Archive for April, 2009

Tim Geithner’s replacement, William Dudley, offered some interesting remarks on the effectiveness of TALF, the expansion of the FED’s balance sheet, and alternative methods of providing liquidity to banks. Above all, Dudley stresses that while deleveraging is inevitable in a credit crunch, it is imperative to facilitate the volatility which comes with it:

In the current crisis, the deleveraging process at times has been very violent and dangerous, with powerful reinforcing feedback loops intensifying the process. During these episodes, bystanders who did not engage in excess may be trampled and fail. This may exacerbate the tightening in financial conditions, intensifying the constraint on credit availability and the downward pressure on economic activity.

We saw that happen to Lehman Brothers…

I specifically like his analysis of how deleveraging occurs, and why it has been central in reinforcing our tight predicament – although it’s a term tossed around endlessly by the media, the effects of deleveraging are seldom explained:

For example, in March 2008, in the run-up to Bear Stearns’ demise, the deleveraging process intensified. Market volatility increased; this caused lenders to increase the haircuts they assessed against collateral to secure their lending. The higher haircuts, in turn, squeezed highly leveraged investors who were forced to sell assets. This drove down asset prices and increased price volatility further, leading to still-higher haircuts. This intensified the deleveraging process, which led to more mark-to-market losses.

“Haircuts” effect margin requirements and collateral levels, and ultimately have to do with the dealer’s profit margin; if the dealer demands a greater cushion to execute a trade, the burden is passed to the buyer (e.g. a hedge fund).

If interested, here’s the full transcript of NY Fed President Dudley’s speech.


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