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Bush does the right thing

The US$700 billion Troubled Asset Relief Program, otherwise known as the mother of all pork, did have one redeeming feature:  It came in tranches.  The first US$350 billion were directly accessible (some of it needed a signature from the president), but the last US$350 billion needs congressional approval.  With just 10 weeks to go in his Presidency and every company big enough to hire a lobbiest bashing on the doors for a piece of the action, George W. Bush has done the right thing:  He’s deciced to not ask for the last 350.  If soon-to-be-President Obama wants to tap it, it’s up to him.

The Bush administration told congressional aides it won’t ask lawmakers to release $350 billion remaining as part of the $700 billion U.S. financial- rescue package, people familiar with the matter said.
…
The Treasury Department has committed $290 billion, or about 83 percent of the total allocated so far in a program Congress enacted last month to inject capital into a wide spectrum of banks and American International Group Inc. The U.S. invested $125 billion in nine major banks, including Citigroup Inc. and Wells Fargo & Co. and plans to buy an additional $125 billion in preferred shares of smaller lenders.
…
Paulson told the Wall Street Journal today he is unlikely to use what remains of the package, estimated at $410 billion, unless a need arises.

“I’m not going to be looking to start up new things unless they’re necessary, unless they make great sense,” Paulson said. “I want to preserve the firepower, the flexibility we have now and those that come after us will have.”

Update: I don’t mean to suggest that the money shouldn’t be spent. Maybe it should. Professor Krugman, for one, might argue that it ought to be spent as part of a stimulus package. I just think that it’s correct for Bush to pass on deciding how to spend it. His moral authority as an economic leader was gone some time ago. Paulson’s flip-flopping, even if what he has moved to is the better plan, demonstrates the same for him. America will – I suspect – benefit from being forced to take a breather in their cries for help. Let the new team think about the whole mess carefully and then take up the responsibility handed to them.

Another update: The anonymous authors at Free Exchange aren’t so sure it’s a good idea:

It is, in effect, calling time-out on the rescue until Barack Obama is sworn in, and even then there will be a delay while funds are requested and authorised. Meanwhile, Congress has all but decided not to pursue a stimulus bill during the lame duck session. The legislature is taking up discussions on an automaker bail-out, but given resistance to a rescue among Republicans and conservative Democrats, it seems clear that any bill signed into law during the lame duck will be quite weak.

Now, Ben Bernanke will remain on duty right through the inauguration. There’s still an executive branch, and there are still plenty of international policy makers working to stabilise the global financial system. But in a very real sense, America is going to coast on its current economic policies for the next two (and in practice, three) months. I’m not sure this is a good idea, particularly given the critical nature of the holiday shopping season. By all accounts, consumers are locking up their piggy banks at the moment. A disastrous shopping season will probably mean a wave of post-holiday failures among retailers, which will, in turn, mean lay-offs (as well as pain for exporters to America).

Yes, it’s only three months, but three months is a long time for people and businesses struggling to pay bills. And if the economic situation deteriorates over that span, then the government may well feel pressured to pass a much larger and more expensive stimulus package in the spring.

I’m not convinced.  I do note that, as Paul Krugman points out, it’s difficult to have too large a fiscal stimulus in this environment.  I also think that we might benefit from backing off a little bit and abandoning the idea that America and the world at large can somehow escape the recession.  It needs to sink in.

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Is there $100 lying on the ground? (Updated)

There’s an old joke among economists:  Two economists are walking along when one of them notices $100 lying on the ground and bends over to pick it up.  The other one says: “Don’t bother.  If there were really $100 on the ground, someone would already have taken it.”  It’s about things like the Efficient Market Hypothesis and the Coase Theorem.  In short, that opportunities for arbitrage ought to disappear quite quickly because their existence represents free money. [1]

James Hamilton is wondering if he’s staring at $100 lying on the floor of the US Federal Reserve.

On the 5th of November, the US Fed announced that starting on the 6th, any depository institution (e.g. a regular bank) with reserves at the fed would be paid the Federal Funds Target Rate (which is what gets splashed all over the news) on both required and excess reserves.[2]  On the face of it, that would appear to set the target rate as a floor for inter-bank lending.  Why would any bank lend money to another bank for less than the target rate and a little bit of risk when they could put the money in their federal reserve account to get the target rate with no risk?

The mystery, then, is why the effective rate (a volume-weighted average of actual lending rates) really is below the target rate:

The latest data at the time of my writing this was for the 7th of November.  The effective rate was 0.27% while the target rate was 1.00%.

