The first of the major league teams to crumble???

Predictable. More than that - REQUIRED.

"If there's no deal Bear Stearns will have to file for bankruptcy..."

Ha Ha!

Nelson Muntz-

GFY, 14,000 employees and you are laughing about this? GFY

So will BSC be responsible for income taxes due to Debt Forgiveness?

FWIW clearing...

"In its widest sense clearing involves the management of post-trading, pre-settlement credit exposures, to ensure that trades are settled in accordance with market rules, even if a buyer or seller should become insolvent prior to settlement.

Clearing generally involves the use of a well capitalised financial institution known as a central counterparty (CCP). The CCP becomes a party to every trade, acting as buyer to market participant sellers, and seller to market participant buyers. In respect of unsettled trades, market participants therefore bear the standardised credit risk of the CCP, and not that of each other in a decentralised market."

from Clearing (finance) - Wikipedia, the free encyclopedia

How do I know Gasporino is not just short Bear? The Ambac experience has destroyed my faith in pundits. Not really. That went in the last century.

the truth surrounding Everquest

That might make a best-seller.

I just hope the justice department gets there with a subpoena before records get lost in the trash.

Credit default swap (CDS) marketplace. Leading the list of companies that saw the prices of their CDS (default protection) surge significantly this week were GMAC, Bear Stearns, Ford, Sallie Mae, Countrywide, and Lehman Brothers. These six companies combine for (as of their most recent financial statements) Total Assets of almost $2.0 TN

Look out below

So perhaps to the point here, many of us have retirement dollars in money market funds held in IRA's and 401K's
having moved out of stocks in past year.

I looked at one of mine in Pioneer Cash reserve today, plenty of bonds, domestic and international, maybe 16% of total net assets, just under $1 billion, being notes owed by U.S. based divirsiefied financial services companies (just over .1 %
of a Bear Stearns note).

Suggestions for Monday?

So when are we going to see it spill over into commercial banks?

Hmmm, Too complex to fail, so Fed has to step in - . They probably should have been far more stringent in regulating the business before this happened, but that's water under the bridge.

Best option, obviously, is a sale within days. Problem is that the complexity makes it very, very difficult to put a value on the business quickly. But nobody wants to act as counterparty to Bear, so the value of the business shrinks incredibly quickly the longer this thing drags out. I suspect the govt. is going to be dragged into this little by little, with full nationalization in a month or so.

"will writes:
One year after New Century eats it Bear Sterns bites it, what will we be seeing a year from now?"

My guess: Wells Fargo.

Just an unsubstantiated hunch.

vikas writes:
given the apparent central role Bear has played in the markets, a bankruptcy may lead to a global meltdown. We may be about to find out how the counterparty risks in the hundred trillion dollar derivatives markets are going to going to be settle out.

Not sure about Asia, Japan, China, South Korea, India regarding derivatives but I do know they are having big problems with the price of food and oil which they import in large quantities. My guess if we do get another Asia sell off much of the blame will be with the FED lowering interest rates again and causing the dollar to tank which blows up oil and food cost for the importing Asia giants.

I still dont understand why BSC price is greater than 0.
Don't they have more liabilities than assets?

I hope the big meltdown happens on Monday so that they can call it "The St. Patrick's Day Massacre."

I've got dibs on the t-shirt rights!

Bear damn well better be chatting with FTC!

I somewhat hate to re-post this from last night, but it is essential that people realize the absurd nature of this type of Fed bailout (for Bear), which IMHO, is obvious collusion and bordering on criminal conspiracy, because -- if The Fed abuses its discretionary powers to bail out Bear, it alters free trade and free market efficiency, thus setting a precident which will morph capitalism into a distorted and chaotic version of socialism that will be based on discretionary abuses. If The Fed connects itself to political nepotism and favoritism, we might as well start thinking in terms of Pre-WWll Nazis!

Please read the following out-take from a hearing related to LTCM:

HEDGE FUND OPERATIONS

THURSDAY, OCTOBER 1, 1998
U.S. House of Representatives,
Committee on Banking and Financial Services,
Washington, DC.

Office of the Clerk - U.S. House of Representatives hba51526_0.HTM

Let me just conclude by saying that the terms of the rescue package engendered by the Fed also raise troubling questions of financial concentration and antitrust. As a group working together, the new owners can have a greater impact on markets than in competition with one another. In this regard, it should be understood that the Fed's unprecedented extension of the too-big-to-fail doctrine to a hedge fund does not insulate the fund and its new owners from the constraints of the Sherman and Clayton acts.

The bailout may involve a tendency toward concentration that the Justice Department has an obligation to review.

wally "Expect $150 oil by July."

