But if the vaults are empty, what will Scrooge McDuck swim in?

January 29, 2008 8:58 PM

According to the latest biweekly numbers released last Thursday by the Federal Reserve, for the two weeks that ended January 16th American banks had negative $1.3 billion in non-borrowed reserves. This is, historically, extremely unusual; just two months ago they had $30 billion (positive, of course) in non-borrowed reserves. The only reason some banks haven't been shut due to insufficient -- negative! -- reserve requirements is that the Federal Reserve is currently loaning them enough money through the brand new TAF (Term Auction Facility) program (also running in Canada and Europe) to make up their shortfalls. Today's TAF press release says that 52 American banks or institutions are currently receiving loans totaling ~$40 billion -- but the Fed refuses to name who they are.

The banks' collateral for these TAF loans are those same yucky hard-to-price CDO's that caused the banks' liquidity problems in the first place -- and the Fed is purposely using outdated prices for the collateral to prevent their being marked-to-market and thus collapsing CDO prices and freezing matters even further. Not surprisingly, some economists see the creation of the TAF as a backdoor bailout of banks in trouble. But how much longer can this go on? [via]

Coincidentally (one hopes), the banking system in the virtual online world Second Life has just collapsed following a run on their banks due to inappropriate valuations and bad counterparty risk, wiping out many players' real-world investments...

posted by Asparagirl (162 comments total)

Asparagirl, I understand about 10% of that fpp, but it sounds scary and I think you blew my mind. I'm going to go to sleep now.
posted by vrakatar at 9:13 PM on January 29, 2008 [2 favorites]

*starts stuffing cash in mattresses*

Wait. I'm a grad student. I have no cash. All right, we're cool!
posted by papakwanz at 9:22 PM on January 29, 2008 [3 favorites]

Does this post have something to do with money and stuff?
posted by zardoz at 9:23 PM on January 29, 2008 [3 favorites]

Someone please tell me at the beginning of the bank run so I can be one of the guys who actually get their money out. I wonder what percentage of the general population is even aware of the fractional reserve system - the fact that the bank doesn't actually have all their money.

LOL to Second Life. Buying computer game money with real money and thinking you now "own" anything besides computer game money is pretty funny, although, what with these negative reserves and so on, it does call into question how "real" our real money is.

I'm glad to read that the BCX computer game bank is "in compliance with the new LL policy effecting in world banks" and simply shocked to hear of an "extreme surplus of withdraws."
posted by TheOnlyCoolTim at 9:26 PM on January 29, 2008 [1 favorite]

If the words in the post don't make too much sense to you, just check out the picture instead. It's bad, and worth a thousand words -- or perhaps three or four thousand words after the coming devaluation...
posted by Asparagirl at 9:32 PM on January 29, 2008 [5 favorites]

Short version, from the last sentence of the "via" link:

Banks in aggregate have now burnt through all of their capital and are forced to borrow reserves from the Fed in order to keep lending.

Thanks for this, Asparagirl. I'm with vrakatar in not being currently up to speed on much of this, but I'm about halfway through your links and think I have at least a partial grip on why this is unusual, and think it's interesting there hasn't been much coverage since the TAF program started in December. If any financial world MeFites wanted to take time with a "non-borrowed reserves for dummies," I'm sure it would be much appreciated.
posted by mediareport at 9:34 PM on January 29, 2008

Buying computer game money with real money and thinking you now "own" anything besides computer game money is pretty funny, although, what with these negative reserves and so on, it does call into question how "real" our real money is.

Computer game money *is* real money if you can convert between the two easily. The divide between virtual stuff and real stuff is getting blurrier and blurrier.
posted by Justinian at 9:37 PM on January 29, 2008

I'm gonna sleep on this one and hope I can make more sense of it in the morning. But by and large it looks like the economy is really screwed and the Federal Reserve isn't doing a great job.
posted by thebigdeadwaltz at 9:39 PM on January 29, 2008

Rates will be cut and money printed until the problem is resolved.
posted by humanfont at 9:46 PM on January 29, 2008 [2 favorites]

If you get a blog, Asparagirl, I'll read it.
posted by blacklite at 9:47 PM on January 29, 2008 [1 favorite]

So, let me see if I understand this ... someone *please* correct me if I am wrong.

1) Banks in general made a whole bunch of bad investments, from what I understand mostly loans to people with poor credit (subprime loans) or secondary investments based on income from such loans.

2) As a result, banks are now out of money, and are scrambling to build up capital so they don't have to tell people, "Sorry, you can't actually take out money today, we don't have it." They are using tactics such as not issuing new loans even to people with good credit, raising ATM fees(!), and offering high-interest accounts to attract high investment. The last two, especially the last one, could bite them in the ass long-term.

3) In response to this, the government has essentially lent them $40 billion dollars at very low interest rates. This is unusual since banks are usually reluctant to borrow from the government because it's taken as a sign of desperation. The government has not released the names of the 52 banks it's lending to because of this.

4) Second Life is having the same problem only 10 times worse because the Second Life banks were being run by whatever nutjob said, "Hey! I'll start a bank!", and offered ridiculous interest rates and now their banking system has collapsed, and people had invested real money in it.

As far as I can tell, this means that ...

A) Any bank freezing loans, raising their ATM fees, or offering surprisingly cushy interest rates (like, er, mine just did) is probably in trouble.

B) The government is trying to keep banks in trouble from completely collapsing. If they do completely collapse anyway, that will be a Very Bad Thing.

C) If they don't completely collapse, this could long-term cause runaway inflation or other Very Bad Things.

Is that accurate? And if so, could someone weigh in on ... exactly what any of us should do?
posted by kyrademon at 9:48 PM on January 29, 2008

"This won't affect us long term. It's just a short-term difficulty," said Mr. Smith, 40 years old, who also has significant land and real-estate interests in Second Life. He said he retired from the real-life mortgage business to devote his time exclusively to his Second Life enterprises.

LOL. _{('retired' sure...)}
posted by delmoi at 9:52 PM on January 29, 2008

Wait in the second link the value is shown as negative 13 billion? Is it negative 1.3 or 13?
posted by ofthestrait at 9:53 PM on January 29, 2008

Not surprisingly, some economists see the creation of the TAF as a backdoor bailout of banks in trouble.

Backdoor?

"Mom, I owe my credit card company $1000."

"Don't you have $1000 in the bank, honey?"

"Yeah, but I lent it all to Crazy Lenny. He spent it all on hookers and blow."

"Oh dear, thats terrible, hon. Here sweetums, here's $1000. Now you can pay off those nasty credit card companies!"

"Gosh, thanks mom, you're swell!"

Of course, what Mom didn't tell her Son is that she got her $1000 from a cash advance on her credit card...
posted by Avenger at 10:01 PM on January 29, 2008

So, banter aside, can anyone spell out implications? Does this mean the dollar is going to crash? Inflation is coming? Deep depression?
posted by msalt at 10:01 PM on January 29, 2008

Wasn't the Fed begging banks to borrow money from them a couple of months ago?
posted by smackfu at 10:03 PM on January 29, 2008

The last link describes how money goes in much more effectively than it comes out. There is also a very real divide between virtual stuff and real stuff, in that there is no real scarcity of the former. Buying crap in Second Life is like paying money for MP3s, something a lot of people have already decided against, but even worse because you then expect to be able to sell those MP3s for money. And also worse because you're not buying MP3s, you're buying virtual penises.

(There are, I guess, a few "real" things you could base a Second Life economy on - processing power, storage space, Linden's bandwidth, and human labor. I understand there's some connection through the "rent" that the bosses charge, but it seems rather tenuous to me, and the first three are cheap enough that most of the internet manages to give them away for free.)

This artificial scarcity of bits and phat lewt is all good for fun in World of Warcraft and so on - unabashed games that don't pretend to be for real.

On the other hand, fiat money is only scarce because the government says so, but they do have guns and I can use fiat money to eat.
posted by TheOnlyCoolTim at 10:06 PM on January 29, 2008 [1 favorite]

Somehow I think the bankers, speculators, and conmen behind the whole real estate cult won't be the ones in the street or watching their savings devalue. I keep watching the market news, seething and muttering "burn wall street burn" but the rich won't feel it.
posted by vrakatar at 10:07 PM on January 29, 2008 [3 favorites]

So, how will this play out with a Fed that is lowering interest rates sharply, while the rate that consumers pay for credit and mortgages are going up?

Isn't that likely to increase bank profitability?

In other words, are we seeing the Fed create the equivalent of "counterfeit money", which banks can borrow from and loan out at high rates, which in turn comes back to the banks as real money?
posted by markkraft at 10:09 PM on January 29, 2008

Snark away, folks, we just hit an iceberg named Bad Mother Fucker.
posted by dbiedny at 10:10 PM on January 29, 2008 [7 favorites]

Probably there is no risk of bank collapses as most deposits (at least of ordinary schmoes) are federally guaranteed.
With the US Fed cutting rates there is a significant risk of inflation, and I believe Bernanke has said he will risk inflation rather than recession. Figure also a lower US$ and consequent higher import and energy prices.
When the liquidity problems hit it was friction in the financial system, as institutions were reluctant to provide each other loans for settlement. That implied that some banks would have excess holdings, while other would run short. The trouble here seems to be that the whole has now dropped into negative, which is troubling.
posted by bystander at 10:17 PM on January 29, 2008

That's pretty close, kyrademon, only I would add the following items to your list:

Some banks made bad loans outright (as you said). But some banks didn't make bad loans at all. But they happened to buy bad CDO's (collateralized debt obligations) that turned out to be made up of bad loans -- mortgages or even other kinds of debts like credit card debts -- that they thought were safe* and thought would pay out a decent rate over time. Except that the mortgages started going bad, so the "paper" that the many mortgages had been turned into (like how you make a sausage out of many kinds of meat) was actually bad stuff. The banks want to sell this stuff to get rid of it, but no one wants to buy it, and it's worth way less than the bank thought it was. So suddenly the banks have a shortfall.

Normally, banks lend money to other banks all the time. But since the banks know that other banks might be holding bad stuff on their books -- but don't know who is hlding the bad stuff, since no one wants to fess up -- all of a sudden no one wants to lend money to anyone else because no one trusts anybody else. This part started blowing up in August of last year. It's called a liquidity crisis, because suddenly the money the banks have isn't liquid or flowing. So the cost of loaning money to other banks has gone up, because it's perceived (rightly) as being riskier.**

So if it starts getting too expensive for banks to lend money to one another, then the Fed steps in and offers something called "the discount window" where the banks can get loans from the Fed at a lower rate than banks would get from one another. But that's like admitting you're on food stamps or something and need a handout, so the banks are scared to go to the discount window because it carries a stigma -- the names of the bank who get money that way are made public. So the Fed, in December, suddenly started this brand new program called the TAF so that the banks can get lower-rate loans from the Fed without anybody knowing who the recipient banks are.

* Why did the banks think the CDO's they got were safe? Why didn't they realize they were made out of bad mortgages? Because these companies called rating agencies -- like Moody's and S&P and Fitch -- told the banks they were safe. Those companies turned out to be idiots, are now getting sued, and some may go under soon. The banks also thought the CDO's were safe because these other companies called monoline insurers -- like MBIA and Ambac -- promised to pay up if the highly-rated CDO's turned out to be bad. Only now the monolines are going broke and may get downgraded themselves really soon. Fitch's downgrading of Ambac two Fridays ago may have started the mini-crash around the world last Monday. So all the good ratings and all the good insurance the banks thought they had may have turned out to be an illusion.

** A rate called LIBOR is one way to measure at what rate banks will loan money to each other just for overnight. It's gone way up since August. Sadly and coincidentally, this is having a bad secondary effect on the mortgages inside the CDO's. When an adjustable rate mortgage resets, it doesn't usually reset to the regular bank interest rate, the one that Fed likes cutting all the time. It actually very often gets reset to whatever LIBOR is! So LIBOR -- the loan rate -- is going up because banks trust each other less and less, because banks are holding paper that is made of bad mortgages that they can't get rid of, but LIBOR going up also makes more of those mortgages go bad. It's a vicious positive feedback cycle.
posted by Asparagirl at 10:20 PM on January 29, 2008 [28 favorites]

"But how much longer can this go on?"

Well, assuming that the Fed can encourage other banks around the world to create funny money too, so as to keep the world's currencies balanced... how about forever?!
posted by markkraft at 10:25 PM on January 29, 2008

I'll be at the big asset securitization conference in Vegas next week. I'm thinking it'll either be the lamest, most depressing party Vegas has ever seen, or it'll be a fuckin' crazy escapist, hedonistic meltdown.

In any case, I'm sure Huey Lewis & the News will kick ass at the Deutsche Bank reception.
posted by mullacc at 10:30 PM on January 29, 2008 [1 favorite]

A rate called LIBOR is one way to measure at what rate banks will loan money to each other just for overnight. It's gone way up since August. Sadly and coincidentally, this is having a bad secondary effect on the mortgages inside the CDO's.

You have this backwards, Asparagirl. One-month LIBOR has been in a freefall--it averaged 5.50% in August and it hit 3.27% today with all sorts of volatility in between.

And LIBOR isn't overnight. The most popular base rate for asset-back facilities is one-month LIBOR, but it comes in 3-, 6- and 12-month flavors as well.
posted by mullacc at 10:37 PM on January 29, 2008 [1 favorite]

Asparagirl: So LIBOR -- the loan rate -- is going up

Come again?

Overnight LIBOR is dropping, compared to 06-07 rates. It spiked in mid-07, and is now well below the spike and prior baseline. Longer-term LIBORs are doing the same thing.

(Uh, on preview -- ditto mullacc.)
posted by theoddball at 10:41 PM on January 29, 2008

Somehow I'm not inspired by the fact that the securitization conference is being held in America's capital of gambling and hookers. (Does Vegas have hookers and blow or just hookers?)

In other words, mullacc, regarding it'll be a fuckin' crazy escapist, hedonistic meltdown: Pics or it didn't happen.
posted by TheOnlyCoolTim at 10:43 PM on January 29, 2008

(Libor rate charts)
All I see is bad programming:

An internal Visual Basic error has occurred in D:\00Economagician-com\cgi-win\daychart.exe.
0 CGI_QueryString
Function:main - call CGI_Main
Error info:
# Function: main - call CGI_Main
# Error: 13 - Type mismatch Please note what you were doing when this problem occurred, so we can identify and correct it. Write down the Web page you were using, any data you may have entered into a form or search box, and anything else that may help us duplicate the problem. Then contact the administrator of this service.

posted by boo_radley at 10:47 PM on January 29, 2008 [1 favorite]

People ask what to do.
My best advice is to try and smarten up your financial situation so any negatives will impact you less.
For example, if you have borrowed money to invest (margin lending) it might be wise to get out of that arrangement. If you have little savings, it would be a good idea to put some money aside, ideally enough to cover your unavoidable expenses for a month or two.
If you have this in a bank account, you should be OK, but I would keep an extra $100 under the mattress in case the shit hit the fan and the banks halted withdrawals for a week or two (pretty drastic, but it came close with Northern Rock in the UK).
The hard bit is knowing what would happen if there was a run on the banks these days.
In 1929 there was no Internet banking, automatic payments, credit cards, auto deposit of wages etc. When a bank closed its doors then it was conceivable that life could still function. If there was a run on Citibank today, would they switch off my Visa card?
One thing that is weird with the current financial problems is that it is the finance sector spilling over into the real economy. Usually, it is the other way around.
Disclosure: I have no bearish investments, a thimble full of superannuation in shares and more mortgage than I like, and I find this news quite disconcerting.
posted by bystander at 10:47 PM on January 29, 2008 [3 favorites]

And LIBOR isn't overnight

Actually, I was wrong about this (see theoddball's chart); there is an overnight LIBOR rate. It doesn't come up on the Bloomberg terminal's money market rates summary page, so I'm not sure how widely used it is (versus the one-month rate, which is used all over the place). Anyway, sorry for the unwarranted nitpick there, Asparagirl.
posted by mullacc at 10:51 PM on January 29, 2008

D:\00Economagician-com\cgi-win\daychart.exe

More like cgi-lose, amirite

(Sorry, sorry. The failblog thread today seems to have ruined my ability to censor these urges.)
posted by blacklite at 10:56 PM on January 29, 2008 [11 favorites]

A) Any bank freezing loans, raising their ATM fees, or offering surprisingly cushy interest rates (like, er, mine just did) is probably in trouble.

