Dead Mice collateral: the SEC is dead.

I read about people posting dead-mice collateral at the discount window of the FED this morning in the FT and almost choked on my frosted flakes. Paulson warned that

"It would be premature to assume" he said, "these institutions should have permanent access to the discount window and permanent supervision by the FED".

This prompted the commentator to speculate that the FED was tired of taking impaired collateral, including dead-mice, food stamps, and other mortgage securities, and making the taxpayer pay for private sector boo-boos. Many people expect legislation to follow and redefine the role of the SEC to enact surveillance in the shadow banking system.

If counter-party surveillance is not up to the task then a healthy dose of spotlights and "what the fuck is going on in here" may be a good measure. Bear was too big to fail, UBS is too big to fail, which is probably why futures say that in the game of chicken, the govt will do the right thing. It has no choice. Is everyone clamoring for legislation.

Legislation is barely argued in the press right now, well actually nothing is really argued in the press. Everyone sports deer in headlight looks. Either it means there is unison, or we haven't really started the discussions. In any case, one can hear the crickets right now. Some argue that the repudiation of the Glass-Steagal act as a depression-era relic, and lack of memory across 3 generations is the main reason we got back in the same mess in the first place. Controlling the amount of risk that a system undertakes via leverage in the shadow system may very well need to be more tightly legislated.

Remember that banks cannot lend more than 10x their capital, which limits the amount of debt that effectively penetrates the system. This needs to be updated. The banks sold the mortgages in structure products (MBS, SIV) got their cash back from those transactions and proceeded to create more debt with it, in a almost the perfect perpetual movement financial machine. Shadow banking entities like hedge funds are leveraged 30x on average.

This meant more net risk, unregulated risk into the system. But correctly priced risk is not a problem. Theory hypothesized that 1/counter-party surveillance would be enough, 2/ market participants are fully aware of the risks 3/ market participants fully know how to employ that information to price risk correctly.

Reality turned out different, no one was fully aware in that big "originate and distribute" machine. Stuff is opaque and complex, no one can price the same, methodologies diverge and there is no markets to talk to each other anyway to do price discovery. "Originate and Distribute", O.D. is now capitalized as one of the 3 reasons for the systemic breakdown (the other 2 being leverage and asset deflation). You need to "originate and hold" to have a real appreciation and control of cost.

Debt in itself is not a bad thing. Au contraire, it enables us to explore more risk. But it appears there is such a thing as too much systemic risk as the system becomes very sensitive to asset variations. With 30x leverage, equity represents 3% of capital. A variation in assets of 3% will wipe out equity capital. A margin call and realization of positions, or in the case of BEAR, a run, is enough for you to be realized ZERO and it seems that investors do not have full control of this in a tangled web of accounting rules, banking calls, runs and funds freezes. Some people are calling for a suspension of "mark to market" which is a suspension of disbelief for other observers...

I believe that under FIAT money, unbridled Capitalism degenerates in debt-ism if the banking system is allowed to create debt unregulated as it has, it has every incentive to and contrary to hope it does not really have an incentive to self-regulate.

After all 3% variation on asset prices is STATISTICAL NOISE of said prices. If shadow entities are allowed to leverage other people capital all the way up so that their equity is exposed to STATISTICAL NOISE variations, it means they are gambling with your money with basic disrespect for your equity. If 3% asset variation means death to the shareholder what do you think 20% means, 7 times death? as in the housing market? Some would argue that the Bear shareholders got a deal, 10 is the new zero?.

So what is the right amount of risk? let's say 20. Why? huh because 10 was too little and 30 is too much? There: 20, means 5% of M2 is theoretically savings. Ok? Phew, that was easy. The SEC is dead, long live the SEC!