this authority can help solve the financial mess at minimal cost to the taxpayer (although there are no magic bullets or easy exits at this stage)

TO BE NOTED: From The Baseline Scenario:

"The Baseline Scenario

What happened to the global economy and what we can do about it

Will The Real Geithner Plan Please Stand Up?

with 3 comments

With all the material and moral support for U.S. mega-financial institutions currently on the table, why are bank holding company credit default swap (CDS) spreads at new highs? (For more on how and why you might want to think about CDS spreads, we have a basic guide.)

The most plausible explanation is that creditors - unlike equity investors - are spooked by the new resolution authority that is now sought by Treasury and the Fed. This would, after all, allow the government to manage something akin to (but potentially better than, from a social perspective) a bankruptcy process for our largest financial institutions.

These creditors are right to be worried; the authority, if granted, would almost certainly be pressed by events (and creditors’ self-fulfilling runs) into use.

But, if handled right, this authority can help solve the financial mess at minimal cost to the taxpayer (although there are no magic bullets or easy exits at this stage). The key - as always in any major crisis - is decisive action. Over on wsj.com this morning, Peter Boone and I outline one way forward.

By Simon Johnson

Written by Simon Johnson

March 31, 2009 at 9:24 am"

Me:

There are three related stories that deal with the rise in CDS spreads in the past few weeks:

1) China saying that it expects the US to honor its guarantees. Many people have missed the fact that they have been claiming this about their corporate bond holdings, especially the banks. Other foreign investors have said similar things, though more politely.
2) There have been a raft of stories about insurers and pensions needing a bailout.
3) Mexico passed a law allowing the US to own more than 10% of Banamex.
These stories all have connections with the defaults of the bank’s bonds, because these are the people that hold most of them. My guess is that they would accept less money ( a haircut ), but would find a default very unwelcome, and would, at the very least in the case of foreigners, tell us to expect to pay much higher interest on loans going forward. The insurers and pensions would just send their lobbyists to the Congress. In other words, the spreads reflect the real possibility of losses and the seriousness of the issue.

Geithner has been saying all the right things about all of this, doing a good job of balancing the anger of bondholders and the need for the US to seize a few large banks. I’ve been puzzled by the criticism, since it’s too early to tell what will happen. Just like the FDIC, we’re not going to announce such a move until it happens.

Citi has been selling assets. The problem with Citi might be that investors just don’t think that they can make it, even if they sell a lot of assets. They’re a good target of a seizure or lots more money, which would be hard to get.

So, although I’ve been for the Swedish Plan since Sept. 23rd, want to seize a few banks for moral hazard reasons, want bondholders to accept their risk, this seems to me to be the best option for now. In the meantime, PPIP is simply the best hybrid that could be agreed upon. Nothing more. Until this new law comes into existence, we’re stuck with PPIP, which is simply a more politically acceptable form of the original TARP, except for the FDIC involvement, I believe. But, if you want the FDIC to be able to seize large banks in the future, this involvement should be welcome, since they’re going to need more powers, staff, and funds. Just think of the Banamex problem.

For these reasons, CDS spreads have become an important tool for supervisory risk assessment.

TO BE NOTED: From Shopyield:

"Does banks’ size distort market prices?

Evidence for too-big-to-fail in the CDS market

~

Discussion PaperSeries 2: Banking and Financial Studies

No 06/2009

Discussion Papers represent the authors’ personal opinions and do not necessarily reflect the views of the Deutsche Bundesbank or its staff.

Deutsche Bundesbank, Wilhelm-Epstein-Strasse 14, 60431 Frankfurt am Main,

Postfach 10 06 02, 60006 Frankfurt am Main

Tel +49 69 9566-0

Telex within Germany 41227, telex from abroad 414431

Non-Technical Summary

The information content of banks’ security prices assumes an increasingly larger role in supervisory monitoring. The interest in this issue is twofold. Investors that share the business risk of banks have an incentive to discipline the business activities of a banks’ management.

