PrefBlog

Willem Buiter has commented on the BoE liquidity operation discussed by PrefBlog on April 21:

The Bank of England is now wholeheartedly committed to acting as market marker of last resort for systemically important securities for which the markets have become illiquid, not to say defunct, since the start of the crisis in August 2007.

Dr. Buiter’s phrase “market maker of last resort” was introduced in his post from last August.

The market maker of last resort function can be fulfilled in two ways. First, outright purchases and sales of a wide range of private sector securities. Second, acceptance of a wide range of private sector securities as collateral in repos, and in collateralised loans and advances at the discount window.

I cannot help but feel that this phrasing is imprecise, because “Market Maker” implies a transfer of ownership; in the current agreement, the participating banks continue to bear the risk of the instruments used to collateralize their loans. Dr. Buiter argued last August that injection of liquidity in the market sector where it was needed most to the participants who wanted it most would achieve desirable effects with less disruption to the general market than across-the-board reductions in the lending rate:

Central banks have not been doing the job of market maker of last resort effectively, indeed they have barely been doing it at all. Following the stock market collapse of 1987, the Russian default of 1998 and the tech bubble crash of 2001, all that the key monetary authorities have done is (1) lower the short risk-free interest rate and (2) provide vast amounts of liquidity against high-grade collateral only, and nothing against illiquid collateral. The result has been that the ‘resolution’ of each of these financial crises created massive amounts of high-grade excess liquidity that was not withdrawn when market order was restored and provided the fuel that would produce the next credit boom and bust. By focusing instead on illiquid collateral, it should have been possible to achieve the same effect with a much smaller injection of liquidity.

This point, that overall liquidity changes can be minimized by a more careful targetting of liquidity injection, was mentioned on PrefBlog on March 31, quoting Xavier Vives. I haven’t seen anybody use the phrase “a rifle, not a shotgun” yet, but I’m sure it will be if the Central Bank actions become a political issue.

Anyway, back to Dr. Buiter’s remarks:

The “£50 billion bail-out for banks” headline of that fount of orginal analysis, the (free) London paper, is rubbish. The Special Liquidity Scheme is priced quite unpleasantly for the banks. The so-called fee (the difference between 3-month libor rate and the 3-month General collateral gilt repo rate) will be quite hefty, because it reflects not only bank default risk (libor is the rate for unsecured bank lending) but also liquidity risk. In addition, the haircuts (discounts) applied to the Bank of England’s valuation of the RMBS, covered bonds and credit card ABS ranges from 12 percent, for the shortest maturity to 22 percent for the longest maturity. That valuation will either be based on observed market prices that are independent and routinely publicly available or on the Bank of England’s own calculated prices. As most of the assets are illiquid, the prices of these assets will for the foreseeable future be set by the Bank of England. In that case it will also apply a higher haircut to the valuation. In addition, Bank officials have told me that should any of the assets lent by the banks to the Bank fall, during the life of the swap, below the required AAA rating, these assets will have to be replaced by AAA-rated securities.
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The UK scheme prices what amounts to a collateralised loan of Treasury bills by the Bank of England quite harshly. And appropriately so. There is no eartly reason for giving the banks a tax payer handout. The banks and their borrowers made the mistakes. They and their borrowers should pay the price.

He contrasts this with the valuation of securities accepted by the Fed:

All this is a lot more sensible and likely to minimise adverse selection than the insane valuation of the collateral offered by US Primary Dealers to the Fed at the Term Securities Lending Facility and the Primary Dealer Credit Facility. The collateral is priced by the clearing bank acting as agent for the Primary Dealer! If ever a scheme was designed to encourage collusion between Primary Dealer and Clearer to dump useless securities at inflated prices on the Fed, this is it.

I hadn’t been aware of that nuance! I am in complete agreement with Dr. Buiter: valuation should be performed by the Fed – with input and advice from the brokers and clearing banks, of course, but the final say should rest with the lender.

And finally, Dr. Buiter points out another nuance:

Unlike the US, where mortgages are non-recourse debt, the UK does not have mortgages that are non-recourse.

The standard terms on US mortgages are ridiculous and the standard provision of non-recourse loans is just one of the problems.

In a new development, a trader has been nailed for spreading false rumours:

Paul Berliner, 32, sought to profit by messaging traders at brokerages and hedge funds on Nov. 29, claiming Alliance Data’s board was meeting to discuss a reduced offer by Blackstone, the Securities and Exchange Commission said today in a suit at federal court in Manhattan. The shares plunged 17 percent in half an hour that day.
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Berliner, who was shorting the stock to profit from the drop in price, made more than $25,000 before the shares recovered, according to the SEC. He didn’t admit or deny the agency’s claims in agreeing to forfeit his gains, plus interest, and pay a $130,000 fine.

The trivial amounts for which a trader will put his reputation on the line never fails to astonish me … one can only imagine that the real-world repercussions for talking like an idiot to other idiots are not really all that harsh.

The story does not address what, if anything, happened to the morons who traded stock on the basis of an unverified text message. If they were acting as fiduciaries, one can only hope that their licenses will be yanked soon.

The market was off a bit today in what has now become normal volume. There were a few good crosses of the more liquid, high quality, perpetualDiscounts.

There were fifteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

This entry was posted on Thursday, April 24th, 2008 at 8:41 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.