At first, James thought that the reason must be the 75 basis-point charge made by the Federal Deposit Insurance Corporation (FDIC) for guaranteeing the repayment of any federal funds borrowed, but then he realised that the charge doesn’t apply to any borrowing made before the 13th of November.

So we’re still left with the mystery.

It’s probably got something to do with the non-depository institutions that play in the fed funds market (e.g. the G.S.E.s like Fannie Mae and Freddie Mac).  Those institutions don’t receive any interest on cash held at the Federal Reserve, so if they want to make a return on it they need to lend it out.  But why aren’t the depository institutions snapping it up?  They can borrow from a G.S.E. at 0.27%, put it in their reserve account with the fed and get 1%. Since the FDIC has waived all charges for guaranteeing fed fund borrowing until the 13th of November, it’s also risk-free at no extra cost.

[1] The joke also says something about economists:  That we need to make up jokes about other economists is pretty sad. 🙂

[2] Strictly speaking, the rate paid on excess reserves is the minimum target rate over a two-week period, but since it’s (reasonably) safe to assume that the Fed won’t lower rates again in the next week, we can operate as above.

Update: The only idea that I can come up with sounds like a conspiracy theory (and I therefore consider it highly unlikely): that fund managers at the G.S.E.s are not seeking the best rate of return for their cash, but instead voluntarily accepting a return well below the target rate.  Since Fannie and Freddie are 79.9% U.S. government-owned now, what are the odds that there is a depository bank out there that is struggling mightily and the government is using its control of the G.S.E.s to give that bank free money?

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VW: Supply, Demand and Elasticity

Something very interesting happened to the share price of Volkswagen this week.  The FT has the story:

Volkswagen’s shares more than doubled on Monday after Porsche moved to cement its control of Europe’s biggest carmaker and hedge funds, rushing to cover short positions, were forced to buy stock from a shrinking pool of shares in free float.

VW shares rose 147 per cent after Porsche unexpectedly disclosed that through the use of derivatives it had increased its stake in VW from 35 to 74.1 per cent.
…
[T]he sudden disclosure meant there was a free float of only 5.8 per cent – the state of Lower Saxony owns 20.1 per cent – sparking panic among hedge funds. Many had bet on VW’s share price falling and the rise on Monday led to estimated losses among them of €10bn-€15bn ($12.5bn-$18.8bn).

For my students in EC102, this is interesting because of the shifts in Supply and Demand and the elasticity of those curves.  The buying and selling of shares in companies is a market just like any other.  Here’s an idea of what the Supply and Demand curves for shares in Volkswagen were originally:

Shares in Volkswagen (original)

The quantity is measured as a percentage because you can only ever buy up to 100% of a company.  Notice that the supply curve suddenly rockets upwards at around 45%.  That’s because originally, 55% of the shares of Volkswagen weren’t available for sale.  20% was owned by the state of Lower Saxony and 35% by Porsche, and they weren’t willing to sell at any price [In reality, if you were to offer them enough money, they might have been willing to sell some of their shares, but the point is that it would have had to have been a lot].  We say that for quantities above 45%, the supply of shares was highly, even perfectly, inelastic.

Notice, too, that the demand curve is also extremely inelastic at quite low quantities.  That is because a lot of hedge funds had shorted the VW stock.  Shorting (sometimes called “short selling” or “going short”) is when the investor borrows shares they don’t own in order to sell them at today’s price.  When it comes time to return them, they will buy them on the open market and give them back.  If the price falls over that time, they make money, pocketing the difference between the price they sold at originally and the price they bought at eventually.  A lot of hedge funds were in that in-between time.  They had borrowed and sold the shares, and were then hoping that the price would fall.  The demand at very low quantities was inelastic because they had to buy shares to pay back whoever they’d borrowed them from, no matter which way the price moved or how far.

On Monday, Porsche surprised everybody by announcing that they had (through the use of derivatives like warrants and call options), increased their not-for-sale stake from 35% to a little over 74%.  This meant that instead of 45% of the shares being available for sale on the open market, only 6% were.  It was a shift in the supply curve, like this:

Shares in Volkswagen (new)

Because at such low quantities both supply and demand were very inelastic, the price jumped enormously.  Last week, the price finished on Friday at roughly €211 per share.  By the close of trading on Monday, it had reached €520 per share.  At the close of trading on Tuesday, it was €945 per share.  In fact, during the day on Tuesday it at one point reached €1005 per share, temporarily making it the largest company in the world by market capitalisation!