They can exercise direct market discipline through an adjustment of refinancing conditions. If market prices reflect banks’ riskiness supervisors can use this information to exert indirect market discipline.

The general consensus in the academic literature is that security prices adequately reflect risks of the underlying bank. However, an important concern is that banks’ security prices may be distorted when a bank becomes large enough to threaten overall financial stability and a public bail-out becomes likely.

These banks are called “too-big-to-fail” banks (TBTF). Consequently, investors are less concerned about the failure of a TBTF bank given that losses are limited which reduces their incentive to exercise market discipline.

This paper examines the information content of CDS spreads for a sample of 91 banks from 24 countries. CDSs have gained increasing prominence in the derivative market and have become a core instrument for the transfer of risk. Additionally, several papers show that CDS markets reflect new market information more rapidly than bond markets and that they are also leading indicators such as ratings.

For these reasons, CDS spreads have become an important tool for supervisory risk assessment.

Overall, we find that CDS spreads reflect banks’ risk. However, we further detect an important size effect that vindicates the existence of a distortion due to too big- to-fail. A one percentage increase in the mean size of a bank relative to the home country’s GDP reduces the CDS spread by about two basis-points.

While this appears small, one has to keep in mind that mergers can involve substantially larger increases in size.

In addition, our results confirm that some banks may already have reached a size that makes them too-big-to-rescue. In other words, we find that the distortion of CDS spreads declines for banks beyond a threshold size of about 10 percent market capitalization relative to the home country’s GDP.

This was written by cate. Posted on Saturday, March 28, 2009, at 6:42 pm. Filed under Regulatory, Restructuring, Uncategorized. Tagged CDS, Wall Street. Bookmark the permalink. Follow comments here with the RSS feed. Post a comment or leave a trackback."

And:

"Abstract
This paper examines the potential distortion of prices in the CDS market
caused by too-big-to-fail. Overall, we find evidence for market discipline in
the CDS market. However, CDS prices are distorted due to a size effect which
arises when investors expect a public bail-out( NB DON ) as a result of too-big-to-fail. A
one percentage point increase in size reduces the CDS spread of a bank by
about two basis points. We further find that some banks have already reached
a size that makes them too-big-to-be-rescued. While the price distortion for
these banks decreases the existence of banks that are considered to be toobig-
to-rescue raises important new issues for banking supervisors.

5 Conclusion
This paper analyzes pricing effects due to banks’ size for the CDS market. We
hypothesized that CDS spreads decline in banks’ size, because of an increase in
the probability of a bail-out due to too-big-to-fail. We find that an increase in the
mean size of 1 percentage point reduces the CDS spread by about 2 basis points.
While this appears comparably small mergers of large banks can induce substantially
larger changes in banks’ size and subsequently in their CDS spreads. This raises two
potential concerns. First, the reduction in CDS spreads may limit any potential
21
influence of market discipline on bank management via refinancing costs providing
a competitive advantage. Second, banks might pursue a socially suboptimal size to
exploit better refinancing conditions. Third, supervisors may receive wrong market
signals, when they monitor distorted market prices.
A further aspect raised by our analysis is the existence of banks that have already
achieved a size that makes them too-big-to-be rescued. The existence of such
banks leaves us with an ambiguous feeling. While a stronger market discipline for
such banks is reassuring from a supervisory perspective it also demonstrates the
limits of public bail-outs. As a consequence, the private sector will have to be bailed
in bearing a larger part of the costs. Additionally, given that large banks typically
pursue a substantial part of their business activities across borders may make the
coordination of national supervisors necessary. An important step towards this direction
represents the Memorandum of Understanding (MoU) on the cooperation
between the financial supervisory authorities, Central banks and finance ministries
of the European Union on cross border financial stability in June 2008. It aims to
facilitate the management and resolution of cross-border systemic financial crises in
order to minimize the economic and social costs, while promoting market discipline
and limiting moral hazard."

