blogs.ft.com/wolfforum/2007/08/fear-makes-a-we.html
Main August 15, 2007 Fear makes a welcome return By Martin Wolf "At particular times a great deal of stupid people have a great deal of stupid money. the money of these people - the blind capital, as we call it, of the country - is particularly large and craving; it seeks for someone to devour it, and there is a plethora'; The great 19th-century economist and journalist, Walter Bagehot, knew this better than anybody. Lombard Street, his masterpiece, is dedicated to the phenomenon. It is devoted, too, to how central banks should deal with its results. Ours has been a world of the "no income, no job, no assets" 100 per cent mortgage; of the "do what you like with our money, as long as you pay the fees" covenant-light loan; and of the "in go poor credits and out comes a triple A-rated security" financial alchemist. It has been a world of confidence, cleverness and too much cheap credit.
Hyman Minsky, who taught at the University of California, Berkeley, laid down the canonical model. The process starts with "displacement", some event that changes people's perceptions of the future. The third stage is easy credit and its handmaiden, financial innovation. The fourth stage is over-trading, when markets depend on a fresh supply of "greater fools". The fifth stage is euphoria, when the ignorant hope to enjoy the wealth gained by those who came before them. The warnings of those who cry "bubble" are ridiculed, because these Cassandras have been wrong for so long. In the latest cycle, displacement began with the huge cuts in interest rates in the early 2000s, which drove up prices in housing. The easy credit was stimulated by innovations that allowed those making the loans to regard their service as somebody else's problem. Then people started to buy dwellings to resell them, not live in them. So, in a different way, was the rush of bankers into hedge funds and of the wealthy and big institutions into financing them. Then came profit-taking, falling prices and, last week, true revulsion.
It was the moment when credit dried up even to sound borrowers. It was laid down by Bagehot himself from his observation of the evolution of the Bank of England. The central bank must save not specific institutions, but the market itself. It must advance money freely, at a penal rate, on good security.
providing money to the markets last week and this, the European Central Bank, the Federal Reserve, the Bank of Japan and other central banks have been doing their jobs. Whether the terms on which they have done this were sufficiently penal is another matter. Financial markets, and particularly the big players within them, need fear. Moreover, it is impossible for outsiders to regulate a global financial system riddled with conflicts of interest and dominated by huge derivatives markets, massive trading by highly leveraged hedge funds and reliance on abstruse mathematics and questionable statistical models. The only thing likely to persuade them to do so is the certainty that the players will be allowed to go bust.
said that "the Fed should respond to market upsets only when it has become clear that they threaten to undermine achievement of fundamental objectives of price stability and high employment or when financial market developments threaten market processes themselves", I gave a cheer.
And they are losing their jobs and these firms are going to go out of business, and he's nuts! So capitalism is for poor people and socialism is for capitalists. The world has witnessed four great bubbles over the past two decades - in Japanese stocks in the late 1980s, in east Asia's stocks and property in the mid-1990s, in the US (and European) stock markets in the late 1990s and, finally, in the housing markets of much of the advanced world in the 2000s. There has been too much imprudent finance worldwide, with central bankers and ministries of finance providing rescue at virtually every stage. Unfortunately, there is every chance of repeating mistakes.
US legislators want Fannie Mae and Freddie Mac to bail out the mortgage markets. The pressure on the Federal Reserve to cut interest rates will also grow. As Larry Hathaway and Mr Magnus of UBS note, this looks a much more significant event than the implosion of Long-Term Capital Management in the aftermath of the Russian default of August 1998. The consequences cannot be "ring-fenced", as those of LTCM were. Trust in counterparties and financial instruments has fled. The likelihood is a period of recognising losses, tightening credit conditions and deleveraging. Such a period, desirable in itself, will lead to strong pressure for swift declines in interest rates, at least in the US, and so for another partial bail-out of a crisis-prone system. Yet the underlying challenge confronting the world's central banks remains: huge surplus savings in important parts of the world; corporate sectors that do not need to borrow and so limited categories of creditworthy and willing borrowers, households in rich countries foremost among them. The pressure for repeated injections of cheap finance is not.
Fear makes a welcome return: Comments Stephen Cecchetti: Once again, Martin's column hits all the right notes, so as a member of the Forum, I am reduced to agreement and amplification. I have been following the events of the last week with very keen interest, collecting as much hard and anecdotal information as I can.
here All of my sleuthing has led to one very clear conclusion: it is much easier to figure out what the Fed is doing than it is to figure out what the ECB is doing. This is a statement about hard facts as well as intentions.
website and you will find that you can download every temporary and permanent open market operation since January 17 2000. In addition, you can download the effective federal funds rate, together with the range and (weighted) standard deviation of the trades. Among other things, this allows us to see easily that there were federal funds transactions at zero on Friday 10 August and Monday 13 August, suggesting that the US money market was literally drowning in funds. There's more esoteric and very interesting detail on the collateral that was accepted in the Fed's repo operations. We learn that in the Friday 10 August operation, which totaled $35 billion, they took entirely mortgage-backed securities. Downloading the history, I can see that taking these securities as collateral in repo was not unusual - taking them exclusively was.
My communication with the ECB's press office confirms that the FT was right and the ECB website wrong. Not only that, but try to get information on the history of past operations off the ECB's website. There is a particular rumor that the action was a response to funding problems at one specific institution. Unable to borrow in the market, the story goes, the ECB told the bank to borrow from them at the refi rate of 4 per cent. I hope this isn't true, but if it is then all the moral hazard arguments that have been made are exactly right. By disclosing more details of their operations, the ECB could dispel such rumors and help us to understand exactly what it did and why. Finally, there is the matter of Jim Cramer and his CNBC diatribe of August 3 Martin is exactly right to single this out as the single most outrageous public comment during this entire episode. When I heard it, my reaction was not only that Cramer was asking the Fed to backstop plutocrats, but also he should be better informed about how monetary policy works before he bad-mouths "academics". His primary point was that the Fed should "open the discount window". Banks decide when to borrow from the Fed, not the other way around.
August 15, 2007 at 05:08 PM Allan Meltzer: Martin's column is again right on. The job of cental banks is NOT to bail out screaming financial firms that did dumb things. As Bagehot pointed out more than a century ago, the central bank is responsible not to foolish lenders but to the rest of us. Bagehot did not criticize the Bank of England for failing to act as lender-of-last-resort to the market. He criticized the Bank for not announcing its policy in advance. This increases uncertainty, ...
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