Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Bernanke and his tag clouds

Paul Kedrosky’s Infectious Greed blog compares
Bernanke’s speech
at the Jackson Hole symposium this year with his speech
at the same event last year. Using Wordle, Kedrosky produces nice tag
clouds for the two speeches that highlight how sharply
Bernnake’s concerns have moved from mortgage markets to the
entire financial system.

I liked the Wordle tag clouds so much that I created one for my own
blog which appears at the end of this post. The tag cloud confirms my
description of the blog as being about financial markets.

Coming back to Bernanke’s speech, I found a few interesting

First, there was the sentence “The company’s failure
could also have cast doubt on the financial conditions of some of Bear
Stearns’s many counterparties or of companies with similar
businesses and funding practices, impairing the ability of those firms
to meet their funding needs or to carry out normal
transactions.” This seems to vindicate those who have been
arguing for quite some time now that the Bear Stearns rescue was a
bail out of J P Morgan Chase. JPM had the largest derivative book by
far of all the commercial banks and was a large counterparty of Bear

Second, was the passage that has been widely quoted in the
blogosphere: “A statutory resolution regime for nonbanks,
besides reducing uncertainty, would also limit moral hazard by
allowing the government to resolve failing firms in a way that is
orderly but also wipes out equity holders and haircuts some creditors,
analogous to what happens when a commercial bank fails.”

I wonder whether a new statutory framework is really necessary to
achieve this. The monoline bond insurance companies have been able to
negotiate cash settlement of the guarantees (which they had issued
when they were AAA rated) at haircuts that reflect their current
reduced credit worthiness. I would imagine that if Bear Stearns had
not been bailed out, similar haircuts could have been negotiated with
its counter parties as well. The Bear Stearns rescue was essentially a
$29 billion loan under a second loss credit note collateralized by
Bear Stearns assets. I do not see why the Fed could not have lent
directly to Bear under a similar structure and adjusted the second
loss trigger point to achieve any desired haircuts for the counter
parties. I suspect that the alleged lack of legal frameworks is an
excuse for lack of spine.

The Wordle tag cloud for my blog is shown below:

Wordle Tag Cloud for my blog


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