The Geithner plan gets rave reviews from the CDS market, with serious spread tightening across the board.

From The Economics Of Contempt:

"CDS Market Reaction to Geithner Plan

The Geithner plan gets rave reviews from the CDS market, with serious spread tightening across the board. The CDX IG12 index closed 14bps lower, at 185bps.

Here are today's CDS spread changes for the major U.S. banks:

BofA: 21 bps tighter
Citi: 27 bps tighter
Goldman: 16 bps tighter
JPMorgan: 5 bps tighter
Merrill: 18 bps tighter
Morgan Stanley: 16 bps tighter
Wachovia: 13 bps tighter
Wells Fargo: 10 bps tighter

Other U.S. financials:

Berkshire Hathaway: 28 bps tighter
AMEX: 13 bps tighter
Capital One: 16 bps tighter

Clearly the CDS market thinks the banks will be willing to sell their troubled assets under the Geithner plan. I probably agree.

Posted by Economics of Contempt "

Me:

Don said...

The TAs will be become liquid, priced, and sold, now that the government has entered the TA business.

Going forward, the problems will be:
1) Large losses to taxpayers
2) A GAO report of some kind saying that the government's actions caused the price of the TAs to rise
3) The subsidies turning out to be very large ( even if some of it is recovered )
4) Pimco et al making good money, but taxpayers not so much
5) The appearance of collusion or favoritism of some kind
6) Complaints that congress was circumvented ( whether fair or not )

I hope it works.

Don the libertarian Democrat

March 23, 2009 10:55 PM

I still think that senior unsecured debt of most major banks is probably safe

From Felix Salmon:

"Bank Funding Datapoint of the Day

Bloomberg reports:

Contracts on the Markit iTraxx Financial index of credit-default swaps linked to the senior debt of 25 banks and insurers were more expensive today than the Markit iTraxx Europe corporate index. That hasn't happened since Lehman Brothers Holdings Inc. went bankrupt in September and, before that, JPMorgan's takeover of Bear Stearns, according to BNP Paribas. It reflects "systemic stress" in the financial system.

So much for rallying confidence in the banking system. This is senior debt we're talking about here, not subordinated debt (which often doubles as regulatory equity). Another word for senior debt is "wholesale funding": if a bank doesn't have a large deposit base, then it makes its money on the spread between its senior debt and the rate at which companies and other clients borrow from it. If that spread is now negative, then it's hard to see how the banking system as a whole can be nearly as profitable as the likes of John Hempton seem to think. (Yes, I know I'm conflating CDS spreads with actual funding costs. I suspect that the actual funding spreads are if anything wider than the CDS spreads.)

Indeed, far from seeing profits, the markets seem to be forecasting outright defaults, certainly on the subordinated debt, and possibly on the senior unsecured as well:

"The current prices imply that the companies' equity is worthless, the government's investment is worthless and subordinated debt holders will lose some of their investment," said David Darst, an analyst at FTN Equity Capital Markets in Nashville, Tennessee.

What's more, if bank-debt spreads stay at their present level for any length of time, they're likely to become increasingly self-fulfilling. Right now, these prices represent significant unrealized losses for people who bought at par. But increasingly they're going to start representing significant potential gains for people who are buying at today's levels and hoping to be paid off at par -- paid off, that is, essentially by taxpayers. Since those people can be broadly characterized as hedge-fund managers, one can foresee a lot of Congressional pushback if a large number of hedgies start pulling in tens of millions of dollars just by playing the moral hazard trade. Or, to put it another way, it's a lot easier to impose a haircut when a haircut is priced in than when it isn't.

I still think that senior unsecured debt of most major banks is probably safe, although the WaMu precedent does give me pause. But anything which can be considered equity is increasingly looking like fair game."

