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Central banks were not the big buyers of synthetic triple AAA …

by Brad Setser
January 28, 2009

Ricardo Caballero argues that the current crisis stems from (flawed) efforts to construct safe assets out of risky assets in order to meet a surge in investor demand for safe assets.

He is on to something.

There was a surge in demand for safe assets that pushed yields on Treasuries (and Bunds, OATS and Gilts) down at the peak of the boom. And investment banks – with help from the rating agencies — did respond by constructing new kinds of products that combined higher yields than Treasuries (or Agencies) and the appearance of safety.

Caballero thinks the banks constructed these securities to meet demand from central banks and sovereign funds.

Global demand for assets was particularly for very safe assets – assets with AAA credit ratings. This is not surprising in light of the importance of central banks and sovereign wealth funds in creating this high demand for assets. Moreover, this trend toward safety became even more pronounced after the NASDAQ crash. Soon enough, US banks found a “solution” to this mismatch between the demand for safe assets and the expansion of supply through the creation of risky subprime assets – the market moved to create synthetic AAA instruments. …. The AAA tranches so created were held by the non-levered sector of the world economy, including central banks, sovereign wealth funds, pension funds, etc. They were also held by a segment of the highly-levered sector, especially foreign banks and domestic banks that kept them on their books, directly and indirectly, as they provided attractive “safe” yields.

I don’t think that is quite right. Central banks and sovereign funds weren’t the main buyers of “structures” that produced a “synthetic” triple AAA credit Central banks generally stuck to instruments with cleaner cash flows and less risk. Many have mandates that require that they invest in fairly short-term instruments that have explicit government backing.

Let’s review the portfolios of the key players:

— Japan (MoF mostly) remains overwhelmingly in Treasuries, with a small number of Agencies. As far as I know, that is about as far as the MoF and BoJ went.
— Brazil’s central bank basically holds Treasuries.
— Russia’s central bank held a lot of short-term Agencies. But it liked the Agencies own debt, not the mortgage backed securities they guaranteed. Russia’s its investment guidelines are quite restrictive. It needed a government guarantee. It wasn’t buying any “private lablel” structured product.
— India has been quite conservative. It doesn’t even hold many securities. Most of its reserves are on deposit at an international institution — likely the BIS. Who knows, maybe the BIS dabbled in structures, but India wasn’t a big source of demand for CDOs.
— Mexico didn’t go further than dabbling with Agencies. Agency MBS were a bid deal. It is mostly in Treasuries.
— Saudi Arabia is a bit of a mystery. I doubt it holds any structures on its own book. But it also likely outsourced the management of a fraction of its fixed income portfolio, and well, maybe the managers had a mandate that allowed them to take a bit of risk. I just don’t know. The Gulf’s sovereign funds liked equities (and private equity) more than they liked complex debt instruments – though they probably invested in hedge funds that made levered bets on complexity. I would be surprised if the Gulf has more than $100 billion of exposure to structured products. the Gulf’s big bet was on the equity market.
— Korea clearly took a few more risks back when it wanted to juice returns to offset the won’s appreciation (how the world has changed). But even if it put a third of its dollar portfolio (say 20% of its total portfolio) in dollar bonds that lacked government banking, it wouldn’t have bought more than $50 billion of “product.”
— Norway also took credit risk with its bond portfolio. But the US only made up about a third of its bond portfolio. Back when bonds were 60% of Norway’s portfolio, Norway could not have have had more than 20% of a $300 billion portfolio in US bonds of all kinds. It thus could not have accounted for more than about $60b of demand for various structures. And it clearly wasn’t just buying structures.

Sum those countries up and they account for a large share of total central bank assets: Japan has a trillion portfolio, the big Gulf sovereign funds probably combined to hold around $800 billion of assets at their peak (less now); Russia and Saudi Arabia were around $500 billion; Norway, India, Brazil and Korea were in the $200-300 billion range.

