Defending the Bank

I don't want to get into a habit of doing this, but I should defend the Bank of England from Jon Moulton's criticism:

Mr Moulton said that during a breakfast meeting with Bank officials “it became clear they did not know what a [collateralized loan obligation] was"...The power of the Bank to control debt markets had been significantly reduced by the proliferation of securitised debt, according to Mr Moulton, who is the senior partner of Alchemy, a mid-market buyout firm. He said the Bank had “no weapons to control CLOs”.

First, it's not the job of all Bank officials to know everything. Here's a hint, Mr Moulton. Look at a £20 note - you've got enough of them. That stuff on the back about the division of labour. They practice it at the Bank. Plenty of folk there know what a CLO is - the fact that you spoke to ones who didn't tells us nothing.
Second, knowing what a CLO is is in itself not terribly useful for the Bank. The question for the Bank is not: what is a CLO? It's: why should we give a damn about them? Why do they pose a threat to the economy? And two months ago, it would have been entirely reasonable not to worry. CLOs, in theory, were tools to help spread risk - not a source of risk. And, Bank officials might have figured; "the guys in the CLO market earn 10-20 times more than we do, so mightn't they have some clue what they are doing?" Detailed knowledge of CLOs, in itself, would not have helped the Bank avoid these forgivable errors.
Finally, it's not the job of the Bank to control CLOs or debt markets. The Bank should not run after traders wiping their noses like a mother with a snotty five-year-old. It's the Bank's job to ensure that the macroeconomy remains stable, whatever damn fools throw at it. And it's been better at its job in recent years than many hedge funds who were just gamblers who got lucky, and are now whining that they've been caught out.

Comments

[dsquared]

There are plenty of people at the BoE who know a hell of a lot about CLOs. There was a really good article about the CLO and CDO market in the Financial Stability Review a couple of years ago. I also have a shrewd idea about who it was that Moulton met, and the official in question is very clever indeed. I'd put quids on it being Moulton who hadn't understood the question asked.

[pommygranate]

Chris

Why the defence of the BoE?

These are perfectly valid criticisms made by Moulton. The BoE should know what a CLO is. They are a very plain vanilla instrument. Nothing exotic or funky about them and they have been the main player in the loan markets for 5 years now.

He is right about the credit crisis, though. I have traded credit since 1993 and i have never seen anything like this. Most players don't have a clue how to even mark their books let alone know how much they are down.

Sell every stock you own as the equity markets are in denial.

[kinglear]

As Corporal Jones would say " Don't panic!" However, now might be the time....

[Alex]

Moulton is presumably spreading FUD in the hope of either a) pushing LIBOR even higher (is he long?) by working up crisis fever, or b) agitating for a helidrop of cash.

Note how many "Ye gods! The Bank knows nothing!" stories are sourced to sources-close-to Barclays; what *is* going on there?

[kinglear]

Follow the money - or in Barclay's case the missing money

[Karthic]

"It's the Bank's job to ensure that the macroeconomy remains stable, whatever damn fools throw at it"
Indeed.
Three Cheers Chris.
The Bank's job now is to effectively contain any Macroeconomic fallout of this "crisis" without contributing substantially to Moral Hazard.
The scheme they devise will be the test of their competence.

[james C]

Can someone knowledeable explain precisely what is causing banks to be unwilling to lend 3 month money to each other? I can't believe it is at all likely that they are scared of a default. Nor can losses be so great that the banking system lacks the capital to support interbank lending.

Something major msut be up, but what is it?

[dearieme]

"The BoE should know what a CLO is." Pommy, the Bank is an abstraction; it's metaphorically from Barcelona. It's the people in it who should know things. Chris claims they many of them do. His pay-off - "just gamblers who got lucky, and are now whining that they've been caught out" - sounds entirely plausible to me. More strength to the Dillow elbow, says I. You tell 'em, son.

[Laban Tall]

Chris - may or may not be off topic, but is there any truth in this - either the stuff about the abnormal volume of AA and UA put options, or the alleged current put frenzy Or is whoever's behind the site trying to manipulate the market ?

http://www.homelandsecurityus.com/Options082907

"In the weeks preceding the 2001 attacks on America, there were very significant financial warning signs that something big – and bad – could be about to happen. Huge surges in purchases of “put options” on stocks of United Airlines and American Airlines, the two airlines used in the attacks, and “put options” on Merrill Lynch & Co., and Morgan Stanley, stocks of two financial services companies hurt by the attack were noted. Put options are essentially “bets” that a stock or stock index will drop on or before a certain date; the larger the drop, the bigger the gain for the purchaser of the option.

Fast forward to the present day, and we have the same type of trading that took place in the days that preceded the 9/11 attacks – but on a larger scale. Nearly $1 billion of “put options” have been purchased, basically betting that Standard and Poor's 500 index will fall significantly by the third Friday in September. "

[pommygranate]

Laban

Far out the money put options (which these appear to be) are incredibly cheap to buy. Given that we are approaching the 6th anniversary of 9/11, it seems reasonable to assume that some nutjob Islamic groups somewhere in the world will be planning to 'celebrate' the occasion with another attack (as in Germany this week).

I suspect that is is more likely to be the result of traders protecting their books by buying a very cheap option... just in case.

[Karthic]

In response to James' query above:
James,
I think the article at the link below will answer your question:
http://tinyurl.com/ywol3t

[Mark Wadsworth]

S&M, totally agreed, Pommy, thanks for tip, James C, very good question. Perhaps none of them have got any money left to lend each other?

[dsquared]

[Can someone knowledeable explain precisely what is causing banks to be unwilling to lend 3 month money to each other?]

How do you explain how a single sniper can pin down a whole platoon for six hours? Everybody knows that the sniper can't really inflict that much damage on the platoon, but everybody also knows that the first man to move is by far at the greatest risk.

[Luis Enrique]

So D2, is the house of cards going to fall or is the wrinkle going to work its way of the system with few casualties?

[james C]

I don't know the answer.

My own feeling is that it must be something to do with the structure of the interbank market. The banks are willing to lend to companies, which I doubt are less creditworthy than Barclays bank.

I understand that banks don't deal directly with each other but through money brokers. It may be that they don't actually know who the counterparty is, only that it belongs to a certain class of institutions.

If that is the case, and some of these institutions were deemed suspect, then I could see how the entire interbank market would dry up.

But if the banks know who they are dealing with, then it is hard to understand why they are unwilling to deal with each other.

Does anyone know what the answer is?