The market hasn’t made any determination as to the value of the assets in question and that’s the crux of the problem: Institutions aren’t lending because they don’t know who is holding what assets, bad or good. Thus, the credit market froze.
[/quote]
Mr. Mortgage, who knows a lot more about this subject than you, says there are buyers for the bad paper, but it is below the level the banks are willing to sell at. If they were to sell at the market price, they would be insolvent. This is the same reason the big banks want to get rid of mark-to-market.
[quote=Allan from Fallbrook]
You contradict yourself by talking about a “massive misallocation of capital”. How do you think capital gets allocated? Through banking. If banking and credit are frozen, then what? Banking, by necessity, needs to get fixed first and fast.
[/quote]
Banking and credit aren’t frozen. We’re barely back to early 2000 standards. Interest rates are below market due to the Fed’s shenanigans and anyone with a reasonable down payment can get a loan. However, if by ‘frozen’, you mean that 110% NINJA loans are no longer available, then yes, on that basis, you could argue that credit is ‘frozen’.
From the above paragraph, I take it you are in favor of the Fed’s buying of $1.25 trillion in mortgage-backed assets?
This is essentially communistic, centralized planning and is the Federal government allocating capital to assets that the free market would not. So you are in favor of economic central planning? I’m kind of surprised as I thought you were in favor of free markets.
[quote=Allan from Fallbrook]
As far as AIG and similar players: The notional value of the derivatives market is $600Trn (yeah, trillion). AIG is positioned, along with other key players, right in the middle, in terms of how large their derivatives portfolio is. If they crash, then their leveraged derivatives position crashes as well, creating a massive ripple effect and possibly systemic failure. Or, what we balance sheet reading accountants refer to as a Bad Thing. [/quote]
I’m not saying that government doesn’t have a role to play, but from what I can see, all that the government is doing is attempting to reflate the bad assets in order to save the politically well-connected.
Instead of continuing to pump money into AIG so that AIG can pay off it’s counter-parties (at full value no less), what the government should be doing is liquidating AIG in as orderly a fashion as possible. If that leads to other institutions failing, then those institutions should be liquidated as well. Printing trillions in order to buy bad assets is bad policy that can only lead to bad things.
And that $600 trillion number is misleading as most of the derivative contracts cancel each other out. The value of all stocks in the world is on the order of a few tens of trillions, so in no way does the market believe that there is $600 trillion in actual derivatives value out there.
Derivatives are just contracts and contracts are broken all the time. If I write a contract and say that I will pay someone $1 billion upon the occurrence of some event, $1 billion has not been created and would never be created unless the government steps in and makes it so (which is what the government is doing so far in the case of AIG).