That leaves China. China clearly dabbled a bit with some kinds of risk. The state banks got $100 billion or so to play with in 2006 (they seem to have gotten burned and retreated; they have been selling their foreign portfolio since mid 2007). SAFE bought a few high quality corporate bonds. It was a big buyer of Agency MBS – and perhaps bought a few structures too. But the overwhelming majority of its assets remained in Treasuries and Agencies not in “structures.’ China, inc – counting the state banks – might have bought $300 billion of bonds that lacked an explicit or implicit government guarantee, but probably not more.

The numbers just don’t work. Unless my accounting is way off, most central bank assets remained in fairly safe assets.* The big shift in the world of reserve management was the shift from Treasuries to Agencies after 20004. Most central banks still wanted bonds with explicit or implicit government guarantees.

Who then were the investors who wanted “safe” – i.e. highly rated – structures? Saturday’s Wall Street Journal provides the needed clue. Think State Street. Actually, think conduits run by State Street. Levitz and Anand in Saturday’s Wall Street Journal:

“It got into conduits, which are instruments that buy such things as asset-backed and mortgage backed securities, using short-term borrowings. It shifted its investment portfolio from predominantly government bonds into mortgage-backed securities which rose the housing boom. And then last year the housing market fell apart and ensnared the financial world – and State Street – in a credit crunch.

I don’t think State Street was alone.

As central bank demand pushed yields on Treasuries and Agencies down (and as the fed raised rates), a host of financial institutions took on more risk. Other financial institutions supplied the product that they wanted. And when it blew up, the financial sector – not the world’s central banks – was left with big losses.

Caballero’s argument works, but with one additional step. Central bank demand pushed yields on Treasuries and Agencies down, and low yields on traditional, safe assets triggered a surge in demand for assets that appeared safe but offered the kinds of returns private investors were used to.

Lord Turner of the UK’s Financial Services Authority:

Very low medium- and long-term real interest rates have in turn driven two effects:

First, they have helped drive rapid growth of credit extension in some developed countries, particularly in the US and the UK – and particularly but not exclusively for residential mortgages – with this growth accompanied by a degradation of credit standards, and fuelling property price booms which for a time made those lower credit standards appear costless. And secondly, they had driven among investors a ferocious search for yield – a desire among any investor who wishes to invest in bond-like instruments to gain as much as possible spread above the risk-free rate, to offset at least partially the declining risk-free rate. Twenty years ago a pension fund or insurance company selling annuities could invest at 3.5% real yield to maturity on an entirely risk-free basis; now only 1.5%: any products which appear to add 10, 20 or 30 basis points to that yield without adding too much risk look very attractive.

… The fundamental macro economic imbalances have thus stimulated demands which have been met by a wave of financial innovation, focused on the origination, packaging, trading and distribution of securitised credit instruments.

Incidentally, One implication of Caballero’s argument is that the US should have been running bigger budget deficits to meet the rise in demand for safe assets. That would have kept yields up and reduced incentives to create “synthetic” triple AAA. Rather than following Dr. Chinn’s advice and trying to bring about rebalancing with a tight fiscal policy, the US should have met the world’s growing demand for truly safe reserve assets by running large fiscal and current account deficits.

Who knows – that could be where we are heading.

Caballero attributes the surge in demand for safe assets to the integration of the emerging world into the global economy. He writes:

“since the late 1990s, the world has experienced a chronic shortage of financial assets to store value. The reasons behind this shortage are varied. They include the rise in savings needs by aging populations in Japan and Europe, the fast growth and global integration of high-saving economies, the precautionary response of emerging markets to earlier financial crises, and the intertemporal smoothing of commodity producing economies. The immediate consequence of the high demand for store-of-value instruments was a sustained decline in real interest rates.

I would add two additional factors.

China’s integration into the global economy coincided with a huge rise in China’s savings rate. There is a world of difference between a China that saves and investing a constant 35% of its GDP and a China that goes from saving and investing 35% of its GDP to savings 50% (or more) of GDP and investing 40% (or more) as its economic size increases. In the first case China isn’t a net lender to the world. In the second case it is. China’s savings rate hasn’t been constant, and China matters.

