{"id":854,"date":"2008-09-18T03:50:26","date_gmt":"2008-09-18T07:50:26","guid":{"rendered":"http:\/\/blogs.law.harvard.edu\/sj\/?p=854"},"modified":"2008-09-19T15:07:09","modified_gmt":"2008-09-19T19:07:09","slug":"a-little-light-market-music","status":"publish","type":"post","link":"https:\/\/archive.blogs.harvard.edu\/sj\/2008\/09\/18\/a-little-light-market-music\/","title":{"rendered":"frightmotif: deleveraging and the veil of illusion"},"content":{"rendered":"<p>Our interconnected global economy is built on the illusion of <strong>trust<\/strong>.\u00a0 Gautama himself would be <strong>impressed <\/strong>by how far we have advanced the texture of societal illusion.\u00a0 While there are certainly many non-illusory sources of trust, the trust most modern men have in our financial instruments and currencies is based on a blind association of &#8220;interest rates&#8221;, &#8220;inflation&#8221;, &#8220;market valuation&#8221; and similar concepts with a hazy set of economic laws, as though they were fundamental laws in the sense that one discoveres <strong>Mathematical <\/strong>or <strong>Physical Laws<\/strong>.\u00a0\u00a0 Not social norms that could change on short notice; not starting rules of <a href=\"en.wikipedia.org\/wiki\/Nomic\">nomic<\/a> games of risk and manipulation; not Massively Multilayered Online Resource-Permuting Guidelines, hundreds of indirections removed from the original social norm of personal credit and unenforcable on any large scale.\u00a0 They are perceived instead as Laws, discoverable and <strong>immutable<\/strong>.\u00a0 <em>Not quite<\/em>.<\/p>\n<p>For better or worse, we live in fascinating times.\u00a0 Thanks to this <strong>motif<\/strong> of fright, many once-in-a-lifetime financial decisions are being made every day.\u00a0 A few recent moves by the <strong>US Federal Reserve<\/strong> <strong>Bank<\/strong>, striving to maintain order:<\/p>\n<ul>\n<li> <em>Sunday<\/em>: an unprecedented <a href=\"http:\/\/www.reuters.com\/article\/newsOne\/idUSN1444498020080914?virtualBrandChannel=10272&amp;pageNumber=1\">4-hour Sunday afternoon org-to-org trading session<\/a>, part of &#8220;last-ditch efforts to prevent toxic assets from ailing Lehman Brothers spilling into global markets and rupturing investor faith in the international financial system&#8221;.\u00a0\u00a0 The result: only $1B in trades, slightly less panic the following day, and a loosening of the shared global trust in unwavering financial regulation.<\/li>\n<li><em>Sunday night<\/em>?: <a href=\"http:\/\/www.ft.com\/cms\/s\/0\/f8834910-82aa-11dd-a019-000077b07658.html?nclick_check=1\">Banks are told they may use <strong>deposits<\/strong> to fund their investment bank subsidiaries<\/a>, <strong>flaunting<\/strong> Federal Reserve Act <strong>Section 23A<\/strong>. potentially stabilizing failing banks at the cost of risk to individual investors.<\/li>\n<li><em>Monday<\/em>: a <a href=\"http:\/\/www.nytimes.com\/2008\/09\/15\/business\/15fed.html?_r=1&amp;oref=slogin\"><strong>&#8216;dramatic loosening&#8217;<\/strong> of the standard for federal loans to banks<\/a>, potentially stabilizing them at the cost of dramatically increased risk of government losses.\u00a0 Meanwhile, the US Treasury&#8217;s S&amp;P <a href=\"http:\/\/www.reuters.com\/article\/idUKN1752966920080917\">AAA rating is vulnerable<\/a>. Shared global trust in regulation dips.<\/li>\n<li><em>Tuesday<\/em>: The Fed lends <strong>$85B<\/strong> to AIG, after refusing them $20B over the weekend.\u00a0 True, AIG isn&#8217;t a bank, but see FRA <strong>Section 13(3)<\/strong>.