Oh yes. Check out this comment I made last August -- of course, that was before Citibank, too, ended up in big trouble!

And really, I don't know what to do either, I'm kind of freaked out by all this economics shit. The only things I can say are:

- Get out of debt as much as possible and as fast as possible, especially credit card debt, which will eat you alive
- Don't be over FDIC limits at any one bank -- or open up accounts at two different banks just in case. I just opened up my infant son's first savings account yesterday, and I purposely picked a different bank than the ones my husband or I use for our own banking, a smaller and more local bank that got a good rating at Bankrate.com.
- Put some money into short-term United States Treasuries and savings bonds; the interest rate is pretty sucky, but the only way that money would go away is if the US government itself folded, which is highly unlikely and in which case you would probably have far worse things to think about than money. You can use TreasuryDirect.gov to open and manage an account there for free. Their website isn't the most intuitive thing in the world, but it works.
- Always have some cash on hand, stashed somewhere safe. Not $100 bills, either -- smaller bills that you wouldn't have to break. Just in case.

Beyond that, I just don't know what peons like us can do. We can insist on stricter accountability for ratings agencies, tougher banking and mortgage origination laws, and jailtime for a lot of people, I guess, but that's all gonna be after-the-fact.
posted by Asparagirl at 10:56 PM on January 29, 2008 [9 favorites]

Mea culpa on the LIBOR!

And on a selfish note, I'm especially worried because I live in California, and this place probably more than any other place in the WORLD, is about to get FUCKED by this whole mortgage mess.
posted by Asparagirl at 11:08 PM on January 29, 2008

"The hard bit is knowing what would happen if there was a run on the banks these days."

You seem to think that the Fed (and the government in general) would actually allow that. I don't see why they would, as there is always more funny money that can be made.

In other words, they'd devalue your savings and put the financial burden on you, while trying to persuade other countries to do similar acts to maintain some degree of parity.

Sure, stocks will fall, some jobs will be lost, prices will go up in good ol' fashioned stagflation... but the banks will constantly be bailed out, as needed. Even the so-called subprime bailout is really just a bank bailout. Even most of the real estate "flippers" are going to get off easy, as will the banks, who will avoid foreclosures and still collect their 6.25% blood money every year.

Ultimately though, exports will increase, deficits will be paid for with funny money, and investor sentiment will gradually change as people become a bit less bearish. ... largely because the problem is partially psychological.

It's a bit like "Balance", only not quite as catastrophic.

...that said, everyone still wants to be the closest to the music box.
posted by markkraft at 11:28 PM on January 29, 2008

Boy the way Glenn Miller played
Songs that made the hit parade.
Guys like us we had it made,
Those were the days.

And you knew who you were then,
Girls were girls and men were men,
Mister we could use a man
Like Herbert Hoover again.

Didn't need no welfare state,
Everybody pulled his weight.
Gee our old LaSalle ran great.
Those were the days.

Seriously -- that FRED graph was like a gutpunch. Combine that with the completely un-telegraphed 0.75-point rate cut and I have this sense of restrained panic erupting behind the scenes. I also wonder whether that graph represents some indirect Soc-Gen fallout.

WHAT.
THE.
FUCK.
BEN?
posted by dhartung at 11:28 PM on January 29, 2008 [2 favorites]

A movie or TV quote. A fella in a very correct English accent. "I don't care for this at all." That just popped into my head out of nowhere.

Claus von Bülow?

One of the best units I did in my BCom was a philosophy of money type unit in my final year. It was a mindfuck, and not what I was expecting from the very pro business Business School.

Pyramid schemes and cheq kiting are illegal in Australia. But as far as I can tell, the current financial landscape is mostly a giant pyramid kiting scheme, relying on the "bigger fool theory" and / or population growth.

I'll just stick with that personal observation and the quote. There are many GRATER Mefites here when it comes to talking about this stuff.
posted by uncanny hengeman at 11:34 PM on January 29, 2008

God bless the United States of Ponzi.
posted by scody at 11:39 PM on January 29, 2008 [2 favorites]

Fucking awesome post. Thanks.
posted by Samuel Farrow at 11:40 PM on January 29, 2008

How about more Federal Reserve transparency and accountability?

Televise Federal Open Market Committee Meetings.
An institution as powerful as the Federal Reserve deserves full public scrutiny.

Expand Transparency and Accountability at the Federal Reserve
Pass H.R. 2754 to require the Board of Governors of the Federal Reserve System to continue to make available to the public on a weekly basis information on the measure of the M3 monetary aggregate and its components.

You'd be surprised whose proposed economic package this comes from. Hint: It isn't Obama, Clinton, McCain, Huckabee, or Romney. If you do enough research on the issue and look at the business cycles over the past 95 years, you'll find the Federal Reserve actually does far more damage than good when it comes to keeping the economy in balance.
posted by vanadium at 11:42 PM on January 29, 2008 [1 favorite]

from what I understand mostly loans to people with poor credit (subprime loans)

The issue is a bit more metastized than that. The central problem is that lenders made loans into a bubble market, full stop.

Four Trillion Dollars of loans, 2003-2006. Here's a graph I made from the most recent Federal Flow of Funds Report.

This wasn't just subprime, or Alt-A, or Prime, though the former two categories had a lot to do with the appreciation spiral. [Alt-A lending is Prime with something goofy added, like stated income, no-doc, or NOO (non-owner occupied).]

How much of that four trillion dollars of lending 2003-2006 is going to end up as dead loss over the next 5-10 years? 10% is an absolute minimum. 30% doesn't seem impossible, given the self-feeding casualities involved with a tanking real estate market and the general unwinding of the debt-fueled Bush Economy we're going to experience.

or secondary investments based on income from such loans

yes, the infamous CDOs.

Anyhoo, I don't quite think this is FPP-worthy since nobody can know what all this TAFfy activity and increasing slosh really means right now.
posted by panamax at 11:47 PM on January 29, 2008

You'd be surprised whose proposed economic package this comes from

DO YOUR RESEARCH! ::eyeroll::
posted by panamax at 11:50 PM on January 29, 2008 [1 favorite]

Panamax, you may not think this is worthy of a FPP, but for a whole bunch of us who just nodded our heads and went "Subprime mortgages, huh? okay, sure, now what's Britney up to today?" it's a rather nasty reminder that the economy is in trouble and there are going to be repercussions that affect *us* in the near future.
posted by librarylis at 11:57 PM on January 29, 2008

But as far as I can tell, the current financial landscape is mostly a giant pyramid kiting scheme, relying on the "bigger fool theory" and / or population growth

and/or productivity -- the creation of new goods to buy -- in general. There's a trillion or two within our somewhat fictitious GDP here in the USA that is hard goods -- actual wealth like new cars, housing, road surfacing -- or intermediate goods (sheet metal, plastics, lumber, asphalt), that soak up this money creation. If money were based on something of fixed supply like seashells then we'd see deflation given the annual productivity of modern society.
posted by panamax at 11:59 PM on January 29, 2008

I talked about some of this in my earlier post here, about a week ago.

Ultimately, this comes down to the loose and easy money policy of the Fed. Originally the "Greenspan Put", it's become the "Bernanke Put"; the fact that the Fed will always try to bail out Wall Street whenever it gets in trouble. That means that Wall Street has gotten riskier and riskier and stupider and stupider over the last twenty years, gorging themselves on profits from high-risk/stupid investments. The Fed has been absolutely unwilling to allow even the tiniest hint of economic pain through, so we've built this gigantic structure of derivatives and risk. It's starting to fall apart now; it's gotten so incredibly risky and fragile that even the Fed's free-and-easy money supply isn't hiding it very well anymore.

The Fed's bailout attempt is incredibly irresponsible. Regular money is fake, just made up out of thin air at will; derivatives created from that fake money is, well, EXTRA fake, supersize fake. The debt structures they've built aren't sustainable. They will collapse under their own weight. The Fed is desperately trying to pump more air into the bubbles, trying to monetize the supersize fake money that the banks are lending against into regular fake money. To the Fed, the survival of their banking buddies is much more important than the survival of the dollar, or the survival of your savings. Any assets you hold in dollars are being stolen to line the pockets of Wall Street.

So. Either they succeed, or they fail. What happens?

If they fail, we go into a deflationary debt collapse, as the structures we've built fall apart and the system comes apart at the seams. The result would probably be called the Second Great Depression. This is the best possible outcome; depressions are horrible, but the core economy tends to survive.

If they succeed, they will set off a new round of frenzied speculation such as we've never seen before. Things may even seem okay for awhile again. But we will eventually go into hyperinflation, as the new supersize-fake money gets created and into circulation. If we go down this path, the destruction is likely to be near-total; this is the same thing that made us sick in the first place. It will be slower, but much more absolute. We're likely go through multiple cycles of inflation/partial deflation/even wilder inflation until the economy just breaks down completely and can't take it anymore.

Fundamentally, the reason we're in such trouble is because the Fed's fake money has disconnected the financial system from the real economy. We're not producing anywhere near enough goods to finance our gigantic consumption binge. Our government is over fifty trillion dollars in debt. (The nine trillion figure is a baldfaced lie.) We owe, we owe, so off to work we'd go.... but we don't have much productive work left. Because of the Fed's financial engineering, we've been anesthetized while all the factories moved to China. Production is still the fundamental key to wealth; real wealth is things, not little green pieces of paper that can handwaved into existence.

We are, at best, a second-world country, and if the Fed is allowed to continue down the path they're on, we're headed for third-world nation status... a ruling, hyper-rich junta, and an entire population of economic slaves.

If we really want to fix it and become prosperous again, we need a commodity money system that can't be gamed by the government for their own benefit, and we'll need to work like dogs for a generation or so to get everything fixed up. Yes, a whole generation, twenty to thirty years of hard work for very little visible payoff.

We are a nation of the people, by the people, and for the people, and We The People have completely abrogated our responsibility to govern ourselves well. We have ignored the problem while the government ran up impossible deficits, and the Fed built up bubble after bubble after bubble. Instead of watching and understanding and reining in our government, we sat around drinking beer and cheering on the Rams. This is our fault for not educating ourselves, and it's our fault for letting those in authority shout down the fiscal conservatives as fringe-case lunatics.

We didn't think for ourselves, we let other people think for us, and they have very thoroughly screwed us. We got the government we deserved, and now the bills they've run up are coming due.

There's no possible way we can pay them.
posted by Malor at 12:05 AM on January 30, 2008 [25 favorites]

reminder that the economy is in trouble

I don't consider the economy in "trouble" per se.

I see the period we're entering into, if we are smart, more akin to the 400lb guy being forced by events to put down the donut and start hitting the gym.

Think of the portion of your income that is going toward housing -- not the dwelling itself but the land it sits on. For most people it is the dominant monthly expense, generally outsizing the rest of our expenses combined.

It is my hope that recessionary pressures will force rents -- and associated land values back down, and people's buying power for the other necessities and luxuries of life will not be impaired.

I currently live in an area -- Sunnyvale, CA -- where 40 years ago a middle class wage earner could easily earn enough to make the ~$200/mo payment on a decent SFH.

But between then and now we've allowed rentiers and Chicago School frauds to corrupt our economics -- our economy is fine, it's our economics that suck.
posted by panamax at 12:10 AM on January 30, 2008

So i should sell my houses on Baltic Ave. and buy hotels on Park Place?
posted by vrakatar at 12:13 AM on January 30, 2008

we need a commodity money system that can't be gamed by the government for their own benefit

I vote for seashells, but I could possibly be won over to peacock feathers!

There's no possible way we can pay them

I disagree with this. Sure we need less Golgafrincham B Ark-type grifters like real estate agents, insurance salesentities, and landlords, but the mythical $50 Trillion infinite-horizon liability calculation, at the end of the day, is just the forward payment of the basic fundamentals of life -- food, housing, medical care.

By delivering these fundamentals wisely we can easily afford them as hand-outs, infinite horizon or no.
posted by panamax at 12:17 AM on January 30, 2008

If money were based on something of fixed supply like seashells then we'd see deflation given the annual productivity of modern society.

Yes, this is exactly right. The natural state of economies appears to be a very slow deflation, as we figure out new/cheaper/better ways to build things. Wages go up very slowly, prices come down very slowly, and gradually standards of living improve. (I say 'appears to be', because it's very hard to find a period in economic history where the economy wasn't being actively manipulated by a central authority of some kind. )

For the last twenty years, we should have been struggling and sweating and in very deep pain from the reality of global deflation; we're now competing, directly, with a billion Indians and 750 million Chinese. We should have been angry and upset about the deflation, about our dropping living standards. We should have been talking about 'the crisis', and absolutely convinced we were in a death spiral as a country.... while, quietly, our productivity improved and improved and improved, and our quality got better and better. We'd have HATED it, but like exercise, it would have made us much stronger.

Instead, we've been anesthetized to the whole process, drugged up on easy money, while the economy rotted away underneath. The Fed saw the deflation and kept increasing the money supply to offset it, creating multiple bubbles and wild economic instability. But because the bubbles and inflation were in areas we liked, stocks and real estate, people loved it and wanted more.

"Give us another hit, Mr. Greenspan!" we begged, and he was more than happy to oblige.
posted by Malor at 12:17 AM on January 30, 2008 [8 favorites]

vrakatar: everyone knows the best strategy in Monopoly is to Go To Jail, ie opt out of the economy and lay low, collecting rents from the poor slobs still stuck in the game.
posted by panamax at 12:19 AM on January 30, 2008 [1 favorite]

Malor: related to your last is the somewhat interesting term I discovered in Marx's corpus called "alienation of labor". While it's got the usual frou-frou Marxist baggage, I do like its implication and application to the millions of people who are apparently helpeless in our urbanized cores.

I don't understand why this nation can happily borrow a trillion dollars to establish a Shiite state in Iraq but is afraid to look for solutions for our own economic and social challenges.

and it's our fault for letting those in authority shout down the fiscal conservatives as fringe-case lunatics

I think the problem is fiscal conservatism consists of country club gated-community "Got Mine -- Fuck You" greedheads quite happily engaged in parasitical profiteering via rentierism.
posted by panamax at 12:28 AM on January 30, 2008 [7 favorites]

Hmmm. Interesting collection of links, but someone is going to have to link NFORBES to Tier 1 capital for me. In fact, link it to Tier 2 & Tier 3 as well.

These are the metrics we use to evaluate the strength - or weakness - of a financial institution. I've never looked at NFORBES myself, and I've been deep into Basel II reporting for several years now.

NFORBES may be a lower level contributor to some numbers I've looked at, aggregated up, I'm just not sure.
posted by Mutant at 12:38 AM on January 30, 2008

I don't understand why this nation can happily borrow a trillion dollars to establish a Shiite state in Iraq but is afraid to look for solutions for our own economic and social challenges.

For the win.
posted by From Bklyn at 12:40 AM on January 30, 2008

Looking at that FRED chart (and I don't pretend to understand it too well), it looks like what's happening now is the equal and opposite reaction to 2001, which I'm assuming was a wealth of capital being created due to all these new financial products and CDO schemes as well as the initense rate cuts after 911. What ever it is, it looks unprecedented uncharted territory for the whole history of those numbers going back to the 50s.

I don't understand why this nation can happily borrow a trillion dollars to establish a Shiite state in Iraq but is afraid to look for solutions for our own economic and social challenges.

I imagine maybe because a good chunk of the money goes to American companies anyway. i.e., The Military Industrial complex and it's stock holders. There's a lot of money to be given away in this country and it's a lot easier to give it to the rich if there's a nice fat war to pump money into. You know, as opposed to building schools, repairing and expanding infrastructure, investing in alternative energy technology and rebuilding New Orleans.

