Tuesday, October 16, 2007

Conduitry: A Blast from the Past?

It appears that the conduit consortium is simply an extra layer of securitization. It reminds me of the way the lender of last resort function was implemented, sort of, with several noticeable failures, in the era preceding the creation of the Fed. It has the potential to further concentrate risk, like an Army Corps flood control project that can withstand a category 3 but not 4 storm—if there are any buyers.

From an equity standpoint, I think James Hamilton has it right:

In my opinion, part of what created the current problem was the perception that participants were too big and too many to fail. If the government won't let Citigroup fail, could it allow a superconduit to go down?

I am skeptical of any claims for a feel-good, this-will-solve-all-the-problems fix. The reality is that someone must absorb a huge capital loss. The question we should be asking from the point of view of public policy is, Who should that someone be?

My answer is: the shareholders of Citigroup.


J.Goodwin said...


Why is a sock stuffed in a mattress starting to look like a better option for my cash reserves than a bank?

Myrtle Blackwood said...

From the NY Times article: "These vehicles essentially are private banks, albeit ones without the benefits of deposit insurance or the right to borrow from the Federal Reserve. They lend long term, and borrow short term. If they cannot borrow money, they are in trouble..."

Lend long and borrow short. Hmmm. If that was such a good idea why didn't my husband and I finance our house purchase from a series of short-term loans?

Lessons from the Asian financial crisis:

".. In Short Term Capital Flows (NBER Working Paper No. 7364), they look at financial crises of the past few years and find that in almost every situation--particularly the East Asia meltdowns--countries set themselves up for trouble because they had far more short-term debt than they did the resources or "reserves" to rapidly repay skittish creditors. "Countries with short-term liabilities to foreign banks that exceed reserves are three times more likely to experience a sudden and massive reversal in capital flows," state Rodrik and Velasco. "Furthermore, greater short-term exposure is associated with more severe crises when capital flows reverse."..

Anonymous said...

Brenda, much more and very much less to it than brought out in the NYTimes article. Norris keeps referring to intended contents of the 'super conduit' or M-LEC as 'securities' and in a technical sense yes but not otherwise as it seems there will be no shortage of CDO and MBS 'toxic waste' which, so far as I know, has mark-to-model pricing only and which, if actually offered, would be worth very much less. The AAA and AA ratings on these are divorced from reality of content.

In concert with some others, I'd say this plan has a lot to do with trying to avoid a setting of market prices for those 'securities' in participants' SIVs (along with other institutions and hedge funds), i.e. preventing transparency, price discovery and associated losses. Notions that Treasury and Fed are not knee-deep in the mess are simply naive or promotional as the somewhat earlier relaxation of Reg. W should have made clear. The whole deal adds another, more political, level of risk to the extent that such important institutions as U.S. Treasury are understood as involved by rest of world, partic. our creditors. Sheesh, the foolishness should be surprising but after so many decades of financial antics including prior bailouts for Citi.
Last straw?

Rather than go on and on, I'd suggest the following for as in depth as possible at this moment.

Further Developments on the SIV Rescue Front
(The author has had many years of Wall Street experience)


Nouriel Roubini's
Super-Conduit or Super-Bailout Shell Game?

Myrtle Blackwood said...

Thanks for the links Juan.

Here's my summary from another interesting article on the topic (plus bits and pieces from other articles). Heaven knows I might accidentally end up writing an article!

2001, 2002 – US Fed drops interest rates from 6% to 1% - effectively creating a negative interest rate since 1% was below the then current inflation rate of 3%. Japan’s interest rate also effectively set at zero. Long term interest rates also dropped as investors increasingly sought out the safest category of investment in the context of the G7 continuing to print money as their trade and budget deficits deteriorated. [BR: How much of the deterioration in long-term interest rates was due to Chinese funds flowing into nations?? And, a comment from another blogger “The phenomenon of subprime mortgages was the result of weak underwriting standards and excess demand for the asset class, not of low interest rates… Spain, a country with one of the most overvalued house markets by some metrics and one of the loosest monetary policy stances (it has enjoyed negative real interest rates for many years now), has little or no subprime problems and its financial sector has not engaged, as far as it is known, in the risk accumulation process that is at the heart of the current crisis. It probably had the right macro prudential settings… ”]

The Money centre and investment banks solved the problem for investors by creating structured finance products. Risk was disguised in opacity, illiquidity, complexity and in concert with the ratings agencies which succumbed to the siren song shareholders for “MORE PROFITS”. Real inflation was running away while reported inflation was low so public servants could “COVER UP” their irresponsibility.

The Insolvency Crisis: How we got here, and what to expect
Saturday, 11 August 2007 Written by Garrett Johnson

So, the problem appears to stem from international imbalances in trade, great inequality of income and other causes of the formation of large pools of money for investment. Other sources of these difficulties are likely to be the deteriorating level of profits related to the actual provision of goods and services, as distinct from the purely financial. Could this now be the result of the phenomena of global overproduction and global deterioration and depletion of natural capital as well as the presence of international cartels and other forms of unfair trade/excessive exploitation?

Some call the latter 'capitalism'.

Anonymous said...


That brings up so many questions that I'm not at all sure where to begin but, without going back the the late 1960s beginning of what has been a long tendential decline or crisis of the capital system and all the reactions to this such as neoliberalism/Washington Consensus, guess that I'd date the present phase from the mid-1990s and evident falling away of profit rate and mass in S. Korea, others, leading into combined real and financial devastation of the then most dynamic region within the global economy.

Well, that's where I would begin if I wanted to write an 'epistle' rather than a shorter post.