Me:

"But anything which can be considered equity is increasingly looking like fair game."

Fair game? More like game over. I'm ready to throw in the towel. William Gross has won this round. Some of these bondholders are going down with the system. They're taking us with them if they can. Some of them are countries, after all. Let's just guarantee these bondholders and regroup, if we've got the brass. They were toying with us. They hold all the cards right now anyway. It's time to start humming "Brazil".

By DonthelibertarianDemocrat Posted: Mar 11 2009 6:59pm ET

"But there are lots of other things that credit default swaps are useful for."

Felix Salmon comes to the defense of CDSs. There's something strange about this constant focus on the products, and not on the people:

"John Dizard wants to kill off the entire CDS market. It does no good, he says, and quite a lot of harm, and we'd all be better off without it.

I disagree. Dizard says there are only "three possible defences for treating the CDS market as a going concern"; in fact, there are more than that, and he misses out the big one, which is that the CDS market has allowed investors, for the first time ever, to hedge their credit exposure. Yes, there's a downside to that -- which is that it becomes easier to simply buy credit protection than to do the hard work of fundamental credit analysis. But CDS by their nature are more liquid than bonds, and it will always be easier to buy credit protection than to sell a bond."

I'm not sure why insurance on mortgages and bonds is inherently indefensible. It seems sensible to me. Buying CDSs for other reasons than mimicking bonds bothers me, but only in the sense that I wouldn't personally come near them because they're risky, and more like a bet. All I ask is that buyers be clearly and truthfully explained the risks in buying them. That's it.

"What's more, CDS prices are a much better indication of credit risk than bond spreads are, for many reasons including the tax treatment of bond coupons and the fact that many bonds simply don't trade. In other words, not only are they more liquid, they're also more transparent. These are good things."

This seems true to me in theory, but I'd like to see more information on how these differences work out in practice.

"But Dizard doesn't concentrate on simple things like liquidity and transparency. Instead, he talks about CDS providing "support for capital raising", which was never something it was designed or even really used for. The whole point of credit default swaps is that they're derivatives: they're not cash instruments to be used for raising capital."

This is something I talked about on Derivative Dribble. Some people understand bonds because they're essentially loans for capital, but don't see the sense in investments that look like side bets.

"Dizard does have a good point that as spreads have widened, banks have seen increasing amounts of money tied up in CDS collateral. That's a concern, and it's a good reason to work hard on compression, netting, and rehypothecation. It's not a reason to kill the CDS market outright."

In other words, ways to free capital for other uses. However, I'd worry about this possibly lowering capital on these investments right now.

"Dizard's other big point, however, eludes me:

Price discovery is a useful economic function; that is the rationale for commodities markets. But CDS are derivative instruments, whose price is "discovered" these days as a function of equity volatility, since buying equity puts is one way to dynamically hedge the illiquid legacy books...
At high levels of default risk and equity volatility, if you hedge the one with the other you get frantic, self-defeating activity.

I'm not sure I understand this, but Dizard seems to be saying that there's a lot of capital-structure arbitrage going on: people hedging equity positions in the CDS market, and vice-versa. That's a strategy which has blown up quite consistently since the summer of 2007, and it tends to require quite a lot of leverage, so I'd be surprised if it was a major factor today. But even if it is, I still don't see why it means the CDS market should be abolished."

I actually don't understand the point at all. It sounds like a weird trading strategy, at best.

"I do understand, however, what Dizard is saying here:

If the default rates implied in investment grade CDS spreads were to occur, the only economic activity would be court-supervised reorganisation. The CDS market has been preventing efficient price discovery.

He's wrong. I just had a long conversation with Kai Gilkes of CreditSights, who confirmed for me that it's pretty much impossible, in this market, to back out implied default rates from CDS spreads. There are so many technical factors in the market, so many reasons beyond expected default that people are buying protection on certain credits, that it's impossible to isolate expected default probabilities. So I don't know what implied default rates Dizard is using, but I do know that they're unreliable to the point of uselessness, since right now CDS spreads tell us precisely nothing about expected default rates.

