For want of a nail
The European Central Bank injected €156 billion ($214 billion) into the banking system over the last two days, amid a major sell-off and seeming panic in securities markets. In the US, the Fed added over $75 billion of liquidity to the system, and issued the same statement it made after the 22% single-day meltdown in stocks in 1987. Holy cow! Something big must have happened — or at least you’d think so. In fact, this is what started Thursday’s rout, via WSJ:
The troubles demonstrated both the global reach of the crisis and its impact on a widening circle of markets and companies. The first jolt came from French bank BNP Paribas, which said early in the day that it was freezing three investment funds once worth a combined $2.17 billion because of losses related to U.S. housing loans….
Three BNP funds totaling a minuscule $2-3 billion in assets are frozen and the markets panic? This situation doesn’t add up from the standpoint of the fundamentals. BNP, France’s largest bank with over $100 billion in market cap, isn’t a sub-prime lender in the US market. In fact, BNP wasn’t even directly involved — the funds are a tiny part of BNP Investment Partners, a series of funds managed by BNP, whose assets total almost $500 billion.
So what is going on? The sub-prime mess, bad as it might be, would not appear to justify the outsized market reactions it has generated. The markets are spooked, but we would venture that the root cause is not the sub-prime mortgage market woes, or even the more general problems caused by a $300 billion backlog of LBO’s waiting to be securitized.
We suspect that one culprit may be the largely unspoken concern of traders with the vast, labyrinthine, moistly unregulated and ill-understood derivatives markets with the complex credit interdependencies they create among financial institutions. That’s where major dislocations would cause fear to become panic. Or maybe the markets have been testing Ben Bernanke versus his predecessor, among many other possibilities. On the other hand, this entire situation could be one of the periodic overreactions that markets enjoy. We’ll all have to wait and see.
August 10th, 2007 at 11:00 am
a $214bn “injection” because of a $3bn shaky fund?
August 12th, 2007 at 9:31 pm
So what is going on?
If I knew, I’d be preparing to get rich instead writing a comment at Dinocrat, but…
In an article that is worth reading in its own right, Malcolm Gladwell describes Jonathan Weil’s investigative reporting on Enron:
…Weil spoke to Thomas Linsmeier, then an accounting professor at Michigan State, and they talked about how some finance companies in the nineteen-nineties had used mark-to-market accounting on subprime loans—that is, loans made to higher-credit-risk consumers—and when the economy declined and consumers defaulted or paid off their loans more quickly than expected, the lenders suddenly realized that their estimates of how much money they were going to make were far too generous.
…
…The Enron officials acknowledged that the money they said they earned was virtually all money that they hoped to earn. Weil and the Enron officials then had a long conversation about how certain Enron was about its estimates of future earnings. “They were telling me how brilliant the people who put together their mathematical models were,” Weil says. “These were M.I.T. Ph.D.s. I said, ‘Were your mathematical models last year telling you that the California electricity markets would be going berserk this year? No? Why not?’ They said, ‘Well, this is one of those crazy events.’
Subprime loans. Highly leveraged, highly complex derivatives. Complex credit interdependencies. Far too generous estimates. Enron.