It has been an interesting week for me. Earlier in the week as part of our radio presence we interviewed Senator Isakson about housing. I have posted that with a link to the interview earlier. Today I attended a meeting where the speaker was from the Federal Reserve.
I am an X banker so I was able to follow his discussion and later able to ask questions. I am writing this blog to sum up what was said, as it is important to us in the industry
The Current Crisis; From the standpoint of the Fed the current crisis had its' immediate cause in the housing market slow down and bubble bursting. However even though that was the immediate cause the real problem was in the CDO's. So for example if a group of mortgages was bundled and sold all was fine. But what happened was that the bundle was split. So the top part may have been sold off at AAA rating the middle at A or BB and the bottom at B. Each decline in rating had a corresponding increase in yield. The assumption of finance managers was that even the lower rated mortgages were good enough to buy as they were backed by the Asset of the home.
Now the fun begins. All are making money, and want to make more, and decide lets take that second group , the A or BB rated one and take the top off it and make it AAA. And so it goes with division after division of these things. In the end the bottom of the bottom are your toxic assets. Enter the slow down.
What happens here is the assets become less liquid. Banks start to worry about lending and suddenly credit freezes up. Because NO one lends. This is what we saw in September of 08. As we were good enough to sell bundled mortgages all over the world everbody starts to freeze up. In fact the Fed lends to foreign banks so they can buy dollars to meet obligations.
Now the Fed believes that the real problem we face is the valuation of the toxic assets. In fact it was pointed out that the Nobel Prize in economics a couple of years ago went to a guy who developed an auction system for these things. If you cannot value the assets on your books whether you manage a hedge fund or a bank then how credit worthy are you as an institution?
Interesting enough as the questions were asked the Fed does not believe the swaps (CDS) will be a problem They feel these will be treated as a commodity as they are today and not have any real effect. Also the pumping of the money into the system as long as it does what it is supposed to do is not going to be inflationary. However it was pointed out that the down side risks at this point out number the upside risks.
As to where the Fed was while this crisis was building , the short answer was they were snoozing. They do not want to regulate this type of risk. However I can tell you in banking they heavily regulate risk when it comes to foreign banks so I am not sure why this should be so different.
So at the end of the day there is a valuation issue to be resolved and the feeling is once that happens assuming there are no more shoes to drop things should start to stabilize over the summer and improve next year