Bernanke Is Fighting the Last War | Hacker News Reader

Bernanke Is Fighting the Last War

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72 pointsAnon8420 comments

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Re: Trust

A good book on this is Hernando de Soto's "The Mystery of Capital".

Re: Saving individual banks rather than the banking system

See the fiasco that was/is the Japanese handling of their bubble bursting.

Re: The complexity of the "toxic", complex securities

Um, er, if you can't explain your pitch in a sentence or two then you(r startup) suck(s). Oh wait. :-)

A serious failure here (which should actually be prosecuted for criminal negligence at the very least) is the fact that the various rating agencies allowed themselves to get conned into believing all of the utter bullshit spouted about these complex securities. It's their bloody job to do their own homework to rate them.

Though, of course, I should also throw in the fact that the ultimate buyers bought into blindly trusting the rating agencies instead of taking responsibility for calling BS on the ratings of things that couldn't be explained in a couple of sentences (or even a couple of pages).

Re: Central banks

Fail!

> Though, of course, I should also throw in the fact that the ultimate buyers bought into blindly trusting the rating agencies instead of taking responsibility for calling BS on the ratings of things that couldn't be explained in a couple of sentences (or even a couple of pages).

QFT. It seems like all the great investor-heroes of this century (Buffet, Philip Fisher, Peter Lynch, Bill Gross, etc.) say roughly the same thing: Buy what you understand. If you don't understand it, don't take someone else's word for it, there will be other opportunities that you do understand.

This is one of the few interesting articles on the current economic situation.

Glad you posted this - I was going to skip it otherwise. One more reason to check the comments before reading the article.

Anna seems to make contradicting statements in the article. On one hand, she seems to be a proponent of avoiding "moral hazard", i.e. the government should let financial entities which made bad decisions fail. On the other hand, she appears to support Paulson's original proposal to buy up the toxic assets.

She says that the basic problem is that we don't know how to value these toxic assets. If we value them at the current market price, it would mean many banks are insolvent (euphemism for broke).

So buying up toxic assets is not incompatible with letting banks fail; if we pay market price, purchasing these assets may reveal a number of banks who are broke by removing unknowns from their balance sheet.

By switching to recapitalizing (euphemism for giving them money), we make no progress in removing unknowns from the balance sheet. This is why we're hearing about banks who are hoarding the capital instead of lending it -- they still don't know if they're broke or not.

But why does the government need to get involved then? Let the market determine market rates which is only determined by actual transactions. Most likely someone in the market will buy the toxic assets, but not for face value. Because of the uncertainty, someone may only pay $0.10 on the dollar. The financial firms, however, are waiting to see if they can get a better deal/hand-out from the government.

If the government made it clear that these businesses were on their own, then they would be forced to sell the assets at market rate, i.e. the amount the market is willing to pay for them.

If that's not enough, then as Anna implies, then they deserve to fail.

I certainly agree that the market should determine the value of the assets, even if they turn out to be worth 1/10th of what the banks would like them to be worth -- that's life.

The problem is that if the banks don't like the market price, they don't have to sell. As long as they hold the assets, the credibility of their balance sheets may be in question, but why sell the assets for cheap and prove their own insolvency. As I understand it, this is the current gridlock.

the lehman credit-default swap (cds) auction a week ago friday (oct 10) brought 9.75 cents on the dollar:

http://blogs.wsj.com/marketbeat/2008/10/10/lehman-bonds-pric...

There was a good article posted here a couple of days ago (can't find the link now) that argued that the difference is that the government can afford to buy the assets at above the market rate, because they can take a long-term view and hold them to maturity. The banks can't do that, though, they must value at market value and need to be able to trade them at a reasonable rate. The question then, of course, is how to estimate the hold-to-maturity value.

Buying them up at market rate, as you say, would just make all the businesses fail. The whole problem is that the market value is almost certainly not an accurate indicator of the intrinsic value of these investments at the moment.

that seems to be the case with all leaders.

Learning from history seems to be very hard for people. We seem to repeat our mistakes somehow allowing ourselves to be under the illusion that it is different this time around. A lot of people don't seem to believe what she is saying is true and actually believe in the contrary that the current crisis is because of free market capitalism.

What most people don't know is that we didn't have one in the first place. Fannie Mae was a Govt. Sponsored Enterprise, started by FDR, and is one of biggest problems in the present crisis. Various Senators and Congressmen were pressuring Fannie Mae to make these horrible bets on the real estate market. This is not an isolated case, the government has been interfering in the market a lot more than it should have and in a bad way.