And it's sad to think the sub prime ponzi scheme slimeballs who put us in this mess are probably not going to learn any lessons. Hell...isn't the ex-CEO of Countrywide walking away with a half a billion dollar bonus?

Socialism for the rich. Capitalism for everyone else.
posted by Skygazer at 12:51 AM on January 30, 2008

God bless the United States of Ponzi.

I'm more of a fan of the United States of Fonzie
posted by matteo at 1:09 AM on January 30, 2008 [1 favorite]

Come on you frownie faces, let's look at the bright side of this.
posted by TwelveTwo at 1:20 AM on January 30, 2008 [2 favorites]

Isn't the ex-CEO of Countrywide walking away with a half a billion dollar bonus

~$100M bonus for running Countrywide into the ground and contributing to the destabilization of the economy. He's already cashed out $300M since 2003 of his CFC stock holdings.

ooh, look, American Idol is on now. Gotta go . ..
posted by panamax at 1:21 AM on January 30, 2008 [2 favorites]

"So. Either they succeed, or they fail. What happens?
If they fail, we go into a deflationary debt collapse"

Deflationary?! Only in some ways. Our currency is becoming worth less, so the price of foriegn energy, the price of imported goods, and the price of most everything we buy is actually going up. Real estate prices may go down somewhat, but given that we've come off of a decade of them going up about 10% per year, at about three times the rate of wages, real estate has a long way to fall.

Falling prices for real estate won't save most people money, because people aren't buying, and if they were, they'd have an increasingly hard time getting a reasonably priced mortgage. Real estate prices are only crashing hard in a few markets with lots of subprime loans, but outside of that, it's just a gradual correction that's being fought against by the government, tooth and nail.

People like Hillary are even talking about freezing mortgage rates on subprime loans, which will, inversely, increase rates for new loans, putting them further out of the reach of Americans.

To add insult to injury, there's not even much of a correlation between lower housing prices in any given marketplace and lower rent prices. Infact, in this case, we might even get an inverse correlation, due to rising mortgage rates, and a general need by landlords for more revenue to make due.

"If they succeed, they will set off a new round of frenzied speculation such as we've never seen before."

Perhaps, but it might change, assuming that we get a president who will strongly tax the wealthy, and get that money redistributed towards the poor.

The real reason for all these financial bubbles is closely related to too much global supply, too little global demand, because the wealthiest people in the world have been getting all of the financial advantages of increased productivity... and they've been doing it for decades. All this extra money gets invested to create more supply, but the investments get increasingly fewer returns, as most people simply can't afford to keep up with it.

The era of easy credit was essentially a way of artificially coping with this... but ultimately, it's not a solution. The solution is to tax the rich again, to redistribute wealth, and to start raising wages. When poor and middle-class people have more money, then demand can start to rise.

The difficult part, unfortunately, is that other countries also have this problem of increasing wealth disparity leading to increasing debt and lower demand, so it may be a difficult problem to address on a simply national level.

Giving people overseas their fair share of the economic pie is also arguably bad for the prospects of global warming, but that's another issue entirely.
posted by markkraft at 1:47 AM on January 30, 2008 [6 favorites]

Actually, I was wrong about this (see theoddball's chart); there is an overnight LIBOR rate. It doesn't come up on the Bloomberg terminal's money market rates summary page, so I'm not sure how widely used it is

Is this overnight LIBOR rate the one lenders peg private school loans to? You know...the ones being pushed hard on TV ads now? The ones that sing beautiful songs about students being able to pocket up to $40,000 (with their parents' co-sign)?
posted by Thorzdad at 3:31 AM on January 30, 2008

I see the period we're entering into, if we are smart, more akin to the 400lb guy being forced by events to put down the donut and start hitting the gym.

But, alas, we aren't smart (And, by "we", I'm primarily referring to the guys with their hands on the money) I think the more apt gym analogy will be one of the 400lb guy who gets to sit on the shoulders of the 97lb guy running on the treadmill. The only difference will be that the 400lb guy will have to switch to croissants in lieu of donuts.
posted by Thorzdad at 3:45 AM on January 30, 2008

Magnificent post Asparagirl. I too would gladly read your blog had you one.
posted by Skorgu at 3:56 AM on January 30, 2008

I'm of the opinion that this fleecing is all the result of Banking, Wall Street (Corporate) collusion via deregulation - i.e. things like the repeal of Glass-Steagall Act and that such repeals need to be reversed because they were there for good reason.

Here's my preferred economic "horror-scope" resource: Dollars and sense
(Especially enjoy the 'Ask Doctor Dollar' section)

A country rife with 'Enrons.'
posted by peppito at 4:39 AM on January 30, 2008 [1 favorite]

I was thinking of developing a theme song for DoomFilter. I inclined to use perhaps the jangly guitar theme to James Bond, or the more elborate theme song to "Goldfinger". What do you think?

This is an excellent post, however, that I have gotten my day off to a depressing start as a result. If the world were a just place, only incompetent, overpaid CEOs and hedge fund punks would be affected by the fallout from this.

I suspect, however, that the world is not a just place.
posted by psmealey at 5:02 AM on January 30, 2008

Bernanke to the Banks: "Your money's not here...it's in Bert's house and Ernie's house! It's in Mr. Martini's house. Your money went to build their homes and their money went to build yours. Now how much do you really need?"

Meanwhile George Bailey gets hauled off to Gitmo.
posted by gimonca at 5:12 AM on January 30, 2008 [1 favorite]

according to this article the economy will be just fine
The US economy is slowing down, but the long-term trends for the country are more favourable than many think. There has also been a sharp improvement in many of America's social pathologies, such as violent crime and drug abuse

posted by robbyrobs at 5:26 AM on January 30, 2008

sorry here is the link
http://www.prospect-magazine.co.uk/article_details.php?id=10022
posted by robbyrobs at 5:26 AM on January 30, 2008

Real estate prices are only crashing hard in a few markets with lots of subprime loans, but outside of that, it's just a gradual correction that's being fought against by the government, tooth and nail.

That's true for the moment, but it's likely to get a lot worse. The last six or eight years have seen the Fed providing currency at all-time historic lows; it's been cheaper to borrow money since 2000 than it ever has been in the US, and probably in history. There have been times with lower interest rates, but in times of near-zero inflation or deflation. We've been in an era of very strong inflation (regardless of government statistical skullduggery stating the contrary), and cheap money in that kind of environment is, as far as I know, entirely unprecedented.

So, yes, house prices have only been 'crashing hard' in a few places, but it's just the beginning of a long, long process. Real prices, that is, as measured against other goods, will probably continue to go down for at least a decade. Higher interest rates will make it harder to buy houses. Their prices tend to hold in place, stubbornly, because owners often won't sell if they can't get out with a dollar in their pockets, but it's very likely that everything else will inflate dramatically as the house prices hold still.

And that's assuming an inflationary scenario; if we deflate instead, god only knows what will happen. Price bottoms could be astonishingly low if we deflate.

Perhaps, but it might change, assuming that we get a president who will strongly tax the wealthy, and get that money redistributed towards the poor.


At best, that will have no effect, and at worst, that will make things much, much worse. If the government redistributes wealth, it should focus on taking money away from the speculators and getting it into the hands of the productive; we need to rebuild our manufacturing base. Giving money to poor people is a feel-good prescription, but in comparison with real investment, it's a very bad use of capital. We need to use that wealth to make more wealth. We need to teach ourselves to fish again, not just try to steal fish from the wealthy.

The real reason for all these financial bubbles is closely related to too much global supply, too little global demand, because the wealthiest people in the world have been getting all of the financial advantages of increased productivity

You're badly confusing wealth with currency. You've also been hoodooed by the productivity numbers, which are garbage.

Modern currency is just a claim on wealth. It doesn't have any inherent value. The first world countries have benefited disproportionately from the easy money flowing from the Fed, and the creation of the associated money-like derivatives, by being able to use that currency to extract wealth from the economy for their own purposes. Sadly, in most cases, it's been consumed and wasted. And, in exchange, we traded away notes that have no inherent value.

The problem is, now there's a lot of those notes in the hands of people who would like to get something with them. And they are going to get most upset if we keep trying to dilute their claims by constantly adding new ones. It's not a good idea to piss off your creditors when you're in such a weak position.

All this extra money gets invested to create more supply, but the investments get increasingly fewer returns, as most people simply can't afford to keep up with it.

I think it would be more accurate to say that a great deal of that money went into financial engineering to extract more goods from the unwary producers of the world. Those producers are going to be mightily pissed when they find out they've been rooked.
posted by Malor at 5:35 AM on January 30, 2008 [1 favorite]

One-month LIBOR has been in a freefall

If LIBOR is a measure of banks' trust for one another, why is it now going down?
posted by mediareport at 5:49 AM on January 30, 2008

So much BS, hysteria, and misinformation in this thread, I don't know where to start. But I am glad that y'all are potential counter-parties.
posted by sfts2 at 6:12 AM on January 30, 2008

That's a highly useful comment, sfts2. So glad you could contribute.
posted by Malor at 6:16 AM on January 30, 2008

I am someone who is certainly very worried about a systemic crisis in our financial markets and in our economy. I have dramatically reduced my exposure to stocks and hedged what I am still holding. I don't claim to understand how the fed works, but let me present another view on the NFORBRES chart and why it may not be as bad as it looks. Then people who do know what is going on can tear it apart and I can learn from it.

The Fed had a problem in that many banks would not borrow from them because such borrowing was public, and being seen borrowing from the Fed was a sign of weakness in the Darwinian financial market. To help solve this problem they took a page from the playbook of the European banking system, and started offering money through an auction facility. This was a new way of the Fed doing business. Banks could pledge assets and borrow against those assets. The assets themselves are not taken at face value, but are discounted to a degree that reflects the danger of holding those assets. Whether the degree of discount is correct or not is arguable, and it seems that some of the assets (especially those backed by mortgages) may be valued higher than the open market would suggest, but since that market is opaque, it is debatable to some degree. So you can't necessarily borrow against the full value of assets.

The interest rate of borrowing against the assets was (and is) determined by an auction process, in which banks compete by bidding up the interest rate they will pay. Participants in the auction process are anonymous; the Fed releases information on how much was auctioned off and at what rate, but not who bought them. This solves the perception problem of borrowing openly from the Fed. It also had the effect the Fed wants: getting money and liquidity into the system so that borrowing and lending and hence spending occurs. In fact, it works very well. As I understand it, the interest rates in the auction tend to be about 3.1% (3.123% yesterday) give or take a few tenths of a percent. This is awesome if you are a bank, even if you are not in trouble, because you can borrow anonymously at that rate and then lend at a higher rate, say the 5% or higher range. As long as you get paid back, you are essentially earning a couple of percent mostly risk free.

So the large downward spike in the graph, while representative of a financial crisis, might just reflect this very new auction facility and the fact that even healthy banks can make some money borrowing from it, rather than a systemic bank insolvency.
posted by procrastination at 6:47 AM on January 30, 2008

and being seen borrowing from the Fed was a sign of weakness in the Darwinian financial market.

That's because it IS a sign of weakness. Banks shouldn't need emergency funds, and the Fed providing anonymous money is entirely unprecedented, especially when taking the really lousy collateral they're accepting.

This is a way of injecting vast amounts of liquidity without letting the world know which banks are in trouble. And if healthy banks can use it too, well, that's a strong sign that it's too cheap, and it's a powerful inflationary impulse.

This is awesome if you are a bank, even if you are not in trouble, because you can borrow anonymously at that rate and then lend at a higher rate, say the 5% or higher range. As long as you get paid back, you are essentially earning a couple of percent mostly risk free.

Yep, this is throughly awesome if you are a bank. It's not so good if you're a holder of dollars.
posted by Malor at 7:03 AM on January 30, 2008

Grr. "thoroughly".
posted by Malor at 7:04 AM on January 30, 2008

VERY IMPORTANT QUESTION:

If my bank collapses, do I still have to pay them the negative balance in my checking account? Because, as it stands, my bank account is like the anti-matter equivalent of money and I'm afraid to drive by the place because I keep seeing little red laser dots appearing all over my car.
posted by Baby_Balrog at 7:26 AM on January 30, 2008

Everybody relax.

First, every crisis is an opportunity. So instead of saying "OH MY GOD EPIC FAIL!", maybe we should be asking how the smart money stays both smart and in money.

Second, the system will never collapse. You really think being $1.3 billion short is any problem? Microsoft is sitting on $40 billion in cash. Apple is sitting on $18b, and Google on $13b. That's just three companies that could recapitalize many of the banks on their own, if they were so inclined. There is more money sitting on the sidelines here in the US than you can imagine.

The reason we are only seeing capitalization coming in from foreign countries (oops, forgot the code word "sovereign wealth fund") under bizarre contractual arrangements is because no one wants to really come clean about their books, and no US acquirer will step in until that happens. If we had a national Air Your Dirty Linen Day, where these banks and mortgage companies would come clean about precisely what assets they have are worth how much, or whose value is unknown, we'd have a lot of near-term failures and bankruptcies, a lot of near term stock market bottoms, but then we'd start to see some M&A activity and Congress waking up and actually doing their job of regulating banking.

The Fed is wise to the fact that the problem is recession, not really inflation. You take out food (ethanol <> Corn Flakes) and energy, and there really isn't any inflation. Furthermore, with so much manufacturing shifting to lower cost producers in China and India, prices of many goods are still declining. But recession is a multivectored disasater. We are spending way to much money to have the economy slow and tax revenue decline.

So the Fed is on board. They cut rates and the system chugs along. Maybe your money is worth slightly less, but that's better than not making any money.

A lot of people in this thread are talking about their savings being eroded. Welcome to the tyranny of the majority, in which you get screwed for doing the right thing. Most Americans don't have savings, they have very negative net worth. They have massive credit card debt. Rate cuts help them. They keep their job. Rate cuts keep people at the margin in a house for another six months, maybe.

Is it a shell game? Sure. But so is everything. You think a car is real value? Then why does that value decline by 40% the second you take delivery? Don't confuse pricing with value. Most things we buy have very little value despite their prices.

Keep the system moving along and everyone, all things considered, will be fine.
posted by Pastabagel at 7:32 AM on January 30, 2008 [6 favorites]

So Malor -- what should I do? I have a reasonable sum of money sitting in the bank. Not all of it is FDIC insured. I'm going to spread it around so it is, but should I just get it out of the country? (I've always been fond of the Korean market but...?)

This is going to suck for a lot of people, probably less for me than for others, but I want it to suck even less for me.
posted by lupus_yonderboy at 7:34 AM on January 30, 2008

Darwinian

you mean Spencerian. Darwin's was "natural selection," not "survival of the fittest."
posted by eustatic at 7:41 AM on January 30, 2008 [1 favorite]

It is my hope that recessionary pressures will force rents -- and associated land values back down, and people's buying power for the other necessities and luxuries of life will not be impaired.

All your doom and gloom and America Had It Coming and THIS is your hope?

Think about it. If people are walking away from their mortgages, what are they going to do, rent an apartment, or live in a cardboard box?

If people are going to sit out the market waiting for the bubble to finish popping, are they going to rent an apartment, or live at home with mom and dad?

Rents in Seattle are already rising. Three people I know have already seen increases in rent. Rentals are moving at the same rate as houses were a couple years ago -- on Craigslist at 9, rented by 5.

But it still looks smarter to rent over the next five years than it is to buy. Even if rent rises at 10%/year, it still beats the 10%/year deflation of owning. And eventually, the math of "owning is cheaper than buying" will return, and people will start buying again. 2012 is what I've seen a few economists offer as a target date for that.
posted by dw at 7:50 AM on January 30, 2008

you mean Spencerian. Darwin's was "natural selection," not "survival of the fittest."

See? I knew I would learn something. Thanks.
posted by procrastination at 7:52 AM on January 30, 2008

And while I'm at it, there are only two ways to deflate the bubble:

1. Fiddle with the value of the dollar. That means massive inflation or an actual devaluation. If we saw across the board 20% inflation (including wages) combined with a freezing of interest rates, then that should shift the values of these mortgages downward to a point that people could afford them. And the economy would probably implode in no time flat, especially because wage growth usually lags behind inflation.