Who said that first-year economics classes aren’t fun?

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Understanding the credit crisis

Steve Waldman has done up a brilliant explanation of the credit crisis:

Alice, Bob, and Sue have ten marbles between them. Whenever one kid wants another kid to take over a chore, she promises a marble in exchange. Alice doesn’t like setting the table, so she promises Bob a marble if he will do it for her. Bob hates mowing the lawn, but Sue will do it for a marble. Sue doesn’t like broccoli, but if she says pretty please and promises a marble, Bob will eat it off her plate when Mom isn’t looking.

One day, the kids get together to brag about all the marbles they soon will have. It turns out that, between them, they are promised 40 marbles! Now that is pretty exciting. They’ve each promised to give away some marbles too, but they don’t think about that, they can keep their promises later, after they’ve had time to play with what’s coming. For now, each is eager to hold all the marbles they’ve been promised in their own hands, and to show off their collections to friends.

But then Alice, who is smart and foolish all at the same time, points out a curious fact. There are only 10 marbles! Sue says, “That cannot be. I have earned 20 marbles, and I have only promised to give away three! There must be 17 just for me.”

But there are still only 10 marbles.

Suddenly, when Bob doesn’t want to mow the lawn, no one will do it for him, even if he promises two marbles for the job. No one will eat Sue’s broccoli for her, even though everyone knows she is promised the most marbles of anyone, because no one believes she will ever see those 17 marbles she is always going on about.

…

Almost whatever happens, the trading of chores, so crucial to the family’s tidy lawns and pleasant dinners, will be curtailed for some time. Perhaps some trading will occur via exchange of actual marbles, but this will not be common, as even kids see the folly of giving rare glass to people known to welch [sic] on their promises. It makes more sense to horde.

A credit crisis arises when many more promises are made than can possibly be kept, and disputes emerge about how and to whom promises will be broken. It’s less a matter of SIVs than ABCs.

Steve later gives an example of the three balance sheets that count produce the situation he described:

Alice (equity: -19)

Assets Liabilities
Physical marbles: 4  
Marbles promised from Bob: 0 Marbles owed to Bob: 7
Marbles promised from Sue: 2 Marbles owed to Sue: 18
Total Assets: 6 Total Liabilities: 25

Bob (equity: 12)

Assets Liabilities
Physical marbles: 6  
Marbles promised from Alice: 7 Marbles owed to Alice: 0
Marbles promised from Sue: 1 Marbles owed to Sue: 2
Total Assets: 14 Total Liabilities: 2

Sue (equity: 17)

Assets Liabilities
Physical marbles: 0  
Marbles promised from Alice: 18 Marbles owed to Alice: 2
Marbles promised from Bob: 2 Marbles owed to Bob: 1
Total Assets: 20 Total Liabilities:


I really enjoy this sort of analogy, because I think that a lot of policy decisions can be enlightened by considering the actors to be individual people rather than the organisations (or entire countries) that they are. So what should Mum and Dad do? Steve also observes the three main possibilities:

Perhaps Mom and Dad will decide that the best thing to do is just buy some more marbles, so that all the children can make good on their promises. But that would mean giving Alice 19 marbles, because she was laziest and made the most promises she couldn’t keep, and that hardly seems like a good lesson. Plus, marbles are expensive, and everyone in the family would have to skip lunch for a week to settle Alice’s debt.

Perhaps the children could get together and decide that an unmet promise should be worth only a quarter of a marble, so that everyone is able to keep their promises after all. But then Sue, the hardest working, would feel really ripped off, as she ends up with a much more modest collection of marbles than she had expected. Perhaps Bob, the strongest, will simply take all the marbles from Alice and Sue, and make it clear than none will be given in return, and that will be that.

Or, perhaps Alice and Bob could do Sue’s chores for a while in addition to their own, extinguishing one promise per chore. But that’s an awful lot of work, what if they just don’t want to, who’s gonna force them? What if they’d have to be in servitude to Sue for years?

The ultimate answer is a combination of all three: Buy some extra marbles (but not all 30), declare each promise to be worth less than a full marble (but not as little as a quarter) and force Alice, and to a lesser extent Bob, to do some chores for Sue (but not full replacement).

The real question is this: Whose fault is it that Alice was able to continue running up debts she couldn’t pay? Should mum and dad been watching all along to make sure that everybody played nicely? Or should Bob and Sue have had more sense when Alice promised to pay them?

