Saturday, March 15, 2008

Helicopter Ben vs. the Black Swan

by Tom Bozzo

Ken probably should write this post from the perspective of someone who isn't necessarily just playing armchair analyst. But here goes anyway.

Brad DeLong figured that the assumption that the Fed wasn't going to allow BSC to fail would be a buy signal: a play on the Fed's willingness to accommodate moral hazard. "Mr. Market" disagreed.

My guess is that Brad is right that there's a moral hazard premium, but that it was swamped by the discount for Mr. Market having failed to put a price on BSC that appropriately reflected the possibility that but for yesterday's intervention it would have collapsed if not yesterday then imminently.

As Dean Baker repeatedly tells us, elite opinion has been busy soft-pedaling the crisis all along. The possibility can't be eliminated that elite opinion believes its own bullshit, at least to some extent. (Just about every recent rally seems to have been on news [i.e., large unconventional Fed interventions] that has had at least a subtext of "things are much worse than they seem, even after accounting for the fact that things are much worse than they seem," to borrow a DeLong-ism.) That would make things rife for Wile E. Coyote past the cliff edge corrections.


Brad's getting royally schooled (in a good way) in his comments section.

The immediate problem with Dr. De Long's theory is that saving the firm, from the Fed's point of view, does not mean saving the shareholders.

It's a simple enough vector analysis: if BSC falls $1, the damage is limited to BSC shareholders. If the dollar equivalent of collateralised, leveraged bonds fails, the contagion hurts a lot of other firms and shareholders.

So the Fed doesn't care about shareholder wealth (PV of expected future cash flows) at a time when the FCF approaches zero at t>0.

What no one seems to be saying is that JPMC isn't doing this out of the goodness of their heart, or because the Fed is guaranteeing everything with our tax dollars.

JPMC is Bear's custodian for most of those underwater transactions.
The possibility can't be eliminated that elite opinion believes its own bullshit, at least to some extent.

I think that's not a possibility, I think its a certainty except in a small number of cases.
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