Today, there is a meeting at the NY Fed of 17 firms this afternoon to discuss changes in "Derivative Infrastructure" and Credit Default Swaps.
This morning, NY Fed President Timothy Geithner published this piece on the Credit Crisis in the FT:
"The world experienced a financial boom. The boom fed demand for
risk. Products were created to meet that demand, including risky,
complicated mortgages. Many assets were financed with significant
leverage and liquidity risk and many of the world’s largest financial
institutions got themselves too exposed to the risk of a global
downturn. The amount of long-term illiquid assets financed with
short-term liabilities made the system vulnerable to a classic type of
run. As concern about risk increased, investors pulled back, triggering
a self-reinforcing cycle of forced liquidation of assets, higher margin
requirements, increased volatility.What should be done to
strengthen the system in the future? First, when we get through this
crisis we have to increase the shock absorbers held in normal times
against bad macroeconomic and financial outcomes. This will require
more exacting expectations on capital, liquidity and risk management
for the largest institutions that play a central role in intermediation
and market functioning. They should be set high enough to offset the
benefits that come from access to central bank liquidity, but not so
high that they succeed only in pushing more capital to the unregulated
part of the financial system."
The entire commentary is must reading . . .
>
Previously:
The Soothing Fed Balm
http://bigpicture.typepad.com/comments/2007/03/the_soothing_fe.html
Source:
We can reduce risk in the financial system
Timothy Geithner
FT June 8 2008 23:30 | Last updated: June 8 2008 23:30
http://www.ft.com/cms/s/0/807c8a64-355a-11dd-998d-0000779fd2ac.html
Related:
Geithner Urges `Unified’ Supervision of Finance Firms http://www.bloomberg.com/apps/news?pid=20601087&sid=apbKkXGo8fwM&
Geithner Pushes for Tougher Rules, Supervision to Prevent Future Crises
http://online.wsj.com/article/SB121302202578857369.html
NY Fed chief urges global bank framework http://www.ft.com/cms/s/0/546b1604-3585-11dd-998d-0000779fd2ac.html
“when we get through this crisis”
???? isn’t that the more immediate task at hand here needing resolution…. how we get through this current crisis…
One, tougher regulatory standards for capital, liquidity and risk management for the largest financial institutions “to increase the shock absorbers held in normal times against bad macroeconomic and financial outcomes.”
Two, take “some of the risk out of secured funding markets, increasing resources held against default in the centralised clearing house, and encouraging more standardization, automation and central clearing in the derivatives markets” to “improve the capacity of the financial infrastructure to withstand default by a big institution. ”
Three, while avoiding the imposition of regulatory capital standards on hedge funds and other leverage institutions, supervisors must take steps to make sure bank and other regulated institutions have risk management procedures that limit “the risk of a rise in overall leverage outside the regulated institutions that could threaten the stability of the financial. To the same end, regulators need “to induce higher levels of margin and collateral in normal times against derivatives and secured borrowing to cover better the risk of market illiquidity.”
Four, the US regulatory framework needs to be streamlined and strengthened. “Our system has evolved into a confusing mix of diffused accountability, regulatory competition and a complex web of rules that create perverse incentives and leave huge opportunities for arbitrage and evasion,” he wrote.
Besides “a unified framework that provides a stronger form of consolidated supervision,” Mr. Geithner called for “a stronger framework of oversight authority over the critical parts of the payments system – not just the established payments, clearing and settlements systems, but the infrastructure that underpins the decentralized over-the-counter markets.? He said that the Fed should play a central role in any new framework.
Finally, he said, “we need a stronger capacity to respond to crises” adding that the Fed plans to leave in place a number “innovative new lending facilities…until conditions in money and credit markets have improved substantially.”
I posted this Friday, but I think it deserves repeating:
Smells like the Fed has [finally] realized the only way they are going to lower inflation [crude at new high of 137.42] is to accept a recession, perhaps a serious one, as the lesser of two evils (namely a recession and lower inflation now…rather than more inflation and a depression later]. This would explain all the recent rhetoric from Bernanke [and others such as Bullard and Poole today]. And it’s the wisest course. They can’t ONLY whine about aweak dollar and high oil prices any longer. They need to act,if only
ending their monetary and verbal support of the risk asset markets and use any existing or accumulated monetary “ammunition” to build up these markets after the recession is allowed to take hold. In short, the Fed is going to have to start acting more like the ECB in focusing on controlling inflation rather than supporting growth and employment which is futile under current conditions anyway. There has been no economic growth traction from their efforts because folks have finally grasped (probably without realizing it fully) that liquidity is not a substitute for solvency and economic viability.
“What should be done to strengthen the system in the future?”
Number 1, repudiate Greenspan, Mishkin, and other Pied Piper clowns. Admit that Bubbles CAN be identified “in real time.” Pre-emptive war is a bitch, but pre-emptive Bubble popping is a must.
