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"ECB, you wankers", says BoE Governor.
Sep. 13th, 2007 10:42 amWell, Mervyn King didn't actually say it, not quite in those terms, but here we had a marvellous example of "short-term gain breeds long-term loss".
As you may recall, about a trillion dollars of commercial paper comes due every month. Usually it's rolled over, and everyone's happy, and no-one mentions it, because it's boring. This week was a particularly "heavy" week, with about $500m in paper coming due. One could even argue that, if we get through this week, we'll get through it all. Although that doesn't stop the worry that the crisis, like Foot and Mouth, might pop up elsewhere, or metastasize into some kind of completely different crisis.
So, why is King calling the ECB a bunch of tossers?
Basically, because the ECB, not happy with throwing liquidity into the market for overnight business when it needed to, has decided by the law of extension that it should do the same for three-month markers (sic) — putting €75bn into the three-month system. The ECB said that it was doing this to support a normalisation of the functioning of the euro money market.
One question that this begs is, who decides what is "normal"? Just because the whole thing is a mess of chaos, that doesn't mean that it isn't "normal". You might just as well institute controls of weather patterns whenever there is a thunderstorm, or lightning.
But King does not concern himself with such etymological niceties. King is more concerned with the metagame. As King said in a letter to the Commons Treasury Select Committe (and one hopes he cc'ed the ECB in on this):
Spot on, Mervyn. He went on to say that central banks should not make cash injections solely to maintain the status quo, because this presupposes that the status quo is good. Sometimes it isn't.
But that's just icing. The main point is that the ECB is making the standard mistake made by mainland European financial institutions, governments, local governments and everyone else bar the owners of football teams. Petrified by the rise of fascism between the wars, they will do anything to stop "sudden" change.
However, sometimes disconnects happen. Gradualism is not necessarily the only way. Sometimes there are improvements that can only be brought about by crises. The short-term pain generates a longer-term good.
Of course, the banks that promised to honour credit lines that they hoped they would never be forced to honour, are (quietly) screaming blue murder at this. They want to be bailed out, and their weapon is "if you don't bail us out, the whole system will collapse. It could cause a full-blown recession". To which I hope King replies "Fuck off you lying twats. You've been caught with your pants down. You won't go broke. Act like a man and stop crying to mummy."
Now, the ECB isn't dumb, and neither is the Fed. They understand moral hazard. They know the risks they are taking. But they cannot accept any short-term pain. They value the "now" far more than the "might be in the future", even if the "might be in the future" has a probability approaching 100%. This is the flip-side of transparency, the difficulty of taking unpopular decisions when politicians are only worried about the next election, not some vague concept of "moral hazard" five or six years down the line.
But I think that King will win. The banks can stand the pain. They just don't want to.
++++++++++
The intricacies of the CDO market are gradually becoming clearer, although the actual numbers are not.
Now that we are a few weeks down the line, the overnight rate has "spread" to the three-month rate. In other words, the arbitrage opportunities are lower, the problem has diffused, but things are still a mess. While punters ponder the state of Northern Rock, the lender with no depositors, the most interesting action of the week was Joseph Lewis's purchase of a big stake in Bear Stearns. Joe Lewis knows what he is doing. He must think that Bear Stearns' is cheap and fundamentally sound.
Anyhoo, another interesting revelation was that the "warehousers" were feeling the pinch. Now, this is the really complex nuts-and-bolts stuff that the men in suits probably don't bother themselves with. It's a bit like having someone to make the tea. You just know whether the tea is any good or not, but don't concern yourself with the intricacies of its construction.
Basically, you have the debts, and these are turned into collateralised debt obligations. But the debts are not issued all at the same time.
In addition, like news stories, or parties, or poker games, CDOs do not magically organize themselves. Someone (usually unnoticed and unappreciated) has to bring the assets together, store them in a metaphorical financial warehouse, restructure them, and sell them on. In terms of transparency, no-one has the faintest fuck of an idea how many of these loans were sitting in warehouses, waiting to be packaged. But if the CDOs are pulled, those loans have to be sold, and at a discount. This could explain why the banks are not getting the money that they want for the debts they are hawking. There are warehousers out there, selling debt, and selling it quietly. I bet a few 92 cents on the dollar trades have gone through, rather than the advertised 95 cents on the dollar.
So, who are our main marketers of collateralized loan obligations? The predictable names - Citigroup, Deutsche Bank, Lehman Bros, bear Stearns, JP Morgan, Merrill Lynch - plus a few unknown names. The question is, how much of the risk did these marketers keep for themselves, and how much was held by the operations that put together the structure? In absolute terms, this is just a small part of the cash that is being rolled over. It's a different area from the fact that interbank loan rates are now spreading far higher than official base rates. What this is about is "how likely are these debts to be repaid and how desparate are the sellers?" Indeed, the prices at which the debts are being traded (92%? 94%?) are probably the best indicator of how desperate the sellers are and how safe the debts being traded are. But this is not an open market. There are no market-makers in distressed debt sales. We just don't know.
++++++++++
I made a quick visit to the Doyle's Room Appreciation Party last night, leaving just as Doyle was arriving (thus sparing me the doubtless cringe-making announcement of his entry and the obligatory round of applause, I guess). I only went in because I felt that, having found the place despite an incorrect address (solution, enter casino and ask Brunson's PA) I might as well blag my way in, despite not being on the list. I don't like blagging my way into things uninvited, even if I'm not nicking free booze. But Kieran persuaded me.
And I did get a goodie bag from it. Nothing sensational, the normal stuff. But one more tee-shirt to wear.
