Mar. 12th, 2008

peterbirks: (Default)
So, it was all apparently going swimmingly. I had contacted npower and given them gas and electricity readings. I had written to the Council. I had phoned the insurance broker to tell him of the change of occupancy (another £80 on my bill and an exclusion of accidental damage for the tenants' part -- the bastards).

Then I phoned Thames Water, and headed into Kafkaland.

Thames Water hadn't yet sent me a letter asking me to supply them with my details (for the ground floor flat), but I put this down to plain inefficiency. But, with the new tenants moving in tomorrow, I wanted to sort things out. So I phoned them.

After gradually establishing when there were people in there doing decorating, etc (and thus using water), for part of the time that it was "unocccupied", the hammer blow was struck.

"Have you converted the building at all?" asked the lady

"No", I said.

"But it's two flats, you say."


"Do you know when it was converted?"

"About 1975," I said.

"Because we have no record of that conversion. Our records show it as being a single building, with you as the sole resident. We've been charging you for the whole building since you moved in. You've been paying £430, which is very high for a flat."

"Oh", I said. Because I am an innocent abroad when it comes to utility charges.

"This might take some time to sort out," she said.

"Yes", I said, somewhat shell-shocked.

And so, there it lies. The good part of that is, I can't be any worse off, and I might even get a substantial refund. The bad part of it is, it might leave a bad taste with the former occupants of downstairs, for whom 16 years of free water might suddenly catch up with them.


$200BN FED BAIL-OUT! the headlines said.

Which kind of conceals a rather more complex situation. The first inkling I got of it was when my profitable long-sterling position zoomed immediately into the red. When I saw the headline, I thought to myself "what on earth makes traders think that this is good for the dollar?"

Nice to see that Alan Ruskin at RBS Greenwich agreed with me. He told the FT that "the economic rationale for buying dollars is that it encourages confidence in the US financial system, but earlier the market was buying risk and selling dollars on exactly the same logic".

So, there was no panic from me, and the markets came back to their senses fairly quickly. Another buying opportunity missed in the face of a market's incorrect knee-jerk reaction. Sterling is up 2 cents today (so, that's my two-cents' worth... hurrr hurrr).

Now, from hereon, it gets a bit technical, but let's look at the Fed's options, and what they are doing.

1) Slash interest rates. The effect of this, as has been demonstrated, does not solve a liquidity problem if no-one trusts anyone else. And when you have Bear Stearns issuing statements that it isn't insolvent, you can see where the mistrust arises. Only gradually will it become clear who was holding all of the parcels when the music stopped. As someone pointed out, a 3/4 of a point cut in interest rates isn't going to make you any more likely to lend money at 25% to BlueScouse.

2) Lend money to the primary market in return for mortgage-backed securities as collateral. Unfortunately, the effect of this is only one step in the chain. "OK," says the Fed, "you can't borrow from the banks using these MBS as collateral, so we will lend you the money instead, using the MBS as collateral".

"Thank you very much", the primary dealers say, promptly sticking the money in their pockets. Because they, like the banks, don't know who among the hedge funds it's safe to bail out. If your problems are transparency and confidence, then offering to lend a large sum of money for 28 days to one part of that sector does little more to improve liquidity than does slashing interest rates. (And it was amazing that it took 18 hours for the equity and currency dealers to work this out).

3) Buy the Mortgage-backed Securities outright. Termed the "nuclear" option, it effectively turns the private sector debt into Treasuries. The frightening thing is, even this might not be enough. The Fed only has just under $1tn to play with. At the moment its various loan moves put about $500bn of this "in play". There is some credit risk. Not much, but it is there. Buying the MBS outright is a far bigger credit risk. It is, both metaphorically and literally, betting the house. In addition, there are legal restrictions on what kind of MBS can be bought. Once again, it might not put the money into the right pockets, if any of the pockets are the right pockets, which brings us to the final point....

All of these solutions have at heart one vital and flawed assumption -- that we are facing a crisis of confidence that is causing a crisis of liquidity. If we can just restore the confidence, the theory goes, then the liquidity will return, and things will be fine.

Unfortunately, it doesn't address the probability that the crisis of confidence is justified. In essence, we still do not know how big a problem the subprime crisis is. If we are really looking at a $200bn loss rather than a $800bn crisis of confidence which will turn out to be just a $10bn loss after everything unwinds, then this is not a problem of liquidity or transparency; it is one of solvency. In other words, the banks and the primary dealers are stone-cold on the button if they are sitting on their hands, because institutions are going to go under when these securities are not repaid.

What can the Fed do about this? Nothing. And this is a famous Taleb dilemma.

"Well, it's one of two possibilities out there. If it's (a) then we are fucked anyway, so we might as well assume that it's (b), to which there is at least some kind of possible solution". The trouble is, making this assumption is fair enough, but it doesn't make it any more likely that (b) is true.


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