Monday, October 13, 2008

Please Pass the Panic - Elephants Holding Tails


If the musings on this page are correct, then the progression of panic has gone as follows:


  • -Credit protection holders "panic" as Fuld's Lehman zips its fly, for the last time, closing shop because of a lot of reasons, but mainly because of worries about mortgage-backed asset quality (possibly), commercial real-estate loans (notably), and collateral calls that could not be met (reportedly), but not margin calls (reportedly).

    There is a market-wide rush to unwind credit protection and to sell some underlying bond holdings, pushing up credit spreads (to be confirmed). Other market participants must engage in significant balance-sheet repositioning/selling, to continue to meet policy requirements (including pending accounting rule changes), causing the cash markets for bills, notes, and bonds to gyrate, too, further spooking the derivatives holders as volatility rises.

    Fearing the optics of looking like they were "too risky" and the redemptions it can cause, some bond mutual funds and some money market funds ... dash for "quality", further pushing up credit spreads (size to be confirmed). Anyone with credit inventory not accounted for as held-to-maturity ... has to take a mark-to-market "hit" to income. Those who only look at "hits" as indicators, get spooked. Amplified short-sellers (a.k.a. hedge funds) ... get motivated.

  • -Interpreting this rush to liquidity as a "credit crunch", leading economists wing flap, appropriately. A few ominous economic numbers come in, and suddenly the equity market needs to discount a profits recession that is not mild. Some economists, equity investors, and reporters focus on "confirming evidence", rather than "dis-confirming evidence", in the form of "hits", "rumors", and other temporarily adverse ... happenings.

    A few big banks need to get sopped up - that becomes a negative, in the worry environment, instead of a positive. Equity investors rush for the door. Some economists use that to project further declines in spending. Worries mount that money-center banks and others have lost their balance sheet capacity to lend.

    Last, the Pandora's box opens. People write openly about long-term problems coming home to roost, like a precipitous fall in the dollar and an end of the Treasury's issuance capacity. "Solutions" get more stridently declared and ... wildly conceived.

  • -Regulators start to throw more money than Xerxes ever had at the problem:
    Central banks in another coordinated effort have agreed to provide unlimited amounts of dollars (against the appropriate collateral) to the markets. This is via the Swiss National Bank, the Bank of England and the ECB. Thank you to reader Milton Arbogast who mentioned that in a comment on a previous post.
  • No one seems to have a handle on the "root causes" of the panic, or even worry about quantifying them or tasking expert testimony to fully understand them. Everything gets swepted up into varagies like "tsunami", "sub-prime", and various symptoms, like, "run-on-the-bank". The solution? A catch-all, a tarp.

    Risky backstops get thrown up in the interbank market, on the presupposition, without much evidence, that banks are worried about settlement risks (?) or counterparty credit risks (?), that have hobbled inter-bank dealing.

    The Fed dis-intermediates the banks, to some degree, during their time of peril, and agrees to buy Commerical Paper (i.e. make unsecured loans to the non-financial sector), keeping another leg of the crisis from developing, centered on large consumer-finance firms like GECC and GMAC and their adjunct manufacturers.

    Not to be outdone, lawmakers pass out more insurance, even as the storm comes in, providing deposit insurance for millionaires (up to $250,000 per institution per depositor).

    As a crowning achievement, the Treasury Secretary gets authority to buy anything at any price, as a "plan" to "stabilize" markets. His go-to guy rushes, with Goldman speed, to hire money managers, lawyers, and set-up clearing arrangements for the U.S. Treasury to become a heavy hitter in the financial markets, at the behest of the Treasury Secretary, drowning out the experts who think that is ... "rubbish-squared".


If only they had done a Brady plan for RMBS (residential mortgage-backed securities), none of the above events would have had to occur.

Ideology ... led everyone to rely on the "HOPE NOW ALLIANCE" instead.

The lessons from this crisis *may* turn out to be all political, rather than economic: to the extent that a set of crisis events is unique, it is not possible, inside a democracy, to take preventive medicine. A crisis needs the catastrophe, before ideologies are cast aside enough to get a fix done. Unfortunately, by then, the cost of the fix is almost invariably magnitudes larger than the preventive once of cure.

Put another way, things do not multiply, without necessity. Organisms adapt, they don't anticipation.

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