The Federal Reserve Expands Direct Borrowing
From Calculated Risk:
Fed Announces New Initiatives, by Calculated Risk: From the Federal Reserve:
The Federal Reserve on Sunday announced two initiatives designed to bolster market liquidity and promote orderly market functioning. Liquid, well-functioning markets are essential for the promotion of economic growth.
First, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York.
Second, the Federal Reserve Board unanimously approved a request by the Federal Reserve Bank of New York to decrease the primary credit rate from 3-1/2 percent to 3-1/4 percent, effective immediately. This step lowers the spread of the primary credit rate over the Federal Open Market Committee’s target federal funds rate to 1/4 percentage point. The Board also approved an increase in the maximum maturity of primary credit loans to 90 days from 30 days.
The Board also approved the financing arrangement announced by JPMorgan Chase & Co. and The Bear Stearns Companies Inc.
This is along the lines of what I've been pushing for lately, though I'd like to see even more and I'd rather see asset trades instead of borrowing. But the Fed seems willing to extend credit or guarantee assets as needed, so now it's time to start pushing to get the mortgage repurchase plan Brad DeLong talked about in place, and to think about other stabilizing measures.
On the financing arrangements referenced in the statement, if you haven't heard:
JPMorgan buys Bear Stearns for $2 a share, FT: JPMorgan Chase on Sunday night agreed to buy Bear Stearns, the stricken US investment bank, for around $230m in shares in a deal that ... highlights the serious risks faced by banks during the credit crunch.
JPMorgan’s cut-price takeover of Bear, which has the backing of the Federal Reserve and the Treasury, was agreed before the opening of Asian markets on Monday morning in an attempt to stave off a run on other banks.
However, the deal, which values Bear at just $2 per share, compared with the $169 hit in January last year and the $30 reached on Friday, will wipe out the value of the investments of Bear’s shareholders including some of its senior management.
JPMorgan said that in addition to the emergency loans extended to Bear on Friday, the Fed had agreed to provide fund up of $30bn of Bear’s less liquid assets.
The rare arrangement significantly decreases JPMorgan’s risks and underlines the authorities’ concerns at the prospect of seeing one of the largest US investment banks go under.
The Federal Reserve and the Treasury feared that unless the Bear crisis was resolved promptly, there was an increased risk traders might turn their sights on other US and European banks.
“The Fed is most nervous about the systemic risk,” said one senior executive at Bear ... before the deal was announced “The government needs to stabilise the financial system.” ...
Updates: The WSJ Economics Blog has more on the expansion in direct borrowing and on the quarter percent cut in the discount rate.
Was it painless?:
More Lucky Duckies, by Atrios: Ouch.
Many well-known investors, from billionaire Joe Lewis to Bruce Sherman, the head of Legg Mason Inc.'s Private Capital Management Inc. money-management firm, have seen the value of their stakes in Bear Stearns plummet. The pain could be most acute for Bear Stearns's employees, who are steeped in a culture of personal ownership -- and hold about a third of the firm's shares outstanding.
Bear has over 14,000 employees.
Perhaps moreso than any other major investment securities firm, Bear promoted a culture of circled wagons, an us-against-the world camaraderie. As part of that effort, the investment bank paid a significant portion of its employees’ compensation in stock. On its Web site, Bear says that its employees own about one-third of the firm. That translates into about a $5.23 billion loss on paper for Bear’s employees over the last year, as the firm’s stock plunged 79.4 percent.
While presumably not evenly distributed across employees, that amounts to about $375K per employee.
Posted by Mark Thoma on Sunday, March 16, 2008 at 04:55 PM in Economics, Financial System, Monetary Policy
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Alan Greenspan: Models of Risk
The short version of this argument by Alan Greenspan is: models of risk are not perfect, they can miss inflating bubbles, so don't expect the Fed to know when a bubbling is inflating or to predict when a bubble might burst. And even if the Fed could identify bubbles, it couldn't stop them since a bubble "will not collapse until the speculative fever breaks on its own." The subtext is: don't blame me for missing the bubble that created the current mess, even if I did recognize it I couldn't have stopped it, and don't use the current crisis as an excuse to limit "market flexibility and open competition" through regulatory responses:
We will never have a perfect model of risk, by Alan Greenspan, Commentary, Financial Times: The current financial crisis in the US is likely to be judged ... as the most wrenching since the end of the second world war. It will end eventually when home prices stabilise... Although inventories of vacant single-family homes ... have recently peaked, until liquidation of these inventories proceeds in earnest, the level at which home prices will stabilise remains problematic. ...