I won't say impossible but I did read somewhere that the Fed might hike margin requirements at commodities exchanges. Of couse they better be careful. They don't want every single market to collapse at once.

Seriously, hiking margin sounds like a good idea. Oil is getting out of hand and the hedgies playing that game deserve a good crack in the head. WHat's good for the hedgies is bad for the US economy.

220 visitors @ 9:00 pst on a Saturday night. Must be somethings up.

This sure looks like the peak of bearish sentiment. Beware of 100% extreme pessimism - the best catalyst for new bull markets.

O-Joe

This sure looks like the peak of bearish sentiment.

Optimistic Joe | 03.16.08 - 12:06 am |

I think you've posted this same message more than a few times by now haven't you, O-Joelioliolioli ?

Hey mp, what's the Conjure Bag up to. I mean right now, this second. What's it doing?

O-Joe. Haa. Sebastion's illiterate cousin.

I think you've posted this same message more than a few times by now haven't you, O-Joelioliolioli ?
acaum

As sure as we have a solid double-bottom in place. So it's even more strange why the bears freak out right now again.
O-Joe

For those who asked:

(a) Assuming there is cancellation of debt (not every restructure generates that; some generate gain or loss) then the COD income is realized unless the debtor is insolvent (see section 108); insolvent has a term of art definition not worth going into here. In English this means its not included in taxable income if the debtor is insolvent. However the tax consequences of a restructuring in this level of complexity are something you have to see to believe.

(b) common stock in a non-defunct business can never be worth $0 as it is a perpetual call option on the future liquidation value of the firm. it should equal the net present value of the expected future terminal liquidation value. unless there is 0% probability of any future value at any time common cannot be worth $0. but it can be dam close.

(c) assuming there were to be a ch 11 filing, it would seem absent fraud that bsc would remain "in business" as a debtor in possession. filing ch 11 does not do anything right away other than generate an automatic stay. of course it will make a bad situation worse re will anyone trade with them but without writing an essay here post-petition creditors are not without protection.

(d) the interesting part of a ch 11 here to me would be the lookback avoidance of preference transactions. in english, some payments to insiders that happened in the 90 days prior to filing will be set aside and some payments to creditors (for which insufficient value was received) can be set aside back at least two years). presumably at least some bonus money, to some people, if it got paid in 2008, is toast. of course, if it wasnt actually paid, but is deemed executory, its avoidable period.

(e) does anyone here really believe they'll file (seriously)???

Gretchen Morgenson: Downsides of the Bear Stearns Bailout
FAIR GAME; Rescue Me: A Fed Bailout Crosses a Line - NY Times

BSC gets bought by JPM.
MS and LEH hit rocks, followed by MER. Then GS...

WMU on rocks, followed by C.

As Bernake said, 'lower rates are not having an impact on home prices' which is at the root of this along with leverage. The Fed may go to 'cash-for-crap' lines rather than the TSLF conditions. Cut 1%. Then it is over.

This is epic.

btw, for those who didnt get the memo.
Mish, who was the last deflationista standing, officially threw in the towel on the dollar.

Every risk manager at every ISDA bound bank/dealer/hedge fund is about to f*&% is all up. They are going to declare a cease trade on Monday to cover their asses. I've seen it happen before in '98. We are going to see real panic that I've not seen since Peso crisis and LTCM.

Spreads on AAA paper is going to blow out Monday and who knows how tight Tsys are going to get.

OK, now that you trolled, you can go to bed.
O-Joe

Optimistic Joe | 03.16.08 - 12:27 am

Trolled.... hardly. I've been reading this blog since before you got out of highschool.

And seriously, if you are going to take the contrarian point of view here you should read up on Sebastian's posts. At least he tries to justify his statements with a little rigour.

Go to bed children. Monday will be a long day.

Missed Information writes:

btw, for those who didnt get the memo.
Mish, who was the last deflationista standing, officially threw in the towel on the dollar.

I didn't see that. Could you provide a link please?

Can anyone comment on UK banks or French banks that have equivalent Level 3 problems or very large Hedge Fund financing operations?

I expect panic starting in Tokyo but the rubber hits the road at the London open.

I feel like a kid waiting for Christmas morning (monday open). For finance nerds this is like waiting for that new bike you always dreamed of.

I'm not thrilled about the System breaking here, but will smile if NYC real estate is spoken about in the same terms as Miami condos.

Ahh yes, one common thread here is that SEC and FBI were looking at Bear, which may have forced Bear to play fair, thus, more shoes are about to fall and IMHO, GOOD!