So will only note that, on top of and within the dollar recycling, adding to the expansion of credit money, there have been/are multiple carry trades, most famous of which is the yen carry, based on interest rate and currency differentials. Estimates for only the yen carry are all over the place but a few from hedge fund managers who have actually analysed BIS data and understand the importance of forward currency swaps, consider that until recently it has been responsible for over $1 trillion in new, i.e. additional, leverage. Even in this era, that's more than a pittance.

Somewhat in concert has been the rapid expansion in use credit default swaps, structured products that can be understood as a form of default insurance and have risen to a notional 'value' over $35 trillion or gross market 'value' in excess of $500 billion.

Without these, it's unlikely that risk spreads, U.S. and emerging markets, would have collapsed to the degree that they did,,,facilitating and part of the whole process of global credit inflation, including availability of no-doc high LTV mortgage loans, house-as-asset price inflation and ability to monetize this for ongoing consumption, so artificially high rates of GDP.
Differently, a process that has mitigated, temporarily postponed, a probably global realization crisis and a process which central banks and the official banking sectors have very little control over.

My mention of these, carry trades and CDS's, is also an attempt to bring out at least part of the actually global nature of the 'brave new world' money creation process which still too often is considered in strictly national terms and, IMO, has less to do with more recent Fed actions than those of the early 1990s, especially the ending of bank reserve requirement for certain types of deposit categories,,,followed shortly by banks' use of this relaxation to create tech enhanced sweep accounts and a de facto reduction of reserve ratios to zero. Obviously(?), at one level, a means to increase available loan capital while at another create a new level of credit multiplication.*

OK, if we consider the interactings of non-bank banks and banks on a world scale, it seems that a self-financing regime of potentially unlimited money creation came into existance during the 1990s. But then we have to take debt accumulation into account and, as is being demonstrated, the impossibility of divorcing this from the real economy, i.e. that the financial cannot be autonomous but in last instance remains dependent, and a dependence which has driven up exploitation in and of the real. No doubt in my mind that the sharpening contradiction between real economy surplus production and the demands of inflating fictitious capital must result in the latter's deflating and, since so much of production capital has become what Hilferding called 'finance capital', (the fusion of production and finance), a deflating unlikely to be limited to the more strictly financial.

Sorry, was trying to keep it short without being way too reductionist and think I've not succeeded but both too long and too simplistic.

*'credit multiplier: magnifies small changes in bank deposits into changes in the amount of outstanding credit and the money supply. For example, a bank receives a deposit of $100,000, and the reserve requirement is 20%. The bank is thus required to keep $20,000 in the form of reserves. The remaining $80,000 becomes a loan, which is deposited in the borrower's bank. When the borrower's bank sets aside the $16,000 required reserve out of the $80,000, $64,000 is available for another loan and another deposit, and so on. Carried out to its theoretical limit, the original deposit of $100,000 could expand into a total of $500,000 in deposits and $400,000 in credit'. See what happens when the posed 20% reserve ratio is reduced to 10%, to 1%.

Myrtle Blackwood said...

thanks for the explanation of the 'credit multiplier' and other, Juan. (I've made a note for future reference and clarification).

What happened in South Korea in the mid 1990s?

I wondered out loud, above: 'How much of the deterioration in long-term interest rates was due to Chinese funds flowing into nations?? '

Juan said that dollar recycling, carry trades and structured finance severely exacerbated the collapse of risk spreads.

With Japan and China leading the flight from the US dollar -- See:
I wonder what impact this will have on US long-term interest rates as well?

“…The US government theoretically could not be happier that foreign Central Banks are willing to finance its perennial budget deficits. However, this borrowing has reached a point where foreigners now control over 40% of the US national debt. Moreover, long-term US interest rates are market-driven, based on the buying and selling of US government bonds. In other words, the US has gradually ceded control of its long-term interest rates to foreign Central Banks, namely China and Japan.."

How China Could Crash the US Dollar on a Whim

Anonymous said...

what happened in s. korea during the mid-1990s?

state enhanced push for world market share, overinvestment, overproduction, drop in profit experienced by a number of the leading conglomerates. samsung, for example, saw a 93 % profit* drop in 1996 and i believe it was the same year that hanbo went bankrupt, others such as hyundai and lg also experienced very sharp declines as chip prices collapsed.

more broadly: "the net profit of listed firms in 1996 dropped by 55 percent compared with the previous year." (bank of korea, 1997)

the export led model was hitting limits well in advance of the later financial crisis. one might wonder why hot money flows had not reversed earlier though i'd guess that had to do with asymmetric information.
while then imf director m. camdessus was assuring the world that 'The fundamentals of Korea's economy themselves are sound', i and obviously others were reading korean articles in world press review which directly contradicted such fluff as he and others such as j. sachs provided.

obviously much more to it but dinner is waiting.

*in that case not profit but earnings, nevertheless extreme.

Myrtle Blackwood said...

Thanks again, Juan.

Looking at the mid 1990s, I suspect the the capitalist world needed the continued existence of the non-capitalist way of life in much of the world to ensure its continued existence. The deathnell appears now with too much production, too many workers, too few resources to go around, a too fragile and damaged environment.

Mid 1990s:
--Derivative sales, merger financing, stock market Keynesianism, subprime mortgaged and stock options take off. Global subsidiary companies, transfer pricing, tax havens.

--US strong dollar policy – keeping its value far higher than fundamental economics would warrant.

-- China’s efficiency drive, through workforce reduction. Chinese farm incomes fall dramatically. Most farmers living conditions described as ‘being able to afford meals, but having no spending money’.

--Doubling of the global workforce.
Financial economy 20-50 times higher than the real economy.

--St Valentines Day massacre on Wall Street.

--Internet and telecommunication revolution.

--Dot com speculative bubble.

--Profits in US manufacturing cease to grow.
-- Global currency crisis.
-- Asian financial crisis.