And exchange rate management. China didn’t buy a lot of US bonds just to protect itself from a repeat of the Asian crisis. it had (and has) a host of controls that limit its exposure to a big swing in interbank flows. its reserve cover has been exceptionally high for a long time. China bought a lot of bonds because it didn’t want the RMB to rise even as China’s booming exports created natural pressure for appreciation. It is hard to separate the surge in demand for safe assets from the rise in Chinese reserves growth (counting the increase in hidden reserves) from under $50 billion a year to close to $700 billion a year (at its peak — it is now lower). Especially as that surge came at the same time that rising oil prices pushed up oil savings and the demand for reserve assets from the oil exporting economies …

Had China allowed its currency to rise in 2004 rather than tightening fiscal policy and limiting lending to avoid inflation, I rather suspect that Chinese demand for safe US and European financial assets would have become demand for US and European goods. That would have produced a more balanced – and ultimately less risky – global economy.

And, well, if the US and UK governments hadn’t looked the other was as leverage in the financial sector rose — as financial institutions made bigger bets to keep profits up as spreads fell — that too would have produced a more balanced and ultimately less risky global global economy.

* Many questions about the global economy could be answered more definitively if central banks disclosed more information about their portfolios to the IMF. Aggregate data on central banks equity holdings would be useful — as would aggregate data about the composition of their fixed income portfolio. Of course, getting more countries just to provide data on the currency composition of their reserves would be a nice start …

75 Comments

  • Posted by Don the libertarian Democrat

    “Most central banks still wanted bond with explicit or implicit government guarantees.”

    You clearly see the importance of implicit and explicit guarantees. How did this relate to US Banks? They did not seek less risk. CDSs and CDOs allow lower capital standards and hence more risk. My understanding is that the Senior tranches allowed the profit on the riskier tranches, and allowed for hefty fees from packaging. What was needed was a AAA rating in order to make more money on the other tranches. It allowed more leverage. The safety that you are claiming people were seeking was a method of lowering capital requirements.

    “a surge in demand for assets that appeared safe but offered the kinds of returns private investors were used to.”

    Maybe I’m missing something, but you seem to be saying that investors were use to, say, 7% returns. When interest rates declined, these investors started getting, say, 3%. So now they start looking for 7% returns. Of course, they could buy riskier bonds which pay what they used to get. Instead, investments are created which appear less risky and pay, say, 7 % , but they’re as risky in fact as the riskier bonds our investors passed up. This is fraud, which I believe it was. You seem to be assuming that the creators of these assets weren’t aware of what they were doing, which looks almost alchemical instead of scientific when you actually look at the risk of these new investments.

    “they had driven among investors a ferocious search for yield – a desire among any investor who wishes to invest in bond-like instruments to gain as much as possible spread above the risk-free rate, to offset at least partially the declining risk-free rate.”

    “… The fundamental macro economic imbalances have thus stimulated demands which have been met by a wave of financial innovation, focused on the origination, packaging, trading and distribution of securitised credit instruments.”

    This makes it sound like an engine. In fact, people were misled into thinking that alchemy was science. My scenario is that the CDSs and CDOs were used to make more money by requiring lower capital standards and hefty packaging fees. You’re saying that the buyers were investors who thought that they were getting a higher yield for free.

    The demand was then for something that didn’t exist, and the investments were sold as something that they weren’t. Again, that’s fraud. There’s no mechanical connection between low interests rates and poor investing. It takes actual people to make these poor decisions.

    Finally, back to the guarantees. The US banks indulged in this behavior, not because they didn’t know it was risky, but that they believed that there was an implicit guarantee by the government to intervene in an economic crisis. The guarantees that foreign banks were seeking with their investments, our banks believed had already been guaranteed by lobbying and collusion and precedent. They were right.

    The search for safe investments can only lead to tragedy when the investments are not in fact safe.

