-agency MBS is on the sell side. it’s a niche specialty on the buy side. outside of PIMCO and WAMCO, very few firms have the resources to take down $20B of non-agency MBS – let alone the $500B it will take to put a dent in the problem.
    but don’t worry. the situation WILL get cleaned up eventually. the risk-reward trade-off on some of these bonds is incredible. anything that was issued before 07 will pay off at par. most of the 07 bonds (only the AAA’s, mind you) will pay off somewhere in the 90′s. and that’s even if the ABX stays about where it is (remember, the ABX only measures the price of the last cash flow bond, which represents roughly 15% of the AAA stack). the key is that you have to be able to withstand downgrades.
    the only other thing i’ve seen like it in my career was the early 80′s, when you could buy 30 year zero coupon treasuries and lock in 15% risk free returns for a generation.

  2. Gegner

    Leaving aside how ’28 days’ could somehow turn into several years (how anxious would you be to ‘redeem’ ‘toxic’ paper?)
    What do you suppose these investors will do once they’ve been ‘made whole’ at the taxpayer’s expense?
    Where will they ‘park’ this money, given how the dollar is sinking like a rock…along with every other major currency (some are just sinking more slowly than others…)
    As it is widely acknowledged, we’re suffering an insolvency crisis as opposed to a ‘liquidity’ crisis, removing ‘damaged’ illiquid assets from banks balance sheets will provide zero relief and it is much more likely removing them for cash will only pump jet fuel onto the already raging inflation inferno. (as this cash crowds into commodities in a vain effort to ‘preserve value’.
    In this respect, the cure will likely be worse than the disease.

  3. Joseph

    When all is said and done, it just amounts to a bailout for idiot investors who otherwise would be unable to unload the toxic sludge they now own. And why are we in this mess? Because greedy investors were trying to eke out an extra half percent return over more conventional investments. What a horrible waste for so little.
    Instead of privatizing the profits and socializing the risks, how about we nationalize the troubled institutions like Britain. Unfortunately that is not the way things are done on this side of the ocean since such actions are considered all communistic and such.
    Also keep in mind that somehow in the midst of all this, over $1 trillion of wealth has to disappear as the housing bubble deflates. It eventually has to come out of someone’s pocket unless the Fed decides to inflate it away from everyone’s pocket.

  4. ndk

    Good news: 28 days wasn’t even close to several years. It turned out to be on the order of 24 hours.

  5. JDH

    anonymous, that’s an interesting point:

    it only made sense to pay L+50 for these securities if you were able to apply a lot of leverage to them. no one in their right mind ever would have bought these bonds if all they thought they were receiving was a 6% yield to maturity. the yield is not commensurate with the fundamental risk profile of the borrower pool.

    The only way that leveraging makes a bad investment look good is if you think somebody other than you is absorbing the downside risk, which sounds like a credit market profoundly distorted by moral hazard problems– precisely my view of the cause of our current problems.

  6. andiron

    my concern is 20 T housing assets, after a few yrs when real estat bottoms out, could well be reduced by 6-7 T to 13 Trillions.
    Now MBS/ABS/CDOS etc were sliced & diced ..a 10T mortgage market will lose say 50% of its value and thus will be reflected in these instruments..
    The reasons that Fanny etc are getting whacked is even their MBS will be reduced by ~50% in value..
    Now out of 800 bil treasury that FED has in its balance sheet, ~50% has already been used. But that is hardly a fraction (10%) of the total possible loss that is in the offing..So beyond another 400 bil of treasury that FED has, would FED be running out of “money” here pretty soon any way or not?

  7. James I. Hymas

    In other words, the Fed seems to be committing the Treasury to cover any losses that may be incurred.

    I should point out that the TSLF represent collateralized loans, not non-recourse securitized loans. In theory, at any rate, the lending companies will be wiped out before the Fed assumes market/recovery risk on the collateral.

    now, it only made sense to pay L+50 for these securities if you were able to apply a lot of leverage to them. no one in their right mind ever would have bought these bonds if all they thought they were receiving was a 6% yield to maturity. the yield is not commensurate with the fundamental risk profile of the borrower pool.