Today’s positive Dow change is concealing some horrific damage in the financials. The BKX bank index is plunging, now MUCH lower than it was during the Bear Stearns crisis in March. Lehman and its investment bank peers, ditto. Regional banks — WM, NCC — ditto. Monoline insurers — ditto. Fannie and Freddie, ditto. Plenty of double-digit percentage drops to be found.
Despite the seemingly flat-to-up day, the foundations are crumbling beneath our feet. Regardless of how it closes, this was an ugly, ugly day. I am appalled.
Something else I have noticed here…many of the talking heads have been indicating they think tech is in the best position to ride out this mess….today the nasdaq was weaker, but tech generally recently has done a little better than the Dow…however, one thing I always check on is the SEMI site..the semiconductor equipment manufacturing site…and for many months now the book to bill has been less than one…this would indicate that orders shipped are not being replaced completely by new orders…April was .81 and the May orders will be released June 20th…we all know the story of housing, airlines, retailers, car dealers, investment banks, but it seems to me tech may not do all that well this year either…..
Bruce in Tennessee
couldn’t release that in say the WSJ now could he??
Would have been more prescient in, say August of last year, just jaw boning crap now…..
One more time: what they do is more important than what they say or project.
Jim H.-
could not agree more…..that LEH has not gone below 28 tells a tale of horror (if you are a counter to LEH that is.)
Ciao
MS
Geithner is a wolf in sheep’s clothing.
He wants more regulatory powers, although he personally failed to exercise even the most rudimentary checks and balances on his clientele – er, constituents – during the boom.
The Fed does not deserve any more power. The Fed deserves to be held accountable for its gratuitous kowtowing to the Wall Street crowd – publically rebuked in word, in print, and for its excesses.
What should be done to strengthen this system in the future?
* No off-balance sheet anything.
* If you issue it, reserve against it.
There’s more, but let’s start there. I bet that’s too much for Geithner to actually accomplish. It’s not too much to bloviate about, but being a Fed chair is an actual job, not an ivory tower endowment.
No SIV, no CDS, no derivatives. Less sexy than what he proposed? Perhaps. Functional? You betcha.
Barry,
It is wrong for people or organizations, individually or collectively, to take actions that put the entire financial system at risk.
It is wrong for any person or organization to take risk without accepting the consequences.
The only thing that is really needed is complete transparency.
I’m thinking that story is just a cover for whatever “alphabet soup” helicopter drop is coming next.
Like they even need to discuss it (from their standpoint-not agreeing with it just looking at what argument they could possibly put forth)….
prepare for surprises overnight methinks…
Ciao
MS
This is a step in the right direction (sanity and fiscal responsibility) — but I’ll be damned if I’m going to pay for it with my tax dollars. Let’s start with a million-dollar fine on every genius who had a hand in constructing this pathetic house of cards…
War and Inflation
You can line up 100 professional war historians and political scientists to talk about the 20th century, and not one is likely to mention the role of the Fed in funding US militarism. And yet the story of central banking is one step removed from the story of atom bombs and death camps. It is the most important priority of the state to keep its money machine hidden behind a curtain. Anyone who dares pull the curtain back is accused of every manner of intellectual crime. We must end the conspiracy of silence on this issue.
http://mises.org/story/3010
you only get a meeting that big when there’s a problem. and you never get a quick solution when there’s 17 people who are trying to figure it out.
And including all the note takers, factotums, gofers, groupies and tea hostesses, there are probably 117 people in the room. ORDER!
To All BP Readers:
Today’s meeting is a function of a report generated months ago by the NY Fed, and discussed by Barry. It outlined a number of serious issues before Bear Stearns failed. The NY Fed knows derivatives are the real reason it acted. Backing the mortgage paper at Bear was the easy part of that rescue. The difficult part is what JPM took on its balance sheet, namely the Bear Stearns derivative book. By adding the Bear positions to its already large derivatives book, JPM and the Fed did NOT spread risk, they focused it. The meeting today is really one of the most important since the credit crisis began. And its outcome is anything but clear. There is a real struggle here. On one side you have the exchanges who are advocates of an exchange based derivatives system, (CME, ICE, etc.) On the other side you have what’s called the “clearing house” concept. Here the Wall Street banks would control derivatives trading. The revenues are huge and growing. If Wall Street banks are going to be forced to reduce their leverage and also lose the ability to offer risky structured product, how are they going to replace that lost revenue?
This meeting is very important. In the same room you have fear and greed. Too bad its not an open meeting. It should be.
best to all,
bob
Bob,
“how are they going to replace that revenue?”
They are not. The quicker they realize that the better. Even the too big to fail algorithm is going to save many of them.
Getting the election over will help too.
The second paragraph of the full text says all that needs to be understood. The salient point is adequately summarized when Geithner notes, “The amount of long-term illiquid assets financed with short-term liabilities made the system vulnerable to a classic type of run.”
This vulnerability remains.
