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Wednesday March 18, 2009 - 17:15:58 GMT
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Forex Blog - Underappreciated Collateral Risks - How bad is the Plumbing?

Underappreciated Collateral Risks - How bad is the Plumbing?


If there is any one figure in the entire credit crisis that has been more responsible for the education of so many in the market, myself among them, on the finer workings or more like failures of the banking system it is James Aitken from UBS London.  The IMF has published a working paper, co-authored by James, on one of those finer details, rehypothecation (post-Lehman), essential to the smooth functioning of the banking system (click on the link below – may need to do Ctrl (control) click to open).   James more recently has been in the forefront of expressing concern over a potential insufficient quantity of quality collateral in the financial system which drives the repo market, the plumbing of global capitalism.


On a separate note, there is a growing view in the market that the AIG FP Salem witch trial underway in Washington is a killer for any buy side participant to cowboy up to the US government in TALF or a private/public SIV for buying toxic assets. 


I think this view is misplaced.  No doubt the show trial underway in Washington turns the stomachs of many, mine too, it is a necessary, if dirty, part of the democratic process in the USA.  Heads on a pike are demanded, not by smarmy legislators, but by the angry mob that is phoning into every member of Congress in an unprecedented rate.  I feel badly for the people at AIG FP, many most surely innocent, and doing their utmost to recoup US taxpayer dollars.  However, in the world when private market failures demand public solutions, there is no way around this kind of nonsense.  It is the equivalent of collateral damage in war.  Anyone who thinks government can ride to the rescue for trillions of dollars of taxpayer money (future liabilities) and do so unobtrusively is living in a fantasy and is not a student of history. 


Yes I think the enablers need to be held accountable not just the pushers…the intermediaries or counterparties now being made whole with taxpayer dollars in the billions…what did they know and when did they know it and what did they do about what they knew (of AIG’s implausible capital position to support its casino operation). 


Does anyone think PIMCO, for the purpose of example, is not going to participate in TALF or a private/public US government sponsored SIV because US Congress and the White House is tar and feathering AIG FP personnel when there are billions of dollars to be made at low cost (thank you Fed and Treasury) and low risk (thanks again)?  Greed may be in hiding but it has not left the human condition.  And cash is king so if the buy side was not happy with intrusive term sheets and agreements from dealer banks responsible for distributing upcoming TALF backed ABS then guess what…form a CDO and get on with it.    The government needs the likes of PIMCO more than PIMCO needs the government and PIMCO needs great risk reward and there will be no better risk adjusted returns ahead than cowboying up with government sponsored investment vehicles.


One lesson from the last 18 months that many in the markets refuse to accept (not a secret) is that we are living through a massive market failure and when the market fails (and as we learned the real economy or private output follows) there is only the government to keep the system alive.  Is this an admission that capitalism is dead and socialism is triumphant?  Not in the least.  It is confirmation in the 100 year flood, government, with all its warts, has to step in and sort or a major disaster to prevent an even greater disaster.  So I ask in this context whether putting Barney Frank’s head on a pike which many in the market seem to want to do is any different than what is happening to many at AIG FP?  I think it is time for some humility in markets – where would we be without TARP, AIG bailout, massive if imperfect government stimulus, an explosion in the Fed’s balance sheet and similar measures across G20?  I have many complaints about what could be done differently by the government and still think some measures may in the end prolong the agony rather than bring it to a less-prolonged end.  And this is a good thing – be critical of government policy, but be constructive.  And be realistic market…none of us would be working right now if not for the government.   The capital markets failed, private real GDP has collapsed.  It is government for the time being and it may never go back to what it was (largely free to choose), not in my lifetime.  But stop viewing the policy response and politics of the moment in a prism of a functioning capital market and private sector.  For better or worse Barney Frank, Harry Reid, Nancy Pelosi, John Boehner, Eric Kantor, Mitch McConnell, Ben Bernanke, Tim Geithner, and Barack Obama are our only hope. 


David Gilmore



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