Collateral: a possible connection between investment banks and the sub-prime crisis

September 15, 2008

In attempt to inject liquidity into the anxious markets, the Fed softened its conditions for extending credit:

The Federal Reserve widened the collateral it accepts for loans to securities firms to include stocks in an effort to help Wall Street weather Lehman Brothers Holdings Inc.’s plans for bankruptcy.

This is a daring move, but a very risky one too, as it opens a door to a vicious circle. The markets where the stocks used as collateral are traded are the same markets that are now recording sharp drops… So, the collateral that will now be offered to the Fed for the loans will possibly be worth less, indeed, a lot less, than the loans against which it offered. In fact, if the securities firms use the loans to restore liquidity in the markets (and this is a big ‘if’) then prices will be established at lower level. Hence, even in such a situation, the Fed will be left with under-collateralised debts on its balance sheet. If that reminds you of the sub-prime crisis then you are not alone.

5 Responses to “Collateral: a possible connection between investment banks and the sub-prime crisis”

  1. danielbeunza Says:

    Agreed. It raises questions about the extent to which market actors (including not just regulators, but specially CEOs of investment banks) understand the dynamics of virtuous and vicious cycles.

  2. typewritten Says:

    What if they perfectly understand vicious cycles and this is just a way of setting the scene for a forthcoming, urgent nationalization of the financial sector and, hence, a step towards socialist harmony?

    One hypothesis: Ben Bernanke has read Mao Tse-Tung’s writings on the notion of contradiction, and is using them right now.

  3. marthapoon Says:

    Could this been interpreted as an old fashioned attempt to create more liquidity by reaching for ‘fundamentals’?

    In the good old days in consumer credit there were three fundamentals: character, capacity and collateral. (For example, for years, the ‘charater’ of the American people was touted as the ultimate fundamental of consumer credit markets.) To increase consumer credit meant expanding the definition of a fundamental.

    The search for fundamentals of course assumes that they are solid – that they themselves are not fluctuating…

  4. typewritten Says:

    About the search for fundamentals: what would be the ultimate, fundamental collateral? Just one idea: Uranium (Nibelungen’s Uranium?). More seriously: it’s interesting that all this fluctuating scenery is fostering conundrums about the “fundamental underlying” of financial wealth which strongly remind of the ones described by Marc Shell in _Money, Language, and Thought_ or by Jean-Christophe Agnew in _Words Apart_.

  5. rumberhaccivelib Says:

    nbibpagufvtyocjpwell, hi admin adn people nice forum indeed. how’s life? hope it’s introduce branch😉

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