The investigation, involving 15 subprime mortgage companies, questions whether Countrywide tweaked the quality of its loans to make them look more attractive before selling them to outside investors. If that's the case, investors owning loans Countrywide sold could be in for a wilder ride than they anticipated. From 2004 to 2007, Countrywide originated and sold more than $100 billion of such mortgage-backed securities.

On top of that, the Securities and Exchange Commission has been conducting its own investigation, looking into improper accounting practices that may have drastically underestimated actual reported losses. As it stands, those losses totaled $422 million in the fourth quarter alone.

Dont be surprised if the nikkei tanks and the futures are down big if the fed drops rates 100 bps, even though they are meeting on Tuesday.

Fed could go to 0% on Monday and it won't matter.

The telegraph article state GS will writedown $3 billion. They have been saying no writedowns for months now, the SEC might want to review some of their previous statements.

Also, BSC earnings - are they before or after the market opens on Monday?

I saw Warsh calls in sick and The Fed will be run by two people from now on, with Ben on a cell to Warren.

Goldman is selling subprime auto loans to stay afloat. Wonder if the FBI is looking at all the fun stuff there?

Homedad43 - meant to tell you. Get yourself a strong chain and a friend's pick-up to pull them out. I used to hack at em with a pickaxe until I turned 43 as well. Makes quick work of pulling stumps.

dd

[i]One year after New Century eats it Bear Sterns bites it, what will we be seeing a year from now?"[/i]

if you want to be pessimistic (which so far has been right):

Washington Mutual

General Motors

very pessmistic:

General Electric (a hedge fund wrapped in an industrial)

direct obligations of Fannie Mae

USA 1933:

insurance contracgts of Fannie Mae

Options Clearing Corporation

Chicago Mercantile Exchange

Depository Trust & Clearing Corporation

{i.e. the counterparties on regulated exchange trades}

State of Florida

State of California

Germany 1933:

FDIC

Why are people expecting a crash Monday? This news was out Friday morning and the Dow declined 194 points. It is already priced in for Monday. It is not even clear on balance whether this is bad news. The Fed is practically guaranteeing an orderly liquidation. That is pretty comforting to me. I don't think there is much chance of forced selling and counter party contagion. Though maybe I am wrong.

I think the Fed is about ready to start buying mortgages to relieve all of this. The Fed can always try to get back any losses later on by effectively taxing the banks when they become profitable. For example, if the Fed loses $200B, they can, say 5 years later, decide to impose a retroactive bailout insurance premium. That way it is really a loan that allows them to function on lower capital but it is not accounted for as a loan since they don't announce this until 5 years later.

What do you think of this idea? I think it is better than getting the US government to organize a bailout because that would be held up by partisan bickering. Plus it allows the Fed to take the blame rather than the politicians which will please them. It is certainly better than letting the financial system collapse.

Late Saturday Night Reggae Music

Everything Crash by the Ethiopians

YouTube -

“Look there now, everything crash
Fireman Strike, Waterman Strike,
Telephone Company, Too
Down to the Policeman, Too.
What Gone Bad a-morning
Can’t Come Good a-evening, whoa.
Everyday carry bucket to the well,
One day the bottom must drop out.”

FBI getting on-the-job-training; may be helpful for 2008:

FBI spokesman Stephen Kodak said the bureau was investigating 1,239 cases of suspected mortgage fraud at the end of 2007, up from 436 open cases in late 2003. The bureau counted 260 convictions related to mortgage fraud in the fiscal year ending Oct. 31, up from 123 in the preceding year.

c&c's prediction at 1:02 am is right on.

Bear Stearns: Whale or Cockroach?

FNArena

I had a good chuckle last week when on CNBC the bobble-heads were all talking about a "Key Reversal" on Tues, after Ben's lame plan to inject liquidity and 400 pts up. Nothing nut another short Op.

Monday will be interesting. I wonder if the US officials let Asia go flop or if they trot out another plan before the NIKKEI opens?

Now wait a second, if Bear is under investigation, then, why is The Fed bailing it out -- in addition to aiding and abetting other banks in antitrust concentration efforts? This is like bailing out Enron and looking the other way on accounting fraud and false and misleading information. Is that what goes on in America now, The Fed bails out crooks in broad daylight?

WASHINGTON, Jan. 29 (Reuters) — The F.B.I. has opened investigations into 14 corporations as part of a crackdown on improper subprime lending, agency officials said on Tuesday.

F.B.I. officials told reporters that the inquiry involved potential violations including accounting fraud and insider trading.

Separately, Bear Stearns, Goldman Sachs and Morgan Stanley said government investigators were seeking information from them about their subprime mortgage activities. But it was not immediately clear if the disclosures by the three banks were linked to the F.B.I. probes.

