Bear Stearns...

[crackerjack]

It's just reminded me of that story a few years back when someone (can't remember who) from the Republican right suggested investors should be able to speculate on the probability of terrorist attacks, the thinking being since the stock market knows everything they would provide an effective gauge of the imminence or otherwise of the next 9/11. Of course, what the idiot never contemplated was the likelihood the 'buyers' would do the deed themselves. Obviously never watched enough Bond movies.

 

[vimothy]

Could you explain the solvency/liquidity thing for me as I was a little confused.

"If you think its liquidity, then the Fed's doing what it should. If you think it's solvency, then there's not really any point in the Fed cutting rates".

Think of it like this:

Liquidity -- if you have lots of assets, say money in the bank, but not in your wallet, then you are illiquid but solvent, i.e. you could potetially pay for your meal, but don't have the cash (liquidity) to do so right now.

Solvency -- the ability to meet long-term expenses. You might be liquid enough to be able to pay for your meal if, say, you'd just been loaned money from the Fed, but be fundamentally insolvent, i.e. skint and in piles of debt you can't pay back.

What's going on right now is referred to as a liquidity crises because everyone's getting nervous about their money -- they all want it back because no one trusts anyone else, seemingly because they're all a bunch of untrustworthy cunts. If banks are liquid enough (which is hard if everyone is doing this at the same time, because banks are all highly leveraged), then this is no problem, if not...

(This is a guess and an oversimplification, but seems correct) Bear Stearns' creditors wanted all their money back at the same time, and the bank wasn't liquid enough to achieve this, so it defaulted on its loans and everything went bad. But its assets (i.e. the loans it had made) were/are not necessarily worth anything less, it simply couldn't make its short-term payments. (Not unlike Northern Rock, in that repsect -- Northern Rock funded itself using lots of short-term loans, which was all fine when there was lots of credit, but not so good come this crisis).

So, re the Fed: if liquidity is the problem, cut the rates at which banks can borrow. If liquidity isn't the problem but sovency is, cutting the Fed Funds Rate won't make any difference, because the banks will just be taking on more debt that they can't afford.

 

[vimothy]

It's just reminded me of that story a few years back when someone (can't remember who) from the Republican right suggested investors should be able to speculate on the probability of terrorist attacks, the thinking being since the stock market knows everything they would provide an effective gauge of the imminence or otherwise of the next 9/11. Of course, what the idiot never contemplated was the likelihood the 'buyers' would do the deed themselves. Obviously never watched enough Bond movies.

Paul Volker had this to say on the Charlie Rose show, and I think he's onto something:

Rose: Somebody said to me that we entered a period in which they were worshiping mathematical models … And mathematical models had no business sense.

Volcker: The market was being run by mathematicians that didn’t know financial markets. And you keep hearing, you know, god, that event should only happen once every hundred years, according to my model. But those every hundred years events are coming along every two or three years, which should raise some questions.​

 

[polystyle]

This whole mess is confusing to just about everyone !
Dogs eating dogs, predators and prey , bailouts for big 'uns ,lumps for the little ones.

 

[IdleRich]

"So, re the Fed: if liquidity is the problem, cut the rates at which banks can borrow. If liquidity isn't the problem but sovency is, cutting the Fed Funds Rate won't make any difference, because the banks will just be taking on more debt that they can't afford."

But it seems to be two things doesn't it? I mean, banks aren't lending because the other banks aren't lending which is a vicious circle the Fed is trying to break by sticking more money in and loosening credit. But the original reason that banks stopped lending is because they do not know which of their potential debtors may have exposure to dodgy loans which may turn out to be worthless. The problem is that if I think that there is an unquantifiable chance that someone may not be able to pay me back at all, I'm not going to lend them money however cheaply I can borrow to fund that loan.

 

[vimothy]

But it seems to be two things doesn't it?

What tipped Bear Stearns over the edge? Why did their rating get changed -- was it exposure to some other collapsing fund?

EDIT: from the Guardian:

So while attention in the UK last Wednesday was firmly on the budget, pressure was again building in the markets. Rumours swirled around hedge funds and in particular a mortgage-backed securities fund floated by the leading US private equity firm Carlyle. Concerns over the exposure of Bear Stearns to Carlyle and other hedge funds ensured that its shares were again sold heavily.

In less troubled times, Wall Street might have rallied round Carlyle, but the mood last week was one of "every man for himself". On Thursday the Carlyle fund was allowed to collapse. The dollar fell to record lows against the euro, dropped through 100 yen for the first time in 12 years, and on Wall Street the wolves gathered around Bear Stearns.

The Fed and the US treasury started to become seriously alarmed. A falling dollar did not only threaten to push up inflation, it was also a slap in the face to the sovereign wealth funds that had helped bail out some of Wall Street's leading investment banks in the wake of the sub-prime crisis. What's more, Bear Stearns was no hedge fund: it was America's fifth biggest investment bank. All week the bank had been insisting that the rumours about its health were groundless.

