The banking regulations promulgated in the 1930s in reaction to the massive failures in the banking system precipitated by the stock market crash of 1929 and the economic downturn that, had they been left fully in place in this era by congress and the last two presidential administrations, and enforced by federal regulators, would have prevented most of what the "system" is experiencing now. Instead, legislation and regulation erred on the side of loosest lending policy and avoidance of regulation.
This isn't that complicated if one can focus on a few details. MBS, "mortgage backed securities" are assets made up of a bunch of home mortgages "lumped together" in "tranches" of a specific number of individual mortgages. Because no one knows for sure what the details related to the probability that each indvidual mortgage is secured by a home property actually worth more than the amount still owed on the mortgage, and the intent and ability of the mortgagee to make timely and continuous mortgage payments, most of these MBS were "insured" by bond insurers. The insurance coverage and the act of inserting what were thought to be only a "small number" of lower credit and collateral quality mortgages in each tranche, persuaded the credit rating agencies (S&P, Moodys, Fitch...) to rate these MBS at "AAA" credit quality.
Since the spring of 2007, there has been a growing awareness and concern that no one knows what the quality of the mortgages in these tranches will actually turn out to be in a residential realty market declining in price, the value of the MBS dropped below the actual price that they were purchased for. This drop triggered claims against the bond insurer's policy coverage. Now the bond insurers are running through their claims payment reserves, and the credit rating agencies delayed lowering the ratings on the MBS. The "primary dealers" refused to mark the MBS they owned or held as collateral from borrowers on loans like the Carlyle group took from banks ($670million collateral from Carlyle in exchange for bank loans used by Carlyle to buy $21 billion of "undervalued" MBS that turned out to be worth much less than Carlyle paid for them.) down to their actual current market price....the price they could be sold for now.
The "primary dealers", last summer began to refuse to lend each other money "over night", because they feared that the other dealers might suddenly announce bankruptcy, even with the Fed coddling, knowing themselves, how precarious their own balance sheets are.....and the Fed stepped in to intensify the manipulation we see them so dramatically practicing this week. They are accepting MBS from the primary dealers at "face value", instead of at market value, in exchange for T-Bills created out of thin air that can be short sold by the dealers in exchange for cash. The intent of the Fed was to help the dealers raise cash. The dealers instead are going out and "raiding" hedge funds like Carlyle to obtain their MBS and exchange them at face value at the "Fed" window, for T-Bills.
All other "players" with cash and rising fear, buy T-Bills as a place to safely "park" uninvested funds. This raises the price of T-Bills higher than the price of the soon to be $1 trillion of T-Bills that the primary dealers borrowed from the Fed and sold into the market. These dealers owe the Fed T-Bills, not dollars. They are also responsible for the difference in face value and actual market price of the MBS they have passed to the Fed in exchange for the T-Bills they've borrowed from the Fed and sold. On monday, three days ago, T-Bills were rising in price as MBS were falling further, and Fannie Mae's stock price dropped 19 percent in just that one day.
This isn't "capitalism at work", and it isn't "free markets". What do you call it, then? It looks like it's imploding, so how does that square with your belief system about what the system is?
The financial editor at BBC News explains how the Fed's decision to accept near worthless MBS at face value from primary dealers as collateral in exchange for T-Bills which are sold for cash, without requiring the primary dealers to pay back the T-Bills loaned to them by a fixed date, has triggered the foreclosure of Carlyle's MBS hedge fund:
Quote:
http://www.bbc.co.uk/blogs/thereporters/robertpeston/
The Fed and Carlyle
Robert Peston 13 Mar 08, 07:13 AM
<a href="http://www.carlylecapitalcorp.com/">Carlyle Capital Corporation</a>, the leveraged-mortgage vehicle of the famous, eponymous private-equity firm, said over night that it has been unable to stabilise its financing and that its “lenders will promptly take possession of substantially all of the company’s remaining assets”.
So almost within the blink of an eye, a business that had borrowed $21bn from the world’s biggest banks to invest in high-quality mortgage-backed securities will be gone, liquidated, kaput.
Such is the whirlwind blowing through global financial markets.
What’s the damage? Well the equity in the business, about $670m, looks as though it will be wiped out.
In the scale of credit-crunch losses, that’s an “ouch” rather than a “yikes”. The suppliers of that equity include Carlyle’s own partners. They’re a bit poorer than they were.
More worrying is the explanation for why lenders are seizing the assets, which are US government agency AAA-rated residential mortgage-backed securities (RMBS).
Carlyle says: “negotiations deteriorated late on March 12 when, among other things, the pricing service utilized by certain lenders reported a drop in the value of RMBS collateral that is expected to result in additional margin calls”.
That statement will reverberate through global markets today.
Why?
Well, the point of Tuesday’s dramatic $200bn intervention by the Federal Reserve in mortgage-backed markets was to stabilise the price of US government agency AAA-rated residential mortgage-backed securities and – by implication – to encourage the big banks NOT to seize assets in the way they’ve been doing at Carlyle.
Right now, it’s not clear that the Fed’s medicine has worked.
In fact, it’s arguable that the banks’ seizure of Carlyle’s $20bn-odd in assets has actually been encouraged by the Fed's mortgages-for-Treasuries offer. Because the Fed’s new lending emergency lending facility allows the banks to swap mortgage-backed debt for Treasury Bills in a way that Carlyle could not do.
So it would be rational for the banks to take Carlyle’s assets and exchange them for top-quality, liquid US government bonds, rather than leave loans in place to a business, Carlyle, whose assets remained highly illiquid.
If that’s the case, there will be some very scared people in hedge-fund land today. Hedge funds that have borrowed from banks against the security of mortgage-backed debt could be about to see their assets sucked into the banking system and their businesses vanish.
It’s a process known as de-leveraging the global financial economy, yet another manifestation of the puncturing of the debt bubble.
Many will see it as a healthy cleaning of the Augean stables. But if it is, it certainly won’t be completed in a day – and, as I’ve said many times, it won’t be painless for the rest of us, because de-leveraging also means they'll be less credit for all of us.
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So what kind of a system is it where there are a group of banks, "primary dealers", considered by the federal regulator to be "too big to fail". A system where these "primary dealers" in T-Bills have borrowed and sold nearly $1 trillion in T-Bills from the Fed as a method to fend off their bankruptcies?
What kind of a system allows liberal lending that pushed up valuations of homes and stock shares in an uncapped manner...."sky high", yet refuses to allow them to decline to a "floor" level in the same manner that they rose in value in....without a government agency "buying" them to fake a higher valuation than the market bids for them? Or a system that changes the terms and conditions of loans to "help" borrowers caught with mortgage debt on property with valuation that has declined to less than the amount owed on it?
How does changing mortgage loan terms or "refinancing" a mortgage loan to permit a "home owner" to borrow more than the home is currently worth, in a market of continuing home valuation decline, help anyone other than the lenders? How can it be claimed that it "bails out" the mortgage holder, when he ends up with the risk that the home valuation will decline further, from a starting point where he already owes more than "his" home is worth?
Isn't this just another manipulation to benefit the "too big to fail" lender vs. a mortgage holder who could just walk away from the home and the mortgage and rent a home for less for a few years until prices and his credit rating stabalize again?