Bernanke tries to slap some sense into the market


The Economist sums up the Fed's attempt to jump start hot wire the credit markets:

And then the Federal Reserve rolled out its latest acronymical weapon, the Term Securities Lending Facility. This involves $200 billion in Treasury securities which can be had for the low, low price of collateral in the form of mortgage-backed securities. It is, according to Mr Krugman, "a REALLY BIG slap in the face." (Caps his). For today, at least, the markets seem pleased.

But will this jolt last? A number of market observers aren't so sure. Writers at the financial site, Minyanville are arguing that Ben Bernanke is using too many of his bullets too fast, which makes one wonder why financial journalists are so prone to the use of violent imagery. Perhaps what the market could really use right now is a pat on the back.

There are real problems in parts of the financial sector, of this there can be no doubt. But the more frightening tremors in the system are those generated by the seemingly irrational unwillingness to hold safe investments, thereby making the safe unsafe. This is what the slaps are meant to address.

A lot of lay people watch banks taking huge writedowns on mortgage backed securities, and the mess in the housing market, and worry that there are even deeper writedowns to come. That isn't the frightening part. The frightening part is that the writedowns are already too deep. The markets in many of these securities have basically seized up, and financial firms are required to use something called "mark to market" accounting for their securities--which is to say that rather than carrying these assets on their books at the historical cost they paid for them, which is the common procedure for assets like factories and delivery trucks, the banks have to update their financial statements to reflect the market price of securities. The problem is, there is no market price. Unable to value their holdings, or other holdings (securities or firm shares) that are dependent on revenue from the illiquid securities, many financial institutions are basically throwing up their hands and saying "I don't know, call it zero."

No matter how bad the economy gets, we are not going to see a 100% default rate in the subprime market. Many of these securities will produce income streams, though perhaps less than what people were expecting. The problem is, since no one knows how much income they'll produce, they're a drug on the market. Worse, Wall Street is seized by the pernicious herd mentality that occasionally makes things so . . . interesting . . . in the financial markets: everyone's terrified of losing their jobs (or their shirts), so no one wants to risk buying stuff that other people aren't buying. If you do what everyone else is doing, you may lose money, but no one can blame you for making a uniquely bad decision. In this case, there are probably a lot of uniquely good buys out there, but not that many players even looking for them.

What's happening to the credit markets is a little akin to a bank run. The underlying conditions may be somewhat shaky, but what's really screwing things up is that everyone's trying to run for the exits--or just play possum--at once.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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