(In) Securitization

The meltdown in the alphabet soup of the derivatives market—from ABCP and CDOs to RMBS and CDS—has given rise to concerns that the problem is systemic to these kinds of financial products. No less than Warren Buffet, one of the most successful investors of our generation has called derivatives “financial weapons of mass destruction”. Given the events of the past month or so, Buffet’s view may strike a more responsive chord than it did when first articulated four years ago. Yet, despite the financial losses borne by the innocent and guilty alike, the view is as wrong today as it was then.

Moral Hazard on Main Street and Wall Street

The Federal Reserve has taken several steps up a policy escalation ladder to address the turmoil in the capital markets. It has allowed the Fed funds rate to deviate sharply from its target, and has created conditions that have allowed an approximate five-fold increase in excess reserves of the banking system.

The Federal Reserve took additional steps earlier today. First, it liberalized the so-called discount window borrowings, which are neither at a discount nor take place at a window. The Fed cut the punitive rate from 100 bps more than the Fed funds target to only 50 bps and lengthened the period that the funds can be borrowed. Yet, discount window borrowings are minor ($265 mln total in the week ending August 15), and the discount rate is still above the Fed funds target and well above the recent average effective Fed funds rate (weighted by size). As such, these moves are largely symbolic.

Moral Hazard on Main and Wall Street

The Federal Reserve has taken several steps up a policy escalation ladder to address the turmoil in the capital markets. It has allowed the Fed funds rate to deviate sharply from its target, and has created conditions that have allowed an approximate five-fold increase in excess reserves of the banking system.

China and the Dollar, Thunder but no Rain

Only the suggestion that China could use its vast US dollar holdings to influence American policy managed to rival the dramatic developments in the capital markets for the attention of investors and the media. Of all the things that investors and policy makers have to worry about, China’s dollar holdings should keep any one up at night.

The Long and Short of It: Outlook for the Dollar

The US multi-year down trend is over. The process we described as “carving out a bottom” has been completed. Recent days have been a watershed, but it has been a long time in the making. The dollar bottomed against the British pound and Canadian dollar (half of the G7 currencies) last November, as the Federal Reserve expanded its lending facilities and these countries prepared to cut rates. The dollar bottomed against the Japanese yen and the Swiss franc in late March, around the time that the Federal Reserve made a stand to protect what it perceived as potential systemic risk from the demise of Bears Stearns. The dollar recorded its low against the euro in early July as the US Treasury and Federal Reserve made it clear that the failure of government-sponsored agencies Fannie Mae and Freddie Mac would not be permitted.