2. Foreclosure city. Everyone who is losing too much value walks away. The foreclosure auction prices would plummet, and banks would take the money rather than holding that much real estate. Of course, this depends on there being a supply of capital to buy those houses, which there won't be any since everyone is walking away from their mortgages. And the economy would probably implode in no time flat.

So at this point, the Fed is panicking. At the same time, they're not. They're risking inflation to stave off a recession. But until the most recent rate cut, they've been fairly conservative about money policy, Jim Cramer be damned.

I really don't think we're staring at the Second Great Depression here. I think what we're looking at is a generation that will struggle with wealth creation. The good news is that the rest of the world is creating wealth. If the next president can return confidence to the dollar, then that should forestall the "Third World" think Malor is stuck on. Even if he/she can't, that should also mean those manufacturing and computing jobs we've lost overseas will start returning to the US. No doubt we're going looking at a long term readjustment to a leaner lifestyle with fewer nice things, and that will suck. But Second Great Depression? That would require something greater to happen, like Hu going on a bender, drunk-dialing Dubya, and deciding to pull the plug on all of China's T-notes as a result.

If China drops its T-notes... then the whole world is fucked.
posted by dw at 8:07 AM on January 30, 2008

For inflation, how does it make any sense to ignore the price of energy or food?

Those are the most impactful of price increases. Yes, they are volatile, but ignoring the fact that food prices are through the roof is akin to plugging your ears and shouting at the top of your lungs "INFLATION IS LOW".
posted by Lord_Pall at 8:23 AM on January 30, 2008 [1 favorite]

Core inflation has been historically useful because food and energy prices tend to be very volatile. However, you can make the argument that in recent years core inflation has consistently run below the consumer price index, and that because of that inflation has been understated. See this post at The Big Picture for a larger discussion.
posted by procrastination at 8:34 AM on January 30, 2008

Second, the system will never collapse. You really think being $1.3 billion short is any problem? Microsoft is sitting on $40 billion in cash. Apple is sitting on $18b, and Google on $13b. That's just three companies that could recapitalize many of the banks on their own, if they were so inclined.

Somehow, the thought of private-sector firms recapitalizing banks strikes me as something to be avoided. I mean...corporations are not going to commit their bankrolls without getting something back. It's just...I dunno. I can't quite come up with the words to describe the levels of dark machinations such a move might engender.

Not that I don't trust corporations, y'know...
posted by Thorzdad at 8:35 AM on January 30, 2008

Malor, and after rereading your comment, I think you know very well what useless commentary is. Your comments are the epitome of unsupported hyperbole and assertion. I've commented in other threads about the doomsayers, and its tiresome. No need to replay that. Think what you want.

Pastabagel has a pretty reasonable take on this whole situation. $13 billion related to the entire banking system in the US? Wow. Just wow.

Interest rates at close to historical lows, even if the double (which they won't) the economy will survive just fine and are less than when I bought my first house. Inflation? Low. Ecomomic growth? Over 6% last year, forward looking? Not robust but nowhere near a recession. Its a possibility, but it happens all the time. The future? Well, if y'all know so much, I expect you'll be rich in 1 year.

Some people that tried to make a quick buck on housing speculation, and some undercapitalized banks will fail. Some hedge funds will take a loss. My heart bleeds. Some well-meaning working middle class that do not have a good appreciation of financial risk will take a hit. Thats too bad, but they will survive and battle their way back, poorer and hopefully wiser. Were the lending practices of some banks too liberal? Why, yes they were. Are certain assets tough to price accurately? Why, yes they are. They have ALWAYS been. No news here. Has the falling dollar challenged those holding dollar denominated assets? And caused oil prices to rise? Why, yes. Surprise! Think its never happened before?

As far as the equity markets go...Guess what the approximate average annual return has been 24 months after a stock market has lost more than 10% of its value in a month for the 5 times in the last 30 years? Well over 10%, meaning that 1 year later people are close to whole in thier 401ks etc, and 1 year after that their assets have appreciated another 10% - for 5% annualized return - better than a savings account. Something north of financial collapse.

Its emotionally more satisfying to think doom and gloom and be wrong, than to think things are rosy and be proven wrong...its an attractive attitude. I've been there and done that, and invested through much worse economic times than these, and made and lost money in good times and bad. There is nothing new under the sun.

Bulls make money. Bears make money. Pigs get slaughtered.
posted by sfts2 at 8:52 AM on January 30, 2008 [5 favorites]

HAY GUYS I STUDY ECONOMICS ON THE INTERWEB AND I HAVE PREDICTIONS FOR YOU!! DOOOOOM!!!!! buy short buy short GOOOO
posted by cavalier at 9:09 AM on January 30, 2008

Ooops. Growth .6% last quarter, not 6% last year. ~2.4% annualized. Not great, not terrible.
posted by sfts2 at 9:23 AM on January 30, 2008

Since the Reagan days the American economy seems to be succeeding with smoke and mirrors.

In the US merchandise is made in other countries in such great quantities, there is tremendous outsourcing, whole chunks of America, like the prairies, have become ghost towns or are crumbling, like Detroit.

Honestly, I don't know how the economy here has held up so long and I do wonder what is going on now. It's mysterious to me. I don't understand economics, wish I did.

Did we go from greater economic stability in the Clinton days to a crash situation now or were we heading towards this anyway? Could anyone say anything about this in plain English? I'd so appreciate it. It does feel scary at this time. Those charts from the OP are almost comic in their their scariness.
posted by nickyskye at 9:30 AM on January 30, 2008

You take out food (ethanol <> Corn Flakes) and energy, and there really isn't any inflation.

What a pile of bullshit that is. First, food and energy are the only kinds of inflation that really hurt, because you can't delay their consumption. You need a certain amount of food to live. Capital goods going up is much less of an issue, because those purchases can be delayed.

The fact that you even quote the 'ex food and energy' number means you're buying into the statistical hoodoo. Use your own brain instead. The reason they want to 'exclude volatile food and energy' is because THAT'S WHAT'S GOING UP.

They also have very good ways of hiding house inflation. Look up Owner's Equivalent Rent sometime if you want to both laugh and cry at the same time.

The reason you're aren't seeing prices going up that much at retail is because of the powerful deflationary undertow of the cheap labor in China. Everything that's local to the US is going freaking ballistic. Look at college tuitions, and cable bills, and medical costs sometime.

No inflation my ass.

But recession is a multivectored disasater. We are spending way to much money to have the economy slow and tax revenue decline.

So we just make things sicker and sicker and sicker, and run up a higher and higher bill as we disconnect the financial system from the economy in new and exciting ways. To avoid today's pain, we'll take even more in a year.... but when a year comes around, well, we won't want to pay the bill then either.

So Malor -- what should I do? I have a reasonable sum of money sitting in the bank. Not all of it is FDIC insured. I'm going to spread it around so it is, but should I just get it out of the country? (I've always been fond of the Korean market but...?)

Boy, I wish I knew what to tell you. I don't know what's going to happen either. I'm personally betting on inflation, but I can't make intelligent predictions because the problems are so large and the Fed is willing to go to such extraordinary lengths to prop up bad business models.

I guess my strongest advice would be: learn more. Don't be afraid to come to different conclusions than I have.
posted by Malor at 9:38 AM on January 30, 2008 [1 favorite]

Did we go from greater economic stability in the Clinton days to a crash situation now or were we heading towards this anyway?

These problems have been building for the last two decades. If you'd like a broad overview, I posted this essay from Doug Noland in that other thread. In short, the Clinton years were full of smoke and mirrors too; we had a huge stock market bubble, and to prevent that pop and subsequent powerful recession, the Fed inflated two more, much larger bubbles... debt and real estate.

Unlimited liquidity on demand to support flawed business/financial models: that's the Fed's modus operandi. We don't have free markets, we have socialized ones... where we want only the creativity of capitalism without failures, ever. But the failures are important; it's called 'creative destruction'. We have, apparently, decided that we will not have bad outcomes ever, and so the government has become a gigantic welfare system for Wall Street. No matter how stupid they get, the Fed and Congress stand ready to bail them out. So, of course, they get stupider and greedier every year.

I'm amazed things have held together this long.
posted by Malor at 9:47 AM on January 30, 2008 [1 favorite]

Time to take a ride on the Reading Railroad. Choo! Choo!
posted by Horken Bazooka at 9:58 AM on January 30, 2008

I'm amazed things have held together this long.

They have because this is a resilient system. Even when there's no money, there's always money to be made somewhere. And the wealth creation of Wall Street drew a lot of middle-class investors in as 401(k)s replaced traditional defined benefits plans in the 1980s and 1990s.

The reason you're seeing so many interventions now isn't because the government is trying to save a few bad actors. It's because just about all of us have money diversified across multiple investments in stocks, bonds, real estate, mutual funds, metals....

The problem with this "burn Wall Street burn" attitude is that it's not Citi losing billions, it's hundreds of millions of us losing thousands. We all bought into the bubble, first in the NASDAQ, now in the real estate market. And we will all pay for it.

But again, this isn't the end. There's still wealth to be made elsewhere. Look at the speculation in the oil futures market the last few years. There's no way oil should be trading at $90/barrel right now; most of that is driven by futures traders pushing up the price. The only thing protecting it from "bubble" status is that everyone is buying into "peak oil" and the increasing needs of China and India. Eventually, though, either the speculators will be right and oil will be at $200/barrel come 2009, or the oil storage facilities will be filled with contact $100/barrel oil and the immediate delivery price will plummet since there will be nowhere to put it. And just like that, it's $2/gallon for gas again. And the economy goes another year without total collapse.

I think a lot of people are turning into dispensationalists sitting around waiting for Armageddon. It reminds me of the fundies who are always preaching that these are the end times. The problem is, people have been screaming that for eons now. And times never really end. They just change, slowly or radically, over the course of years. Then either Jesus comes back, or we just evolve into some new form of society.
posted by dw at 10:13 AM on January 30, 2008

In short, the Clinton years were full of smoke and mirrors too; we had a huge stock market bubble

I disagree with this thesis. The Clinton high-growth years featured 4 things:

1) The commodification of Macintosh-quality PC usability (Windows 95)
2) The arrival world wide web as a commercial New Frontier (Netscape, IE)
3) Cheap, CHEAP oil (thanks to significant non-OPEC sources coming online)
4) An increasing trade deficit with China bringing (borrowed) wealth

The stock bubble was a redistribution of wealth that prompted investment in arguably useful, wealth-producing commercial sectors that the US still leads the world in today.

I do agree, however, that the present system is entirely too reliant on equities returning 8.5% for all eternity. The stock market itself is one helluva crooked game and too much of the government tax code is designed to force people into it.
posted by panamax at 10:13 AM on January 30, 2008

You really think being $1.3 billion short is any problem? Microsoft is sitting on $40 billion in cash. Apple is sitting on $18b, and Google on $13b. That's just three companies that could recapitalize many of the banks on their own, if they were so inclined.

That's right. All Google has to do is withdraw some cash from the bank and...

Oh, wait, I think I see a problem.
posted by srt19170 at 10:21 AM on January 30, 2008 [3 favorites]

Did we go from greater economic stability in the Clinton days to a crash situation now or were we heading towards this anyway? Could anyone say anything about this in plain English?

Much like 9/11, every deleterious trend & event of the Bush economy -- except the federal deficit -- got its start in the 2nd term of the Clinton administration.

The trade deficit with China, outsourcing to Mexico, immigrants from there flooding here, rising energy prices, and the housing bubble.

The 2nd-term Clinton economy is what it looks like when several interesting long-wave secular trends line up nicely.

It would have taken more enlightened Central Planning to avoid a pullback. The raw market itself is by definition powerless to redirect itself to avoid pullbacks. It is too short-term and reactive to do that.
posted by panamax at 10:23 AM on January 30, 2008

sfts2, you're "Chill Dude everything will work out" counter-argument is ignorant of the financial stresses coursing through the system.

Eg.: Citibank paying 11% for short-term capital from Dubai.

Recession is some creative destruction and devil-take-the-hindmost. Depression is a grand mal seizure in capital flows.
posted by panamax at 10:30 AM on January 30, 2008

You think a car is real value? Then why does that value decline by 40% the second you take delivery?

because the secondary market is pricing in unknownable wear & tear & reliability factors.

If cars couldn't be abused, or have gremlins, then the price wouldn't fall so significantly.

The price drop is really a few thousand, ~10%, btw.
posted by panamax at 10:39 AM on January 30, 2008

There are a few things I'd like to see cited in the FPP. For example, I previously asked about capital adequacy ratios and the Non Borrowed Reserves. When I was working at Moody's we certainly didn't look solely at deposits to arrive at a quantitative measure of a financial institutions default probability. However the FPP implies a large number of banks are ill liquid. Upon looking at the Basel II documentation in a little more detail this afternoon, it seems Non Borrowed Reserves are aggregated into Tier2 capital. So they are a component not the definitive indicator of an institutions financial health.

I'm also rather puzzled by the conclusion in the FPP - "Today's TAF press release says that 52 American banks or institutions are currently receiving loans totaling ~$40 billion -- but the Fed refuses to name who they are.

The banks' collateral for these TAF loans are those same yucky hard-to-price CDO's that caused the banks' liquidity problems in the first place ..."

Wait a second - the Fed won't name who they are lending money to but somehow we know the collateral?

I'm not so sure. The TAF appears to be structured to accept a wide range of collateral. A CDO could be submitted as collateral. As could a AAA Corporate or even US Sovereign debt. And just as not all CDOs are created equal, all tranches in a CDO are not identical; there are very solid, very credit worthy tranches on CDOs being created and traded out there. How do we know these very senior tranches aren't being used as collateral for loans? But the FPP implies that CDOs and only CDOs are being submitted to The Fed. Please cite source.

I spent several years at Deutsche Bank as a quant on the Government Securities desk and I have a problem with statements from the linked blogs like "In practice, it never mattered what the discount window was, because it was so little used."

That's not true at all. Banks did indeed make use of the discount window. However The Fed themselves tried to discourage frequent and repeated use of this facility and in fact it was a relatively expensive source of capital (100 bps spread I believe). I can't agree with the statement that the discount window was little used. That's just not true. The discount window was indeed used, and especially so during times of systemic stress. 911, for example, saw The Fed aggressively utilise this mechanism - shortly before the attack borrowing from at the window ran a little under $200 million. And on September 12th the first day after the attack lending peaked at a record $45.6 billion.

TAF appears to be little different from the discount window, except for the range of collateral accepted (once again, more than just CDOs) and a lot less stigma for the borrowing institution.

And I've got problems with blogs linking to excel spreadsheets - even off The Feds own site - and claiming these are definitive haircuts (i.e., price deltas) applied to collateral. Has anyone priced a loan using The Feds own interbank pricing system? I suspect the haircuts this system applies - actual prices, by the way - would be a lot different than what we're seeing from a two year old excel spreadsheet found on the public internet.

Finally, keep in mind both TAF as well as the discount window before it operated as a lending facility. In other words, The Fed was functioning as a counterparty in a repo-like transaction, with collateral (of various quality) being offered in return for necessary funds. So The Fed is stepping up to the plate, injecting liquidity in to the system in another way, trying to re-lubricate the domestic economy? Yes, we all knew Bernanke was going to engage in non-traditional techniques. In some form, this seems to be the public face of one of his tactics. Well, I'd rather see something done that a Japan style "lost decade".

There is some really good commentary in this thread (as usual for MeTa finance topics), but I have to say I feel the FPP is rather inflammatory and a little light on citation.
posted by Mutant at 10:50 AM on January 30, 2008 [2 favorites]

But the FPP implies that CDOs and only CDOs are being submitted to The Fed. Please cite source.

The Fed lowered the standards of what it will take as collateral. Basic common sense would tell you banks visiting this new discount window will hand over the crappiest crap they have on their crappy crap-stained crap books of crap.
posted by panamax at 11:16 AM on January 30, 2008 [1 favorite]

That's right. All Google has to do is withdraw some cash from the bank and...