F.B.I. officials did not identify the companies they were looking at, but said the investigation reached across the industry to include developers, subprime lenders, companies that securitized loans and investment banks that held them.

The cases could lead to potential civil or criminal charges, the officials said.
The F.B.I. said it was investigating the cases with the Securities and Exchange Commission, which has opened about three dozen investigations into the subprime market collapse.

Targets of the S.E.C. probe include the investment banks Bear Stearns, Morgan Stanley and Merrill Lynch, as well as the Swiss bank UBS and the bond insurer MBIA. It was not clear whether any of those companies were involved in the F.B.I. investigation.

The S.E.C., which has formed an internal subprime-mortgage task force, is looking at how financial firms priced mortgage-based securities and whether they should have told investors earlier about the declining value of those securities. - New York Times

ore than 67 percent of auctions in the market that includes cities, colleges, hospitals, student lenders and closed-end funds failed this week, based on data compiled by Bloomberg. The market became unhinged last month, after dealers who supported the securities for more than two decades stopped bidding for bonds investors didn't want.

``Nobody is giving me any inkling that it's getting any better,'' said Arnold Goldner, a 56-year-old owner of a jewelry repair business in Fort Lauderdale, Florida. Goldner said he hasn't been able to sell $5 million in auction-rate preferred securities sold by funds from Nuveen Investments Inc. and BlackRock Inc.

From Bob Eisenbeis ex-FRB Atlanta now Chief Economist of Cumberland Advisors. Very savvy shop specializing in munis (see Kotok as well], worthy of a bookmark.

Cumberland Advisors - Market Commentary

"It is time to stop pretending"

[Namely that it's a liquidity issue rather than an insolvency issue]

This is also not an “animal spirits” problem but rather is the classic example of George Akerloff’s “market for lemons.” Essentially what Akerloff tells us is that, absent better information, it is rational for potential buyers of assets to assume that the assets offered for sale are “lemons,” hence the flight to quality.

[Wikipedia has entry for Akerloff]

Look to Japan:

TAISUKE TANAKA, CURRENCY STRATEGIST, LEHMAN BROTHERS, TOKYO
"We are expecting 95 yen in the second quarter. This is our official forecast. The U.S. economy is falling into a recession, and we are expecting 50 basis point cut next week by the Fed. they will cut further in April and June. So in this circumstance, the U.S. dollar, the currency of the biggest debtor country, tends to decline. And the yen, as currency of the biggest creditor country, tends to go up. Some in the market ask why people are buying yen while the Japanese economy is also deteriorating. But in these circumstances, the creditor currency tends to be under upward pressure.
"We expected the MOF would not intervene because the real effective exchange rate in yen is still low, and the G7 is requesting that China make their currency regime more flexible. In this situation, Japanese authorities may hesitate to manipulate the currency. I think Japanese monetary authorities are also hoping that the yen should be treated as one of the key currencies, especially in Asia. So the MOF may think that currency manipulation should be avoided.
"But political pressure or requests to intervene in the dollar/yen market will be increasing. The Japanese stock market is also dropping. So if the European authorities should call on concerted actions in currency markets, Japanese authorities would accept or join it. But at the moment it would be difficult. If they intervene in the market, the market trend, upward trend in yen against dollar, would not change as long as the fundamentals don't change."

Investors have learned from recent experience to be wary about what else might blow up, and that anxiety is putting the pressure on markets all around,'' said Park Sehick, who helps manage the equivalent of $1 billion at Hanwha Investment Trust Management Co. in Seoul.People will freeze up at times like this when they see panic selling.''

DaveJ: The well funded hedge funds know where the banks' "stops" are - liquidity, collateral, AAA MBS. They will attack those stops and it will be a tsunami.

I don't think the deflationary forces, particularly consumption, will overcome a move out of the dollar by SWF and oil producers.

I agree that the the Dems will kill Wall Street. Even Paulson's new regs are horrific. I despise socialism and what I am seeing is unsettling. Free markets only work when they are free.

Very old news:, but what happened to 'Counterparty Risk Management Policy Group' ??:

MORAL HAZARD - A problem whereas investors, after being insulated from the consequences of risk by intervention, might pay insufficient attention to similar risk the next time, or operate on the expectation of official intervention.

We traders know this government intervention more as the 'Greenspan Put'.

'Private Counterparty Surveillance' is another phrase that I read several times. This is basically the large NYSE member banks, a couple of well connected hedge funds, and that form the 'Counterparty Risk Management Policy Group'. The one financial member of this group that is not a bank or a hedge fund is General Motors Asset Management. I guess with $300 billion in outstanding paper they want to be sure GM has a seat at the table.

