PrefBlog

The Fed has announced:

that it is prepared to undertake a substantial expansion of the Term Asset-Backed Securities Loan Facility (TALF). The expansion could increase the size of the TALF to as much as $1 trillion and could broaden the eligible collateral to encompass other types of newly issued AAA-rated asset-backed securities, such as commercial mortgage-backed securities, private-label residential mortgage-backed securities, and other asset-backed securities. An expansion of the TALF would be supported by the provision by the Treasury of additional funds from the Troubled Asset Relief Program.

The Board’s objective in expanding the TALF would be to provide additional assistance to financial markets and institutions in meeting the credit needs of households and businesses and thus to support overall economic growth in the current period of severe financial strains. Decisions concerning the expansion of the TALF, which will be made in consultation with the Treasury Department, will draw on initial experience in administering the program and the Board’s assessment of the likely effectiveness of possible enhancements to the program in advancing its broad economic goals.

Under the current specification of the TALF, the Federal Reserve Bank of New York will lend to eligible owners of certain AAA-rated asset-backed securities (ABS). The Federal Reserve had previously announced that it would accept AAA-rated asset-backed securities backed by newly and recently originated auto loans, credit card loans, student loans, and SBA-guaranteed small business loans as collateral for TALF loans. The date that the TALF will commence operations will be announced later this month.

They will make credit available against good collateral – exactly what a central bank is supposed to do – but I will note that Across the Curve disagrees:

If I read the literature correctly, I would conclude that the TALF will be financed with a large scoop of funding from the central bank. Maybe I am being rigid in my thinking but that does not seem like something which should properly fall within the purview of the central bank.

This sounds like fiscal policy and not monetary policy and it would seem to me that the proper path would be for the elected representatives of the people should authorize the expenditure of one of the largest pools of money in human history. Allowing the Federal Reserve that much latitude, without a proper grant of authority from Congress seems literally undemocratic.

It also begs the question of Federal Reserve independence. The central bank has surrendered independence as the crisis has unfolded and Congress should step forward and provide a clear demarcation and definition of [roles] for the Treasury and its companion.

I disagree. I take the view that it only becomes fiscal policy if and when credit losses are expected and until then it’s monetary policy. I will presume that Bernanke & Co. are insisting on good enough collateral with high enough haircuts to keep it in the latter camp; and I will defend their authority to make the decision until it has been clearly shown otherwise.

Canadian auto subsidies have attracted notice from a Belgian academic, Johannes Van Biesebroeck, in a VoxEU piece Money for Nothing?:

Firms can draw on a long list of programmes for investment support. As of January 2009, the Ontario government’s web portal for initiatives to attract foreign investors listed 78 programmes offering subsidies or tax credits. Among the most important programmes are the Advanced Manufacturing Investment Strategy ($500 million over five years) geared towards innovation and advanced technologies, Strategic Manufacturing Investment grants (average annual budget of $63 million), and the Next Generation Jobs Fund ($650 million over five years) for green technologies.

Total support from just the four largest Ontario programmes has averaged a staggering $400 million per year, much of it for automotive investments.
…
Government discretion is often viewed with suspicion on political economy grounds, but a pure rules-based approach runs the risk of the winner’s curse if there is competition with other jurisdictions (Van Biesebroeck 2008). The largest subsidy package will be offered by the participant with the most upwardly biased information on potential benefits of the project. When the actual benefits become clear over time, the winner might regret having won.
…
On the day of the announcement, Canadian Press Harris-Decima completed a four-day survey showing strong popular support for a bailout of the carmakers. Supporters outnumbered opponents by a large margin – 56% versus 33% of respondents. This makes it easier to understand why the politicians stepped in. Ontario Premier McGuinty said “Our choice is to passively preside over the demise of the industry in Canada and observe its consolidation in the (US) or to act. We chose to act.” Apart from slowing down the demise, they have not made it clear what they hope to achieve with their actions.

Why do we subsidize them? Because they’re good jobs. Why are they good jobs? Because they’re subsidized.

Here’s a cheery update from the CDO market:

Almost half of all the complex credit products ever built out of slices of other securitised bonds have now defaulted, according to analysts, and the proportion rises to more than two-thirds among deals created at the peak of the cycle.

The defaults have affected more than $300bn worth of these collateralised debt obligations, which were built from bits of other asset backed securities (ABS) such as mortgage bonds, other CDOs and structured bonds, or derivatives of any of these, according to analysts at Wachovia and Morgan Stanley.
…
CDOs of ABS were used increasingly at the peak of the credit bubble to keep the securitisation machine moving by recycling hard to sell bits of subprime mortgage bonds and other risky tranches into new structures with top-notch credit ratings.

However, the ratings of these deals proved unsustainable, as evidenced by the fact they have accounted for 92.9 per cent of all 16,587 ratings downgrades globally from all rating agencies since the beginning of last year, according to Morgan Stanley.

