Bring it on

I can’t help entertaining the idea that Ben has been reading my blog.

No sooner than I challenged the size of his “cojones” (pardon my Spanish), do we get a commitment by the Fed to buy $600 billion worth of Fannie and Freddie debt and mortgages and another $200 billion to finance private purchases of other asset backed securities (ABS).

Talk about instant gratification! I mean, I’m now tempted to post a piece calling for the Fed to finance ABS backed by Caribbean vacation loans to, urh, myself, my pet iguana and maybe those poor investment bankers who suddenly have to live with government restrictions on executive pay.

But I won’t. Instead, I would like to hail the Fed’s decision as a (significant) step in the right direction—the endpoint of which should be an unclogged, clean and well-capitalized system of competitive, “survivor” banks. So what’s missing?

A number of things. First, a clear communication about the endgame. For example, I just gave above the Chevelle version of “an” endgame, but it would be a tad more helpful if Ben offered his. I’m sure we concur, of course, but it would be nice to hear it.

In fact, it would be nice to hear that the Fed (and the Treasury) finally have a sense of the true size of the problem, the size of government intervention needed, and the timeframe they envisage for the clean-up. Else, we remain with a discomforting feeling of ad hocness, which can’t be good.

Second, call me greedy but I personally wonder whether the $200 billion facility (named TALF) available for the ABS is enough for whetting private appetite for that market. This is a market which, at its peak, was producing $1.2 trillion of securities annually—the bulk of which likely still lies, in carcass form, in the books of banks, hedge funds or even the pension plans of Belgian grandmas, waiting for a buyer.

A related issue is the credit rating. Under the TALF, the Fed can only accept triple-A rated ABS as collateral for the loans it will offer—presumably with the interest of taxpayers (like you and me) in mind. But what about the lower-quality ABS? Who will remove those carcasses from banks’ books? Any hope that the Fed’s financing of the AAAs might free up private capital for the other stuff is likely wishful thinking.

You can get a taste of that by looking at the commercial paper (CP) market: While the yields on the highly-rate CP declined substantially after the Fed got into that market, the yields of lower-rated companies diverged higher. So, with all due respect to the American taxpayer, we may well have to go for a Bigger and Braver TALF, and some Fed guidance on this would help.

Third, let’s go back to the desired endgame: A clean, well-capitalized system of “survivor” banks—by which I mean that the Fed’s (and Treasury’s) facilities should, well, “facilitate” the extinction of the weak. Unfortunately, this process may have to involve some non-meritocratic picking of survivors, based primarily on the too-big-to-fail principle.

Such a process is already happening, by the way, by virtue of the government’s Capital Purchase Program which has been injecting capital in financial institutions of (its) choice. No, not because they are the most “deserving,” but because they are the most “systemic.” Cruel? Yes. Unfair? Perhaps. But, in a world of limited resources, that’s life.

As to what’s missing on this front, it’s basically still unclear how prepared the government is for dealing with more bank failures, which are bound to (and should) occur. I mean, you would expect that after the Nth failed institution to have gotten it straight, no? Yet, the hasty and ad hoc resolution of the Citi case, after the company’s stock collapsed to the level of a Starbucks latte, gave the inevitable impression that these guys are still experimenting.

Finally… To those who bombarded me with emails of outrage in the aftermath of my proposal of a Big Bang Fed intervention: If you want to go ideological, bring it on, though let’s pick a more appropriate forum, like the Journal of the Collective Contemplation of a Laissez-Faire Utopia, to which I’ve been dying to become a regular contributor.

But when it comes to policy, and our sorry state of affairs, let’s face it: We screwed up on the way up, let us not screw up on the way down too!

Glossary: Asset backed securities, commercial paper, structured investment vehicle, survivor

Originally published at the Models & Agents blog and reproduced here with the author’s permission.

3 Responses to "Bring it on"

  1. blindman   November 28, 2008 at 2:05 pm

    fur rust.Child’s Christmas in Wales, by john cale.With mistletoe and candle greenTo Halloween we go.Ten murdered oranges bled on board shipLends comedy to shame..The cattle graze bold uprightlySeducing down the doorTo saddle swords and meeting placeWe have no place to go..Then wearily the footsteps workedThe hallelujah crowdsToo late but wait, the long legged baitTripped uselessly around..Sebastopol AdrianapolisThe prayers of all combinedTake down the flags of ownershipThe walls are falling down..A belt to holdColumbus too, perimeters of nailsPerceived the Mamma’s golden touchGood neighbours were we all………………as i imagine it the truth underlying the “utopia”program is that macro and micro players are irrational, so government intervention is ultimately arbitrary and counterproductive. maybe. the questions still remain, at what point is rationality relevant and what is the aim of production? what need be produced and for who must it be produced? “markets”, which means nothing without a description of the players and their needs and their capacities. the word “needs” implies rationality which in “utopia” is an unknown. the problem is so desperately incomprehensible that the only correct course is to get out of the way of the destruction and see what happens. this outlook suffers from generalizing the demand and needs side of the model. while luxury demand may be incomprehensible and require further investigation into the psychological and behavioural sciences, need demand is not so irrational. it seems they fail to separate needs from luxury. when luxury markets impact needs markets you invite systemic failure, exploitation and revolution. imo a reconsideration of certain commodity markets is called for. heresy? so what.the me me crowd needs to look around and ask the question, by whose graces do i see this that stands before me? heresy!fire fighters sometimes allow a burning building to burn as the potential cost of intervention is greater than the preservation effort. a strategy of containment. it is done from a distance and is therefore safer than actually battling the fire to extinguish it. this is seldom the approach when people are in the building though and the question becomes a very fundamental one. which people are to be saved. what tools are available to save the mostpeople in the shortest amount of time? who is saved? the ones on the top floor or the ones in the basement?if all the people can be saved then the question becomes, is the structure worth any further risk or is it too damaged to save. is it worth the cost of salvation efforts because of the structures proximity to other viable structures or is the whole neighborhood in need of overhaul?i hope our approach, first, doesn’t forget that their are people in the basement of this building, so lets not flood the basement to save the foundation so the evacuation of the upper floors can be comfortably accomplished. who are our firefighters? do they know there is a basement full of people. the people who dreamt the building into existence in the first place and, if not drowned, some would willingly risk their lives to save even a dog on the roof, even if they suspected the dog of starting the fire. people are crazy, thank god…”With mistletoe and candle greenTo Halloween we go.” john cale.

  2. Anonymous   November 28, 2008 at 6:39 pm

    The problem from the beginning is the ‘too big to fail’ concept.If any corporation gets that large — then by definition ina ‘free market’ its too large and something is drasticallywrong.What needs to be done — ALL the time and not in just theseeconomic circumstances — is to breakup the corporation intosmaller parts … and anti-trust action.Government can help in th breakup so as not to impact themarkets adversely. Howeever , these separate piecesshould survive or fail on their own.THIS should be the ‘end game’ you mention. Instead, weseem to be getting just the opposite — putting more amd morefailing corporations together to make bigger one.Only word for it is INSANITY.

  3. Anonymous   November 28, 2008 at 7:47 pm

    At least once in the body of writing an article with acronyms the author should give a complete description.i.e.TALF