Now bailouts have been around for a long time. Going back a bit I remember the Chrysler bailout. Did you know that Alan Greenspan was against the government bailing them out. Wow! Did he change his tune in later years or what!

What we also know is that we had a series of bailouts in the mid to late 90's that started out with the Mexican bailout. Robert Rubin of Goldman Sachs was sworn in as Secretary of the Treasury on the evening of January 10th, 1995. That same evening an emergency meeting was held to finalize a plan to bail out Mexico. I guess this could not be done until the well connected Rubin was in office. The administration waited until Rubin was confirmed and sworn in to move ahead. Greenspan's "irrational exuberance" speech, Long Term Capital Management (LTCM) bailout, the "Asian Flu" economic crisis and Y2K followed. All contributed to what we all now know as a 'moral hazard'. In 1999 the 'Counterparty Risk Management Policy Group' (CRMPG) was formed to address the issues with LTCM and to develop policy that would protect the financial world from another threat to the financial markets such as the LTCM incident.

Now fast forward to 2002. In May of 2002 the SEC appears to have fears that a major bank - one of two that clear government paper - may become insolvent due to derivative issues. The possible problem bank is JP Morgan. By the end of the year CRMPG recommends the foundation of a new bank be put in place just in case. The new bank would be a coordinated effort of the members of the CRMPG. The Federal Reserve and the SEC approve.

Also in 2002 it just so happens that we see a big jump in the use of program trades. The major players are also members of the CRMPG. Those without large proprietary trading units such as Citigroup, start them. Citigroup is quoted as saying something along the lines that due to "new" innovations they see less risk in trading

There might just be some inflation. 6% inflation for 4 or 5 years is not going to destroy the United States.

you must be kidding?
Inflation is already 10% for average american, and higher for poor american.
Social pressures are building, unnoticed from behind the walls of segregated society.

Dollars goes down and down only.

Any attempt to generate even more inflation as a means to get your way out of this crisis is going to result in HYPER inflation.

MI: The Fed is not going to be able to do much more on a sterilized intervention basis. It will we dollars for assets and the taxpayer is on the hook for the risk. 500bn+ is now what we are talking about.

What is the best protection against this for cash on hand? Gold? CHF? Euros?

re: SC

when Russia had a crisis in 1998, the only people who were left with anything were the people who kept USD under the mattress.

So if you don't trust brokerages to survive, get paper euros and hide them.

If you do trust brokerages, buy GLD.

If you think government may declare GLD illegal, buy Japanese large cap stocks.

This is not an investment advice, but a food for thought from a nobody.

Worth thinking about:

The July 2005 Report of the Counterparty Risk Management Policy Group II draws a distinction between financial disturbances and systemic or potentially systemic "financial shocks." An excerpt from the report follows:

“Financial disturbances arise with some frequency and can have their origins in a number of factors ranging from a geopolitical event such as September 11 to a failure of a specific financial or nonfinancial corporation. However, financial disturbances do not exhibit the very rapid contagion effects present in financial shocks. The absence of rapid and far reaching contagion effects may be due to any number of factors including: (1) the event was widely discounted in the first place, (2) public or private policy responses are swift and decisive, and/or (3) the event does not raise broad-based concerns about potential or actual credit losses that could compromise the ability of financial counterparties to perform in a manner consistent with their obligations. Credit-related problems, as discussed below, are of special concern because — as we have seen on many occasions — financial markets have a remarkable capacity to cope with financial disturbances so long as widespread credit problems are not seen as an imminent threat. Experience also shows that the fact or the fear of large credit losses is often the key variable through which financial disturbances become financial shocks.”

Missed,

I am trying to get short Japanese exporters as Yen is killing them at time when they are competing with better Chinese, Vietnamese etc products and facing a weaker global economy.

Why would a govt outlaw GLD? What are odds of that?

Troy,

the AAA MBS for Tsy under the TSLF is not enough. They can't exchange BBB MBS for AAA Tsy unless... Guess that all depends on how much we trust ratings agencies.

Repo against below AAA assets and broader securities will solve a world of hurt for a lot of firms. For a while.

re: SC, DaveJ

American is not Russia. Enough said.

Why would a govt outlaw GLD? What are odds of that?

Well, US did exactly the same things during Great Depression that most other countries do during their crises - they robbed their citizens. Gold was declared illegal, and dollar was devalued literally overnight. Google executive order 6102.

Oh, and Dave, you will soon be cured of your "america is better than the rest of the world" syndrome. In your defense, this disease was present in even worse form in Russia.