    Ashcraft & Schuermann, in a paper reviewed in Calculated Risk, Econbrowser and my own PrefBlog (there may be others), gave the example of the Ohio Police & Fire Pension Fund: the share of non-agency MBS in the total fixed-income portfolio increased from 12% (245/2022) in 2005 to 34% (740/2179) in 2006. In other words, the pension fund almost tripled its exposure to non-agency MBS.

    This is one thing that I completely fail to understand about the reporting of the sub-prime crisis: why are we not hearing about the pension funds and ordinary investors? I have great deal believing this exposure was minimal and eagerly look forward to pension fund reporting season, when we get a look at how they’ve done over the past year and – maybe – what prices they’re marking to.

    And thanks for the link, Prof!

  8. Anarchus

    It’s more of a short-term issue on the TSLF, Professor, but you miss an important point that marks Bernanke as an unmitigated fool: the TSLF (which as I understand was designed to help primary dealers over this rough patch of illiquidity) STILL doesn’t begin operations until March 27th !!!
    Bear Stearns will most likely not make it past Monday, March 17th, and there are also addition primary dealers with illiquidity issues. What are THEY to do in the countdown to salvation?
    I don’t have any Fed operations background (thankfully, I think), but I’ve been told that the Fed is hamstrung by: (a) being a bureaucratic institution, (b) the technology underlaying the Fed Wire is archaic and (c) the Fed has historically only been set up to handle the highly predictable coupons from treasuries and is confused about how to collect and administer the irregular, volatile payment streams from mortgage securities.
    Monday is NOT going to be fun.

  9. David Pearson

    JDH,
    While acknowledging there is credit risk to the TSLF, you state the risk is small. Fair enough: $40b (a 10% loss on a $400b TSLF) is small change these days.
    Let’s take that logic one step further.
    My guess is that most banking crises do not produce losses in excess of 5% of GDP, and even those losses are drawn out over a period of years. 5% of our $14tr economy yields $700b in losses. Why not have the Fed create $235b in money in each of the next three years, and use the money to recapitalize financial institutions by buying convertible preferred shares? Surely this 1.67% of GDP annual addition to the money supply is “small” enough for our economy to handle without moving to hyperinflation? “Poof”, the problem would go away, with (maybe) some moderate incremental inflation.
    A small cost to fixing a small problem, right?
    I imagine the above is a fair summary of what Chairman Bernanke might be thinking this weekend.

  10. Charles

    James Hamilton says, “In other words, the Fed seems to be committing the Treasury to cover any losses that may be incurred.”
    Thank you for tracing through the balance sheet and income effects in this careful detail.
    This has been evident from the autumn, when the Fed agreed to take securities other than Treasuries in repos. Everything hinges on the valuation of those securities. The haircut represents the valuation. If it is insufficient, risk is transferred onto the balance sheet of the USG and that risk can easily turn into costs.
    However, I think anonymous is correct, that the difference between the face and equilibrium value could well be extremely large. Based on a graph that Bloomberg presented on the real solvency of those securities, one might guess that typically 15-40% or more of collateral is at risk in AAA securities.
    I don’t necessarily bailing out security holders, but we absolutely need to be clear about what we’re doing.

  11. Joseph

    anonymous said: the risk-reward trade-off on some of these bonds is incredible. anything that was issued before 07 will pay off at par. most of the 07 bonds (only the AAA’s, mind you) will pay off somewhere in the 90′s. and that’s even if the ABX stays about where it is (remember, the ABX only measures the price of the last cash flow bond, which represents roughly 15% of the AAA stack). the key is that you have to be able to withstand downgrades.
    This sounds like a golden opportunity for Warren Buffet who is sitting on billions in cash.
    He has already ventured into the municiple bond insurance business. Munis have a minuscule default rate so the premiums are almost free money. The insurers currently in the business are under capitalized so can’t survive a panic but Berkshire can.

  12. Corentin

    A question: How could the Fed extend its assets to be able to continue its interventions if it run out of ammo ? I mean, technically, what are the tools available ?

  13. Joseph Somsel

    If I follow this correctly, the Federal Reserve System will someday soon be the owner of thousands of foreclosed houses. Many of those securities “pledged” in exchange for “risk free” treasuries will be, at heart, a bunch of non-performing mortgages.
    That’s an interesting Republican twist on the resurgence of “public housing.”