Oh, wait, I think I see a problem.
posted by srt19170 at 1:21 PM on January 30

"Cash" means short term assets, like t-bills, etc. held and managed by a myriad of banks and brokers. They don't operate out of a savings account at ING Direct.

And the Fed just cut another 0.5%, FYI.
posted by Pastabagel at 11:22 AM on January 30, 2008

"Basic common sense would tell you banks visiting this new discount window will hand over the crappiest crap they have on their crappy crap-stained crap books of crap."

But the fundamental question remains the same - at what price?

I'm not convinced The Fed will take an equity tranche at par, for example. Maybe The Fed would take some equity tranches for one cent on the dollar, and others at higher rates. I don't know, and apparnetly nobody posting on this thread knows. And I don't believe prices paid by The Fed would be homogenous, one price for any tranches or even class of tranches. So my point still remains, we don't know. But the FPP implies relatively high prices.
posted by Mutant at 11:25 AM on January 30, 2008

Stop, Mutant. you'll pull folks back from the window!

panamax,

"banks visiting this new discount window will hand over the crappiest crap they have on their crappy crap-stained crap books of crap."

Jeez, I wish I could craft such enlightened analysis of our financial system. By the way, son, I've been around this shit professionally for 25 years, what do you do for a living? I posit that you don't know your ass from your elbow - maybe I'm wrong and you're just inarticulate, but please tell me again how ignorant I am.
posted by sfts2 at 11:35 AM on January 30, 2008

what do you do for a living

I'm a professional adult video performer.

I posit that you don't know your ass from your elbow

I knew enough back in August to know that Ben Stein was full of shit when he was arguing the subprime issue was likely $35 billion in losses, tops.

please tell me again how ignorant I am

I prefer to let events do that.

My position is simply that $4 trillion of exceptionally risky lending at unsustainable asset valuations went into the US housing market 2003-2006.

Optimistically, I think we'll see $400B of losses from this lending orgy. Realistically, $800B. Quite possibly, $1.2T.

These numbers have . . . interesting . . . ramifications.
posted by panamax at 11:51 AM on January 30, 2008

I'm a professional adult video performer.

In that case, we can assume you know your ass from your elbow.
posted by Armitage Shanks at 11:53 AM on January 30, 2008 [5 favorites]

Mutant: we don't know

Perhaps the most surprising discovery we made today was the high value the Federal Reserve is willing to assign to some of the asset classes that have lately been causing so much turmoil in the markets. Even as some banks have said that the value of their CDO portfolios is unknowable and the ratings agencies have been mercilessly—if belatedly—downgrading formerly highly rated debt securities, the Federal Reserve has announced it will pay 85 cents on the dollar for CDOs with no market price available. That sounds like a pretty sweet deal in today’s markets.[1]

Now you do.
posted by panamax at 11:55 AM on January 30, 2008

The Fed just cut rates another half percent.

EKONOMY NEEDZ MOAR MONEYZ.
posted by Avenger at 11:59 AM on January 30, 2008

phew. this is a heavy and though-provoking post and thread. i'll admit, i'm largely out of my depth on these subjects, but one thing i've always wondered is this: why is it that whenever there's a fed rate cut, and the market suddenly picks up again, everyone looks to the market's performance as if that performance has some meaningful, direct connection to the overall well-being of the economy? it seems to me that, at best, the performance of the market is only an indication of how well investors might think the economy is doing; at worst, it's completely unrelated to overall economic health. when the market's go up, people feel reassured. when they go down, they panic. meanwhile, we all know market performance is driven more by human psychology than sound economics. i mean, sure there's a connection in theory between overall economic health and market performance, but as far as i can tell, there's no necessary relationship between the two at all.
posted by saulgoodman at 12:04 PM on January 30, 2008

In that case, we can assume you know your ass from your elbow.

Elbow Assers #5 was the number twenty five DVD rental last year.
posted by tkchrist at 12:05 PM on January 30, 2008 [1 favorite]

there's no necessary relationship between the two at all

IM untrained opinion it's not the cut per se, it's the direction that is meaningful. The market is now in the process of pricing in ZIRP monetary dynamics. It will take some time since there will be plenty of dislocations and ancilliary stresses by these actions.

Remember those 0% credit offers and 0% 60mo auto loans? They're coming back. There's going to be a war on savers and yield-chasers will be forced to find returns where they can.
posted by panamax at 12:09 PM on January 30, 2008

What happens when there's no interest points left to cut? Can it go into negative territory? Cos that would mean we could collect interest for taking out a loan from a bank and frankly I think that's a sweet deal. I'm looking forward to foreclosing on my bank when it can no longer make the payments on the 10 Googlizillion dollar loan I plan to take out..
posted by Skygazer at 12:12 PM on January 30, 2008

Now you do.

Well, I did see that blog and in fact I referenced in my questions the two year old spreadsheet on The Fed's on web site that seems to have folks all in a tizzy. And I'm still connot convinced.

For example, as I pointed out we're light on details. And the web site I've linked clearly states these are indicative prices only - Depository institutions should direct questions regarding specific assets to local Reserve Bank staff. This is by no means a get out of free card. The prices on the web site - and that you quoted in your reply - are indicative.

In fact, the same web site that provides the idicative pricing clearly states "The Reserve Banks accept performing mortgages. This could include sub-prime mortgages.". So there's the rub - if you want to pledge a specific CDO is must be performing, in other words, the underlying assets must still be generating revenue.

So it looks like The Fed is only injecting liquidity, by Bernanke's "non traditional means".

Other questions still stand.
posted by Mutant at 12:16 PM on January 30, 2008

Fortuitously, the latest The Pain - When Will It End? comic is "After All the Money's Gone".

It is my working hypothesis that there is a Tim Kreider cartoon for almost every occasion, but usually that cartoon is not published at precisely the appropriate moment.
posted by dansdata at 12:17 PM on January 30, 2008

Mutant: I stand corrected. stfs2 is also correct that the information here is highly technical and while the bloggy sources are relatively informative, there's a difference between information and understanding.

I too didn't find the fpp information particularly useful, as it's just an barrage of news items and I don't think anyone really knows the full elephant and where its heading.

Well, if anyone does they're busy establishing positions and not "talking their book" yet.
posted by panamax at 12:21 PM on January 30, 2008

There's still wealth to be made elsewhere. [...] Either the speculators will be right and oil will be at $200/barrel come 2009, or the oil storage facilities will be filled with contact $100/barrel oil and the immediate delivery price will plummet since there will be nowhere to put it.

For those of you looking for hints as to how to make money, I think this is among the best forecasts you're likely to find. By 2009, oil prices will go up, or else they'll go down. Not that it's a sure bet, but I think the odds are in favour of this prediction proving correct. Place your crazy leveraged speculative bets accordingly.
posted by sfenders at 12:24 PM on January 30, 2008

Elbow Assers #5 was the number twenty five DVD rental last year.

I think you mean Ass Elbowers. The only thing I'm sure of is that with most of my money in cash, the Fed is really beginning to feel like the elbow in this relationship.
posted by Armitage Shanks at 12:27 PM on January 30, 2008

"I don't think anyone really knows the full elephant and where its heading."

Ain't that the truth pal! I just try to make money in situations like this. It's really all one can do. Nobody in Washington would read any letter I'd write anyhow. And as I've lived outside the United States for the past eleven years, I ain't got me no Congress Critter no more.

Lots of good comments in this thread guys. MeTa Finance threads rock!
posted by Mutant at 12:30 PM on January 30, 2008

What happens when there's no interest points left to cut? Can it go into negative territory?

Given recent rates of inflation, the rate might now actually be in negative territory.
posted by one_bean at 12:35 PM on January 30, 2008

The long term problems with the U.S. economy, to me, are caused by the same short term thinking that has worsened the situation with the environment. Basically, no one is willing to accept a period of "pain" now to alleviate a much greater problem in the future. The short term quest for profit wins out over the long term goal of sustainability.
posted by drezdn at 1:04 PM on January 30, 2008 [3 favorites]

i'm with mutant :P from the handy TAF FAQ:

What happens if the value of a Participant’s available collateral drops below the amount it has won in the Auction before Settlement Date?

The value of each winning Participant’s available collateral must be large enough to cover the TAF Advance when the advance is booked on the Settlement Date. If the margined value of a winning Participant’s available collateral were to fall below the amount of TAF Advance awarded to it in the Auction at any time before, on, or after, Settlement Date and before Maturity Date, the Participant would need to pledge additional collateral to cover the shortfall or the Reserve Bank may exercise its remedial rights under OC-10.

so technically it's not a backdoor bailout (keynes' term) unless the Fed exercises its "remedial rights under OC-10," whatever that means!
posted by kliuless at 1:08 PM on January 30, 2008

I really wish people would be more careful in using the word "never", especially in sentences like "the system will never collapse."

"Never" is hardly ever true, except for some very carefully worded positions in mathematics and physics. Instead, the word used in sentences like "the oil will never run out" usually mean the following:

1. "I don't like thinking about the possibility, so I'll use the word never as a kind of magic totem to wish it away."
2. "Never actually means n number of years, usually beyond my lifetime, and a number I have piulled from thin air, so I don't have to worry about it."
3. "Never means I hope or believe it's going to happen to you, but not to me." (also known as the "Screw you, Jack, I've got mine" defence).

posted by Bora Horza Gobuchul at 1:17 PM on January 30, 2008 [2 favorites]

This all reminds me of reading this cant-possibly-come-true impossibly-apocalytic posting on a Saturday afternoon just a couple of years ago.

I'm not bright enough to understand much of this, but Asparagirl's check out the picture instead link looks pretty alarming to me.
posted by marsha56 at 1:33 PM on January 30, 2008

What a pile of bullshit that is. First, food and energy are the only kinds of inflation that really hurt, because you can't delay their consumption. You need a certain amount of food to live. Capital goods going up is much less of an issue, because those purchases can be delayed.

The fact that you even quote the 'ex food and energy' number means you're buying into the statistical hoodoo. Use your own brain instead. The reason they want to 'exclude volatile food and energy' is because THAT'S WHAT'S GOING UP.

You don't seem to understand that the government has several measures of inflation which are used for different purposes. The Consumer Price Index includes food and energy and is appropriately used for the annual cost of living adjustment for Social Security and for the interest paid on Treasury Inflation Protected securities.

On the other hand, the Fed is concerned with measuring how fast the economy is growing, whether the supply of labor is becoming short and if wages are increasing too fast. For this purpose the core rate of inflation (ex food and energy) is the proper measure. When the core inflation rate is too high, the Fed tries to slow the economy by raising interest rates. Energy and food prices are volatile due to circumstances not directly related to the growth of the economy. If the Fed included food and energy in their measurement, every time there is a refinery fire and gas prices spike or there is a drought in the mid-west increasing food prices, the Fed would put the brakes on the economy, which makes no sense. A refinery fire or drought does not mean that labor is in short supply. That is why the Fed mostly pays attention to the core inflation rate. They do not totally ignore food and energy prices, but instead look at their long term trends.

There is no government conspiracy regarding inflation measurement. They make several kinds of inflation measurements and use them appropriately for the purposes intended.
posted by JackFlash at 1:52 PM on January 30, 2008 [1 favorite]

There is no government conspiracy regarding inflation measurement. They make several kinds of inflation measurements and use them appropriately for the purposes intended.

JackFlash: As I read it, I don't think anyone's really suggesting a conspiracy so much as a fundamental disconnect between the Fed's understanding of what constitutes a meaningful measure of economic health versus what the average person might consider a meaningful measure--in other words, the suggestion is that the Fed's economic priorities don't necessarily align with those of the average citizen. That said, I don't know whether it's a valid criticism or not, but they do call economics "the dismal science" for a reason.
posted by saulgoodman at 2:23 PM on January 30, 2008

There is no government conspiracy regarding inflation measurement.

that is, if you believe the 'boskin omission' :P yikes!
posted by kliuless at 2:24 PM on January 30, 2008

i stand corrected. maybe some are suggesting a conspiracy after all. either way, i think the less conspiratorial point is still just as relevant.
posted by saulgoodman at 2:30 PM on January 30, 2008

As I read it, I don't think anyone's really suggesting a conspiracy so much as a fundamental disconnect between the Fed's understanding of what constitutes a meaningful measure of economic health versus what the average person might consider a meaningful measure--in other words, the suggestion is that the Fed's economic priorities don't necessarily align with those of the average citizen.

Well, that is certainly a worthy topic of debate -- whether the Fed should be concerned more about inflation or more about unemployment -- because they require different actions. But the original proposition that the Fed under-estimates inflation would have the opposite effect that you seem to be concerned about. If the Fed raised their estimate of inflation then they would be more likely to slow down the economy which would be bad for wage earners. It is good for the average wage earner that they don't include food and energy for this particular purpose.
posted by JackFlash at 2:39 PM on January 30, 2008

^ Peter Schiff disagrees.
posted by panamax at 2:49 PM on January 30, 2008

Peter Schiff disagrees.

So we should just take the word of a stockbroker who just happens to be an adviser to R.P., is widely known as Dr. Doom for his perpetual bearishness, and contributed to a book with his father called "The Great Income Tax Hoax: Why You Can Immediately Stop Paying This Illegally Enforced Tax", leading to his father going to jail for tax evasion.
posted by JackFlash at 3:05 PM on January 30, 2008

You forgot to mention he's often on FBC.
posted by panamax at 4:06 PM on January 30, 2008

asparagirl: nice post. one clarification: you're more or less on the money on LIBOR, though you shouldn't be looking at the absolute level as an indication of credit market distress. For our purposes, you can view LIBOR as moving largely in sync with the relevant countries' cash rate. The Fed's been busy cutting rates from 5.25% to 3.00% over the past six months - thus absolute LIBOR has fallen with it.

What really matters is the LIBOR spread over the equivalent term treasury (or the official cash rate, or any other supposedly risk-free rate) - this gives you a pure read on how the market perceives overall bank credit default risk as measured against government debt for a given term (in theory, given they can pay down their obligations by printing money, the safest form of credit).

All the money markets bother quoting is the spread (the difference) between the two rates. I'm oversimplifying, but let's say 10 over is 10bp over the cash rate (ie 3.10%). That extra 10 basis points interest is meant to compensate you for the risk of lending to a bank, rather than to a government. Stupid? Inadequate? Yes, I agree. The higher the spread, the greater the perceived risk - and hence the higher the return for lending to any given institution. The problem with LIBOR is that it doesn't effectively filter out bad credit risk, as the same rate is offered for all qualified participants (to differentiate between banks, you need to chase up individual CDS prices). As a result for a brief period last year those with capital hoarded it and refused to lend to anyone via interbank, and those without capital starved.

There is indeed overnight LIBOR, though you'll find more information in the current environment in, say, 3month LIBOR over the offical cash rate, or a widely accepted benchmark like the TED spread (3month USD bank deposit rates over 3month treasury yields). I'm going from memory, but last year in rough numbers the former blew out to 100 from 10, and the latter 200 from 20. In reality it was much, much worse than this - for a brief period, the interbank lending market simply ceased to exist, and no term money could be had at any price. Good times.

There are, at least in half-baked theory, limits on how far these spreads can jump, given alternate sources of funding like the discount window (which was 100 over cash, now 50 over - once you hit these hard limits, you might as well run for the Fed rather than fight it out in the interbank clusterf*ck. And then there's the benefit of anonymity. Provided, of course, you have adequate collateral ... *cough cough*

The LIBOR spread has improved markedly in recent weeks (largely due to cash and discount rate cuts, discount window access, TAF auctions, collateral changes, perceptions of Fed, Treasury and Government action, passing through the overhyped year-end 'turn' funding window etc etc etc) meaning in effect distressed borrowers are now accessing cheaper credit from alternate sources. In the States they're back to 27ish, somewhat elevated by historical standards and coloured by the market pricing in further rate cuts inside the 3month term (making it look better than it really is).