The way these complex and risky transactions were exploited at the peak of the bubble can be seen in data from analysts at Wachovia, who reckon that 47.6 per cent of all CDOs of ABS by volume issued since the market substantively began in 2002 have now hit an event of default.

Equity markets expressed extreme disappointment with the Stimulus and Financing package as a whole, shocked that Obama didn’t wave his magic wand and make everything go away. Across the Curve has rather daringly republished a JP Morgan analysis of the Fed’s statements.

Canadian bonds had a reasonably good day, but the pref market simply yawned. Split shares did poorly, presumably due to asset coverage fears.

Svein Gjedrem, Governor of Norges Bank (Central Bank of Norway), in the Financial Times, 3 February 2009:

As today’s financial crisis progressively gets resolved, it will be necessary to start the process of preventing future crises. This will require substantial reform of the regulatory framework. Banks will have to strengthen their capital and their liquidity buffers. And financial regulation must have a less pro-cyclical effect. The objective must be to enable the banks to curb the impact of shocks on the economy, rather than to amplify them, as is the case now, where negative spirals are generated between the financial system and the real economy.

The trouble with attempting a counter-cyclical (or less pro-cyclical) regulatory policy is that it requires the authorities to determine what the cycle is – and I don’t believe that they are any smarter or better informed that the rest of the world. It also opens up a greater possibility of political interference in what is a rather dry, technical and confusing area … can’t you just hear What-Debt? as Pooh-Bah of banking regulation? ‘Thanks to my wise tax-cutting, we are all going to be rich forever. It is impossible for a bank to go bankrupt. Therefore …’

I have heard some things about a Spanish model of “Dynamic Provisioning”, but haven’t investigated any of the details.

Michael Pomerleano, Harald Scheule and Andrew Sheng write a nice piece of VoxEU, The devil is in the details, emphasizing the dangers of cliff risk through model homogeneity:

the price of all risky assets may have dropped below their fundamental value. Therefore, leveraged markets are prone to overshoot in booms and underprice in downturns. If this is true, the current losses in the trading book may be overestimated. If policy does not respond well (or is ineffective), the pessimistic view becomes self-reinforcing. Under the present “fair market value” regulatory regime, market risk exposures are marked to market and a large fraction of the losses reported to date relate to market-risk exposures.
…
A little understood problem is that the model provider, financial intermediation, and model auditing industry is highly concentrated, leading to systemic risk. Several examples suffice: the small number of credit rating agencies for bond and structured finance issues, the growing market share of “too big to fail” financial institutions, and joint ventures in model construction designed to reduce costs. The problem is compounded by the use of similar quantitative frameworks and frameworks that are calibrated based on similar loss experiences.

An anecdote illustrates this point. Some years ago the chief risk officer of a major U.S. bank presented the asset correlation matrix used by his institution. Another major financial institution at the event confirmed its use of the same matrix. While the institutions were fundamentally different in nature, they shared the same reputable consulting firm. Neither this firm’s model nor any other model has been formally validated. The oligopolistic structure was nurtured by the limited data availability and the propensity of financial institutions to outsource risk modelling. A similar situation prevails in the accounting industry, which is dominated by the “Big Four.” The public sector has abdicated too much authority to vested interests in the private sector.

This behaviour is lauded and encouraged by regulators and large firms, under the twin banners of eliminating regulatory arbitrage and encouraging “best practices”. The authors recommend:

Deconcentration of risk models is another priority. This may involve generating a compulsory global warehouse for financial risk–related data (particularly regarding credit risk) and encouraging alternative modelling techniques. While limited data-sharing initiatives reportedly are being undertaken in Japan, they need to be far more extensive and systematic.

while – in a decision I consider to be inconsistent with their stated thesis – recommending:

Regulatory arbitrage has transferred risks to off-balance-sheet special-purpose vehicles and hedge funds. This practice may have to be limited by homogenising rules across financial instruments and institutions as well as across industries and countries.

The Fed is having difficulty coming to grips with the question of what to do next:

Federal Reserve officials have failed to resolve an internal debate over whether to purchase long-term Treasuries, even as rising yields on the securities threaten to undermine the central bank’s objective of cutting borrowing costs for consumers and businesses.
…
“The Fed will get a lot more bang for its buck by buying mortgages than buying Treasuries,” said John Ryding, founder and chief economist of RDQ Economics LLC in New York and a former Fed economist.
…
Lacker preferred to expand the money supply “by purchasing U.S. Treasury securities rather than through targeted credit programs,” the FOMC statement said.

Accrued Interest comments on pending revisions to TARP, which he states will include FDIC insured 10-year covered bonds. The source WSJ article does not reference covered bonds, but the idea has been floating around for a few weeks. As yet there is nothing on the FDIC website regarding such a guarantee – the last mention was a policy statement cleaning up legal loose ends in August.

The market ticked up today on reasonable volume bolstered by all the recent new issues.