Here's an article about the proposed new powers of the Fed.
http://www.bloomberg.com/apps/news?pid=20601068&sid=aZ8kIhVPApw8&refer=home
The proposal includes combining the Office of the Comptroller of the Currency and the Office of Thrift Supervision, transferring state bank regulation to the FDIC, and expanding the Fed's legislated "lender of last resort" function.
It also includes the establishment of three new regulators: the prudential financial regulator, the business conduct regulator, and the corportate finance regulator.
Some would assert that a reason behind the current financial turmoil was the increased regulations on banks that created incentives to expand the use of these new financial derivatives. So regulation may have gotten us into this, but let's see if it can get us out of this.
Let me know what you think.
Saturday, March 29, 2008
Monday, March 17, 2008
What happend to the Bear?
This latest worry for the Fed stems from the essential collapse of Bear Stearns, one of the largest U.S. investment banks.
Some of the trouble for Bear Stearns stemmed from the Global Legal Settlement of 2002 in which the 10 largest investment banks were barred from combining research and underwriting activities and required to pay substantial fines. Bear Stearns' original fines were approximately $80 million. The investment bank did have some insurance to help with the penalties except they management of Bear Stearns signed the Settlement agreement without talking to its insurers first as their contract stated. So there was $45 million of the penalty that Bear expected would come from insurers, but the insurers felt they hadn't been given sufficient notice. So, the two sides went to court.
Late last week, a NY appeals court ruled that the insurance companies were not responsible for that $45 million. So, Bear Stearns would now have to pay the $45 million penalty out of their own pockets. Worried that the investment bank would not be able to do so, shareholders got out fast. It was a fire sale on Bear Stearn shares dropping from a price of $68 per share on Tuesday, to under $30 per share on Friday to a buyout by JP Morgan on Sunday for $2 per share.
The problem for Bear Stearns is the same as all firms in today's securities markets - asymmetric information. Savers are having a hard time determining the risk of banks, investment banks, and publicly traded companies. With an increase in uncertainty comes an increase in the lemons problem. Without being able to tell stable investment banks from unstable, savers choose to pull back their lending.
The risk that this will spread is high. The increase in adverse selection problems after Bear Stearns has stopped most bank-to-bank lending. The interbank and federal funds markets are not functioning well. Those banks with reserves to lend are holding on to them for fear of getting a lemon.
Some of the trouble for Bear Stearns stemmed from the Global Legal Settlement of 2002 in which the 10 largest investment banks were barred from combining research and underwriting activities and required to pay substantial fines. Bear Stearns' original fines were approximately $80 million. The investment bank did have some insurance to help with the penalties except they management of Bear Stearns signed the Settlement agreement without talking to its insurers first as their contract stated. So there was $45 million of the penalty that Bear expected would come from insurers, but the insurers felt they hadn't been given sufficient notice. So, the two sides went to court.
Late last week, a NY appeals court ruled that the insurance companies were not responsible for that $45 million. So, Bear Stearns would now have to pay the $45 million penalty out of their own pockets. Worried that the investment bank would not be able to do so, shareholders got out fast. It was a fire sale on Bear Stearn shares dropping from a price of $68 per share on Tuesday, to under $30 per share on Friday to a buyout by JP Morgan on Sunday for $2 per share.
The problem for Bear Stearns is the same as all firms in today's securities markets - asymmetric information. Savers are having a hard time determining the risk of banks, investment banks, and publicly traded companies. With an increase in uncertainty comes an increase in the lemons problem. Without being able to tell stable investment banks from unstable, savers choose to pull back their lending.
The risk that this will spread is high. The increase in adverse selection problems after Bear Stearns has stopped most bank-to-bank lending. The interbank and federal funds markets are not functioning well. Those banks with reserves to lend are holding on to them for fear of getting a lemon.
Fighting a Financial Crisis
The Federal Reserve made the bold move this weekend to extend the discount window to investment banks. The Fed's lender-of-last-resort function is normally reserved for commercial banks and bank holding companies.
In an attempt to calm the financial markets after the essential collapse of Bear Stearns, the Fed has extended this safety net to investment banks as well. At the same time, the Fed lowered the discount rate to 3.25% only 25 basis points above the current federal funds target although the target is expected to be lowered at the meeting on Tuesday. It is not clear how long the Fed expects to maintain this reduction in the premium on discount loans.
