Post by jeffolie on Aug 24, 2007 10:44:33 GMT -6
Federal Reserve Bank of New York Staff Reports
Rediscounting under Aggregate Risk with Moral Hazard - Staff Report no. 296 - August 2007
James T. E. Chapman and Antoine Martin
Mechanically, here's how it works. The Fed will only do business directly with banks that maintained good loan practices and are the most credit-worthy. Lenders of various flavors such as investment banks and hedge funds that took on a lot of bad loans can only deal with the banks that deal directly with the Fed. They do not have access to the new and improved discount window on their own. The credit-worthy banks can use the weak creditors' assets as collateral to borrow from the Fed.
For example, a distressed hedge fund can't access the Fed directly but can take the mortgage-backed securities they hold and bring them to a credit-worthy bank that does have access to the Fed. That bank uses the paper as collateral for a one month loan. That's why Bank of America, Wachovia, Citigroup, and JP Morgan all hit up the discount window at the same time, each for the same $500 million amount yesterday, to let hedge funds and others know where to go to put up their asset backed securities and CDOs and other paper as collateral for loans. The banks borrow from the Fed, and the hedge funds borrow from the banks. Hedge funds and others can still fail, but in an orderly way versus a simultaneous dumping of assets into a frozen market.
The Fed can turn the discount window knob as need to control the rate of failure, averting the dreaded "break in the chain of payments."
While its too early to call an all-clear on the debt deflation at the top of the debt pyramid, evidence is that this new system is working–so far. Even the secondary market in CDOs is opening up, as we heard from a company that structures them that contacted us yesterday.
www.itulip.com/forums/showthread.php?p=14679#post14679
I have 2 problems with this approach:
1. Only $2B was taken from the Discount window. This is not enough to bailout even 2 large hedge funds as Bear Stearns found out.
2. The Discount window loans are for only 30 days. This postpones the day of reckoning to mid September while the redemption fiasco for hedge funds is at the end of September.
Still, the reality is that the equity markets and ABX index have calmed. So, the Fed's approach is temporarily working very well.
Rediscounting under Aggregate Risk with Moral Hazard - Staff Report no. 296 - August 2007
James T. E. Chapman and Antoine Martin
Mechanically, here's how it works. The Fed will only do business directly with banks that maintained good loan practices and are the most credit-worthy. Lenders of various flavors such as investment banks and hedge funds that took on a lot of bad loans can only deal with the banks that deal directly with the Fed. They do not have access to the new and improved discount window on their own. The credit-worthy banks can use the weak creditors' assets as collateral to borrow from the Fed.
For example, a distressed hedge fund can't access the Fed directly but can take the mortgage-backed securities they hold and bring them to a credit-worthy bank that does have access to the Fed. That bank uses the paper as collateral for a one month loan. That's why Bank of America, Wachovia, Citigroup, and JP Morgan all hit up the discount window at the same time, each for the same $500 million amount yesterday, to let hedge funds and others know where to go to put up their asset backed securities and CDOs and other paper as collateral for loans. The banks borrow from the Fed, and the hedge funds borrow from the banks. Hedge funds and others can still fail, but in an orderly way versus a simultaneous dumping of assets into a frozen market.
The Fed can turn the discount window knob as need to control the rate of failure, averting the dreaded "break in the chain of payments."
While its too early to call an all-clear on the debt deflation at the top of the debt pyramid, evidence is that this new system is working–so far. Even the secondary market in CDOs is opening up, as we heard from a company that structures them that contacted us yesterday.
www.itulip.com/forums/showthread.php?p=14679#post14679
I have 2 problems with this approach:
1. Only $2B was taken from the Discount window. This is not enough to bailout even 2 large hedge funds as Bear Stearns found out.
2. The Discount window loans are for only 30 days. This postpones the day of reckoning to mid September while the redemption fiasco for hedge funds is at the end of September.
Still, the reality is that the equity markets and ABX index have calmed. So, the Fed's approach is temporarily working very well.