\u00a0 AIG uses &#8216;all of its assets&#8217; as collateral, giving the Fed an 80% stake.<\/li>\n<li><em>Tuesday<\/em>: the <strong>FDIC <\/strong>feels the crunch, says it&#8217;s ok for a while, but makes a medium-term <a href=\"http:\/\/news.yahoo.com\/s\/ap\/20080916\/ap_on_bi_ge\/bank_deposits_safety\">request for a $500B line of credit<\/a>.\u00a0 Why?\u00a0 Well, while there are over $6,000B in bank deposits in the US, more than half of them FDIC insured, banks report less than $300B <strong>cash on hand.<\/strong> And the FDIC reserve is down to $45B, only enough to cover ~15% of the difference in case of a widespread bank run.<\/li>\n<li><em>Wednesday<\/em>: <a href=\"http:\/\/www.nakedcapitalism.com\/2008\/09\/banks-now-permitted-to-count-goodwill.html\">Banks may count goodwill as capital<\/a> when meeting regulatory requirements for capital onhand.\u00a0 This allows a deepening of the leveraging of assets of troubled banks, which only caused trouble during the<strong> S&amp;L<\/strong> crisis; what&#8217;s different now?<\/li>\n<li><em>Thursday<\/em>: After three <strong>Reserve<\/strong> Fund money market accounts drop below $1 a share, <strong>Putnam<\/strong>&#8216;s Prime Money Market Fund <a href=\"http:\/\/www.nytimes.com\/2008\/09\/19\/business\/19money.html\">shuts down<\/a> to avoid losses.\u00a0 <a href=\"http:\/\/www.nytimes.com\/2008\/09\/17\/business\/17fund.html?_r=1&amp;oref=slogin\">It&#8217;s been a while<\/a>.<\/li>\n<li><em>Friday<\/em>: The Treasury pulls out a few more stops and <a href=\"http:\/\/www.ustreas.gov\/press\/releases\/hp1147.htm\">assigns the $50B in the Exchange Stabilization Fund<\/a> to current money market funds.<\/li>\n<\/ul>\n<p>Updates as the week progresses.\u00a0 The large market swings are reminiscent of the <strong>month before<\/strong> Black Monday&#8230; so stay tuned, <strong>relax<\/strong>, stick to insured banks, and (remind your loved ones to) <em>stay out of the stock market<\/em>.<\/p>\n<p>Liquidity pyramid diagrams, fractional reserves, and other comments below the fold.<!--more--><\/p>\n<p>Before we continue, you may want to revisit the <strong>origins <\/strong>of the modern <a href=\"http:\/\/en.wikipedia.org\/wiki\/Fractional-reserve_banking\">fractional-reserve banking<\/a> system.\u00a0 The international banking scene includes an additional layer of <strong>derivatives<\/strong> (&#8220;<em>Not Your Father&#8217;s Financial Calculus&#8221; <\/em>), leading to a world with over 15x as many financial tokens as could ever be redeemed for underlying assets.\u00a0 Here is the liquidity &#8216;pyramid&#8217; from a few years go; it is twice as top-heavy now :<\/p>\n<p><img data-recalc-dims=\"1\" loading=\"lazy\" decoding=\"async\" src=\"https:\/\/i0.wp.com\/www.marketoracle.co.uk\/images\/global_liquidity.gif?resize=407%2C314\" alt=\"Global liquidity pyramid\" width=\"407\" height=\"314\" \/><\/p>\n<p>Bear in mind in the weeks to come : what scares the central parts of global banking systems is the knowledge that <strong>their empires<\/strong> are built on air&#8230; not just a cushion of air, for a single country, but clouds all the way down, for everyone.\u00a0 People may talk about 10:1 or even 60:1 <strong>leveraging <\/strong>of assets, but even\u00a0 the 1 in those equations relies on shared standards of value and basic trust.<\/p>\n<p><em>Other comments:<\/em><\/p>\n<blockquote><p><span style=\"text-decoration: underline\">Wednesday<\/span>: Kenneth <a href=\"http:\/\/www.ft.com\/cms\/s\/0\/dd9aa390-84d6-11dd-b148-0000779fd18c.html\">Rogoff suggests a $2T bailout<\/a> may be needed to &#8216;contain the contagion&#8217;.