  • Posted by Twofish

    DJC: With his ill-advised blistering attacks on China’s government, Geithner has single-handedly destroyed any prospect of global economic cooperation with the Chinese people.

    I doubt it. The latest rumor is that some junior staffer copied Obama campaign literature into Geithner’s prepared remarks without thinking about it. It was one paragraph in a 240 page Q&A paper.

    If these sorts of random statements start World War III then we are all doomed. Fortunately they don’t, and the US and China have enough channels so that it looks like some storm over nothing.

  • Posted by Ying

    Agree with the principle that globalization needs to be scaled back. Democracy is impossible with a global system. It’s just too large to manage. Brad, you send a clear message to Chinese leaders and business sectors: don’t count on us for your export market and don’t buy our treasuries.

    However, means are subject to study and input from both sides. While US media is pushing their solutions to the imbalances of trade, have they ever considered Chinese leaders’ suggestions to reform the global financial and trade system?

  • Posted by Twofish

    bsetser: perhaps tho we should go back to discussing how CBs shaped demand for synthetic triple AAA …

    They really didn’t. Synthetic credit derivatives are trading at extremely low prices right now, and if any central bank has them, it would have been a blowup by now.

  • Posted by Twofish

    Don: When interest rates declined, these investors started getting, say, 3%. So now they start looking for 7% returns. Of course, they could buy riskier bonds which pay what they used to get. Instead, investments are created which appear less risky and pay, say, 7 % , but they’re as risky in fact as the riskier bonds our investors passed up.

    Actually no. If you look at CDO spreads, you didn’t get 7% for AAA rated bonds. Typically you got about 4% instead of 3% with Treasuries. It’s not so much more that you would say “what’s going on here”

    Also if you were worried about the CDO, you can get the investment bank to guarantee payment of those bonds. If you were really worried, you bought credit insurance on the CDO’s. So when everything fell apart, the banks went under and so the insurance companies that paid credit insurance.

    Finally, CDO’s have worked very well in the commercial bond market. It’s when people started applying the technology to residential mortgages that things really fell apart.

  • Posted by Twofish

    ReformerRay: I favor bankruptcy as the cleanest and best way to wipe the toxic assets off the books. No reason for the Federal government to back them.

    They’ll be mass chaos and riots if they don’t.

    The Federal government doesn’t have any choice. If you wipe out toxic mortgage assets, then most people’s checking accounts become worthless since there aren’t the assets to redeem deposits. Since the Federal government has promised to insure those deposits, it’s going to end up paying pretty hefty amounts of money.

    Right now, it’s a given that the Federal government is going to be paying large sums of money to keep people’s checking accounts from being worthless. The only real question is how.

    The big problem is that you have to fix the system in place. Bankruptcies can take years, and the you just can’t shut down the world’s ATM’s for a week to figure out what to do.

  • Posted by Twofish

    bsetser: A finding of manipulation actually just requires ….. negotiations. No sanctions are specified in the legislation that requires the treasury to issue a report on finding of manipulation.

    This manipulation thing is an example of how something unimportant can become important if people think that it is important. The reason that politicians played up this “currency manipulation” thing was that they could look tough while doing nothing, but this has taken on a life of its own.

    bsetser: I think the Chinese threat to sell treasuries is being a bit over stated.

    I don’t think that there is much of a threat. The funny thing is that the politicians on both sides are behaving more or less rationally. It’s the media circus that is playing things up to be have more confrontation that there really is.

    In any event, if the Chinese sell treasuries that will devalue the currency, and as such it is a curious “threat.” Stop complaining that I’m not devaluing the RMB, or else I’ll get angry and devalue the RMB. Huh?

  • Posted by DJC

    Brad,

    For the record, the Federal Reserve is on the record for being responsible for the suppression of interest rates to below inflation rates. The Federal Reserve’s monetary policy is irresponsible. See below Fed Statement.

    http://www.marketwatch.com/News/Story/fed-prepared-buy-treasuries/story.aspx?guid=%7BA9F7568E-3239-4B2F-A85F-3044349421F8%7D

    The Fed is using all the tools it has available including buying long dated treasuries to break the downward spiral of the economy.