So yes, if you try to use CDS spreads as a guide to default probabilities, you're not going to get very far. But there are lots of other things that credit default swaps are useful for. So let's not abolish the entire market quite yet."

That's correct. Here's my comment:

Posted: Dec 09 2008 3:30pm ET

I too believe that CDSs can be useful. As to spreads on many bonds right now, the question is whether or not they are moved more by panic than clear analysis of a company's fundamentals. Right now, there's so much uncertainty, that it must contribute as well.

The real question is do you believe that these spreads are accurately predicting default rates, or simply overshooting in our current crisis.

James Grant had a good piece in the FT about default rates recently I believe.

By DonthelibertarianDemocrat

Report Abuse

Felix also posted a couple replies:

"Posted: Dec 09 2008 3:20pm ET

My point is that you need to combine default probabilities with an opaque risk-aversion function to get credit risk prices. We can use CDS prices as a great way of pricing risk. But how much of that is default probabilities and how much is something else, we don't know.

By Felix"

"Posted: Dec 10 2008 09:39am ET

Let me try one more time: the *price* of credit risk is a *very* important number in financial markets, and the CDS market is the best way of discovering it. The implied probability of default, on the other hand, is basically bullshit, and neither the CDS market nor anything else is going to help you very much on that front.

As for Whalen, his numbers make zero sense to me, sorry, and I think the reason that he's unable to explain them in English is that they just make zero sense, period. I do like the way though that when he stuns an audience into silence, he takes their lack of questions as assent.

By Felix"

"Here’s an interesting thought: saving Bear Stearns increased risk in the financial system"

From Alphaville, an excellent and very important post by Sam Jones:

"A systemic risk counterfactual

Here’s an interesting thought: saving Bear Stearns increased risk in the financial system.

From Bank of America:

…the support of Bear Stearns appears to have unintentionally exacerbated the systemic risk of the Lehman Brothers’ default as short-term investors did not reduce their exposures leading up to the default despite the steady erosion in Lehman’s stock price and CDS spreads.

That leaves the potential interpretation that by supporting Bear Stearns, systemic risk from its default was postponed, but in having done so, unintentionally that action exacerbated the systemic risk resulting from the Lehman Brothers’ default.

After Bear Stearns, counterparties to banks were lulled into a false sense of security — assuming that default risks were reduced - or at least recovery rates increased - by a sort of faintly implicit guarantee from the US government against too-big-to-fail banks.

The principle example that would support that being the collapse of Reserve Primary — the money market giant which broke the buck the week LEH went under. Reserve Primary failed because it had bought a lot of commercial paper issued by Lehman. Commercial paper is, of course, unsecured.

Anyway, here’s what happened to the commercial paper issuance of both Bear and LEH in the runup to bankruptcy:

And the after-effects of Lehman’s collapse:

…money fund investors responded to the “breaking of the buck” issue at the Reserve Fund by withdrawing funds from “Prime” funds and placing most of those proceeds in Treasury or Government-only money market funds. That’s the 21st century equivalent of a “bank run,” and its consequences contributed to the severe freezing up of interbank lending in September and October.

Here's my comment:

1. Nov 27 16:27Posted by Don the libertarian Democrat [report]

   "After Bear Stearns, counterparties to banks were lulled into a false sense of security — assuming that default risks were reduced - or at least recovery rates increased - by a sort of faintly implicit guarantee from the US government against too-big-to-fail banks."

   My only disagreement with this is that the implicit guarantee had been in effect since the S & L Crisis. Although there was a chance of not being bailed out, as Lehman showed, the underlying belief was that the government could not allow large and interconnected financial institutions to fail. This was so well understood, that there was really no Plan B for these large institutions.