Wall Street ignored the attempts at reassurance. Shares in Bear Stearns collapsed and its ability to find access to funds that would tide it over until the following day dried up. Faced with a Northern-Rock style collapse, the president of the New York Federal Reserve, Timothy Geithner, started orchestrating a deal whereby JP Morgan would channel emergency funding from the Fed to rescue Bear Stearns.

The news broke before Wall Street opened on Friday and was greeted with predictable mayhem. It was, however, only the start of a weekend that would eventually see an agreement to sell Bear Stearns - worth $160 a share at its peak last year - to JP Morgan for just $2 a share.​

 

[jenks]

Isn't that the ridiculous point - if it were your money you wouldn't lend to soemone who is less likely to be in a position to pay it back (unless you are doing it charitably). Yet the banks have actually cultivated people who really shouldn't be lent money. Is this the consequence of the end of state sponsored housing and expectation of all to own their own houses whether they have the wherewithal or not? Or the greed of buy to let gone bad?

What then makes it worse is the selling on of this debt to others (like the money lenders in 19th C novels who sell on bonds etc that the hero has signed to help a friend out - the debts are called in and the hero falls)

Volcker: The market was being run by mathematicians that didn’t know financial markets. And you keep hearing, you know, god, that event should only happen once every hundred years, according to my model. But those every hundred years events are coming along every two or three years, which should raise some questions.

I just read something similar last night in Black Swans about the market's inability to predict 'events' because they are always looking backward - modelling on what has happened rather than waht is coming up over teh horizon

 

[vimothy]

I just read something similar last night in Black Swans about the market's inability to predict 'events' because they are always looking backward - modelling on what has happened rather than waht is coming up over teh horizon

Totally excellent book, btw! Not too sure about your other points.

 

[jenks]

Yeah i am enjoying it - could do with a little bit less of the egotistical 'me, me, me' in it!

 

[IdleRich]

"What tipped Bear Stearns over the edge? Why did their rating get changed -- was it exposure to some other collapsing fund?"

Who knows? Can you say how much was down to rumour, how much to systematic bad practice and how much was down to big events like that one.

"Isn't that the ridiculous point - if it were your money you wouldn't lend to soemone who is less likely to be in a position to pay it back (unless you are doing it charitably). Yet the banks have actually cultivated people who really shouldn't be lent money. Is this the consequence of the end of state sponsored housing and expectation of all to own their own houses whether they have the wherewithal or not? Or the greed of buy to let gone bad?"

I think it's the consequence of the fact that all the good loans had been made so people competed to do the bad loans. Also, the loans were predicated on the idea that house prices would always go up so if there was a default they could get the house back and still be quids in. If you offer people money they are always going to take it especially with that home-owning expectation you mentioned.

"I just read something similar last night in Black Swans about the market's inability to predict 'events' because they are always looking backward - modelling on what has happened rather than waht is coming up over teh horizon"

Thought of that book when I read that bit. Gonna have to read it I guess.

When options trade they trade on a price that is based on their volatility - but far out of the money puts trade at a higher implied volatility than other puts even though they are based on the same stock. This is called skew and some people think it's an implicit recognition that large (downwards) stock moves occur with more frequency than models predict (it may also be because hedge funds buy lots of them as insurance and this means they trade at a higher price).

 

[vimothy]

Who knows? Can you say how much was down to rumour, how much to systematic bad practice and how much was down to big events like that one.

What I want to know is, what are the value of the loans that JP Morgan Chase "bought" (maybe "acquired" is more appropriate), what state are BCS' assets in. If you read through the conference call transcript (if I remember correctly), JP Morgan seem to think they're priced accurately. I wonder then what the expected return to capital is on these. Must be truly massive, and the Fed is taking all or most of the downside risk.

 

[vimothy]

Carlylse Capital still trading!

Bernanke -- is he trying to devalue his way out of the crisis?

And for anyone having trouble with all this, here's a good primer in the NYT.

 

[jenks]

This also by Lanchester in London review of Books is quite good, although I still had to read it twice:

http://www.lrb.co.uk/v30/n01/lanc01_.html

 

[DWD]

Good thread!

I've got one observation to share: everyone's been very quick to blame the banks in this crisis. When the banks haven't been blamed, it's been the fault of greedy investors, or naive borrowers, or disingenuous credit rating agencies - or even the central banks.

But no one's blaming the accountants yet, and they definitely deserve a share - perhaps even the lion's share. Why? Well, the banking industry has reported something like an aggregate $120bn loss so far as a result of this crisis. But the majority of that loss has come in the form of write-downs. In other words, banks are devaluing assets that they hold and are forced by current accounting standards to report the change in value as an actual loss. This is a fairly recent change of accounting regime.