    The Federal Open Market Committee kept its interest rate target in a range of zero to 0.25%, as expected. Rates will need to stay close to zero for “some time,” the statement said.

    The lack of action on interest rates was expected, as was the FOMC’s statement that rates were likely to stay low for a considerable length of time.

    All of the action in the statement was related to the Fed’s continuing efforts to flood the financial system with money.

    The Fed has adopted a “throw the kitchen sink” approach to combating the downturn, which is being fueled in part by weak banks.

    “The Fed stands ready to buy anything that anyone suggests might help. The sky is the limit,” said Mike Englund, chief economist at Action Economics.
    Buying longer-term Treasurys would be a new tool in the Fed’s arsenal to repair financial markets. Some economists worry that buying Treasurys would cause foreign investors to lose their appetite for the securities.

  • Posted by Rien Huizer

    Add a few thousand greedy people in investment banking departments without too much supervision to a mountain of easy, other people’s money and this is what you may get. Some people blame the mountain, others the greedy people and others the lack of supervision.

    I am sure that many people knew that this could lead to big losses (but, of other people’s money, all you may lose is your job or your franchise, well, if you do not play the game at all, you are out anyway) and (1) most of them were to inexperienced to understand it could also hurt them and (2) the end investors (the people financing the conduits, the bank depositors etc) were counting on being bailed out. So far so good.

    I guess that the main blame for the problems should be laid at the doorstep of governments:
    – poor macroeconomic management in the first place (imbalances). And Caballero’s argument that there should have been a lot more good paper available to service all those emerging market saving needs, is of course, nonsensical. That money should not have been saved in the first place. Governments, especially of not so rich countries with young populations should be small and basically balanced. BOP should be in deficit caused by private investment over savings..
    – lax supervision over pension funds. Pension funds should not be able to lower their premiums by gambling. Premiums should be adequate to fulfill obligations assuming only the risk free rate. Higher yielding investments should be fully disclosed and voluntary at the beneficiary/contributor level. The corrolary would be far more expensive pensions and less money available for true private sector risk capital, plain old equity.
    – ignoring the scope for trouble in the shadow banking system, especially the scope for non-regulated bank’s conduits ending up on bank balance sheets. Banks should have been explicitly forbidden to refuse assistance to shadow banks (in which case it would have been very hard to finance these things using commercial paper.

    Everyone with a minimum of financial services knowledge could have seen this coming. No doubt most people in charge of these activities and their regulators preferred to stick their heads in the sand, for fear of losing their short term benefit from keeping this crazy circus going and their private belief that the potential for a global catastrophe did hardly exist

    The trouble is, assuming that these issues will get fixed for a while (perhaps not the macro side, but the rest looks like it will offer totally different opportunities for the greedy (scavenging rather than selling snake oil) so reallocating the available “talent” will take a while.) But again, assuming we will tame finance for a while (a decade perhaps) how will the real economy look in the meantime, without borrowers being used to paying too little and savers expecting too much. What kind of new equilibria would a more correctly pricing financial system allow to exist. If the financial system is the brain of the economy (as several nobel laureates and lesser luminaries have asserted), what we are going to get now is a brain transplant. And the new brain is still underway but it may well have come from a 1930s economy. Plus, it does not look like we are going to get a single big brain that fits the world economy.

  • Posted by Cedric Regula

    Rien:”If the financial system is the brain of the economy (as several nobel laureates and lesser luminaries have asserted), what we are going to get now is a brain transplant. And the new brain is still underway but it may well have come from a 1930s economy. Plus, it does not look like we are going to get a single big brain that fits the world economy.”

    Someday they will make a sci-fi movie about this. But I think it is Ben’s big brain the US gets. He is rapidly transforming the Fed into the Big Bad Bank. And he pays cash for assets even if they are toxic.