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On the indispensability of (investment) banks

As might be expected, there’s a fair amount of questioning about the finance system as a whole going on.

The claim is that the market is best able to distribute this cash to the most worthy of projects, but at what point is their judgement questioned? How are these bastards allowed to be indispensable?

It’s true that the purpose of the finance industry is to, as efficiently as possible, allocate capital (i.e. savings), risk and returns; or, as the Economist puts it, to write, to “write, manage and trade claims on future cashflows for the rest of the economy.” In that regard, the industry as a whole plays a vital role in the economy. But that on its own doesn’t necessitate the indispensability of individual banks. That comes from a variety of inter-related factors:

  • There are banks and there are banks. Ceteris paribus, nobody cares if a Small-Town Bank (STB) goes bust because it is provincial: nobody other than its direct debtors and creditors are affected. Investment banks are (effectively, sort of) where the STB goes to borrow money, though. If they go down, so do all the little commercial banks that depend on them. To use a cheap analogy from The Wheel of Time series of fantasy novels, one might think of the central bank as the True Source, the investment banks as Rand al’Thor using one of those artefacts and all the little banks as power-wielders that are vastly powerful compared to civilians but insects next to Rand. Rand channels the hundreds of little power-wielders and adds his own enormous ability to suck down the juice in order to draw massively on the true source. If somebody were to kick Rand in his privates while he’s doing his thing, half the planet gets ripped asunder. Therefore, the protection of Rand while he’s doing his thing is paramount. He is genuinely indispensable. This analogy neatly explains why you don’t actually want a single investment bank, btw. Having a single, semi-god-like character that’s able to channel the über-load of the True Source is great in a novel, but bloody stupid in real life. Redundancy is key. You want several investment banks that are competing with each other so that if one goes belly-up, the others can take over.
  • Real innovation is rare, so when somebody has an idea, all the banks leap on it at once. That’s nominally fine in itself, but it unfortunately means that the actions of the (investment) banks are highly correlated, which makes for fantastic profits when it all works and a world of pain when it doesn’t. In essence, even though they’re are several investment banks competing with each other, since they all offer the same services at the same prices using the same strategies, they’re acting as though they’re a single investment bank.
  • The latest round of innovations has served to tie a lot of financial institutions together from the perspective of policy makers. This point really comes in two parts:
    • Securitisation and the splitting of those securities into tranches of risk exposure, in principle, allow financial institutions to spread and share individual risk between themselves so that if a Bad Event happens, they all lose a little rather than just one of them losing a lot.
    • There has been a general move away from transparency, with most of these securities being held off balance sheets and being traded in private sales instead of on open markets.

    The securitisation and tranching may have gone too far over the last few years, but that on its own isn’t the problem. The problem is that it was combined with a lack of transparency, meaning that it has become enormously difficult to pick apart the pieces when somebody falls.  To quote the Economist again, “Bear Stearns may not have been too big to fail, but it was too entangled.”  While they could have let Bear Stearns fall rather than be swallowed by JP Morgan, doing so would have required the careful unpicking of all of Bear Stearn’s positions, which would have taken months.  That would then have fed into the final point …

  • People are nervous lemmings. Even if the investment banks were properly competitive and transparent and each employed different strategies so that if one fell, there wasn’t so much risk of the others falling, a major bank collapse is still a problem because we’re all idiots. We panic. Then we see each other panicking, which helps us justify our own panicking and makes us wonder if maybe we’re not panicking enough.  The panic can then develop a momentum of its own, causing other banks to collapse when they otherwise didn’t need to.

So … that’s why they’re indispensable. But that doesn’t mean that we should be paying them the way we do.  Judgement of bankers’ performance is really only measurable after we pay them, which is stupid.  I’ve written briefly on bankers’ pay before here.  It is worth noting, though, that calls for bankers’ pay to be made in the form of stock have to face up to the fact that many employees of Bear Stearns had a huge share of their savings invested in Bear Stearns stock.

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Believing the “experts”

One of my favourite topics – indeed, in a way, the basis of my current research – is looking at how we tend to accept the declarations of other people as true without bothering to think on the issue for ourselves.  This is often a perfectly rational thing to do, as thinking carefully about things is both difficult and time consuming, often resulting in several possible answers that serve to increase our confusion, not lessen it.  If we can find somebody we trust to do the thinking for us and then tell us their conclusions, that can leave us free to put our time to work in other areas.

