Tuesday, September 4, 2007

[Latest Global Dollar Liquidity Measure: +14.8% annual growth rate; latest Endogenous Liquidity Index: -28.7%]

- Two academic papers on markets & liquidity. [1] Markus K. Brunnermeier & Lasse Heje Pedersen: "Market Liquidity and Funding Liquidity", June 2007; [2] Ricardo J. Caballero & Arvind Krishnamurthy: "Collective Risk Management in a Flight to Quality Episode", August 2007. See a short review by The Economist's Buttonwood column:

In the past, liquidity crises have been solved by the emergence of a confident buyer with deep pockets, such as John Pierpont Morgan in 1907. But who could it be this time? Pension funds and insurance companies no longer have the flexibility, while hedge funds are facing tighter funding and the prospect of redemptions. That leaves the sovereign wealth funds of China and the Middle East. But even if they want to buy in bulk, do Western governments want to let them?

- Jean-Pierre Mustier interview. The chief executive of SocGen's corporate and investment banking division talks to the Financial Times:

Mr Mustier reckons that credit conditions will normalise at around the level they were late in 2004. This means that private equity groups will be able to borrow to finance leveraged buy-outs, but at one or two multiples of cashflow less than the average level earlier this year, he says. Similarly, he believes that credit spreads for senior debt instruments will ultimately end up at about 60 basis points higher than they were at the market’s peak.

- Jim Bianco on the Fed. The always sharp Jim Bianco told Bloomberg TV that the liquidity crisis would likely force the Federal Reserve to review the way it conducts monetary policy. Mr. Bianco suggested that, in order to avoid further episodes of "boom-and-bust" behaviour, procedural changes were needed. Mr. Bianco didn't elaborate, but I think he was hinting at the possibility of adopting a formal procedure to keep the Fed funds rate closer to market rates. (Many on Wall Street think that the 1% Fed funds rate in 2003-2004 is at the root of the current turmoil).

- Ben Bernanke and the liquidity of home equity. In his Jackson Hole speech, Fed chairman Ben Bernanke dwelled on "the history of housing finance" in order to clarify "the interaction of housing, housing finance, and economic activity". The goal, ultimately, is to "better understand the behavior of the economy". This brief passage caught mi attention:

The increased liquidity of home equity may lead consumer spending to respond more than in past years to changes in the values of their homes; some evidence does suggest that the correlation of consumption and house prices is higher in countries, like the United States, that have more sophisticated mortgage markets.

In other words: liquidity analysts will have to revise their models to incorporate the effects of "the increased liquidity of home equity".

- Blog Watch. [1] T. McGee on the carry trade; [2] Bill Luby on "echo volatility"; [3] Rich Karlgaard: "Liquidity Crisis or Credit Crunch?"; [4] Morgan Stanley on "soft decoupling" in AXJ (Asia ex-Japan); [5] F-Trader and a new blog: Futures Day Trading.


F-Trader said...

Why did free reserves fall so much on the last report? Because the Fed is encouraging the use of the discount window?

Agustin said...

F-trader. If you look at the Fed funds *effective* rate (as opposed to the 5,25% target rate), you´ll note that it is trading consistently below the target. That forces the Fed to withdraw liquidity, in a attempt to restore the target rate. In other words: this looks like a temporary thing. The Fed will ease!