Comments on: Welfare for Wall Street, Federal Reserve-Style

By: Reinko

Reinko — Wed, 27 Feb 2008 23:35:29 +0000

I agree with Jeff H:

1) The derative positions at the Bank for International Settlements are so huge, they are just not realistic any longer.
2) The present Basel 1 system is not only deaf for derivatives but in general for lots of other ‘off balance’ items. If my info is correct, in the year 2009 the FED will go to Basel 2 but I cannot comment on that because I need to study Basel 2 further.
3) The climbing of the leverages without proper margin calls (only more leverage on what you have left) is in my view one of the most deadly details in the impending crash of this financial system.
4) After the crash even the FED will go on a regulary tour, likely it will not be Bernanke but some Volckel (I hope I spell his name right) kind of guy. I think that in this fiat money system central bankers need to be feared and not those Alan Greenspan kind of folks.
5) The present speed of bank equity destruction can be anything between 0 and 2 billion a day (under Basel 1), time will tell…

By: fuguez

fuguez — Sun, 10 Feb 2008 15:58:14 +0000

I too agree with sentiment, but not with your arguments.
Interest rates have been lowered simply to put money in bankers pockets from increased profits from interest margins rather than changes in asset prices.
Mortgage rates, credit cards and even simple deposits have all lagged the fall in rates as there is a real credit problem. Fed lowers rates; Bankers don’t. Mucho money very little risk. A State-sponsored recapitalisation of banks balance sheets.
One is always generous with someone else’s money

By: Jeff H.

Jeff H. — Sat, 09 Feb 2008 13:35:27 +0000

There is no question that the Fed has lowered rates abruptly to respond to financial system crisis, more so than to real economy crisis. The ‘meltdown’ is due to a systemic failure of risk management. This includes banks and regulators.

The core of the failure has to do with capital requirements for financial institutions. Var and RAROC systems for quantitative assessment of risk and capital have failed completely. They are based on statistical analysis, which makes no allowance for the gaming and evolution of the macro system generating the statistics. In future, the Basle capital system for banks will have been seen to have been a near total failure because of its inadequacy in dealing with derivative credit risk.

The solution for the future is to reject naive statistical models on their own, and increase capital requirements in order to accommodate more sensible approaches to the dangers of systemic leverage. Broader and deeper regulation unfortunately is inevitable. Greenspanâ€™s laissez faire approach as head technology cheerleader and head housing leverage cheerleader has been a failure. The Fedâ€™s ignorance of the risks, including their ignorance of the data, which were evolving in the mortgage markets, has been shocking.

Dealing with the current mess is a massive challenge. The Fed should be lowering rates. Yes, it does constitute a quasi-socialization of losses at the margin, but there is no choice when the best case for losses otherwise is so close to systemic catastrophe. Any inflationary concern must be tempered by the recognition that much of this is required to offset otherwise deflationary forces put in motion by the housing and credit contraction.

The system is painfully cleansing itself via credit contraction and related bank equity destruction. But the current risk management system at micro and macro levels is broken and finished. It requires a fix followed by a systemic overhaul. This unfortunately requires more government intervention at all stages.

By: stanton braverman

stanton braverman — Sun, 03 Feb 2008 01:56:44 +0000

Mr. Palley: I read your article on the Fed and the interest rates. I disagree. My view is that the Fed is lost and they just do not know what to do. Lowering interest rates will not pull us out of the depression but the Fed feels they had to do something if it only is for moral support. It was lower interest rates that led to the mess we are in. In my view lower rates will A) discourage savings at a time when we need to increase the saving rate, B) push inflation C) put added pressure on the dollar as the money supply increases and as money flows out of the US seeking higher rates of return abroad. One serious adverse affect of the drop in rates is that a number of US companies will borrow huge amounts to buy back their own stock from the market. This will give the market an artificial short term lift in price but will leave the companies in an over debt to equity situation. I have already sold off a number of my stocks because companies have announced that this is what they intend to do. One example is Home Depot who said they would borrow funds for this purpose if they could not get the price they want from selling off a subsidiary.

By: Marie Duggan

Marie Duggan — Mon, 28 Jan 2008 21:19:30 +0000

Well, this does clarify things! Given that the unemployment rate is only 5%, and the inflation rate is already 4.1%, it seemed rather odd to me that the Fed would reduce interest rates in such an drastic and urgent manner. In fact, it seemed odd that the Fed would reduce interest rates at all, going by the textbook I teach. But propping up bond prices makes more sense, given that everyone is writing that the possible downgrading of the bond insurers would be catastrophic. Now, more on that latter issue would be appreciated.

By: Bruce Gossage

Bruce Gossage — Mon, 28 Jan 2008 04:29:06 +0000

Although I agree in sentiment with the title of your essay, I’m not sure you prove it. If lower interest rates support stock prices while also having several other effects (such as leading low risk borrowers to refinance, which may ultimately hurt stock prices), then it’s not clear that it’s actually or intentionally welfare.

Also, would like to hear your views on the stimulous package on the verge of being passed.

By: Don

Don — Sun, 27 Jan 2008 15:31:44 +0000

Maybe I am confused but I thought Bond Insurers guaranteed the stream of revenue from these bonds rather than the value of the bonds themselves. So if the debtor defaults then the Insurer steps in and makes the normal payments to the bondholder for the life of the note. So I don’t see what a lower Fed Funds Rate really does for the bond insurers.