I think it's time to dismiss one of the falsehoods perpetuated by MSM and this article: that the main reason why the credit market is seizing is because banks do not trust each other.... wrong! the real reason is they either don't have any spare cash or that they have no more risk appetite to lend.

The UK market would make for a good case. With interbank lending guarantee by the govt, you would expect the credit markets to resume flowing, but it has not materialized. The banks have made a decision to lend less and deleverage.

So don't expect the capital injection by Paulson to make the banks start lending. They won't. Which is why the Fed will have to go into the markets and be the direct lender (which is what they did in the commercial paper market)

You wrote: it's not " do not trust each other", it's "have no more risk appetite" - those are the same thing! You are directly contradicting yourself in the same paragraph.

You wrote "[the problem is] ... don't have any spare cash" and "don't expect the capital injection [to fix it]", which is again a self contradiction.

So sorry, I think I'm going to trust MSM (or at least this article) and not you.

No. It's not the same thing.

Eg. Usually I loan out $1 billion. But now, my risk appetite is smaller because of my desire for a smaller leveraged balance sheet, hence i will loan out only $100 million.

So even if I trust that you are able to pay back the loan, I will no longer lend to you because I have no desire to lend so much anymore. The overall credit supply decreases.

Maybe my initial post was not clear, I believe the main reason for the tight market is this: Constriction of desired leverage -> Decreased credit supply

Eg. Assuming the precrisis loan-to-cash mean leverage is 500%, USD 100 billion of cash can yield USD 500 billion of loan supply in the credit market. Now, the loan-to-cash mean leverage is about 200%, so the same USD 100 billion of cash will yield only USD 200 billion of loan supply. Thus, the Fed has to print a lot more cash to restore the precrisis credit supply. The announced capital injection is not enough. They have to inject a lot more. If they don't wish to print that much cash, the Fed can be the direct lender and assume the precrisis leverage themselves.

Here's a good article that explains it all: http://www.bbc.co.uk/blogs/thereporters/robertpeston/2008/10...

Except that loan amounts are not decreasing:

http://www.cato.org/pub_display.php?pub_id=9685

If you want to see the actual data, check here:

http://www.federalreserve.gov/releases/h8/data.htm

loan amounts are not decreasing

Yes. But because of decreased supply, the cost of borrowing is higher now.

But a higher borrowing cost is not a problem unless it is so prohibitively high that it prevents lending, which, judging by the relatively steady loan amounts, it has not.

The necessary supply of funds is there, it's just that no one trusts anyone, so they are charging lots more for the risk.

For an analogous situation, consider this: The Fed decides to institute a lottery, where they pick a random bank every day. Whichever bank is picked gets shut down, and all their creditors and depositors get nothing. This is obviously very bad for whichever bank is picked, and bad for anyone who lent money to that bank. No one knows who is going to be next, so they charge everyone higher rates to account for the risk. There is still plenty of money to lend, and there is still a market for the loans, it's just that there is extra risk of a random insolvency event.

In the real world, the illiquid and non-transparent Asset Backed Securities are like the Fed lottery, in that, by marking them to market, all it takes is one lowball transaction by third parties to crater a bank's balance sheet, forcing it into insolvency. Since no one knows who still is at risk, they are charging higher rates. It's not because they don't have the money to lend, it's because it is better to have the money sit idle than to lose it. (And in the case of some banks, it is better to have cash on hand in case their own asset-backed securities become worthless. Even lending it to a perfect borrower is riskier in that case, because even if the borrower can repay, it's no good to the bank if they need the cash in a pinch.)

it is better to have cash on hand in case their own asset-backed securities become worthless. Even lending it to a __perfect borrower__ is riskier in that case, because even if the borrower can repay, it's no good to the bank if they need the cash in a pinch.

In other words, the issue here is that the banks are reducing their leverage and not because they don't trust each other, which is my main point. If the Fed inject so much money into the banks that they can afford a few loan defaults here and there, the credit market will start to go back to precrisis levels. An interbank lending guarantee without the capital injection won't help much.

Conversely, if the Fed sets a price for troubled assets, each bank will know where they stand, and they won't have to hoard cash any more. Those banks that made bad decisions will fail, as they should, and those that didn't will see confidence in them restored.

A direct capital injection offers blanket protection to all banks, good and bad, and does nothing to discourage this from happening in the future.

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