Ali’s blog

Mostly quant stuff with occasional digressions

Fleckenstein on credit contraction

Posted by alifinmath on March 18, 2008

Fleckenstein’s weekly column:

This just goes to show you the Fed will move heaven and earth to try to keep Wall Street (and, by extension, the economy) running. The Fed cares nothing about capitalism, inflation or the dollar, and it really cares nothing about the message that it sends to the world regarding its aims.

Consider the potential ramifications of the Term Securities Lending Facility, under which the Fed will lend Treasurys for a period of 28 days, taking mortgage-backed debt as collateral.

Before its implementation, the chance of the Fed buying a piece of paper that could deteriorate rapidly over the course of a couple of repo terms would have been small. But now that the Fed, through this facility, is willing to accept (exchange for Treasurys, actually) “AAA-rated” paper — and remember that the rating agencies are suspect — it’s not inconceivable that the following could occur:

The Fed might actually start taking paper at one price and then find out (by the time XYZ financial institution is supposed to take it back) that the paper is trading at a different price. Inquiring minds would like to know what the Fed would do about these losses if the repo’ing entity was determined not to take back the collateral.

Creating liquidity and stalling for time won’t make those credits good. Credit is contracting all across the financial system, in America as well as around the globe. At the same time, credits are going bad. Both of these problems keep lapping up against each other, and their magnitude will render bailouts useless.

Despite that glaring reality, the Fed remains intent on monetizing whatever needs to be monetized, as Chairman Ben Bernanke thinks this can prevent the underlying mass of home-price issues and the economic consequences of the burst housing bubble from doing what they will do.

But in the end, he’s going to shred the currency market and at some point the Treasury market.

I’m tempted to say that what one should have in these circumstances¬†are 1) a bag of gold coins, 2) a rifle, 3) access to clean water, and 4) a plot of land to cultivate.

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One Response to “Fleckenstein on credit contraction”

  1. […] Read the rest of this great post here […]

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