  14. JDH

    Corentin, with $800 B in original Treasuries and $400 B committed under the latest plan, the Fed will be halfway there by the time last Tuesday’s proposals are all implemented.

    Of course, the Fed could always “buy” itself some new ammo just by printing more money. But if it were to do that on anything remotely like this scale, it would produce some whopping inflation.

  15. jg

    Very nice review article, Professor. Thank you for bringing to the fore how the cost could get borne by the Treasury; very enlightening.
    D-P-, $235B per year is little compared to GDP. But, isn’t the proper comparison to M2 ($1.4T) or M3 ($7.6T)? M*V = P*Q: pouring 15% per year into M2, we had better see a nice drop off in velocity, or else we see an ugly rise in prices.
    A-, no way do those MBSs payoff at those high levels. The debt burden of households is off the charts high, and with the risk premium returning, defaults are going to be terrible, in both alt-A and prime. But, hey, differences of opinion make markets possible.

  16. melfin

    As someone involved in pension investments, it’s true, in aggregate I don’t see a lot of direct exposure to subprime. My guestimate is that 2% to 3% of all pension fixed income is directly related to subprime. It’s the indirect effects on equity valuations and higher corporate spreads that are hitting pension plans, so there is plenty of pain, it’s just that very little of it is due to direct holdings of subprime paper.
    Most fixed income exposure is based on the Lehman Aggregate Bond Index, which is about 35% Agency MBS, 25% Treasuries, 10% Agency, 25% Investment Grade Corporates, and 5% ABS & CMBS. (Or the Lehman Long Gov/Credit, which has zero MBS exposure.)
    Many managers do have permission to put about 10%, maybe 20% maximum exposure outside the Lehman Agg, but this is generally directed to high yield and non-US bonds, though structured finance is permissable. Overall, CDOs are rare.
    There are some problems: WAMCO, State Street, for example. Funds that invested in hedge funds may have had some losses.
    By in large, pension plans are hugely diversified. To have the fixed income portfolio with a large exposure to outside Lehman Index securities would be the exception, not the rule. And the trend is to Liability Driven Investing, for which anything related to mortgages is a gargantuan mismatch.
    Also, corporate pension funds by ERISA cannot borrow to achieve leverage without paying UBIT, which they are loathe to do. Thus, almost no leverage.

  17. Stuart Staniford

    JDH:
    1) I think it’s pretty clear after the events of this weekend that the Fed is quite operating under the assumption that the entire financial system is at risk here (correctly in my view). It has now proven willing to act very decisively to avoid that outcome. The risks you describe are small compared to the risks of a systemic failure of the system (which could be a Great Depression scale event).

    Increasing the size of the monetary base will only be inflationary if velocity is constant. There would seem to be considerable reason to think the velocity might fall in the midst of a severe credit crunch.

  18. Anarchus

    Stuart – I still think that while the Fed sees the entire financial system at risk, they’re still NOT willing or able to act decisively to avoid the outcome.
    The ill-starred TSLF actually precipitated the current crisis rather than helping avoid or moderate it – because it didn’t start up until March 27th, illiquid primary dealers such as Bear Stearns got NO LIQUIDITY last week when they needed it, and EVEN worse, the coming TSLF actually hastened the demise of over-levered players such as Carlyle Capital because it gave an incentive to their lenders to start taking legal action to seize AAA MBS collateral, knowing that it could be presented to the Fed for cash in two weeks.
    What the Fed should have done today is cut FF immediately by 150 bp to move FF more in line with the Two Year Treasury at 1.50%. Bernanke is one of those booksmart economists who can’t see how fast the real world moves and tries to anticipate, outrun and dodge around clever bureaucratic actions.