   From my perspective, the reaction to Lehman was panic at the thought that the government wouldn't intervene, and that there was no real Plan B.

   I think that the idea that the people involved in this belief were adherents of zero government intervention on principle has been proven false. Rather, they believe that the government and Fed are an essential backstop to our financial system. Simply because people try to get around regulations or have them abolished for their own ends, doesn't entail that they don't welcome and depend upon government when it suits their interests. Free market rhetoric is very useful when you're trying to get the government out of your way, but it's not a binding contract on future behavior or behavior in other circumstances.

   Phil Gramm and others might have actually believed their rhetoric, but the people with the real money are not so foolish as to not believe and expect that when they could really use government help, they damn well better get it. Surely actions speak louder than words, and the actions, after Lehman, said, "For God's sake help us, and don't bother mouthing nostrums about the free market, because if we go down we're taking you with us. Did you think we gave you all those donations for your eloquent defense of principles?"

"particularly at the shorter end, that the spread provides little information about expected inflation. "

Via Greg Mankiw, a Robert Barro quote that I like:

"Therefore, especially at the shorter end, the relation between indexed and conventional Treasuries has shifted--the real rate on indexed bonds now has to be well above the expected real rate on nominal bonds. This observation also means, particularly at the shorter end, that the spread provides little information about expected inflation. "

I don't think that they measure expected inflation rates, but the fear and aversion to risk. Flight to safety of this magnitude is premised upon an unnatural fear and aversion towards risk. The spread measures the distance between these two correlated positions.

"What is the least bad option?": Unfortunately, It's Not What They Recommend

From the WSJ, the following post:

"Following the fresh declines in markets, Peter Boone and Simon Johnson argue that the TARP is no longer succeeding in stabilizing markets. Below they lay out the government’s options. Boone is chairman of Effective Intervention, a U.K.-based charity, and a research associate at the Centre for Economic Performance, London School of Economics, and Johnson is a former IMF chief economist, and is currently a professor at MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. They run the economic crisis Web site http://BaselineScenario.com.

Treasury Secretary Henry Paulson announced earlier this week that the Troubled Asset Relief Program (TARP) has succeeded in stabilizing the U.S. banking system. This unfortunately no longer appears to be the case.

It is true that immediate financial meltdown was averted in mid-October through a dramatic bank recapitalization program. This convinced the market that leading banks were less likely to default and turned around debt prices.

But the share prices of major banks have declined steadily since that intervention and fell again sharply yesterday. The numbers now are remarkable. The market capitalization for Citigroup is below $40 billion. This is a bank with a $2.05trillion balance sheet, plus substantial off-balance-sheet liabilities that yet may come back on balance sheet. And it is not alone. For example, the market capitalization yesterday for Bank of America was under $70 billion, while its balance sheet is around $1.7 trillion. Some top banks are now worth less than their Tier 1 capital, which means that investors expect large or at least uncertain future losses.

The market view is clear: a severe recession is coming and big banks need a lot more capital. The private sector won’t provide enough. Despite the G-7 statement in October that systemic banks will no longer fail and despite the promises implicit in the TARP, no one knows what will happen as the economic outlook worsens. The particularly worrying development on Wednesday was that credit default swap spreads jumped (again) for some major banks — in at least one case, rising to over 350 basis points for the first time since the bank recapitalization program took effect. There is a real danger that access to private finance for major banks will dry up completely."

This is completely correct. The markets are completely focused on the government. There is no Plan B. At this point, non-intervention would result in an even worse eruption of fear and avoidance of risk, which I see to be the main problem now.

"In effect, the market is testing the government, pushing to find out how far it will let market conditions for banks deteriorate. The situation is analogous to that of a fixed exchange-rate regime, in which investors test how long a government is willing to hold a particular exchange rate. Eventually, the costs of holding the exchange rate may be too high and there will be devaluation, so why not get out now? Selling the currency, in that situation, is a one way bet. U.S. bank stocks and debt currently feel like the same sort of one-way bet to many. The solution to such crises requires two key ingredients: a credible plan, and actions to ensure that investors betting against the plan lose money. What is the right plan?