It seems fair enough, in principle - but this form of accounting doesn't cope very well with a liquidity crisis. Many of these assets are actually still performing - the loans are being repaid, and money is flowing to the owner of the debt as intended. But because expectations of default have risen massively and no-one wants to buy these assets any more, their value has fallen to a fraction of what it was a year ago. The market for them barely exists any more.

As a result, the assets may well be substantially undervalued. And banks have to report that as a loss. Which freaks the market out a little bit more, scares investors away from buying any of these assets, cutting their value further and prompting more write-downs. It's a vicious circle.

If Bear Stearns had a secure non-market dependent source of funding (as with Northern Rock and the BofE) and had been able to simply sit on its assets and wait for the crisis to subside, they'd have been laughing. As it was, it's JP Morgan that's going to benefit from the current mispricing of risk.

And it's all the fault of those fucking accountants!

Who's with me?

 

[DWD]

This also by Lanchester in London review of Books is quite good, although I still had to read it twice:

http://www.lrb.co.uk/v30/n01/lanc01_.html

Thanks for posting that. Even if it is just another "derivatives are complex and dangerous" article, at least it's a well-written one.

 

[vimothy]

Good thread!

I've got one observation to share: everyone's been very quick to blame the banks in this crisis. When the banks haven't been blamed, it's been the fault of greedy investors, or naive borrowers, or disingenuous credit rating agencies - or even the central banks.

Not quite... I think that banks are responsible whern they misprice risk, and I don't think that shareholders & execs should be able to pocket gains while nationalising losses. But lots of this is, as you kinda suggest, self-perpetuating.

And it's all the fault of those fucking accountants!

That would be regulation, no?

 

[IdleRich]

"And it's all the fault of those fucking accountants!

Who's with me?"

Good points but it is it the fault of the accountants or the rules that they have to follow?

Also, no-one has blamed the credit ratings agencies (well they have but not in this thread).
I mean, you can't blame someone for grabbing with both hands their first opportunity to buy a house. You can't fault the business sense of giving such a person a loan IF you can shift that loan off your books straight away (although it may be immoral). You can't put too much blame on the people buying the loan if it's been assessed as solid by an independent agency. To me, the agencies haven't done their job. They've just gone "yeah, it's fine" and stood back and watched as they've been proved totally wrong. Luckily for them they don't have to wear it and there is no comeback for people who trusted them. Their credibility ought to be in tatters now.

 

[crackerjack]

Also, no-one has blamed the credit ratings agencies (well they have but not in this thread).
I mean, you can't blame someone for grabbing with both hands their first opportunity to buy a house. You can't fault the business sense of giving such a person a loan IF you can shift that loan off your books straight away (although it may be immoral). You can't put too much blame on the people buying the loan if it's been assessed as solid by an independent agency. To me, the agencies haven't done their job. They've just gone "yeah, it's fine" and stood back and watched as they've been proved totally wrong. Luckily for them they don't have to wear it and there is no comeback for people who trusted them. Their credibility ought to be in tatters now.

What do you mean by credit ratings agencies? I thought they just told a bank/mortgage company whether or not mr x had a history of defaulting on loans etc. If mr x has a spotless history but has been lent 6 times his salary, that's the mortgage company's fault, surely.

 

[IdleRich]

"What do you mean by credit ratings agencies? I thought they just told a bank/mortgage company whether or not mr x had a history of defaulting on loans etc. If mr x has a spotless history but has been lent 6 times his salary, that's the mortgage company's fault, surely."

I mean things such as S&P or Moody's that are supposed to give a value to securities. From (what else) wikipedia

"A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations. In most cases, these issuers are companies, cities, non-profit organizations, or national governments issuing debt-like securities that can be traded on a secondary market. A credit rating measures credit worthiness, the ability to pay back a loan, and affects the interest rate applied to loans. (A company that issues credit scores for individual credit-worthiness is generally called a credit bureau or consumer credit reporting agency.)"

http://en.wikipedia.org/wiki/Credit_rating_agency

 

[DWD]

Not quite... I think that banks are responsible whern they misprice risk

I don't think it's that simple. As with any market, it's not just the seller that determines the price. Banks weren't forcing this down investors' throats. In addition, banks weren't just selling this stuff - they were buying it too.

For another, although the risk associated with the riskier slices of subprime mortgage securities was definitely mispriced (by lenders, investors and rating agencies), I'm less convinced that the risk associated with senior and super-senior debt was off - like I said, actual defaults still haven't eaten into a lot of this paper. But because everyone's terrified that losses will emerge there, no-one's willing to buy it. The market as a whole has effectively repriced the risk, and the pendulum may well have swung too far the other way - but banks are the only ones who have to recognise this repricing by reporting it as a loss.

That would be regulation, no?

That's right. Is it good regulation, though?