The real issue, now, is not so much the price of credit (interest rates) but rather access to credit. Those who have it shall survive. Those who don't ...
posted by bookie at 7:32 PM on January 30, 2008

MeTa
posted by Mutant at 10:57 PM on January 30, 2008

On the plus side, this is an ideal time to fix any lingering bad credit, as most creditors will go ga-ga over cold, hard cash. Most of them are going to be assuming the worst over the next few years as bankruptcies and foreclosures increase--if you can guarantee them 30 cents on the dollar, it's still better than YAB (yet another bankruptcy). If you're sitting on a load of cash, and you've got crap credit, best thing to do would be to try and cut some deals with it. With inflation just around the corner, the real buying power of your savings is only going to go down. Might as well spend it on something worthwhile...
posted by Civil_Disobedient at 11:47 PM on January 30, 2008

What happens when there's no interest points left to cut?

Japan's last couple of decades post-bubble.
posted by stavrosthewonderchicken at 12:09 AM on January 31, 2008

Look at the speculation in the oil futures market the last few years. There's no way oil should be trading at $90/barrel right now; most of that is driven by futures traders pushing up the price. The only thing protecting it from "bubble" status is that everyone is buying into "peak oil" and the increasing needs of China and India. Eventually, though, either the speculators will be right and oil will be at $200/barrel come 2009, or the oil storage facilities will be filled with contact $100/barrel oil and the immediate delivery price will plummet since there will be nowhere to put it. And just like that, it's $2/gallon for gas again. And the economy goes another year without total collapse.

Yes, this could happen. But it's more of a supporting example of financial disorder than, perhaps, you realize. The Fed's easy money and support of derivatives allows speculators to have a massive influence on the economy. There is no bigger market than oil, to my knowledge. If, as you say, the speculators are driving the price up to that degree, in a commodity that trades in such enormous volume, they have an unbelievable amount of economic power.

Now, I don't know if it actually is just speculation or not. I don't know much about the oil market. But if we grant your scenario, and take it at face value, the speculators think oil will go to $200. That drives the prices up. They're able to get extraordinary leverage on their bets, and they're able to distort the economy underneath. This does damage; businesses that would prosper at $40 may fail or be unable to expand at $90, and new businesses may not start at all. Stock bubble, debt bubble, real estate bubble, possible oil-price bubble (although I'm not sure it's high enough to truly count as a 'bubble', just... an unusually high price).... all symptoms of too much money sloshing around.

But yes, you're right, if the oil price drops precipitously, things could get much better for awhile. But whether or not that's good news is questionable... if it's just speculation, how on earth did the speculators get that much economic power?
posted by Malor at 1:39 AM on January 31, 2008

Now, I don't know if it actually is just speculation or not.

No, it is not. Maybe things have changed since this attempt to estimate the effects of noncommercial traders on the energy markets was written in 1996, but I think its conclusion is still probably close to the truth; large speculators follow the price trends, not set them. Speculation might contribute to moving the price around between $87 and $100, but it's not going to add any huge amount to the long-term trend. In the long run, for every pure speculative buy there's always a corresponding sale.

"U.S. regulator data on Friday showed NYMEX crude oil speculators slashed their bets on rising prices in the week to Jan. 22 to their lowest since mid-December, cutting net long positions by nearly 50,000 lots to 37,000." So they were net long by about 1.5% of the open contracts, and had been generally selling over the past few weeks... it's hard to imagine how that could have been adding $37 to the price.
posted by sfenders at 6:23 AM on January 31, 2008

how on earth did the speculators get that much economic power?

shadow banking! (a fairer treatment of derivatives btw) + (mal)incentives... [cf ;]

fwiw, here're some other articles i've found helpful recently:

• The start of the great unwinding
• I See What You Mean, It Is Broken
• Welfare for Wall Street, Federal Reserve-Style
• Paying the Price for the Fed’s Success
• House Of Cards: The Mortgage Mess
• To Build Confidence, Try Better Bricks (also see*)
• A Better Way to Deal With Downturns
• Death of VaR Evoked as Risk-Taking Vim Meets Taleb's Black Swan
• Old-School Economics
• U.S. Credit Perspectives

---
*modified from a comment near the end here: a neat (imo) way to look at the monetary/regulatory/financial system is as hardware abstraction, or an instruction set architecture (ISA); like a translation can be made from the arbitrary nominal world -- where K-Fed albums have currency -- to the 'real' world thru the inflation rate (however measured and/or believed). if i may presume, moldbug would like to do away with the monetary abstractions of the nominal world (or at least make them explicit -- it's mold, not gold, of course!) and would instead have us operate or 'program' on bare metal, so to speak. for me, i think abstractions are convenient yet prone to misinterpretation if not abuse -- there are good and bad translations (even languages, if you subscribe to sapir-whorf) -- so, in the end, how these abstractions (or lack thereof) affect the real world should provide the basis for any analysis, altho our understanding of what constitutes the real world should also be open to interpretation...
posted by kliuless at 8:11 AM on January 31, 2008 [2 favorites]

Mutant was upset that I hadn't replied to his comment yet, and was that I was out of this thread for almost a whole day -- upset enough to start a MetaTalk thread. I appreciate being missed so much! :-)

A CDO could be submitted as collateral

Sure, and as panamax quickly responded, it only makes common sense that the credit-seeking banks would put their CDO's up as collateral, now that the Fed is relaxing the rules on what they'll take. And those CDO's are also, as mentioned in the post, the very sort of thing that's been causing the banks' liquidity crisis in the first place. And the Fed was specifically opening the discount window, and now the new TAF auctions, to deal with the illiquidity. So what's the problem here?

But the FPP implies that CDOs and only CDOs are being submitted to The Fed.

By saying that the Fed is taking banks' hard-to-price CDO's as collateral for TAF loans, I definitely didn't mean to imply somehow that that's the only thing the Fed is taking. If I say a restaurant takes American Express, I'm not trying to imply that they don't also take cash. I'm not sure how you read CDO-exclusivity into what I wrote, and if I should have been clearer, then I apologize, because that's not what I meant. Because I too don't think it's the only thing they're taking. But do you honestly think banks are as equally likely to submit a good piece of collateral as an impaired one, especially if the impaired collateral might be more impaired on the open market than it would be at the generous Fed? (I know, you think the Fed is not and would not offer prices on the CDO's that are different than market price. I'll get to that in another comment.) And furthermore, let's say that banks might instead be submitting, I dunno, commercial real estate loans of dubious quality or something, as collateral. Does that somehow make the TAF situation better?

No, my issue with the Fed's taking on CDO's (or other things) as collateral is one that I don't think I've seen addressed in this thread yet: namely, what happens if a CDO (or other thing) the Fed is holding as collateral for a TAF loan is suddenly revealed to be nearly worthless, and therefore the Fed (and by extension the American public) has suddenly become the bagholder on a piece of shit? Looks how many CDO's have gotten downgraded lately, slashed in one fell swoop from sparkling clean AAA down to far lower values. S&P downgraded $524 BILLION of them just LAST NIGHT alone! So when you say...

How do we know these very senior [CDO] tranches aren't being used as collateral for loans?

...I say, what does it matter if the Fed thinks it's holding a champion piece of collateral if there's a decent chance it could, in an instant, be revealed as highly insufficient? So when you say in another comment...

if you want to pledge a specific CDO [it] must be performing, in other words, the underlying assets must still be generating revenue.

...I say, we only know that a CDO is performing based on the ratings agencies like Moody's and S&P, and lately they've been kinda bad at their jobs, so this isn't a very reassuring statement.

Your issue with my post is that I presume a few of these things are definitely happening right now, but I do not post hard proof. Totally fair enough. But that's because the Fed does not release such data, to you or to me or to anyone who's not a bank, as far as I can see -- and obviously, we personally can't go bid for a loan at the TAF auction, and even if we could, such a thing would only help us get a general sense of what the Fed might do for us, and not for each bank's special circumstances and not for the TAF loan recipients as a whole. So we're all kind of groping in the dark a bit here, and I'm trying to post my concerns. If it's coming off as too shrill, well, it's not like Wall Street or the Fed has been a very transparent place of late...er, make that ever.

So maybe you know the answers to this, so we can both be satisfied: is there any way to get the Fed to reveal (1) what specific kinds of collateral they're currently and in the recent past holding for the TAF loans, (2) are banks more likely to submit CDO's than other types of collateral, (3) if they do submit CDO's, what kind of a floor is the Fed putting on CDO quality, (4) what's the average tranche type that banks are putting up as collateral, (5) what happens if a tranche the Fed is holding gets downgraded severely while the Fed is holding it as collateral.

(Also, while you're at it, I'd like a pony, please.)

But all of this is missing the forest for the trees, a little. The main thing is that a whole bunch of banks suddenly need money from the Fed, and badly -- and banks in other countries too, like European banks getting sudden loans from the ECB. And, as our favorite picture shows, this is way out of line, historically, and even the most charitable takes on the situation imply that there's a rough time going on behind the scenes. I'm sorry if that comes off all mouth-breathy and stuff, and maybe it makes me look silly for gibbering on about the issue, but I just think it's warranted. It's okay if we disagree.

Also, I have to wonder if you're not maybe a little peeved that I referred in a comment to ratings agencies like Moody's as having been "idiots" in this mess and mention in another comment that they need stricter regulation in the future, and then you mentioned you used to work there, and maybe you're a little bit upset about that. I'm sorry, it had to be said.
posted by Asparagirl at 8:53 AM on January 31, 2008

Also:

Yes, we all knew Bernanke was going to engage in non-traditional techniques. In some form, [the TAF] seems to be the public face of one of his tactics. Well, I'd rather see something done that a Japan style "lost decade".

I do agree there. I'm glad they're trying something. Malor might claim (sorry to put words in your mouth here, Malor buddy, so correct me if I'm wrong) that any interference at all, any attempts to slow the unwind, would only end up causing more pain in the long run, and so should be avoided at all costs. I don't agree with that; I think it's only right to try to stem the pain a bit, try to keep it orderly. But the problem is that an awful lot of people are in Jim Cramer la-la-land perma-Bull territory and are deluding themselves that these fixes are meant to be a long-term solution and everything will be totally fine again very soon -- because clearly it ain't.

Bernanke's paddling his feet under the water's surface as hard as he can and I actually feel kind of bad for him.
posted by Asparagirl at 9:08 AM on January 31, 2008

my issue with the Fed's taking on CDO's (or other things) as collateral is one that I don't think I've seen addressed in this thread yet

it (sort of) was here :P

btw naked capitalism (sort of) addressed a lot of your questions here:

...I am not certain how much of this is due to real stress as opposed to banks taking advantage of a free lunch, since the TAF is giving out one-month loans at 3.123%. at the Jan. 29 auction. That's less than interbank rates, and you get to post terrible collateral too. Everyone with an operating brain cell should be taking as much of this dough as they can, and they clearly are.

But having now created dependence on unduly cheap money, and getting an unprecedented and (at least to me, Shedlock, and concerned readers) scary chart, how is the Fed going to wean the banks off the TAF? And if we have another credit seize up despite the TAF, one can only expect the Fed will crank up the level of funding on offer...

cheers!
posted by kliuless at 9:24 AM on January 31, 2008

Aren't we supposed to get a mess of pottage with that?
posted by ikkyu2 at 9:47 AM on January 31, 2008

And regarding the "is the Fed taking the CDO's as collateral for the TAF loans at par, or not" question: I didn't mention that one way or another in the FPP, though DealBreaker, Mish Shedlock, and just about every other financial blog I've seen out there (some linked in the post, but it's easy to find others) says that this is so, that the Fed is giving banks a better rate on the CDO's than they might find in the open market. You disagree, or else say that there's not enough evidence to say so one way or another. I think we'll have to agree to disagree on this one, because I here must quote ssg's comment from the MetaTalk thread, because I agree completely with him/her:

There is nothing about two year old data in the FPP and the linked blog post only claims that the data is over one year old. You've been pointed to the current available data (of which the substantive part is more than a year old, but the most recent update was only about 5 months ago) on the Fed's website once in the post and again in the thread. There is nothing to suggest that table isn't current on the Fed's website. That would count as a cite to most people, your objection that the Fed might not always apply that rate notwithstanding.

That being said, you also mentioned in MetaTalk that...

the data posted on the internet - indicative pricing only. These things do change vallue, very frequently. The Fed isn't going to purchase securities at two year, one year or even one day old prices. They reprice in real time and Mondays price for a three month T-Bill will be different than Friday's price.

Okay, then, why doesn't the Fed post what they are using as current prices? Given that when it did do its last update five months ago, some of it updated but some of it is the same price from a year ago, how often does an update even change things materially?

Also, I don't think it makes logical sense for the Fed not to give a discount. The discount window (and now TAF) was opened because banks had trouble pricing their CDO's (or else figured out a price just fine but didn't like it), so banks became more cautious about lending to one another, so rates for lending went up, so banks needed a cheaper way to get money so that things wouldn't freeze worse. In other words, trying to mark the CDO's to actual market values touched off the initial problems. If the Fed is now marking the CDO's to actual market values (which might be crappy) when taking them as collateral, instead of more favorable values, wouldn't the Fed just be replicating the same problem, and thus not solving much of anything? Alternately, if you're right and the Fed really truly is marking the CDO's to fair market value when taking them as collateral for TAF loans, then doesn't that mean the Fed might be mispricing their risk, since the banks would now be getting a better rate on the collateral than the free market would give them? Also note the other issues mentioned earlier about the fair market value for CDO's sometimes changing drastically in very short timeframes, based on ratings downgrades.
posted by Asparagirl at 10:43 AM on January 31, 2008

>Mish Shedlock

Michael Shedlock

Either he or Peter Schiff are wrong about the inflation/deflation outlook; fun-stuff to read their debate.
posted by panamax at 12:49 PM on January 31, 2008

Also, this repo stuff is highly technical and one must be cautious about us laymen trying to get a handle on the dynamics from just financial bloggers. If you didn't study this in upper-div college *AND* presently have a ring-side on Wall Street or in the Fed then chances are your understanding is lacking, kinda like the Congresscritter from Ohio who recently thought the B-man was actually Paulson. . .
posted by panamax at 12:54 PM on January 31, 2008

Well now, I wasn't upset that you hadn't responded - that's a stretch - I was more concerned about misinformation being posted and wrong conclusions reached. Thanks for taking the time to reply. A lot to catch up on so I'll proceed point by point and hopefully not miss anything that would detract.

"...it only makes common sense that the credit-seeking banks would put their CDO's up as collateral..."

Well, The Fed insists that all CDOs are performing, and not all CDOs can in fact be submitted - see the MeTa thread. Sometimes there are covenants, prior claims, on and on. Sure, classic moral hazard, the banks would love to dump their toxic waste, but more than likely The Fed ain't buying it at any price and for many tranches they probably won't be interested at all.

"...what happens if a CDO (or other thing) the Fed is holding as collateral for a TAF loan is suddenly revealed to be nearly worthless, and therefore the Fed (and by extension the American public) has suddenly become the bagholder on a piece of shit?"

Well, what the Fed is doing is called "Repo", and they are offering a highly collateralised - emphasis on "highly" - loan to a bank. Perhaps accepting a CDO in return, but not at par, again, as mentioned on their web site. So if the CDO "suddenly" becomes worthless I guess they'd be stuck but that risk - the uncertainty - would already be priced in. And I don't think The Fed is that inept a market participant that the IBanks are gonna run rings around them, and fleece 'em. The Fed will look at default rates for lower rated tranches, and price the tranche on offer accordingly (as any rational market participant would). Some tranches may indeed see par, others that $0.85 that's oft been (mis)quoted as the price, while others perhaps single digit prices.

"Looks how many CDO's have gotten downgraded lately, slashed in one fell swoop from sparkling clean AAA down to far lower values."

But we track these changes - in both direction, upgrades as well as downgrades - and calculate the probability of such movements using what's called a ratings migration table (page four in the pdf); we used them at Moody's when rating securities & issues, S&P has their own, and The Fed another set. They

"I say, we only know that a CDO is performing based on the ratings agencies like Moody's and S&P, and lately they've been kinda bad at their jobs, so this isn't a very reassuring statement."