The trick is in that “trust” component.  To my mind, we not only tend to accept the views of people widely accepted to be experts, but also of anybody that we believe knows more than us on the topic.  This is one of the key reasons why I am not convinced by the “wisdom of crowds” theory and it’s big brother in financial markets, the efficient market hypothesis. I’m happy to accept that they might work when individual opinions are independent of each other, but they rarely are.

Via Greg Mankiw, I’ve just discovered a fantastic example of a person who is not an expert on a topic, but definitely more knowledgeable than most people, who nevertheless got something entirely wrong.  The person is Mark Hulbert, who is no slouch in the commentary department. Here is his article over at MarketWatch:

I had argued in previous columns that inflation might not be heating up, despite evidence to the contrary from lots of different sources …

I had based my argument on the narrowing yield spread between regular Treasury bonds and the special type of Treasuries known as TIPS. The only apparent difference between these two kinds of Treasury securities is that TIPS’ interest rates are protected against changes in the inflation rate. So I had assumed that we can deduce the bond market’s expectations of future inflation by comparing their yields.

… My argument appeared to make perfect sense, and I certainly was not the only one that was making it. But I now believe that I was wrong. Interpreted correctly, the message of the bond market actually is that inflation is indeed going up.

… My education came courtesy of Stephen Cecchetti, a former director of research at the New York Fed and currently professor of global finance at Brandeis University. In an interview, Cecchetti pointed out that other factors must be introduced into the equation when deducing the market’s inflationary expectations from the spread between the yields on TIPS and regular Treasuries.

The most important of these other factors right now is the relative size of the markets for TIPS and regular Treasury securities. Whereas the market for the latter is huge — larger, in fact, than the equity market — the TIPS market is several orders of magnitude smaller. This means that, relative to regular Treasuries, TIPS yields must be higher to compensate investors for this relative illiquidity.

And that, in turn, means that the spread between the yields on regular Treasuries and TIPS will understate the bond market’s expectations of future inflation.

Complicating factors even more is that this so-called illiquidity premium is not constant. So economists have had to devise elaborate econometric models to adjust for it and other factors. And those models are showing inflationary expectations to have dramatically worsened in recent months.

I have never met Mr. Hulbert, nor read any of his other articles.  I cannot claim that I wouldn’t have made the same mistake and I have to tip my hat to him for being willing to face up to it.  There are remarkably few people who would do that.

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A prediction: Only Bear Stearns will fall; Lehman Brothers is safe

The “orderly liquidation” of Bear Stearns is certainly dramatic, but I think that it will be the only US investment bank to fall from the current mess. The reason can be found in this press release from the Federal Reserve:

Release Date: March 16, 2008

For immediate release

The Federal Reserve on Sunday announced two initiatives designed to bolster market liquidity and promote orderly market functioning. Liquid, well-functioning markets are essential for the promotion of economic growth.

First, the Federal Reserve Board voted unanimously to authorize the Federal Reserve Bank of New York to create a lending facility to improve the ability of primary dealers to provide financing to participants in securitization markets. This facility will be available for business on Monday, March 17. It will be in place for at least six months and may be extended as conditions warrant. Credit extended to primary dealers under this facility may be collateralized by a broad range of investment-grade debt securities. The interest rate charged on such credit will be the same as the primary credit rate, or discount rate, at the Federal Reserve Bank of New York.

Second, the Federal Reserve Board unanimously approved a request by the Federal Reserve Bank of New York to decrease the primary credit rate from 3-1/2 percent to 3-1/4 percent, effective immediately. This step lowers the spread of the primary credit rate over the Federal Open Market Committee’s target federal funds rate to 1/4 percentage point. The Board also approved an increase in the maximum maturity of primary credit loans to 90 days from 30 days.

The Board also approved the financing arrangement announced by JPMorgan Chase & Co. and The Bear Stearns Companies Inc.

You might argue that this should have been in place a while ago, but now that it’s in place, I doubt that any more US investment banks will fall. You can safely assume a 50bp drop in the base rate in the next week, I think. As with the previous drops, I think that we will see little, if any drop in longer-term paper. That increased gradient in the yield curve, combined with the effectively-intentional inflation (their liabilities are largely nominal and a fair fraction of their assets are real), should be enough to recapitalise the banks over time. The new lending facility from the New York Fed seems designed explicitly to give them that time.