    No global big brain. Maybe little IMF & World Bank brains. Everyone wants an independent brain thinking for their country, so CBs will volunteer of course. Eurozone will develop a split personality however.

    So it looks like we will try time travel back to 2002, and do what Keynesians do, same as they did in 2002, except we’ve used up everyone’s credit limit if we still figure that on ability to pay.

    We could have an alternative universe in the movie. One based on Milton Friedman’s later career suggestion that the Fed be abolished and replaced by an computer that added 2% to the money supply every year.

    Or maybe the Keynes universe that listened to Keynes’ later career suggestion that the government pay off debt in good times. Then we could have Germany invade France to get France’s gold and pay off Germany’s debt.

    But we will see how it goes first, then we can see the movie later.

  • Posted by beezer

    Seidman and three ex fed govs were asked, on CNBC by Larry Kudlow tonight, if they favored the bad bank idea. None of them did, unless using the bad bank also wiped out insolvent bank shareholders first.
    The CNBC house economist was on the panel as well (seems like a nice fellow but can’t remember his name), and he did favor the bad bank, even if shareholders were not taken out. Just another confirmation one shouldn’t pay too much attention to economists.

  • Posted by Rien Huizer

    For some reason my tirade (which could have been written for, and discarded by Mr Wen for balming the virtuous savers as well) stated that banks should have been forbidden to refuse financing to conduits. Hmmm, should have been the opposite I guess. Certain types of bank facilities enabled conduits to raise money in the commercial paper market. Disallowing support to own conduits is not enough, because banks have friends and do each other favors.

  • Posted by Ying

    An interesting article about Asia Trap by Steven Roach in 2007

    http://www.morganstanley.com/views/gef/archive/2007/20070529-Tue.html

    Latest comments from Steven Roach(from Bloomberg): Allowing the yuan to strengthen would be “economic suicide” amid an economic slump, Stephen Roach, Morgan Stanley’s Asia Chairman, told a panel in Davos, Switzerland, yesterday. “I’ve never seen an economy in recession voluntarily raise their currency. It’s horrible advice.”

    I think that the timing of exchange rate adjustment and adjustment of trade imbalances are not working for anybody.

  • Posted by ReformerRay

    Twofish says there will be chaos and mass riots if the Federal Government were to declare that they were not going to back the bad assets. The entire banking system would fail, according to him.

    There are banks in my town that have not participated in the party going on in New York.

    Let’s give the bankruptcy idea another test. In my mind the Lehman experiment worked out very well. A considerable amount of toxic assets were eliminated. What other action has eliminated toxic assets?

    My proposal is to announce that AIG and Citi group have received all the money they are going to get from the Federal government. And that all the other firms that are going broke because they are tied to these two firms also will get no help.

    BUT, that a large sum of money has been set aside to be loansed to banks that are still alive after 35% of the existing bank resources have been destroyed.

    If they choose, those in the current administration who have all this money at their disposal could arrange a procedure where a certain % of banks will fail but the rest will be sustained by government help.

    This process means that no bureaucrat will decide which banks fail and which do not. After the market sorts out the first few victims, those that remain will be sustained.

  • Posted by ReformerRay

    Should be “There are banks in my town that have not participated in the greed in New York”.

  • Posted by Don the libertarian Democrat

    Twofish,

    CDOs were used because you could use the senior tranche’s rating to get lower capital requirements for the riskier tranches. That’s how they made more money. They locked up less capital. They also charged for fees and made a bit more more on the risk in the split up into tranches.The benefit and money from them was not made on the safest assets. I understand that is what is being claimed. Many banks kept the safer tranches for themselves, and sold the riskier ones, because that’s where the money was.It was not a flight to safety that led to CDOs. CDOs were used precisely because they lowered capital requirements, which is inherently riskier.The flight to safety occurred in the crisis.

    As to my example, it was simply to show that people wanting the same old returns needed to increase their risk. They could not, in any real world, expect the same old returns for the same risk. My point stands.