Well, I'll tackle (hopefully all) of your comments here; a CDO is typically structured as multiple tranches. All losses (defaults) are absorbed by the lowest rated tranche until it is totally wiped out , then the next tranche, and so on. So the senior tranches never see any losses until all the lower level tranches are eliminated. Some CDOs have in excess of twenty tranches, each with hundreds of names (i.e., obligors).

BIG difference in spread earned - and risk undertaken - between a Senior tranche and an equity tranche. In fact, looking at an old deal we'd priced about five hundred basis points between lowest and highest.

The reason yields are so low on the senior tranches is it's the least risky, an excessively large number of defaults would have to be experienced before this tranche would be rendered worthless.

"...what the Fed might do for us, and not for each bank's special circumstances and not for the TAF loan recipients as a whole. "

But the TAF is NOT a new practice, its just the discount window reinvigorated. I don't understand why bloggers have such a problem with the TAF.

"The main thing is that a whole bunch of banks suddenly need money from the Fed, and badly -- and banks in other countries too, like European banks getting sudden loans from the ECB"

Once again, we've got an assumption working in here - this is NOT a new practice. Central Banks have always stood ready to lend to member banks. Its one tool of monetary policy, a tool used towards their goal of a stable financial system.

"... like Moody's as having been "idiots" in this mess and mention in another comment that they need stricter regulation in the future, and then you mentioned you used to work there, and maybe you're a little bit upset about that. I'm sorry, it had to be said."

Ha! Absolutely not upset about that (or anything for that matter) at all!! I'm a banker and just passed through Moody's for three years (the KMV division actually), and would largely agree that they need tighter regulation, in some areas. In fact I'd argue more effective Chinese walls perhaps leading to forced spin offs of certain divisions, but that would be for another topic.

"Okay, then, why doesn't the Fed post what they are using as current prices? "

Uhhm, if you participate in the Open Market Operations you do find out what the current price is. Nobody owning a CDO is gonna look on the Internet for a price - you actually noted this as well. I have no idea what's wrong with the Fed's spreadsheet out there on the public internet, other than it's an indicative price, but I do know there are systems used by The Fed to conduct Open Market Operations and prices for assets to be pledged as collateral are provided by these systems; an excel spreadsheet isn't the system.

"The discount window (and now TAF) was opened because banks had trouble pricing their CDO's..."

But it wasn't recently opened. The Discount Window markedly predates CDOs; in fact, it (the Fed's Discount Window) was established in 1913, long before CDOs (as we now know them) were invented.

Ok, what I think The Fed is doing by establishing the TAF is to widen member use of the Dicsount Window. I mentioned in another thread that while working on Wall Street we hear rumours of banks taking funds at the window. But it was a practice that was discouraged.

Now that we had the crunch last summer, The Fed is trying to inject liquidity into the system, buy a variety of means. The TAF is another.

No stimga and a wider range of assets accepted as collateral for loans. There really isn't anything untoward going on with The TAF - they are just trying to insure that if a bank needs money it asks for it - before they go under.
posted by Mutant at 1:28 PM on January 31, 2008

The TAF - they are just trying to ensure that if a bank needs money it asks for it - before as they go under

ftfy . . .

The TAF is a short-term credit facility and as such default risk is low, since the Fed has the power to bash heads together (eg. the recent BofA-CFC shotgun marriage) to keep the game going.

The larger question of the TAF and the Fed's reaction to the current situation is simply we bubble-bloggers see the present situation of the past year much like the RMS Titanic laying dead in the water with 5 compartments breached and the cold, cold water coming in.

The TAF andrate cuts are the pumps keeping us afloat, but it remains to be seen how well this pulls us out of the unwinding.

$1.4B was sufficient to sink Barings Bank. The RTC cost the US taxpayers $124B. The [slight, but present] possibility of lending losses over the foreseeable future totalling an ORDER OF MAGNITUDE greater than the S&L debacle is . . . sobering, and industry insiders telling us "Don't Panic -- the pumping is working" is, well, not believable.
posted by panamax at 2:00 PM on January 31, 2008

The TAF - they are just trying to ensure that if a bank needs money it asks for it - as they go under

"as they go under?" I didn't know any institution accessing funds via the TAF - or the discount window had already gone under. At least during the current crisis.

"The TAF andrate cuts are the pumps keeping us afloat, but it remains to be seen how well this pulls us out of the unwinding."

But do you think things are really that bad? Sure, 125 basis points in two cuts across eight days is a shock to the system, but Bernanke had gone on record as saying he'd engage in non traditional tactics to insure this didn't get out of control. FT had an article today talking about Bernanke's Fed, how it was "getting ahead of the curve", not being reactionary but rather proactive.

Perhaps some observers are seeing proactivity from an institution that previously was perceived as measured and slow moving, almost staid by comparison to some of the same banks it regulated, and are simply interpreting this as panic from The Fed?

Seems likely to me. Meanwhile, other observers seem to think THIS panic from bystanders is indeed THE panic, and while things aren't fine they aren't as bad as they previously were.

I can't call it either way at this point. And I don't believe anyone posting here can either.

And I just gotta follow up on this - "Also, this repo stuff is highly technical and one must be cautious about us laymen trying to get a handle on the dynamics " - repo ain't complicated. The mechanics are simple - loans backed by collateral. Now you're an expert. The math underlying the calculations - about high school algebra. Master quotients and exponents and you're a repo master - seriously! REPO IS ONLY LOANS!. REVERSE REPO IS LOANS - BACKWARDS - IN REVERSE. The TAF and Discount Window are nothing more untoward than LOANS.

I work in finance, I'm educated in finance, I love finance but despise how The Street (and The City) try to convince folks they can't understand finance. That's crap. And that's part of what bugged me about the FPP; weak on explanations and too much jargon introduced. If you can't say it simple, you don't understand it.
posted by Mutant at 3:16 PM on January 31, 2008

But do you think things are really that bad?

Now, no. Things have only been $100B~$200B bad so far.

This year? Not really. "Only" $200B or so more bad.

2009-2011 is where I see the real systemic stress, when borrowers who grossly overpaid in 2004-1H07 with Alt-A and other debt products come under greater stress.

I saw this movie play out already twice -- SoCal 1989-1992 and Tokyo 1992-2000. I am not sanguine.

repo ain't complicated. The mechanics are simple - loans backed by collateral

I was talking about the dynamics, not the elements. Eg. the "slosh" here.
posted by panamax at 3:57 PM on January 31, 2008

But the TAF is NOT a new practice, its just the discount window reinvigorated. I don't understand why bloggers have such a problem with the TAF.

Right, so if I follow your explanation, you've got the central bank probably taking CDOs as collateral for repos, though nobody's really sure if in fact they are, since they're making these loans in secret, sometimes below the fed funds rate, to unknown parties, taking unknown collateral of the kind where the maybe the market valuation, where it exists at all, can vary widely from week to week, but here it's instead evaluated by a top-secret proprietary method which even you, apparently expert in this business, can't describe with any precision, but is presumably similar to those used by the industry, or hopefully the parts of it that didn't manage to lost billions of dollars by getting it wrong.

That does seem like a slight departure from tradition.

Also, everyone stop mentioning Japan, or next thing you know they'll be proposing "a broad-based tax cut accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, which would almost certainly be an effective stimulant to consumption."
posted by sfenders at 4:40 PM on January 31, 2008 [1 favorite]

Asparagirl said: Malor might claim (sorry to put words in your mouth here, Malor buddy, so correct me if I'm wrong) that any interference at all, any attempts to slow the unwind, would only end up causing more pain in the long run, and so should be avoided at all costs.

Honestly, I don't know. The only good solution to bubbles is not to have them. Now that we're in this incredible mess, I don't know what can be done to help fix it.... but keeping people fed, clothed, and in basic shelter would strike me as the first priority; the second priority is to rebuild a saner economy using whatever resources we have left over. Attempts at engineering a 'fix' to the economy from a central standpoint will only make things worse over the long haul -- witness Japan for the last two decades -- but spot measures to keep people alive and eating would seem entirely appropriate.

Mutant said: Well, what the Fed is doing is called "Repo", and they are offering a highly collateralised - emphasis on "highly" - loan to a bank. Perhaps accepting a CDO in return, but not at par, again, as mentioned on their web site. So if the CDO "suddenly" becomes worthless I guess they'd be stuck but that risk - the uncertainty - would already be priced in. And I don't think The Fed is that inept a market participant that the IBanks are gonna run rings around them, and fleece 'em.

Mutant, the Fed doesn't care about that. They can't go broke. Their job is to stabilize the banking system, which has gotten incredibly stupid. They can provide unlimited amounts of cash in exchange, and taking the CDOs as collateral is just to gloss over lending them all the cash they want. Even if the bank fails, and the CDOs are actually worthless, that's not important to the Fed, because it can't go broke. Ever. No amount of stupidity can bankrupt it. It can bankrupt the country, and I would argue is doing so, but can't itself fail.

Market forces don't really apply to the Fed; they're not a normal bank.

The reason yields are so low on the senior tranches is it's the least risky, an excessively large number of defaults would have to be experienced before this tranche would be rendered worthless.

Yes, but a great number of even the most senior tranches are failing. That's what's precipitating the entire crisis. The risk models don't work when everyone is doing them. The models themselves, put into widespread use, poison the well.

No stimga and a wider range of assets accepted as collateral for loans. There really isn't anything untoward going on with The TAF - they are just trying to insure that if a bank needs money it asks for it - before they go under.

Right, but no stigma also means incredible moral hazard. Recapitalize the stupid without letting the world know they're stupid?

This is great for the banks, but it's really, really bad for the system as a whole over the long term. No more fiscal caution required; Uncle GreenspanBernanke will bail us out!
posted by Malor at 9:28 PM on January 31, 2008

And, even better ... he'll do it in secret so that the market won't punish us!
posted by Malor at 9:35 PM on January 31, 2008

"I was talking about the dynamics, not the elements" - Ah, panamax, I'm with you and you're correct. Its a strange market at best.

"but here it's instead evaluated by a top-secret proprietary method which even you, apparently expert in this business, can't describe with any precision..."

sfenders - I'm by not means an expert but I do know this; The Fed isn't using a single model to value the assets pledged for collateral against these loans. I would expect the haircutting applied to corporate bonds and other fixed income products would be textbook; a Grad student could probably crunch the numbers on their own and get close results. However I'd suspect The Fed is using some proprietary model for structured products, especially so the CDOs that are the subject of this thread.

But what's the big deal here? Everyone active in structured products uses their own model, with a few changes they feel appropriate to help them make a market (sidenote - this is true even in instruments as simple as options, where different shops will use slightly different models to arrive at different estimates of fair value).

And on a final note - thanks, but I'm not an expert in structured products nor would I say in any single area of finance. I've got some strong backgrounds (along fixed income products, certain classes of derivatives, structured products and Risk Management, mostly Market & Credit but I'm strongly interested in Operational Risk now) but I'm immediately suspicious of anyone who claims to be "an expert" in this stuff.

"Yes, but a great number of even the most senior tranches are failing. "

malor - are we sure about this? I'm aware of some equity tranches getting wiped out, stressing more senior tranches, but the mosts senior tranches? But I'm not aware of senior tranches failing let alone super-senior, the chunks of a structured product that pay very little above the risk free rate of return.

I won't be near a Bloomberg terminal until this afternoon, and will check then but I'm genuinely curious about these failures. Even so if the equity tranches are failing - so what? That's what th e structured product is designed to do, ordinalise failure across a set of heterogeneous assets and each tranche is priced according to its risk / reward profile.

So someone is holding an equity tranche and it failed? I don't care - they knew the risk when they purchased the product. Senior tranches failing? Well that would mean entire CDOs were being rendered worthless, and that changes things significantly. I'm curious. Not saying it can't / won't happen, but I seem to be reading your post as CDOs have already failed.

On another note I've read some academic research about accelerated failure rates in CDO squared, and I believe there is even a lawsuit floating around from some investors who were "surprised" to learn this.

"Recapitalize the stupid without letting the world know they're stupid?"

But that isn't what's going on here however the conclusion is inevitable given the type of "facts" that were presented on the FFP (and complained about in MeTa) . The TAF is a loan facility. Highly secured loans. Not a gift, but a loan, secured by assets, that must be repaid. And like any market participant, The Fed will price in the risk of those assets becoming insolvent - worthless - during the term of the loan and act accordinginly.

This entire thread has generated a lot of great commentary, but I'm still troubled by some of the arguments presented in the FPP.

Specifically, Non Borrowed Reserves - would someone please explain why we should care? I believe it slots into Tier 2 capital, and as so is just a single measure of a financial institutions overall health. So this isn't important, but it is presented here as earth shaking news.

Also its stated that some 52 banks are receiving loans from The Fed. Again, who cares? This happens all the time. Is 52 a low or high number? Its not said in the post, and I believe this to be irrelevant as banks approach The Fed for loans all the time. Since 1913 this has been done.

Just a few questions that I'd like to see clarified.

Also someone else commented on the Second Life link. Well, OP must be aware that previously pretty much anyone could setup a bank in Second Life. And there was almost no regulation; so linking the Second Life crisis to what's going on in the modern banking system?

Banking in Second Life (pre regulation) was about as relevant to modern finance as The Simpsons is to - well, I'm sure you get my point.
posted by Mutant at 1:00 AM on February 1, 2008

are we sure about this?

Why do you think we're having such a market crisis? The biggest rate cut in the entire history of the Fed in relative terms, and possibly even in absolute percentages (I haven't looked)... the subprime meltdown is all over the news ... banks aren't able to lend money back and forth because they don't trust each other ... and you're asserting that the senior tranches aren't taking losses?

One of us is badly misunderstanding what's going on here. It could be me, and you're welcome to educate me to the contrary. Why are we seeing so many gigantic market moves and massive balance-sheet-stuffing by the Fed, if the senior tranches in the CDOs aren't failing?

But that isn't what's going on here however the conclusion is inevitable given the type of "facts" that were presented on the FFP (and complained about in MeTa) . The TAF is a loan facility. Highly secured loans. Not a gift, but a loan, secured by assets, that must be repaid.

Yes, I understand that. Really, I do. But the Fed is, apparently, taking garbage as collateral. When they're willing to pay 85% of listed value for unpriceable securities, that's a big problem. They're unpriceable because nobody else will buy them. There's no market. They might as well scrawl 'fifty dollars!' on a napkin and get a $42.50 loan from the Fed for it.

Yes, I realize they're loans and need to be paid back. But if the banks happen to fail.... then somehow, all the garbage securities will be in the Fed's hands, and all the remaining solid ones will be the property of the bank, so the stockholders will still recover a great deal of value. The Fed's left holding the bag, but they don't truly care, since they paid for the original securities with a handwave, stealing money out of YOUR pocket.

Normal market forces do not apply to the Fed.

Another thing that's worth pointing out... in the Meta thread, you were strongly emphasizing how important it is that the Fed conducts "Open" Market operations, that its lack of secrecy is really critical... but then seem to be defending their secrecy in this thread. What the heck is up with that? If the Open part is that critical, don't you think it's a really big deal that they're now conducting Secret Market Operations?

As far as Second Life banks go.... yeah, Asparagirl really shouldn't have included that. It's just noise. You are entirely correct. I think we can safely ignore that bit. :)
posted by Malor at 1:23 AM on February 1, 2008

ABX AAA is going for ~70 c on the dollar now.

I only know what I read from the blogs like 'calculated risk', but it's common knowledge that Wall Street packaged & tranched TRILLIONs of subprime, Alt-A stated income/low-doc/NOO, and prime 2nds on loss models that did NOT account for greater than 5% valuation drops.

A senior tranche on Central Valley garbage is still going to be garbage later this decade.

Again, I consider this graph to be highly informative. To my uninformed eye everything over the $400B plateau is at-risk lending.

How much of it actually goes into loss is unknowable right now, but there's about TWO TRILLION of overhang here from the bubble years 2003-2006.