Then Geithner asks, “What should be done to strengthen the system in the future?” Here begins the error of his thinking. He wastes no time, either, to demonstrate he is dreaming when his very next statement begins, “First, when we get through this crisis…”
This is followed with a bunch of blather assuming all that’s needed to eliminate the vulnerability of a classic type of run are technical adjustments.
THE SYSTEM IS BANKRUPT. Hence, get ready for all sorts of craziness as the run proceeds. There is no way technical adjustments made within the framework of the present arrangement will do a thing.
Consider technical adjustments and accommodations made thus far. Now, bear in mind the Fed fears a run on the dollar. Why do you think Bernanke spoke out last week?
The system is finished … and between now and next January’s inauguration things should get real interesting. (Do not forget, either, America’s Tories will maintain their reign on power until that time … so, in the final days wherein turning a blind eye to criminal acts conducted on Wall Street have become a psychological operations science one can expect anything … including melt-ups.)
p.s. Great comment Bob. Today’s meeting demonstrates the run is rapidly turning into a shark feeding frenzy.
Does anyone have an opinion on Australian Government Bonds as a safe haven? Need to move some cash out of a bank with derivative exposure.
Any Fed Governor who would conclude his remarks on the present financial system vulnerability saying, “Regulation can distort incentives in ways that may make the system less safe” MUST GO.
Like his colleague, Treasury Secretary Henry Paulson, these represent sentiments far more friendly to those financiers who created the present mess than the People who are supposedly be served.
Worries about excessive regulation at a time when the average American is being squeezed by a hyper-inflationary crisis created by wildcat finance, DEREGULATION and an utter lack of regulatory enforcement seem so ill-placed as to conjure a sentiment that might better bring charges of acts of treason against the People of the United States of America than give thoughtful consideration to policy prescriptions whose only benefit would consolidate power in the hands of those criminals who brought us to the present moment.
“Authority to pay interest on reserves would give the Fed the ability to respond to acute liquidity pressure in markets without undermining its capacity to manage the federal funds rates in line with the federal open market committee’s target.”
Paying interest on the reserves is a hidden tax. Today, the Fed must return the interest paid on the treasuries they own to the government (after costs). Paying interest on the reserves to their shareholders and banks within the system, means this money does not get returned. Either more taxes or more debt.
One of the reasons the Fed does not purchase so many treasuries directly is to protest having to return the interest. This more than anything else is responsible for the ballooning debt owed to foreigners.
The Fed now seems to prefer worthless CDS’s with which to create money to give to it’s shareholders who couldnt find a buyer for the crap.
The USD that China uses to buy their treasuries from us, are bought with RMB, that they create out of thin air to buy from their manufacturers who exchange the dollars for RMB. Kind of like the Fed has outsourced their business to China. The difference is, we have to pay interest to China.
It’s a wacky world. If people only knew the real truth, there would be millions marching on Washington and on Wall Street.
A certified rebate check comes in your mail.
“Fed Stimulus in Your Favor!!” it says on the envelope. You can see the amount in the cellophane window. It looks big. You tear it open, grab a beer, and slump onto the couch.
A check for $80B falls into your lap. Wow!!
“That’s right, Joe!”, an accompanying letter says, “You’ve been selected to receive the first National Improvised Economic Device!”
You flip the check over, and in big letters, it blares out, “Sign here, quick!! Cash it, quick!! Go spend it, quick, and don’t stop shopping until it’s gone!! Clear and hold!”
You look for a disclaimer, and there it is:
“Terms of the First National IED are $160B principal payable over a 15-year term at 5% Treasuries, for a total repayment of $320B. All amounts paid out are taxable in Federal, State & local income and sales taxes/fees. Overall interest rate on IED loan is 270%. Any payout amounts deposited now unspent are guaranteed to devalue by over 35% annually.”
So do you cash the check? Call it, friendo!
Next year the payout is $800B on $3.2T due!
The year after that, you’ll receive your monogrammed Saudi dog collar, and Mandarin barking lessons tape, with free kibbles!!
Come here, boy, good dog! You’re a good dog!
Yes you are! Yes you are! Now go fetch…
As an artist who coincidentally happens to sight cite site, I have to add two cents(since sense) and say: First of all, the checks folks receive should bounce like rubber balls. The cold and harsh reality that most hard working day to day people don’t want to grasp is the simple fact that illegal activity in America is what IS fueling the economy. Despite the literal pun or word play using fueling, I am implying that the black markets are supporting all legitimate realms. Secondly, as astute as the previous posted comments are and I am coming solely not sole-less addressing this post. I’m shocked that no one had the balls to toss the sphere rotating everyones coinage: America has got to get a new currency. It is “the plan” and it is “perfect”. Collectively, we have really low math comprehension. Thus, creating a SEEMING abstract currency exchange which will marginalize further those who know not the real meaning of coincident, which is how I found this post to begin with.
p.s. Paradigm shifts aren’t new, the patterns reoccur and definitions reform privilege, if we the people don’t take our own responsibility for making the tangible abstract.