____________________
As you may recall, about a trillion dollars of commercial paper comes due every month. Usually it's rolled over, and everyone's happy, and no-one mentions it, because it's boring. This week was a particularly "heavy" week, with about $500m in paper coming due. One could even argue that, if we get through this week, we'll get through it all. Although that doesn't stop the worry that the crisis, like Foot and Mouth, might pop up elsewhere, or metastasize into some kind of completely different crisis.
So, why is King calling the ECB a bunch of tossers?
Basically, because the ECB, not happy with throwing liquidity into the market for overnight business when it needed to, has decided by the law of extension that it should do the same for three-month markers (sic) — putting €75bn into the three-month system. The ECB said that it was doing this to support a normalisation of the functioning of the euro money market.
One question that this begs is, who decides what is "normal"? Just because the whole thing is a mess of chaos, that doesn't mean that it isn't "normal". You might just as well institute controls of weather patterns whenever there is a thunderstorm, or lightning.
But King does not concern himself with such etymological niceties. King is more concerned with the metagame. As King said in a letter to the Commons Treasury Select Committe (and one hopes he cc'ed the ECB in on this):
The provision of large liquidity facilities penalises those financial institutions that sat out of the dance, encourages herd behaviour and increases the intensity of future crises".
Spot on, Mervyn. He went on to say that central banks should not make cash injections solely to maintain the status quo, because this presupposes that the status quo is good. Sometimes it isn't.
But that's just icing. The main point is that the ECB is making the standard mistake made by mainland European financial institutions, governments, local governments and everyone else bar the owners of football teams. Petrified by the rise of fascism between the wars, they will do anything to stop "sudden" change.
However, sometimes disconnects happen. Gradualism is not necessarily the only way. Sometimes there are improvements that can only be brought about by crises. The short-term pain generates a longer-term good.
Of course, the banks that promised to honour credit lines that they hoped they would never be forced to honour, are (quietly) screaming blue murder at this. They want to be bailed out, and their weapon is "if you don't bail us out, the whole system will collapse. It could cause a full-blown recession". To which I hope King replies "Fuck off you lying twats. You've been caught with your pants down. You won't go broke. Act like a man and stop crying to mummy."
Now, the ECB isn't dumb, and neither is the Fed. They understand moral hazard. They know the risks they are taking. But they cannot accept any short-term pain. They value the "now" far more than the "might be in the future", even if the "might be in the future" has a probability approaching 100%. This is the flip-side of transparency, the difficulty of taking unpopular decisions when politicians are only worried about the next election, not some vague concept of "moral hazard" five or six years down the line.
But I think that King will win. The banks can stand the pain. They just don't want to.
++++++++++
The intricacies of the CDO market are gradually becoming clearer, although the actual numbers are not.
Now that we are a few weeks down the line, the overnight rate has "spread" to the three-month rate. In other words, the arbitrage opportunities are lower, the problem has diffused, but things are still a mess. While punters ponder the state of Northern Rock, the lender with no depositors, the most interesting action of the week was Joseph Lewis's purchase of a big stake in Bear Stearns. Joe Lewis knows what he is doing. He must think that Bear Stearns' is cheap and fundamentally sound.
Anyhoo, another interesting revelation was that the "warehousers" were feeling the pinch. Now, this is the really complex nuts-and-bolts stuff that the men in suits probably don't bother themselves with. It's a bit like having someone to make the tea. You just know whether the tea is any good or not, but don't concern yourself with the intricacies of its construction.
Basically, you have the debts, and these are turned into collateralised debt obligations. But the debts are not issued all at the same time.
In addition, like news stories, or parties, or poker games, CDOs do not magically organize themselves. Someone (usually unnoticed and unappreciated) has to bring the assets together, store them in a metaphorical financial warehouse, restructure them, and sell them on. In terms of transparency, no-one has the faintest fuck of an idea how many of these loans were sitting in warehouses, waiting to be packaged. But if the CDOs are pulled, those loans have to be sold, and at a discount. This could explain why the banks are not getting the money that they want for the debts they are hawking. There are warehousers out there, selling debt, and selling it quietly. I bet a few 92 cents on the dollar trades have gone through, rather than the advertised 95 cents on the dollar.
So, who are our main marketers of collateralized loan obligations? The predictable names - Citigroup, Deutsche Bank, Lehman Bros, bear Stearns, JP Morgan, Merrill Lynch - plus a few unknown names. The question is, how much of the risk did these marketers keep for themselves, and how much was held by the operations that put together the structure? In absolute terms, this is just a small part of the cash that is being rolled over. It's a different area from the fact that interbank loan rates are now spreading far higher than official base rates. What this is about is "how likely are these debts to be repaid and how desparate are the sellers?" Indeed, the prices at which the debts are being traded (92%? 94%?) are probably the best indicator of how desperate the sellers are and how safe the debts being traded are. But this is not an open market. There are no market-makers in distressed debt sales. We just don't know.
++++++++++
I made a quick visit to the Doyle's Room Appreciation Party last night, leaving just as Doyle was arriving (thus sparing me the doubtless cringe-making announcement of his entry and the obligatory round of applause, I guess). I only went in because I felt that, having found the place despite an incorrect address (solution, enter casino and ask Brunson's PA) I might as well blag my way in, despite not being on the list. I don't like blagging my way into things uninvited, even if I'm not nicking free booze. But Kieran persuaded me.
And I did get a goodie bag from it. Nothing sensational, the normal stuff. But one more tee-shirt to wear.
____________________
