I would like to post more at present, but my family and work have kept me busy. A few notes:
- There have been many who have suggested that FAS 157 (or 159) is to blame for the current crisis. Sorry, but that doesn’t fly. The trouble does not stem from the accounting, but from the rotten investments. High-quality liquid investments do not have problems getting priced for reporting purposes. If you can’t get a liquid price, there is a reason for that. Prices in illiquid markets jump around — that is a rule.
- AIG might survive if banks that face a lot of counterparty exposure decide to lend to them to minimize their own losses. At this point, it looks unlikely, but it is possible that banks that would have large credit exposures to AIG would make a loan to AIG. One other note, the $20 billion loan from their subsidiaries appears to be contingent on AIG getting significant help from other sources of financing. No link, but from Bloomberg — “AIG hadn’t gotten access to the New York lifeline as of about 10:30 a.m., said David Neustadt, a spokesman for state Insurance Superintendent Eric Dinallo.
“It would be part of a broader deal,” Neustadt said. “If there’s no broader deal, then it doesn’t happen.” The regulators didn’t say yesterday that access to the cash would require such conditions.“ - So what does the FOMC do today? My guess is that they loosen 25 basis points, or do something that gives an expectation of expanding the monetary base. I suggested that this might have to happen last month, when I saw credit stress continuing to build in the banking system.
- That said, the FOMC could stand pat, and offer to take in lower grade collateral via tri-party repos in order to help keep marginal instituions afloatt, while leaving the monetary base flat. That’s been their default policy for the past year, and it may have delayed some of the credit stress, but it has not solved the basic problem of too much bad lending. Not that the FOMC can solve it without buying all the bad debt, and extinguishing it in a burst of inflation.
We ask too of the Fed in bad times, and in good times, we don’t ask them to restrain the banks as much as we ought. The problems we face today stem from the monetary and banking laxity from the mid-90s to 2007. There’s a lot of bad debt out there, and no easy way to change it. We are witnessing history now, as leverage collapses in big complex institutions, and in small places too (home mortgages), and we realize that even the government is too small to deal with the problems that they let grow for over a decade, and we didn’t care while the good times rolled on. At present, the main open question is whether the defaults are big enough to trigger another wave of defaults. As for that question, I don’t know the answer, but will try to gauge the risks as time moves on.
I will post later after the FOMC statement.
Who thinks that FAS 157 “caused” this problem? Not I.
Meanwhile, it does not work well for illiquid holdings. Examples abound. Most corporate bonds do not trade that much. Plenty of CDO’s trade only at fire sale prices.
AIG had business lines that cannot have no direct comparison. Many portfolios contain holdings that have little trading.
Your choices (and mine) can be readily marked to market, but the world is more complex.
There is a real issue here — how to value illiquid holdings. Sometimes a well-constructed model is better than a trade…..
Jeff, I agree, but I go back to my main discipline when I was an insurance risk manager — liquidity analysis. Never finance illiquid assets with liquid liabilities. Almost all financial failures can be boiled down to that, though one has to broaden the paradigm for ratings triggers and other contingent demands for liquidity.
Illiquid assets, if financed with equity or non-putable debt, won’t kill any company. That doesn’t mean the strategy will succeed, but it does mean they won’t face a “gun to the head” scenario.
I saw three or four articles yesterday that laid the blame at the feet of FAS 157. It’s hooey, but none of them stood out enough to make me link to them. I just saw a trend — the only other one is blaming short-sellers — the last resort of those scoundrels who bought companies with bad balance sheets.
I pulled a few of these together last night for RealMoney. My idea was to explain why the rule was important — in part because it raises a barrier to private solutions. Even potential buyers with strong balance sheets may balk at the capital requirements. If you get a “good deal” on a buy, it costs more on your other marks and everyone else’s.
So when they all follow your liquidity precept, there is little alternative but government action.
I think you know that I do not mean to “lay the blame” on FAS 157 alone. I do think that the accountants do not have sufficiently broad perspective to set our national policy.