Investment banks are large players in the smooth functioning of financial markets. Until this new lending facility from the Fed, these investment houses did not have a government safety net. I believe the Fed is hoping that the availability of support from the Fed will decrease the uncertainty plaguing these investment banks to the extent that the loans will not even be needed. After all, the last time the Fed took steps to extend the discount window was when the markets tumbled after September 11, 2001. The availability of support from the Fed was enough to calm the market and very few loans were actually extended.
The fundamental question: Will all this frantic activity by the Fed instill confidence or increase uncertainty?
Let me know what you think.
In an attempt to calm the financial markets after the essential collapse of Bear Stearns, the Fed has extended this safety net to investment banks as well. At the same time, the Fed lowered the discount rate to 3.25% only 25 basis points above the current federal funds target although the target is expected to be lowered at the meeting on Tuesday. It is not clear how long the Fed expects to maintain this reduction in the premium on discount loans.
Investment banks are large players in the smooth functioning of financial markets. Until this new lending facility from the Fed, these investment houses did not have a government safety net. I believe the Fed is hoping that the availability of support from the Fed will decrease the uncertainty plaguing these investment banks to the extent that the loans will not even be needed. After all, the last time the Fed took steps to extend the discount window was when the markets tumbled after September 11, 2001. The availability of support from the Fed was enough to calm the market and very few loans were actually extended.
The fundamental question: Will all this frantic activity by the Fed instill confidence or increase uncertainty?
Let me know what you think.
Wednesday, March 12, 2008
If at first you don't succeed, try, try again.
On Tuesday, the Fed announced its latest effort to ease the credit crunch in the banking sector. It has created a Term Securities Lending Facility. Through the TSLF, the Fed will auction $200 Billion in U.S. Treasury securities to the commercial banks that deal with the Fed. These securities will be on a 28-day loan. The new and interesting dynamic is that the collateral for the loan can now include mortgage-backed securities.
On Friday, the Fed also increased its Term Auction Facility by $100 Billion. The drawback of the TAF is that the FOMC must conduct open market operations to offset the decrease in the federal funds rate from more reserves in the banking system. With the TSLF, the Fed is aiming to ease liquidity problems without pumping cash into the economy which fuels inflation.
This new facility will allow banks some liquidity with respect to mortgage backed securities since the market for these securities has precious few buyers lately. Although it increases liquidity, it does not alleviate the underlying adverse selection problem that has caused banks to pull back their lending. It most likely will not lead to looser lending practices. Therefore it's unlikely to help businesses struggling to find funds for investment.
At the same time, the Fed's announcement of this new tool a week before their next FOMC meeting would suggest a smaller cut in the federal funds target. This would ease inflationary pressures but would be unwelcome in the stock market.
At the very least, we can be optimistic that they're still trying.
On Friday, the Fed also increased its Term Auction Facility by $100 Billion. The drawback of the TAF is that the FOMC must conduct open market operations to offset the decrease in the federal funds rate from more reserves in the banking system. With the TSLF, the Fed is aiming to ease liquidity problems without pumping cash into the economy which fuels inflation.
This new facility will allow banks some liquidity with respect to mortgage backed securities since the market for these securities has precious few buyers lately. Although it increases liquidity, it does not alleviate the underlying adverse selection problem that has caused banks to pull back their lending. It most likely will not lead to looser lending practices. Therefore it's unlikely to help businesses struggling to find funds for investment.
At the same time, the Fed's announcement of this new tool a week before their next FOMC meeting would suggest a smaller cut in the federal funds target. This would ease inflationary pressures but would be unwelcome in the stock market.
At the very least, we can be optimistic that they're still trying.
Sunday, March 2, 2008
Career Advice
Via Newmark's Door: Solid Career advice from Hal Varian.
Hal Varian tells the kids what to study
Q: Your job sounds extremely interesting. What jobs would you recommend to a young person with an interest, and maybe a bachelors degree, in economics?
A: If you are looking for a career where your services will be in high demand, you should find something where you provide a scarce, complementary service to something that is getting ubiquitous and cheap. So what’s getting ubiquitous and cheap? Data. And what is complementary to data? Analysis. So my recommendation is to take lots of courses about how to manipulate and analyze data: databases, machine learning, econometrics, statistics, visualization, and so on.
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