See also this comment from Deutsche Bank’s Mike Mayo (HT to Calculated Risk):

Lehman is Not Bear. 1) It has more liquidity, 2) It has support among its major counterparties, evidenced by an extension on Friday of a $2B working capital line with 40 banks (one issue w/Bear Stearns [BSC] seems to be that counterparties pulled in lines). 3) Its franchise is more diversified given almost half outside the US and an asset management business that is more than twice as large relative to its size (BSC was more plain vanilla). 4) It has a seasoned and experienced CEO (Bear’s CEO was new). We maintain our Buy rating given a belief that LEH will weather this storm and our estimate of a price to adj. book value ratio of 83%.

The industry issue seems more liquidity than solvency, and LEH protected itself more fully after it’s problems similar to BSC in 1998. At year-end, it had $35B of excess liquidity combined with $63B of free collateral, implying $98B available for liquidity, or $70B more than needed for $28B of unsecured short-term debt (which includes the current portion of long-term debt). While it also has $180B of repo lines, we take comfort that 40 banks extended credit on Friday and believe that some of the repos are likely to be termed at least to some degree.

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Bear Stearns

Just after the loans to Bear Stearns from J.P. Morgan with the unlimited backing of the US Fed were announced, but before it became public that it was actually a buyout, my brother sent me a quick email:

This is [bad word removed]. Surely if the Fed bails out a large bank/ financial company they should receive some equity in return for their cash. Otherwise you just ensure the rich stay rich no matter what.  Please respond with a thoughtful rightwing diatribe.

Fed moves to bail out major US bank: http://www.abc.net.au/news/stories/2008/03/15/2190458.htm

I responded with:

*) Yes, it’s [bad word removed]. It should be allowed to collapse on its own. If the government does get involved, it should be to nationalise the thing outright, close its operations and then immediately sell the various arms off to the highest bidders on the market. The government should not attempt to keep it running as a going concern (as the UK is with Northern Rock).

——

*) No, it’s not [bad word removed]. It is commonly said (including by me) that central banks have two tasks: control inflation and minimise unemployment. The US Fed, unlike most central banks, (a) does not have real independence from the executive or legislature; and (b) is forced to consider unemployment at the same time as inflation. For the BoE, RBA and ECB, fighting inflation comes first and ONLY THEN, when it’s under control, do they look at unemployment.

This isn’t quite true, though. The US Fed actually has three roles:

a) As an independent institution, to control inflation, but not — as yet — with an explicit target like the BoE, RBA and ECB have;
b) As a semi-independent institution, to minimise unemployment; and
c) As simply one of a collection of government agencies working together, to ensure the ongoing stability of the financial system.

That third point, for the US, takes absolute priority over everything else. To be honest, it does in Britain, Australia and Europe as well. It’s important because if the entire financial system melts down, you end up with 3rd-world-style catastrophes and we know that those aren’t fun.

It was clearly on that third point that the US Fed offered its recent US$200 billion facility to the market at large and also on that third point that they declared Bear Stearns too big to fail. They are clearly worried that that the market is a long way from rational right now and that the collapse of even one investment bank would have domino effects that really would threaten the entire system.

——

Personally, I think the US$200 billion facility was reasonable but I think the Bear Stearns bail-out was not. I appreciate the domino risk, but so long as the Fed is acting to ensure that there is market liquidity, I don’t think there is too much cause for concern. To the extent that they prop Bear Stearns up at all, it should be under the explicit understanding that a) it is short term; b) Bear Stearns open their books to the world; c) Bear Stearns negotiate for someone else to buy them out; and d) if they fail to sell themselves within a month, they get nationalised and the Fed then sells it off in chunks.

Some people are likening the Fed’s reactions to those of the Bank of Japan in the 1990s: propping up banks and ought-to-be-bankrupt borrowers so their financial system never had to recognise the dodgy loans on their books. As far as I can tell, the two main differences are that a) the BoJ initially had much lower interest rates, so they had less room to manoeuvre in keeping the real economy out of recession; and b) the US banks are notionally required to “mark to market” when doing their accounts rather than their preferred “mark to model”, which means that so long as the market for sub-prime-mortgage-backed assets is illiquid, they’re obliged to mark those assets as having a value of zero. That is, they’re forced to recognise the bad loans upfront rather than hanging on to them for a decade or so.

And this morning I wake up to this:

In a shocking deal reached on Sunday to save Bear Stearns, JPMorgan Chase agreed to pay a mere $2 a share to buy all of Bear – less than one-tenth the firm’s market price on Friday.

Well, waddayaknow …