Well, dour analytic geek that I am, I find it rather interesting to have something more exciting to talk about than geopolitics. That is the economic hash we're swimming through these days. I have found a new primary source of prime juicy information which is the daily Bloomberg On The Economy podcast hosted by Tom Keene. Every day I'm learning something new, so I will try to share what I understand here.
The Irish Solution
Today's talk circulated around the problem of LIBOR. LIBOR is the overnight interbank lending rate. Right now it's around 6% which is academic because banks are not lending each other money. They essentially don't trust each other. Ireland, who has had some problems in their banking industry has come with their angle and it is for the government to essentially guarantee all bank liabilities.
It turns out that the FDIC does indeed have the ability to do exactly that, and what raises eyebrows all around is that according to its charter, all it needs to do so is the agreement of the Federal Reserve, the Secretary of the Treasury (Paulson) and of the President. Guess whose input is not required? That's right, Congress.
But exactly how big is the sum total of all bank liabilities. According to today's guest, it's around 11Trillion dollars. American GDP for one year is 14T, so it's a very big number.
What's Broken
The economy is not. It's just part of the big business cycle with the small caveat that we are in a panic. The panic has a lot to do with the fact that an somehow incalculable amount of credit swaps are leveraged against a dicey set of mortgages which in turn are leveraged against real estate in a soft market. We are experiencing a rolling set of downturns starting in real estate markets which have affected the financial sector which in turn is restricting credit, which will have a negative effect on the ability to buy inventories. Everything will slow down.
The panic, the selling on Wall Street has destroyed a lot of capital, and today, now that the moratorium on short selling is off, cost the market another zillion in capital. But short sellers do help establish a bottom - or at least a psychologically quantifyable bottom to the market which is what we need. Once the panic is over, all we have is a slowdown, a real recession. The question of liquidity is very specific and is being addressed by the Fed which has it within its power to put money into the system and take money out if it gets inflationary.
What I've come to understand today is that although it is a precedent for the Fed to buy commercial paper, which helps particularly with inventories, since banks are not buying it, this can work. There are problems of course. What if they buy some and not others? Does this change the credibility of commercial paper ratings and rating systems? These are the unknowns.
Clearly there are a lot of options, I am coming to understand some of them - there are a huge number of things to learn here. But it's clear that those people who know how monetary policy and the Federal Reserve and money markets work, will have a close eye on developments. They are certainly not saying that our economy is broke.
Mark To Market
What I also heard today is that the idea of 'mark to market' pricing of financial assets is a good idea and has served us well. It's a common sense kind of logic behind that. Bottom line, when you mark to market it makes visible those assets which are in trouble. The alternative is to use a 'book' value of your assets. In the current crisis, the effect of marking assets by book value would be to mask the effect of losses in value to those assets.
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