  19. Stoneleigh

    Stuart,
    I agree with you that the Fed is assuming the entire financial system is at risk, as am I. Unfortunately, their decisive actions smack of desperation and are being interpreted that way by the market, which means that everything they do will tend to make matters worse. They’ll end up damned if the do and damned if they don’t, and Bernanke will go down in history as an abject failure (really through no fault of his own).
    The market is now set to pick off banks and hedge funds one at a time, and this could very quickly turn into a set of self-fulfilling prophecies. This kind of decline doesn’t unfold gradually once it reaches ‘critical mass’. What happened to Bear Stearns – being sold for 1% of its market cap from two weeks earlier, or one fifth of the price of its headquarters alone – is not at all atypical under the circumstances.
    The velocity of money will certainly fall in a cash-scarce environment where hoarding becomes normal, and that will compound all of the other looming problems (defaults, margin calls, etc). The Fed has chosen to inflate, but inflation is not an option under these circumstances. Without confidence, there is no liquidity.
    For daily coverage of the credit crunch, see The Automatic Earth.

  20. Stuart Staniford

    Stoneleigh:
    I disagree that “Unfortunately, their decisive actions smack of desperation and are being interpreted that way by the market, which means that everything they do will tend to make matters worse”

    The S&P is basically flat, and the TED spread has only widened fractionally this morning. It’s hard for me to believe that things wouldn’t have looked a lot worse if Bear Stearns had filed Chapter 13 this morning.

    A number of countries have gone through the sequence of asset price bubble/crash/insolvent-financial-institutions before. There is only one solution with a decent track record, which is some form of partial/temporary/nationalization. However, that has generally worked to alleviate the worst of the damage. (Not saying all damage – but maybe mitigating a 30% Great Depression level contraction to a 5-10% contraction – something of that order is probably required to get the US operating on a fiscally sane basis again).

  21. Stoneleigh

    I would say the Fed is doing its best, but can’t really make much of a difference (on the positive side anyway) that lasts for more than a few days. The headwind it’s fighting is too strong for it to do more than spark a temporary counter-trend rally. Every time such a rally ends, confidence in the Fed takes another beating, making its job harder when the next casualty presents itself.
    Other banking sector restructurings have taken place against a backdrop of a stable global financial system, but that won’t be the case this time. The problems now are global.

  22. Anonymous

    Other banking sector restructurings have taken place against a backdrop of a stable global financial system, but that won’t be the case this time. The problems now are global.

    True – but the US only has to figure out how to rescue it’s own troubled financial institutions. Other countries can figure out how to rescue theirs in parallel (with their own public resources).

  23. Stuart Staniford

    Stoneleigh:
    I think to convince anyone who didn’t already agree with you (that the financial crisis is going to more-or-less destroy Western civilization and there’s nothing the government can do), I think you’d need a quantitative story. For example, if you could make a plausible estimate that recapitalizing the financial sector was going to take 150% of GDP, I might be persuaded that this was a millenial scale event. However, right now it seems a lot more likely that it’s going to cost O(1 $trillion), thus O(10%) of GDP). Obviously, nobody really knows with even one whole significant figure of precision, but I can’t see how to construct a story about how this costs more than a few tens of percent of GDP at the outside. Add that to the national debt, and we’d still be less indebted than Italy or Japan (relative to the size of the economy).

    I’m not saying this is going to be easy or pleasant – it’s not, and the worst is yet to come. But I find your views on why government intervention will be useless to be quite unjustified.

  24. David Leitch

    Anoymous notes up the top about the bond math is one of the most interesting comments I’ve seen on the pricing of non agency AAAs. Thanks very much for taking the time to make such an informed and succint post.
    This is a great site, speaking as one who works in markets for a living and reads analyst and economic comment for hours every day.

  25. PrefBlog

    March 17, 2008

    The big news today is the JPMorgan takeover of Bear Stearns, which has been the subject of so much commentary I’ll keep mine to a minimum. The interesting part is that the Fed is taking a first-loss position on the mortgage paper:
    The steps were …

  26. Anarchus

    In the “this is going to be hard to explain to someone who wasn’t there at the time” category goes the bizarre example of the moment: Bear Stearns.
    This mornings’EPS reports from Goldman and Lehman CLEARLY suggest that there was little wrong with Lehman that a highly focused BURST of liquidity couldn’t have fixed . . . . the TSLF may go down in financial history as the Edsel Refi Attempt of ’08. IF access to the funds had only been immediate !!!!!

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