Doing nothing is not really an option. There is a risk that corporations, hedge funds and others will reduce their exposure to the most problematic banks, and this would effectively be a run. You can forestall collapse with massive quiet Fed support, but this is not even a band-aid. Problems easily spread to other banks and exacerbate problems on Main Street, as banks scramble to raise capital and liquidity by contracting credit, selling assets and competing with high deposit rates to find funds."

This is also correct, and explains, for example, why the servicers and managers and owners of bundled assets are unwilling to negotiate more settlements. The alternative will be awful, and they'd just as soon wait for a possible government plan. In essence, there is a Flight From Risk that only the government can combat .

"There are no good options, but three of the less bad choices are:

1. Repeat a TARP-type injection of capital, on similar financial terms, to all systemically important institutions. This will achieve a great deal: investors betting against the major banks in credit markets lose money, and — since the TARP terms are generous to current owners — some bank equity prices likely rally. Next time everyone will be more reluctant to bet against the banks. This plan is expensive — the entire remaining $410 billion in TARP may need to be deployed in this fashion. But the real problem is that, because the TARP terms were so favorable and the debate over auto makers has exacerbated bailout fatigue, there is dangerously little political will to support such actions.

2. Recapitalize the most troubled banks, but make the financial terms tougher. Banks cannot afford to pay much higher interest rates, but the government could take more warrants (i.e., options to buy common stock). This heads towards nationalization — if the government invests $50 billion in Citigroup on the same terms that Warren Buffett invested in Goldman Sachs, the tax payer will effectively get control. The message to markets will be: sell equities now because the government is set to effectively nationalize, but at least creditors would feel safe.

3. Some banks go into conservatorship, while all other banks get large new injections on original TARP terms. This would prevent contagion from failed banks to others, and it would penalize equity investors betting against “good” banks. However, some massive banks would probably see their business go under and this would prove highly costly for the government.

I'm for 2, although in an even stronger and clearer form.

"What is the least bad option? You need to keep the major banks private and able to raise capital again when the economy recovers, so option 3 is not appealing and this also puts a cap on the warrants in option 2. You can only keep the purely private route open with terms similar to what TARP offered, which is option 1. This will be unpopular. The only way to make this intervention at all palatable is by capping executive pay and benefits (perhaps they should sell their private jets and fly commercial?), and encouraging departures (without parachutes) at banks where confidence in management has been lost.

The message from a new TARP capital injection will be that America stands behind its commitment to systemically important financial institutions. But there is a good chance these commitments will need to be reinforced with still further TARP-type capital rounds in the future. This is the cost of the administration’s growing lack of market credibility, helped by the numerous abrupt (often warranted, but poorly explained) policy changes emanating from the Treasury, and the prospect of a very severe recession.

One longer term approach may now appeal to the Federal Reserve, i.e., a more expansionary monetary policy steepens the yield curve, raising profitability for banks and generating sufficient inflation. This is not without substantial risks, but house prices recover. Most large banks can and should survive in that scenario."

They make quite a bit of sense, given the current situation, but I still don't agree. This hybrid approach is a big reason that this government intervention is working so poorly, and the abrupt policy changes are built into a hybrid plan. Having said that, I doubt that 2 or something like it will happen.

TED Spread

On the TED spread, the necessary blog Calculated Risk:

"Here is the TED Spread from Bloomberg. The TED spread hit a record 4.13 this morning. This is far above the highs reached during the previous waves of the credit crisis.

Note: the TED spread is the difference between the LIBOR interest rate and the three month T-bill. Usually the TED spread is less than 0.5%. The higher the spread, the greater the perceived credit risks (compared to "risk free" treasuries)."

Read the whole post.