<\/p>\n<p><span style=\"text-decoration: underline\">Wednesday<\/span> night: The UK Telegraph <a href=\"http:\/\/www.telegraph.co.uk\/money\/main.jhtml?xml=\/money\/2008\/09\/18\/ccambrose118.xml\">reports on the day&#8217;s global credit freeze<\/a> and the ongoing hit to the Moscow <em>bourse<\/em>, where trading was suspended after the Micex dropped 24% in 2 days.<\/p><\/blockquote>\n<p>&#8230;<\/p>\n<p>On this motif : compounding the fear of having no fundamental support : our urban centers have in theory no hard backstop preventing total financial collapse, with a loss of faith in any institution to protect and safeguard value over time, and a loss of any shared sense of abstract value or usable currency.\u00a0 In contrast, the closer one gets to self-sufficient communities with their own natural resources and balanced sets of local skills, the more superfluous these abstractions, and the less deadly their dissipation.<\/p>\n<p>There is something to be said here about the stabilizing value of multiple competing (or even not entirely substitutable) currencies in a community, in comparison with a strong central bank, but I don&#8217;t know how to formulate it.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Our interconnected global economy is built on the illusion of trust.\u00a0 Gautama himself would be impressed by how far we have advanced the texture of societal illusion.\u00a0 While there are certainly many non-illusory sources of trust, the trust most modern men have in our financial instruments and currencies is based on a blind association of [&hellip;]<\/p>\n","protected":false},"author":1202,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_feature_clip_id":0,"_jetpack_memberships_contains_paid_content":false,"footnotes":"","jetpack_publicize_message":"","jetpack_publicize_feature_enabled":true,"jetpack_social_post_already_shared":false,"jetpack_social_options":{"image_generator_settings":{"template":"highway","default_image_id":0,"font":"","enabled":false},"version":2},"jetpack_post_was_ever_published":false},"categories":[210,216,211,213,214,1],"tags":[],"class_list":["post-854","post","type-post","status-publish","format-standard","hentry","category-chain-gang","category-fly-by-wire","category-international","category-metrics","category-poetic-justice","category-uncategorized"],"jetpack_publicize_connections":[],"jetpack_sharing_enabled":true,"jetpack_shortlink":"https:\/\/wp.me\/p7iVvB-dM","jetpack-related-posts":[],"jetpack_featured_media_url":"","_links":{"self":[{"href":"https:\/\/archive.blogs.harvard.edu\/sj\/wp-json\/wp\/v2\/posts\/854","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/archive.blogs.harvard.edu\/sj\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/archive.blogs.harvard.edu\/sj\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/archive.blogs.harvard.edu\/sj\/wp-json\/wp\/v2\/users\/1202"}],"replies":[{"embeddable":true,"href":"https:\/\/archive.blogs.harvard.edu\/sj\/wp-json\/wp\/v2\/comments?post=854"}],"version-history":[{"count":0,"href":"https:\/\/archive.blogs.harvard.edu\/sj\/wp-json\/wp\/v2\/posts\/854\/revisions"}],"wp:attachment":[{"href":"https:\/\/archive.blogs.harvard.edu\/sj\/wp-json\/wp\/v2\/media?parent=854"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/archive.blogs.harvard.edu\/sj\/wp-json\/wp\/v2\/categories?post=854"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/archive.blogs.harvard.edu\/sj\/wp-json\/wp\/v2\/tags?post=854"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}