Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation

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Sat, 23 Aug 2008

Bernanke and his tag clouds

Paul Kedrosky’s Infectious Greed blog compares Bernanke’s speech at the Jackson Hole symposium this year with his speech at the same event last year. Using Wordle, Kedrosky produces nice tag clouds for the two speeches that highlight how sharply Bernnake’s concerns have moved from mortgage markets to the entire financial system.

I liked the Wordle tag clouds so much that I created one for my own blog which appears at the end of this post. The tag cloud confirms my description of the blog as being about financial markets.

Coming back to Bernanke’s speech, I found a few interesting things.

First, there was the sentence “The company’s failure could also have cast doubt on the financial conditions of some of Bear Stearns’s many counterparties or of companies with similar businesses and funding practices, impairing the ability of those firms to meet their funding needs or to carry out normal transactions.” This seems to vindicate those who have been arguing for quite some time now that the Bear Stearns rescue was a bail out of J P Morgan Chase. JPM had the largest derivative book by far of all the commercial banks and was a large counterparty of Bear Stearns.

Second, was the passage that has been widely quoted in the blogosphere: “A statutory resolution regime for nonbanks, besides reducing uncertainty, would also limit moral hazard by allowing the government to resolve failing firms in a way that is orderly but also wipes out equity holders and haircuts some creditors, analogous to what happens when a commercial bank fails.”

I wonder whether a new statutory framework is really necessary to achieve this. The monoline bond insurance companies have been able to negotiate cash settlement of the guarantees (which they had issued when they were AAA rated) at haircuts that reflect their current reduced credit worthiness. I would imagine that if Bear Stearns had not been bailed out, similar haircuts could have been negotiated with its counter parties as well. The Bear Stearns rescue was essentially a $29 billion loan under a second loss credit note collateralized by Bear Stearns assets. I do not see why the Fed could not have lent directly to Bear under a similar structure and adjusted the second loss trigger point to achieve any desired haircuts for the counter parties. I suspect that the alleged lack of legal frameworks is an excuse for lack of spine.

The Wordle tag cloud for my blog is shown below:

Wordle Tag Cloud for my

Posted at 14:12 on Sat, 23 Aug 2008     View/Post Comments (0)     permanent link