Federal Reserve & Interest Rates

In a speech today, Treasury Secretary Henry Paulson called for new regulations to help liquidate failing firms without it affecting overall market stability.

“For market discipline to constrain risk effectively, financial institutions must be allowed to fail,” Paulson said in excerpts of a speech he will deliver in London.

“It is clear that some institutions, if they fail, can have a systemic impact, so we must give regulators the authorities to limit that impact and facilitate an orderly failure,” Paulson said.

Why are these regulatory changes needed?  Well back in March, the Fed intervened when it looked like Bear Stearns was in danger of failing, financing a buyout from JP Morgan and putting to risk potentially $30 billion in taxpayer dollars.

Through it’s excessive risk taking in the residential mortgage market, Bear Stearns deserved to fail but it couldn’t be allowed to due to the impact it would have on other financial firms.  Financial firms are tightly interconnected these days through counterparty risk in the credit derivatives market, a largely unregulated market that has had explosive growth in the past decade. 

It is a massively leveraged market that has the potential of causing financial Armageddon according to some well known industry leaders.  Although firms are slowly de-leveraging, there will still be the potential of a failure cascade as the credit crisis is far from over. 

Over the past few weeks speculation has run wild on Wall Street that Lehman Brothers would meet the same fate as Bear Stearns and need to be sold at a discount, although those rumors have abated somewhat recently.  While this is one potential trigger that has been avoided, the danger will likely exist as long as home prices keep falling and firms face the prospect of more writedowns.

History has shown, at least for the past three decades that if the price of controlling inflation is a recession, then the Fed is usually willing to pay it.  However the difficulty the Fed is facing now is keeping the fragile financial system stable.  The Fed received a lot of criticism back in March for their bailout of Bear Stearns using taxpayer dollars to finance the acquisition by JP Morgan.

What most people don’t realize is how much the financial system is interconnected.  The staggering growth of credit derivatives in the last decade, whose notational values have grown to the hundreds of trillions, leaves firms open to massive counter-party risk.

The derivatives market was a new profitable arena which financial firms jumped into with abandon.  Since it is largely unregulated, firms were able to make sizable profits due to highly leveraged positions.

You can think of most derivatives as financial insurance policies that companies purchase to hedge against exposure to certain kinds of risk.  However, unlike true insurance companies, these policies are largely unfunded due to the above mentioned lack of regulation and highly leveraged positions.

Bear Stearns was the smallest of the investment banks but it’s failure would have caused a tsunami in the financial landscape.  While financial leverage can open the way to superior profits when times are good, it can spell disaster when times are bad.

 The Fed has had to pretty much step in and inject billions of dollars into the money supply in order for financial firms to increase their capital reserves that had been depleted from the subprime meltdown.  The capital was needed to prop up fragile derivative positions while they attempt to de-leverage themselves from the mess they’ve created.

The Fed isn’t afraid of a recession, they’re scared to death of another Great Depression that would most likely be the outcome if all those derivative positions get unwound.  It wouldn’t be limited to this country either, it would be a failure cascade of global proportions.Il scopo di Keno e quello di indovinare quali numeri, iniziando da 1 a 80, saranno selezionati dalla macchina di casino online on net Keno.