Home prices have been receding rapidly under the weight of ... inventory overhang. ... The level of home prices will probably stabilise as soon as the rate of inventory liquidation reaches its maximum... That point, however, is still an indeterminate number of months in the future.
The crisis will leave many casualties. Particularly hard hit will be much of today’s financial risk-valuation system, significant parts of which failed under stress. ...
The problems, at least in the early stages of this crisis, were most pronounced among banks whose regulatory oversight has been elaborate for years. To be sure, the systems of setting bank capital requirements ... will be overhauled substantially... Also being questioned, tangentially, are the mathematically elegant economic forecasting models that once again have been unable to anticipate a financial crisis or the onset of recession.
Posted by Mark Thoma on Sunday, March 16, 2008 at 02:26 PM in Economics, Financial System, Monetary Policy
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Arbitrary Coherence
How do we decide if something is worth purchasing?:
Shhh . . . Don't Say 'Recession,' by Dan Ariely, Commentary, Washington Post: ...[Could] current talk about a recession ... actually be creating one? Well, maybe. Or so one general finding of behavioral economics would have us believe.
With all this chatter about a recession, consumers might, for example, hold off on buying that new dishwasher because of the "bad economy," or pass up the more expensive restaurant because "we're in a recession."...
Consider the experience of eating a Godiva truffle... Now think about ... how much it's worth to you. A quarter? 50¢? 75¢? $1.25? $2.50? While the experience of eating a truffle is very familiar, figuring out what we would be willing to pay for it proves difficult. So what do we do when we make purchasing decisions? Generally, we use past decisions as a guiding principle. If we have paid 50¢ for a Godiva truffle in the past, we remember this decision, assume it was a good one and probably repeat it again and again. ...
What ...[does this show]? The existence of what we called arbitrary coherence. The basic idea of arbitrary coherence is this: Although initial prices can be "arbitrary," once those prices are established in our minds, they will shape not only present prices but also future ones (thus making them "coherent").
So would thinking about one's Social Security number be enough to create an anchor? ... That's what we wanted to find out. ...
Prelec ... passed out forms... "Now I want you to write the last two digits of your Social Security number at the top of the page," he instructed. "And then write them again next to each of the items in the form of a price. In other words, if the last two digits are 23, write $23."
"Now when you're finished with that," he added, "I want you to indicate on your sheets whether you would pay that amount for each of the products."
When the students had finished, Prelec asked them to write down the maximum amount they were willing to pay for each of the products (their bids). ... The students enjoyed this exercise, but when I asked them whether they felt that writing down the last two digits of their Social Security numbers had influenced their final bids, they dismissed my suggestion. No way! ...
Did the digits from the Social Security numbers serve as anchors? Remarkably, they did: The students with the highest-ending Social Security digits bid highest, while those with the lowest-ending numbers bid lowest. The top 20 percent, for instance, bid an average of $56 for the cordless keyboard; the bottom 20 percent bid an average of $16. In the end, students with Social Security numbers ending in the upper 20 percent placed bids that were 216 to 346 percent higher than those of the students with Social Security numbers ending in the lowest 20 percent. ...
Social Security numbers were the anchor in this experiment only because we requested them. We could just as well have asked for the current temperature, or your shoe size. Any question, in fact, would have created the anchor.
Does that seem rational? Of course not. But when we make one decision, even when it's about an arbitrary number, we bring this history into our future decisions, and continue to make the same decisions over and over without going back and questioning their wisdom.
This suggests that if we just ignored the talk about recession, we would repeat our past behaviors and not deviate much from our pre-recession pattern of purchasing decisions. But when everyone is talking about recession, it's likely to make us stop, rethink our past decisions and feel that something needs to change. And so we change our patterns, start acting as if we're in a recession -- and thereby create one. ...
I wonder if this could generate sticky prices. If the anchor price is the price people are hearing about in local markets rather than the price consistent with the fundamental (long-run equilibrium) value, it would be more difficult for prices to return to equilibrium since people would be unwilling to depart from recent average prices even if the fundamental value is quite a bit different. A "good deal" would be assessed relative to average prices or prices people are hearing about rather than relative to the true value. Thus, I see this mechanism more as a way to propagate departures from equilibrium (i.e. this would make business cycles longer and perhaps more severe) than a fundamental driving force behind the departures from equilibrium. It's possible to imagine this mechanism creating a business cycle through self-fulfilling expectations - people believe a recession is coming so they begin to cut back on consumption and investment causing the problem they are worried about. But in, say, the case of the housing market bubble I would be unwilling to say this type of behavior is the driving force that caused the problem, but quite willing to acknowledge that something like this could create the sluggish adjustment we see in housing markets in response to other types of large, disruptive shocks.
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