By Arnold Kling
Start with Markus K. Brunnermeier.
While the overall mortgage losses are large on an absolute scale, they are still relatively modest compared to the destruction of about $8 trillion in stock market wealth that occurred in the period from October 2007, when the market reached an all-time high, to a year later in October 2008.
Not to mention foreign stock market wealth. This is a very valuable paper. Pointer from Menzie Chinn.More from the paper:
These structured investment vehicles (SIVs) raise funds by selling short-term asset-backed commercial paper with an average maturity of 90 days and medium-term notes with an average maturity of just over one year primarily to money market funds. The short-term assets are called “asset backed” because they are backed by a pool of mortgages or other loans as collateral…To ensure funding liquidity, the sponsoring bank grants a credit line, called a “liquidity backstop.” As a result, the banking system still bears the liquidity risk from holding long-term assets and making short-term loans.
So we have Mencius Moldbug’s favorite whipping boy, maturing mismatching. But it’s not taking place through ordinary fractional-reserve banking. Instead, it’s completely off-balance-sheet.
Next, we have my favorite whipping boy.
In hindsight, it is clear that one distorting force leading to the popularity of structured investment vehicles (SIVs) was regulatory and ratings arbitrage. moving a pool of loans into off-balance-sheet vehicles, and then granting a credit line to that pool to ensure a AAA-rating, allowed banks to reduce the amount of capital they needed to hold to conform with Basel I regulations while the risk for the bank remained essentially unchanged.
It sounds very wise nowadays to say that we need an international regulator. But the international-based capital regulations opened loopholes that banks could drive a truck through.
Another part of the ratings arbitrage game was the use of insurance.
As losses in the mortgage market mounted, the monoline insurers were on the verge of being downgraded by all three major rating agencies. This would have led to a loss of AAA-insurance for hundreds of municipal bonds, corporate bonds, and structured products, resulting in a sweeping rating downgrade across financial instruments with a face value of $2.4 trillion…a rating downgrade would have triggered a huge sell-off of these assets by money market funds.
Next, we have wonderful news in a report from FBR research
The financial services industry is in dire shape and needs between $1.0 trillion and $1.2 trillion in tangible common equity pumped into it
Meanwhile, Henry Paulson has engaged in a round of image-buffing in the last few days. Felix Salmon is not convinced.
And regarding the other member of the dynamic duo, Tim Duy writes,
I see a distinct lack of leadership from the Federal Reserve, and it suggests that Bernanke has used up his bag of tricks. And I don’t think that he knows what to do next.
My opinion continues to be that you cannot prop up until you clean up. The first order or business is to shut down the weakest institutions. Only then should you look around and decide about capital injections and bailouts. We don’t need a chief rescuer. We need a head janitor.
Think of the financial sector as a bunch of dishes sitting on shelves during an earthquake. Bernanke and Paulson are running around trying to hold the shelves in place. I think we would be better off letting a lot of the dishes fall and then tossing them into the trash. You can understand why my view could be unpopular, and it also could be wrong. But so far, the stock market isn’t telling me that Bernanke and Paulson are right.