    Thanks for the response,

    Don

  • Posted by bsetser

    Sargon — i agree with your point. Rien — i also agree with most of your points.

  • Posted by Cedric Regula

    We should also keep in mind that inflation will kill pension funds. It won’t take much to make real return on fixed income go negative. Then you still get to pay taxes on it, which is very annoying.

    If the ’70s were any indication, inflation was not good for stocks since the DOW was at 600.

    And if somehow the market ever takes back the ability to set interest rates, stocks get pressured to go down when fixed income yields go up(unless there is a very strong bull market).

    On average pension funds need 10% gains to meet obligations.LOL.

    So if all this stimulus gets out of hand and roils markets, or ends up causing inflation either sooner, or later, we can look forward to 80 million impoverished retired baby boomers, because it looks like SS is a goner too, and Medicare will gobble up what’s left.

    Have a nice day.

  • Posted by Indian Investor

    Rien:
    Everyone with a minimum of financial services knowledge could have seen this coming.

    In the absence of too much knowledge I’m evaluating the possibility that stock markets have already bottomed out. As far as the Nifty is concerned, we can tell by the end of this week’s earnings releases. The two considerations are the earnings releases of firms, and the macroeconomic policy announcements. Barring widespread trade protectionism, markets can be expected to recover.

  • Posted by Observer

    Brad, what role if any did restrictions on direct investments of foreign capital have in this crisis? Would great freedom of foreign ownership have resulted in less of a logjam for the Treasuries?

  • Posted by Glutton for Gluts

    Brad,

    Savings glut? Global? Correlation? A good contrarian contribution.

    http://mises.org/story/3203

  • Posted by Glutton for Gluts
  • Posted by locococo

    so it s official now. we ve had gold vs the derivatives in the “safe asset” contest. all you had to do is keep the gold bugs terrified and naked short the treasuries. Another two sets of derivatives for this op. then you get to attract all the pensions and the other cb s to subscribe to the idea that gold is out and derivatives are in and that they should start hedge funding for yields. and now, the financials are currently in the lead.

  • Posted by Twofish

    ReformerRay: There are banks in my town that have not participated in the party going on in New York.

    They did. Indirectly or directly they did. This is why you have to be careful with how you structure the bailout. If you do it wrong, then the people that didn’t know they they were benefiting from bad behavior get hit, and the lesson becomes “if I’m going to get punished for something that I didn’t do, I might as well be hypergreedy the next time.”

    Look at your typical community bank and see what they have their balance sheet in.

    ReformerRay: My proposal is to announce that AIG and Citi group have received all the money they are going to get from the Federal government. And that all the other firms that are going broke because they are tied to these two firms also will get no help

    Which is pretty much everyone in the entire world.

  • Posted by Twofish

    I assume that the comment was reversed:

    Huizer: Banks should have been explicitly forbidden to refuse assistance to shadow banks (in which case it would have been very hard to finance these things using commercial paper.

    The trouble is that the whole reason for investment banks existing is to support the securities market. I don’t think that the solution is forbidden them from doing this sorts of investments. The basic problem was that risk was not well valued here.

    Also people talk about the “shadow banking” industry as if it was some small side light. In fact most capital allocation in the United States takes place through the securities market, and the “non-shadow” bank sector is smaller than the “shadow banking” sector. So the tail is larger than the dog.

  • Posted by Phillip Huggan

    IDK the motives of Central Bank secrecy. Maybe preserves sovereign power, maybe allows some strategic investing activities. *If* transparency decreases odds of financial crisis, can’t the WB/IMF/BIS/illuminati just give discounts to open CBs and penalties to secretive ones?

    Your analysis of low Chinese currency stimulating savings instead of spending on imports is good. But China might not be looking at it from that point of view. Developing economies (SK) have functioned best by initially protecting their new industries while those (South America) that free traded and followed IMF reforms lost their social nets, new industries and a generation. China was/is probably keeping Yuan low to develop a manufacturing base. 2/3 of the country is still 3rd world.