1. Chairman Ben S. Bernanke
   At the Federal Reserve Bank of Atlanta’s 2006 Financial Markets Conference, Sea Island, Georgia
   May 16, 2006
   Hedge Funds and Systemic Risk
   FRB: Speech--Bernanke, Hedge Funds and Systemic Risk--May 16, 2006

The principles articulated in the CRMPG's reports are a good starting place for firms, and senior management should rigorously assess their operations against those principles and commit the resources to address deficiencies. Authorities' primary task is to guard against a return of the weak market discipline that left major market participants overly vulnerable to market shocks. Continued focus on counterparty risk management is likely the best course for addressing systemic concerns related to hedge funds. This public policy approach does not entail the moral hazard concerns created by authorities' monitoring of positions using a private database. Rather, a focus on counterparty risk management places the responsibility for monitoring risk squarely on the private market participants with the best incentives and capacity to do so.

1. Governor Randall S. Kroszner
   To the 2007 Credit Markets Symposium at the Charlotte Branch of the Federal Reserve Bank of Richmond, Charlotte, North Carolina
   March 22, 2007
   Recent Innovations in Credit Markets
   FRB: Speech, Kroszner--Recent Innovations in Credit Markets--March 22, 2007

   In 2005, a private-sector group, the Counterparty Risk Management Policy Group II, or CRMPG II, chaired by E. Gerald Corrigan, produced a report highlighting many of these issues.9 That report also made a number of useful recommendations to market participants on how they could address some of the challenges I have mentioned here.

• Where is Warsh?

I am trying to get short Japanese exporters as Yen is killing them at time when they are competing with better Chinese,

I didn't suggest it as a way to increase wealth. Notice it was at the end of my list , i.e. if you cant preserve your wealth choose the option with smallest loss.

Japanese are likely to have the strongest currency in the end, so you may lose the least with Nikkei.

In any case, it's just a way to weather the crisis for a couple years.

Thanks, Missed information, for setting people straight on inflation/deflation.

It kills me that Americans are so complacent about the horrors of inflation.

the country did not have the institutions that the US has, the entrepreneurial culture, democracy, a strong legal system etc.

I certainly agree with this - but you only have these advantages at the low end of society.

Your elite is just as corrupt as soviets ever were, if not more. There is no legal system in US capable of keeping them in check.

Think about this: even with the amount of inflation we've had this year, which some think is "not too bad", a lot of small businesses are biting the dust. They cannot pass these costs on.

Small businesses are what this country used to be about.

Bonus material:

Alternative Instruments for Open Market
and Discount Window Operations

Federal Reserve System Study Group
on Alternative Instruments for System Operations

Board of Governors of the Federal Reserve System, Washington, D.C., December 2002

http://www.federalreserve.gov/BoardDocs/Surveys/soma/alt_instrmnts.pdf

If the Federal Reserve was to conduct the bulk of its operations in assets other than Treasury securities, the risk of
affecting relative prices across private assets could be significant...

The Federal
Reserve's current approach limits its credit risks by confining its holdings to Treasuries
and other perceived high-quality assets, as well as to repurchase agreements and
collateralized discount window loans that represent secured credit exposures to strong
counterparties. Thus, the Federal Reserve has been able to maintain both liquidity and
high credit quality. As the pool of marketable Treasuries shrinks, judgments about how
much credit risk to bear and how to employ diversification to manage such risk will
become more critical. Among debt instruments, a portfolio of higher credit quality and
greater diversification often tends to be more liquid under a broad range of conditions
than a portfolio of lower credit quality and lesser diversification, but the relationship is
not ironclad.7 Nonetheless, efforts to minimize credit allocation effects may be reason to
hold a portion of the portfolio in less liquid, less high quality assets.
Whatever its appropriate level, credit risk should be well managed and should not exceed
what is necessary to meet the Federal Reserve's monetary objectives. One important
reason for much prudence is that knowingly accepting excessive credit risk, like engaging
in credit allocation, can be thought of as an action exercised more appropriately by the
fiscal authorities than by the central bank. Moreover, significant credit problems might
give rise to misunderstandings of the rationale behind the Federal Reserve's asset
allocation policies and possibly to political interference in these policies. Transparency
about strategy and tactics can reduce the risk of misunderstanding but probably cannot
fully eliminate it.

