John At The Center

A very popular paragraph today:

So the US authorities should have known – and presumably did know – that by allowing Morgan Stanley and Goldman to become banks they were in effect forcing a serious contraction in the hedge-fund industry, which in turn would lead to sales of all manner of assets held by hedge funds and precipitate turmoil throughout the financial economy.

http://www.nakedcapitalism.com/2008/10/emerging-markets-capital-flight.html

From FT:

When banks extend credit to hedge funds, they often use so-called “value at risk” models (VAR) to measure the risks attached to such loans. These models typically assess the riskiness of an asset by measuring how its market price has moved in the past.

Moreover, since banks typically use VAR to measure the risk attached to their own assets too, these models also seduced banks into feeling complacent about their own risks.

What is crystal clear is that it was sheer madness for financiers ever to have relied so heavily on these VAR models during the first seven years of this decade – particularly when they were so badly distorted by a false belief that the Great Moderation would always last.

Don’t blame the model, blame the bad assumptions in those models.  As with any other model, VAR is just that– a model.  In times of volatility, you’re going into unchartered territory so VAR models should not be relied on.

So next time you hear about “25 standard deviation moves several days in a row“,  don’t blame VAR.  You should blame the people who put the (bad) assumptions into VAR and also didn’t question the model for several days after they saw a 25 standard deviation move.

The VW squeeze play may well generate sympathy for short-sellers after months of vilification from politicians and executives who should know better. Shorts have been accused of manipulating stock prices through secretive means. Now they have been the victims of similar force.

http://www.portfolio.com/news-markets/top-5/2008/10/28/Volkswagen-Is-the-Biggest-Company?tid=true

Note that highs on low volume, from a technical standpoint, say a rally is tenuous and subject to reversal. However, one positive sign was the the recent lows were seeing fewer and fewer new lows for individual stocks.

http://www.nakedcapitalism.com/2008/10/dow-up-890-after-ten-times-increase-in.html

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The Mortgage Meltdown,
The Economy, and Public Policy

>>> A two-day Berkeley-UCLA symposium <<<

Thursday & Friday, October 30-31, 2008
Cal Alumni House, UC Berkeley

Speakers Include:

Fed Chair Ben Bernanke

SF Fed Pres. Janet Yellen

CA State Sen. Darrell Steinberg

Robert Shiller (Author, The Subprime Solution)

Panels And Presentations

· “Future of Housing Finance System”

· “Are Govt. Agencies Up to the Task?”

· “The Crisis In Financial Markets”

· “Demography of Foreclosures”

· “The New Regulatory Frontier”

http://urbanpolicy.berkeley.edu/pdf/mortgagemeltdown.flyer.pdf

http://urbanpolicy.berkeley.edu/pdf/mortgagemeltdown.pdf

NYT on senior secured loans:

Historically, these loans rarely traded below their par value because the risk of default was thought to be very low. But that has all changed as hedge funds started off-loading assets in fire sales this past month.

The value of these loans now implies a default rate of around 23.4 percent, according to S.&P. That means the market is suggesting that almost a quarter of current leveraged borrowers could default before their debt matures.

But the chances that a quarter of the safest bonds will go into default might not be as high as the market believes. For example, junk bonds, the riskiest type of debt, have a default rate of just below 3 percent. Back in 1992, when the junk bond market froze up, the default rate climbed only to 12 percent. The chance that a super senior collateralized loan obligation would have a default rate twice as high is highly unlikely.

In addition, the loans are “overcollateralized,” meaning the value of the bonds backing a collateralized loan obligation is higher than the C.L.O.’s value, allowing for some cushion to protect investors. They are also backed by hard assets, so in the event the borrower defaults, there are real, tangible assets to seize and sell off.

http://dealbook.blogs.nytimes.com/2008/10/27/worries-perhaps-too-many-about-collateralized-loans/

I know people are involved in the trust/custody of these instruments and they agree with this view, at least for the debt that they see through their lens.

Just wanted to connect The Economist to this online conversation about the Myths of The Credit Crisis

At the same time as they are struggling to raise money from outsiders, banks may face more claims on their capital. In the good times they promised to provide back-up loans to companies—which they thought would never be asked for. On some estimates, the value of these promises is $6 trillion. But with the commercial-paper market tightening and the economy deteriorating, more companies will be asking banks to keep their word.

Indeed, companies already seem concerned that banks will be unable to maintain promised loan facilities. So they are using those credit lines earlier than expected, in case they vanish. A prime example is Duke Energy, an American utility, which recently drew down $1 billion from a credit agreement. Chris Taggert of CreditSights, a research group, foresees a “funding blitzkrieg” by high-yield borrowers tapping their banks for cash if the mayhem does not abate.

http://www.economist.com/displaystory.cfm?story_id=12342237

Money markets
Blocked pipes

Oct 2nd 2008 | LONDON AND NEW YORK
From The Economist print edition
When banks find it hard to borrow, so do the rest of us

Tyler Cowen writes this about inflation (emphasis added):

I should add (contra Alex) that a rising monetary base, without a robust credit market, won’t get you much inflation. In fact the base has so risen because the Fed desperately has been trying to prevent…a credit crunch. Just imagine the credit boom that the observed recent path of the monetary base would have brought if we were not in…a credit crunch.

I’ve always thought along these lines as well but we have lots of very smart people saying otherwise.

http://www.marginalrevolution.com/marginalrevolution/2008/10/deflationary-ex.html

Mankiw from NYT

But the financial situation they face is, arguably, more difficult than that of the 1930s. Then, the problem was largely a crisis of confidence and a shortage of liquidity. Today, the problem may be more a shortage of solvency, which is harder to solve.

http://www.nytimes.com/2008/10/26/business/26view.html