A large part of my pessimism is the knowledge that this bubble-era lending was THE PRIMARY engine, along with unsustainable DoD spending, driving economic growth 2003-2006.

We simply don't have the productive base to service this debt, which was fueled by speculative borrowing and a complete abandonment of traditional mortgage lending standards.
posted by panamax at 2:07 AM on February 1, 2008

"...and you're asserting that the senior tranches aren't taking losses? "

No sir, someone else said they were. In fact, that the a great number of the senior tranches were getting wiped out (failing actually, but that's how I read it). And I simply asked which ones?, 'cause that's news to me and if true the game has well and truely changed for the worse. I'm not saying there aren't CDOs out there where we'll see senior tranches wiped out, we definitely know there are equity tranches taking losses, close to or perhaps already wiped out. But senior tranches? I haven't heard the news. I won't be near a Bloomberg terminal until this afternoon, and was / am curious.

"When they're willing to pay 85% of listed value for unpriceable securities..."

That $0.85 quote that someone found on an ancient spreadsheet off The Fed's own web site is indicative only. Multiple bloggers linked to the site, noted the spreadsheet but - one can only speculate why - chose to ignore this very, very relevant note - Depository institutions should direct questions regarding specific assets to local Reserve Bank staff. The Fed won't be held to the price on the spreadsheet - it's as simple as that.

The Fed isn't the Central Bank equivalent of eBay, posting bid / ask spreads for all to see. It just doesn't work like that. All member banks have access to an interbank system where collateral can be submitted - electronically - bids hit, offers taken. I might be wrong, but as far as I know this is NOT connected to the public internet.

"But if the banks happen to fail.... then somehow, all the garbage securities will be in the Fed's hands, and all the remaining solid ones will be the property of the bank, so the stockholders will still recover a great deal of value."

Sure, but the restructured bank would then owe The Fed a debt. Shareholders are wiped out in the liquidation scenario presented here, debt holders become the new owners. But as The Fed doesn't want to own banks, rather regulate them, its not clear if they would let this happen. More than likely we'd see another LTCM urgent deal, where The Fed tells some consortium of banks they will take over this institution, and tells them to work out the details amongst themselves.

"But then seem to be defending their secrecy in this thread. What the heck is up with that?"

But when The Fed conducts Open Market operations they announce the amount of money they're dumping (or removing) from the economy. Nobody on a desk really cares what assets will be accepted, what's important to the economy in general and your trading specifically is how much money and at what price. And in the MeTa thread I mentioned that not all assets held by a bank can be freely utilised; covenants (both internal and external), prior claims, market events, lots of stuff can happen that would render an asset inelligible to be used as collateral for a loan. So in the end we still don't know what percentage of assets used as collateral are Structured Products vs Corporates vs Sovereign Debt, etc. Open Market operations don't imply total transparency; simply naming amounts is the way The Fed has Malways conducted themselves when seeking to manipulate the money supply.

And I don't think I'm defending their secrecy more than simply trusting them. The fundamental fallacy - started in the FPP by the way, not in your (excellent) comments nor anyone elses - here is that The Fed is bailing out the banks.

I really don't see it that way. They've enhanced liquidity via the TAF by accepting a wider ranges of collateral and removed the stigma previously associated with asking The Fed for funds. They want banks to approach them sooner rather than later.

And I do agree with you that these are different - and dangerous - times. I suspect the numbers are changing rapidly in those ratings migration matrices I previously posted. In my personal account I went long gold back in 2005 (physical unfortunately as this position predates the ETFs), and have been adding to a Sliver position since 2006. Having lived through Vietnam, seeing the economic aftermath of that war in the 80's, I didn't see how anything other that inflation was the way out of this mess for the US Government.

But I don't agree this is the end. Someone else made the comment that the system is resilient. I believe it is, and we'll get through this crisis. Not to say something else won't get us later rather than sooner. BIS was warning us about a credit crunch since 2005, and I do feel that if not for Basel II and the regulatory rigour imposed by that accord this thing would be a lot worse.

Although in the near term I'm still (selectively) moving my personal assets out of equities and into commodities...

Agreed on The Second Life post. Still, it was funny to read about a virtual bank run.
posted by Mutant at 2:29 AM on February 1, 2008

Mutant, I see we agree more than disagree ;)

I am curious, however, to see how this inflation actually comes to us.

I can see a two-tiered economy where the licensed guilds with bargaining power -- the doctors, teachers, bankers, plumbers etc -- maintain their real incomes and their BMWs, but as this decade has shown so far J6P wage-earner is well and truly fucked in maintaining his real wages, outside of domestic beer and free internet porn perhaps.

I see landlords and land values taking it in the ass as wages and household formation continue to fall and debt servicing, commodity prices (and taxes!) rise. Rents are the under-appreciated shock-absorber IMV in our economy since when the going gets tough rents basically HAVE to come down.
posted by panamax at 3:46 AM on February 1, 2008

panamax

Yeh, I think most of us in this thread agree in terms of the direction, its just the end state we might not totally agree on.

And I'm somewhat pessimistic about the economy as well, especially so in the near term. Unfortunately, I fear the inflation they're engineering to float their way out of this problem may prove be, minimally, as severe as what we went through back in the 1980's. With a good chance it will be far worse.

Thanks for posting the ABX; I haven't seen it for a while. Curious that it started bouncing back up again in November, just to be pulled back. Any ideas what caused it to move back up post August?

"...prime 2nds on loss models that did NOT account for greater than 5% valuation drops."

I've read similar numbers but the question is and forever will be - are those underlying assets still performing?. Sure, lots of product was structured - AND SOLD - based on those loss assumptions. So the lawsuits that are probably already in the works will be interesting to observe, given these products were exclusively marketed to other (qualified) market participants. Who should have known better.

"A senior tranche on Central Valley garbage is still going to be garbage later this decade."

You are absolutely correct, the underlying assets, garbage or not, won't change. But the fundamental question I'd raise here would be have equity and lower level tranches been wiped out? . Because if they haven't then no worries - a holder of a CDO really only has to worry once the next lower tranches start to undergo stress.

Li's insight applies here - CDO tranche valuation is similar to the "joint mortality problem" in insurance; the probability of one spouse passing away increases when the other dies. Same thing for a CDO If none of the lower level tranches have been wiped out, that senior tranche is looking pretty good (especially at today's prices!). If closest mezzanine tranches is undergoing stress - or already wiped out - senior tranche has a problem.

So if a senior tranche on Central Valley garbage is sill around in a decade then good on who ever bought it, 'cause they assumed the risk and should get the reward.

However getting back to the FPP; is this a bank bailout? Nope. Not even close. The Fed working to restore liquidity & confidence in the system, to relive pressure on the banking system? I'd suggest everything we've seen to date supports this hypothesis.

Now the next problem this cure will cause?
posted by Mutant at 4:47 AM on February 1, 2008

I don't see how you can say this isn't a bank bailout, when the Fed is:

A) taking things for collateral that they've never accepted before, and
B) refusing to admit who's being helped.

That's a bailout. Pure, simple, 100%. If it weren't a bailout, they'd require normal collateral and they'd publish names. If all they wanted to do was add more money to the system, they could do that the old-fashioned way. It's been working for a long, long time. The only reason to change something that fundamental to the banking relationship is it's a freaking emergency.

Claiming it's not a bailout strikes me as willful blindness.

Encouraging banks to go to the discount window is a Big Deal. The inflation we're likely to see is also a big deal. We're coming off a triple bubble; debt, real estate, and the stock market. Monetary adjustments to try to reinflate those will require staggering interventions, and will result in even larger side effects with even worse consequences than the ones we'd face now, if we just let the bad derivatives evaporate.

"More methampetamine for the patient!" declared the Fed in 2000. "His productivity numbers are dropping!" In 2008, said patient seized up with a heart attack. Prescription.... quadruple the dose! We'll get his heart started again, if only we can pump enough stimulant into his veins....
posted by Malor at 5:25 AM on February 1, 2008 [1 favorite]

"If it weren't a bailout, they'd require normal collateral and they'd publish names."

Ok, a couple of points. What is considered normal for collateral can - and should - change over time. That strikes me as prudent banking, just helping your customer achieve shared goals (The Fed, stable banking system, the customer, short term funding). Happens all the time in retail banking. So Bernanke's thinking different, shaking The Fed up. Good. Nice service orientation.

After all, The Fed is simply providing service - in this case, necessary, short term liquidity - to their clients. And all they've done with the TAF is widen the assets they'd take as collateral. Please help me understand why this is bad, but preferably without revisiting the $0.85 quote someone found on the internet and others (erroneously) insist is the one single price paid by The Fed for CDOs (or is it CDO tranches, nobody is really clear on that and there is a big difference) of all varieties.

No bank is required to use the TAF, some probably won't once they look at prices The Fed is willing to pay, while others will use the TAF. The flip side to that is The Fed is NOT taking any and all assets as collateral, comments claiming they'd accept "impaired" assets (presumably loans, and if we're using the banking definition of impaired and not a laypersons, no they wouldn't accept an impaired loan as collateral) up thread aside. Again, this selectivity in terms of assets was made clear on The Fed's own web site, the same site other folks are selectively quoting in this thread.

And The Fed never publicized who used the Discount Window in the past. Why should they start now, especially when we're seeing bank runs in other countries? Seems like that would set folks off and just pressurise weaker banks, perhaps to the point of insolvency.

If The Fed is consistent with the policies in place since 1913 (specifically not naming who uses their facility) that single mindedness hardly constitutes a banking bail out.

A banking bail like the FPP is trying to make a case for would see drastic changes in banks balance sheets, as non performing assets are shifted to The Fed's. And we haven't seen this. Quite the contrary, we know two facts - 1) balance sheets have become frozen as banks are trying to work out bad debts they've already got on balance sheet, and 2) loan loss provisions have been sharply increasing (money set aside for expected losses). So no, I'm still not convinced.

And calling my arguments willful blindness seems a tad unfair; I've only asked that folks present evidence supporting their arguments. Like I have for mine. So I'd suggest the exact opposite - I don't want to blindly adopt a position. And that was the problem I had with the FPP; lots of attention grabbing headlines with a dramatic conclusion that wasn't really supported by the facts.

"The inflation we're likely to see is also a big deal."

Ah I agree with you there except a minor quibble - we're already seeing it. I don't, and haven't for a long time now, believe official numbers for many reasons. First they keep changing the basket of goods and weightings used for the "official" inflation calculations. And hedonic adjustments applied to inflation calculations are nothing more than out and out lies.

Looking at the most recent copy of The Economist I see US inflation is running at 4.1% for Q4 2007, projected at 2.8% for 2008. And inflation in the UK (where I live) is, well, we're lucky as it's only 2.1% Q4 2007 and forecast to run at 2.1% for all of 2008.

Well I tend to purchase the same stuff every week at Sainsburys, and my weekly bill has gone up by about 30% YOY. Admittedly, we eat a lot of fresh fish, vegetables and fruit, but we don't own a car so I'd expect this to net / net. And it doesn't. Other bills have similarly spiked. So the leading wave of inflation is already upon us and given The Feds actions the past ten days it won't be getting better.
posted by Mutant at 6:36 AM on February 1, 2008

I agree that the Fed isn't permanently monetizing this debt yet so it's not a "bail out".

They bought a new brand of pumps, and signalled the market that more are on order should the need arise.

Mutant, my point is that the 70s featured aggressive wage inflation.

Granted that wage inflation must follow price inflation, but with globalization and the terminal decline of trade unions since the 70s I just don't see the bulk of Americans (or UKans for that matter) having the bargaining power to successfully demand higher wages.

Food can go up 10%. Energy can go up 10%. Taxes can go up 10%. But if rents go down 3%, the consumer is saved since rents are 3x the burden of food, energy, and taxes together.
posted by panamax at 9:07 AM on February 1, 2008

Who should have known better.

despite the vaunted quantitative methodologies of experts, it's hard to argue that CDOs weren't misrated, altho default assumptions might have been similar to 'traditional' bond ratings, their recoveries/loss severities are anything but; they should have used an entirely different ratings scheme, but they didn't...

btw, merrill has just bought back $13.9mn in CDOs from springfield, MA even tho they're only worth $1.2mn because they didn't want to get sued; a sign of things to come? i think so (for the fed?), but more disturbingly it's just indicative of another 'off-B/S' liability coming home to roost -- afterall, even tho you can individually* offload externalities, if the system is closed (or the sink is finite) it'll eventually come back to haunt you/everyone.

this is just a microcosm of the macromess that a lot of 'should haves' have gotten us into, like more than greenspan/bernanke taking rates to 1% in 2003/4, i think by 5 the fed should have known that stated-income loans and whatnot were a problem and at least issued some guidance, but they didn't... see a pattern here?

have equity and lower level tranches been wiped out?

yea, it's only been in subprime and other 'exotic' mortgages that have seen delinquency/default rates really rise, and to a lesser extent prime ARMs, so it's worth taking a step back to look where defaults are occurring and likely to occur next... that's actually the point that roubini has been hammering on for awhile -- separating out liquidity concerns from solvency issues -- because they require different policy responses:

In the second mode, asset prices fall because investors recognize that they should never have been as high as they were... This kind of crisis cannot be solved simply by ensuring that solvent borrowers can borrow, because the problem is that banks aren't solvent at prevailing interest rates. Banks are highly leveraged institutions with relatively small capital bases, so even a relatively small decline in the prices of assets that they or their borrowers hold can leave them unable to pay off depositors, no matter how long the liquidation process.

The problem is not illiquidity but insolvency at prevailing interest rates. But if the central bank reduces interest rates -- and credibly commits to keeping them low in the future -- asset prices will rise. Thus, low interest rates can make the problem go away... the Fed has shifted over the past two months toward policies aimed at a second-mode crisis -- more significant monetary loosening, despite the risks of higher inflation, extra moral hazard and unjust redistribution.

how this inflation actually comes to us

i think that's the real intermediate term problem; with gold hitting new highs (altho half its peak 1980 level adjusted for inflation) [cf. how much is that?] and the dollar new lows, you've got to wonder who's buying gov't bonds below the rate of inflation... if real rates are negative, inflation is accelerating higher and the fed is still cutting short-term rates, well, it's all rather reminiscent of the 70's, isn't it? which i guess brings up the next point...

We simply don't have the productive base to service this debt

some have suggested that it's not the productive base that matters so much as the military base for maintaining global dollar hegemony (and america's 'AAA', altho it's lost its cachet!) so as long as might makes right and the pentagon carries the biggest stick (and we're nice to our major creditors**) then we may just be able to inflate our way of it yet :D

fake it 'til you make it!

---
*well, corporately :P
**who, btw, are experiencing inflation approaching and in some cases above 10%, including wage inflation cuz they're getting paid in depreciating dollars...
posted by kliuless at 3:11 PM on February 1, 2008

Mutant, I think we're actually much closer on overall outlook than I thought. You realize the skullduggery going on with inflation figures, and you realize the likely outcome of what's happening. I think the major differences are twofold: you trust derivatives more than I do, and you trust the Fed more than I do.

I figured I should add a link to this post that I put up a few months ago. That post in reference to a video about the Fed and fiat money, and I tried to explain what I know about derivatives, why they're the real problem, and why fiat money has let them get so out of control. The thrust of the original video is the old "the Fed is a con job, and fractional reserve banking is bad". That's far more extreme than my own position... I don't reject it outright, as I think it does have at least some validity, but overall that's not high on my list of worries at the moment.
posted by Malor at 1:05 PM on February 2, 2008

Oh, and kliuless: I think trying to force people to accept dollars at gunpoint is likely to have, at best, only short-term success.
posted by Malor at 1:06 PM on February 2, 2008

hey, re: the asset securitization conference in vegas, looks like it got the FP treatment in the nytimes today!

oh and just to cross the streams :P
posted by kliuless at 6:36 AM on February 8, 2008

and if anyone's still following along :P

cheers!
posted by kliuless at 11:11 AM on February 9, 2008 [1 favorite]