Purchasing assets with greater credit risk also would raise practical issues. The potential
for credit losses, which often can occur at or just after cyclical troughs, would require the
Federal Reserve to adjust the way it values its portfolio. With risky assets, it would make
sense to place some portion of earnings into a credit loss reserve and conduct frequent
reviews of the portfolio to assess the adequacy of the reserve. Indeed, systematic
reserving and prompt write-downs over a large, highly diversified portfolio should be an
expected part of managing such a portfolio. With risky assets, the Federal Reserve also
would need to develop standards for acquiring and retaining such assets. Higher (that is,
narrower) standards would reduce the total asset pool available to the Federal Reserve
and could make diversification more difficult

These things alternate. The rich have had it great for the last 25 years. It is time to redistribute some of that wealth back to the middle class and poor. Inflation is part of that. Tax policy and government fiscal policy is the other part.
DaveJ | 03.16.08 - 2:41 am | #

I agree. I think that is the trade off of living in a country with a stable government, reasonable infrastructure, and so far, no social unrest. Small price to pay, IMO, for corporations to operate in the USA.

I have to say, even my ultra conservative, free market friends and associates, and other contacts are very distrubed at the gap of pay between the haves and have nots. Those bonuses paid to the Ivy League MBAs on Wall Street and CEOs appears to be nothing but greed now, while taking huge risks and ruining their companies. As layoffs and unemployment increase later this year, I fear social unrest may rear it's head. And the finger of blame will be pointed directly at Wall Street for the economic mess. So many similarities leading up to 1929 - 1933.

scotty

I don't know how the Fed accounts but it doesn't really matter. They are not a real bank because they alone can print dollars. This is why they say they can always prevent deflation by forcing inflation. They can print dollars and drop them out of helicopters.

However, they do need other assets to prevent inflation. They raise rates by selling bonds. This takes money out of circulation. However, if they run out of treasury bonds and gold, they would have nothing to sell. They might have to issue their on bonds. Lets not go there.

I don't think the Fed needs to eat the whole loss. I am not saying that. Banks can raise capital as well. The trouble is that we, as a country, would never want our banking system owned 70% by Saudi Arabia and China. The tax payer must also contribute some as well, especially rich people and corporations and extra-especially banks and hedge funds.

One last thing, related to be there and the printing press. Think Plaza Accord: Plaza Accord - Wikipedia, the free encyclopedia 

1. The exchange rate value of the dollar versus the yen declined 51% over the two years after this agreement took place. Most of this devaluation was due to the $10 billion spent by the participating central banks.
2. The Plaza Accord was successful in reducing the US trade deficit with Western European nations but largely failed to fulfill its primary objective of alleviating the trade deficit with Japan because this deficit was due to structural rather than monetary conditions.
3. The recessionary effects of the strengthened yen in Japan's export-dependent economy created an incentive for the expansionary monetary policies that led to the Japanese asset price bubble of the late 1980s.
4. The Louvre Accord was signed in 1987 to halt the continuing decline of the US Dollar.
5. Look at bond yields during that period as bonds and equities decoupled.
6. Look at Ben and the printing press and hyperinflation.

The easily obtainable credit that had helped create and engorge the real estate bubble continued to be a problem for several years to come, and as late as 1997, banks were still making loans that had a low guarantee of being repaid. Correcting the credit problem became even more difficult as the government began to subsidize failing banks and businesses, creating many "zombie businesses".
The time after the bubble's collapse (崩壊 hōkai?), which occurred gradually rather than catastrophically, is known as the "lost decade or end of the century" (失われた10年 ushinawareta jūnen?) in Japan.

Oyasumi nasai

In the meantime, the Bear debacle is a huge blow to New York City and its Metro-area economy where most of Bear's workforce lives. Many will be out of work. Bankers and other execs have lost fortunes since many were paid in Bear stearns stock.

given that prices are set at the margin, maybe this will become the tipping point in NYC's RE market.

Two comments from this insomniac.

First, for you geeks out there----Nelson Muntz is a character on the Simpsons whose trademark comments is in fact "Ha, Ha!"

Second, I think Dave J's following comment is very important in the long term scope:

"These things alternate. The rich have had it great for the last 25 years. It is time to redistribute some of that wealth back to the middle class and poor. Inflation is part of that. Tax policy and government fiscal policy is the other part."

The story of the past 25 years has been the enormous, and I mean gi-normous returns to CAPITAL at the expense of returns to LABOR. I too think that will reverse. That means continued poor market returns for a very long time. It doesn't mean depression or Road Warrior World.

I couldn't give a hoot about politics,--this is strictly an investment observation.

No Road Warrior World?

Dammit!

left-em

I am just saying that the inflation-deflation dichotomy is way too simplistic. People are greatly confused about this. In fact it is very difficult to sort it all out. Inflation is not simply a monetary phenomenon (Milton Friedman is wrong). Changes in prices are caused by many things. It is always supply and demand but it doesn't always mean supply of money. There is supply of labor, supply of goods and services. Profits bring more demand for money and credit. Industrializations bring demand for commodities and create changes in demand for consumables. Governments interfere in the currency markets in order to create jobs and boost their economies. There are asset price bubbles and the consequences.

