FISA and the market

If I was very clever I would try to figure out how to combine these two, but I can't think of a way to do that right now. The recent FISA amendment is an ugly rip in the constitution. Still, I am hopeful that there will be push back, if not now, at least in 2009.

The market is more in the here and now. This long post has a number of interesting points. One of which is a description of something I hadn't heard of before:

One focal point in the current credit market meltdown is a sector of the market known as Asset-Backed Commercial Paper (ABCP). This paper is issued by legal entities called conduits or Structured Investment Vehicles (SIVs) set up by the largest banks to purchase mortgage securities, auto loans, credit card receivables and all sorts of other debt that these banks want to issue but do not want to keep on their own balance sheet. To finance these assets, the conduits issue short term commercial paper, and the investors who buy this ABCP know it is not an obligation of the bank, but only of the conduit. Theoretically, if the conduit fails the investors may lose all their investment, because they cannot turn to the bank for help.

Because of this legal independence, conduits have an array of credit protections, often including an emergency loan facility from the bank to provide liquidity if the conduit is having trouble selling its commercial paper. Investors cannot always be sure if the ABCP they are buying is going to be collateralized by mortgage assets, auto loans, etc., so in the current crisis many are assuming that sub-prime mortgages are involved and they are refusing to buy the paper. The conduits are now facing potentially dire circumstances because they survive only on the steady reissuance of their commercial paper. Many are beginning to turn to their bank sponsors to take down emergency loans from the bank. There is an estimated $1.2 trillion of ABCP currently in the market, so we are talking about multi-billions of dollars of emergency liquidity being required from the banks.

The ABCP business sprung up to help Wall Street move a growing number of mortgages from the balance sheets of the banks to the hands of investors through securitization. But this business also showed banks that the credit creation machine didn’t have to stop at mortgages, but could include other forms of retail debt. And if this could be done, why not apply the concept of securitization to corporate debt?

Numerian's argument is basically that this process of securitization created debt upon debt for all sorts of things -- setting up a process of credit creation parallel and eventually larger and more important than banks' traditional credit creation process. It started with ABCP's then spread to mortgages and eventually was used to fund huge leveraged buyouts and became the engine for hedge fund's wild growth

Rearing it's head again from the Enron debacle is "mark to market accounting", the securitization process counted everything from the newly created security at once -- big bonuses all around -- rather than traditional pokey 'ole bank loans -- where the income from a loan is counted in interest that will come in slowly over time. Banks giving over their credit assessing responsibility to credit rating agencies that failed dismally also hurt, hopefully Frank's hearings in the fall will be illuminating.

Rather than the world being "awash in liquidity", Numerian argues the world is really awash in debt. People have used this securitization process to leverage lots of money into existence. Fiat money, but not backed by the government. And likely to go away, unless the rich people that hold it can convince the government to bail them out -- the question is -- will rich people's desire for secrecy over come their desire not to take a bath in the current tailspin?

Numerian concludes:

The global economy cannot survive for long on the traditional credit creation process, and unless Wall Street can revive confidence in its securitization process almost immediately, a global recession starting later this year is a high likelihood. Wall Street might have a chance if it could make public very soon the nature and extent of the problems with its credit creation process. But this is one of the key differences between the two processes – problems in the commercial banking system are quicker to surface, and there are regulators ready to intervene. Not so with the complex, sprawling, opaque, and unmanaged Wall Street process, whose raison d’etre seemed to be to generate fat bonuses for many involved, with little thought to the systemic and economic risks being created.

We shall see what good the Fed and other regulators can do with interest rate cuts and any other interventions they can think of, but the problems are so large and unwieldy that no one should hold out much hope. The implosion of the Wall Street credit creation process is unprecedented in its depth and international scope, and the global economy will be fortunate indeed to avoid severe and prolonged damage.

It's a battle between the very-very-very rich (who already have gotten out to the newest secret spot to hide their money) and the only very-very rich (who may actually take a teeny tiny loss). But if this is an insolvency crisis rather than a liquidity crisis there's a hole in the boat and all the bailing in the world just puts off the inevitable.



The captain and crew abandon ship and leave the passengers in the hands of the musicians, who call in helicopter Ben to save the day, but that's easy compared to what we face today.