It is all very complicated and non-linear. Just because prices are going up for some things doesn't mean the Fed is to blame. The 1970 style US inflation is not the proper model to apply to the US of 2008.

The Chinese have so many dollars and treasuries because they don't consume enough. Their government sends all the money back into treasuries in order to keep their people poor and to create a seemingly endless supply of jobs in manufacturing. The Chinese have an inflation problem not us.

The Saudi's are complete bastards. Their common people are too poor to consume hardly anything. The rich rulers sell the oil that happened to born over and have nothing to do but invest it back into the US. They don't improve their people's situation. They just hoard their wealth.

To think that the US does not have a major inflation problem is lunacy. Just as to think that the US does not have a major deflation problem is lunacy. Because they do and in spades on both counts.

The real problem is that because both exist simultaneously, semantics such as what DaveJ is getting into outweigh the serious relative importance of the facts as they unfold on the ground.

There is no textbook or Ecobabble solutions for what is happening now. A blind person can see it is a disaster. You can't manage disasters like this. What really matters to every blogger here and anyone else is; wht to do?

Well, stop trying to label this mess would be a good start because semantics don't offer protection. Isolate the drivers for both DE and INflationary and find hedges/investments that afford protection would then be another.

I disagree entirely with this statement of DaveJ's"It is all very complicated and non-linear." It is not. Take what is happening at face value- some assets are deflating while others are inflating. There are sound and quite obvious reasons for this- the dollar being sacrificed is but one. Idiots lending mountains of fictitious capital to morons is another.

It is clear as crystal DaveJ. The US financial system is in the process of imploding and the Fed is sacrificing the dollar in it's failing efforts to prevent that. It doesn't matter who wins beacuse no one knows what a win will look like anyway.What matters is how long that process lasts. That determines current trajectory for a lot of things, which is all anyone needs to know.

The middle class and poor did better (in the 70's) since they were able to pay off their debt loads due to higher nominal wages.

And that's because the US had something called "manufacturing" and "unions" back then.

How much of a real economy does the US have left to absorb all those workers cast off by the collapse of the sham economy?

Suppose the shredders are humming 24/7 at BS
.
Anderson (the kaput accounting company) destroyed tons of Enron records to protect???????? I'm betting lots of big TX families had money in those "special purpose entities", those can't loose great investments (all off the books by the way and bogus as hell)Enron was famous for.

But the records were destroyed, isn't it amazing how those things work. What kind of power would it take to get Anderson to destroy themselves to by destroying Enron records.

Crony capitalism at its' finest.

Sub-Kommander Bernanke talks about preventing deflation via the printing press while at the same time bemoaning gubbermint spending on SS payments etc. BB is a mouthpiece for the maggot bankers only.

Hum, those that say we don't really have inflation because wages aren't going up or not everything is inflating at a high rate, are the same people that think debts don't matter, we can cut taxes, start a war and spend like drunken sailors. The upper 10% or so are making out like bandits, but the vast majority is struggling.

NEWS FLASH: Energy and food matter a great deal to 80-90% of the US population. When they is going up it doesn't matter that the government doesn't include these items in their calculations.

Bottom line is that wage arbitration has kept wages low, commodities are inflating wildly and the financial health of the US is under great stress. To put lip stick on this pig makes the government and supporters look really in la-la land. It also makes any hope of meaningful solutions
almost impossible, because the leaders don't think their is a problem.

Here is the problem . . . 30 years ago, a financial institution the size of Bear Stearns could have failed because its functions were limited and understood and could correspondingly be offloaded. Now, each of these larger financials institutions represent a single point of failure (SPF). Therefore, in order to keep the system functioning the fed must make sure each SPF does not fail. This may work for a short time. However, if market sentiment continues to be nervous and tests the resolve of the Fed, the Fed will run out of resources to fix each SPF. This is a mathematical certainty. So, the Fed is trying to manage sentiment. They know that is the only option they have. My guess is that the Fed (and federal gov't for that matter) will show their strains in terms of limited resources to fix the situation in a matter of weeks. At that point, there is a likely outcome of a collapse.

Nemo - you're right - the fed will provide them with the liquidity they need for the next 28 days - however, BS may choose to file before that 28th day if they come to the conclusion that they wont have the cash to survive beyond that which will be the case without a deal. I doubt they would come to that conclusion tomorrow since they're trying to cut a deal with someone - that someone is JPM - its either them or no one. Flowers doesnt have the horsepower for this deal and is likely only fishing and potentially looking for scraps. If a deal is done shortly they'll have no choice but to file. The Fed has sent them and the markets a signal that it will be an orderly liquidation.