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Source link: http://archive.mises.org/8034/friedman-and-the-fed-is-liquidity-the-answer/

Friedman and the Fed: Is Liquidity the Answer?

April 17, 2008 by

Anyone who believes that the Fed can pretend that heavily damaged mortgage securities are worth more than toilet paper and literally build a $200 billion loan portfolio upon them does not understand finance. Just because Ben Bernanke declares something to be “valuable” does not bestow value upon it. One hopes that Bernanke does not earn Hoover’s mantle. However, as long as he tries to follow the Friedman thesis, he runs the risk not only of destroying his own reputation but of destroying the US economy as well. FULL ARTICLE


Deacon April 17, 2008 at 9:24 am

Attn: William Anderson

Why do you write as if there HAS NOT BEEN a shadow-government type of manipulation of the West’s at-large financial underpinnings these past 80 years, beginning with the market/financial manipulations leading up to the Great Depression?

Those secretive movers and shakers don’t care about “the Friedman thesis,” or any other attempt at explaining radical business cycles, as they’re concerned only with robbing national treasuries–taxpayers’ hard-earned money–to acquire POWER and WEALTH.

The Great Depression was not caused by mismanagement but BY DESIGN, as this impending “Greater Depression” is by design.

Read and learn and teach the truth, Mr. Anderson:



If you don’t believe in conspiracies, as with Rush Limbaugh, who calls anyone discussing conspiracies, “kook,” then you’ll forever be ignorant of what’s afoot with GLOBALISM and this LOOMING FOOD CRISIS.

Person April 17, 2008 at 10:07 am

Whoa whoa whoa … the stressed mortgage securities aren’t worth more than toilet paper?

Tell you what, Mr. Anderson. I’ll give you the value the MBS would have as toilet paper. Times 5. In exchange, all you have to do is pay me whatever the MBS turn out to pay their holders.

Do we have a deal?

Chris April 17, 2008 at 10:07 am

I was extremely disappointed that I could not find a Bernanke action figure after seeing that picture.

jaqphule April 17, 2008 at 10:10 am


It hardly matters whether it’s done by stupidity or willful evil. The result is the same. Focusing on the possibility is blaming the individuals, and not the system as a whole. If you replace either or all of the idiots and evil geniuses, you’ll end up with an entirely new set of more of the same.

Whether by evil or stupidity, we’re in for a food crisis no matter what. Stock up, but quietly.

Bill, that picture has me laughing hysterically. The Mises Institute should try selling *that* on a T-shirt.


CarlJ April 17, 2008 at 11:45 am

Suppose Bernanke doesn’t care about helping failing businesses, couldn’t it then be that he is worried about the unemployment under TGD? That is, what if Friedman wanted the FED to have increased the money supply, because the government and the unions didn’t allow the wage rates to fall, so as to avoid mass-unemployment?

hjmaiere April 17, 2008 at 11:46 am

“Galbraith held that underconsumption occurred because the income ‘gap’ between the wealthy and poor grew during the 1920s — another ‘natural’ outcome of capitalism…”

Note that this is canonical Marxist economics.

Fephisto April 17, 2008 at 3:45 pm

“Bill, that picture has me laughing hysterically. The Mises Institute should try selling *that* on a T-shirt.”

I would most definitely buy such a shirt.

Beach April 17, 2008 at 4:10 pm

Can we get that picture in a larger size? I wanted to put it on my dorm door, but expanding it makes the text illegible.

Curt Howland April 17, 2008 at 5:08 pm

To heck with the Tshirt, I actually had the 10″ G.I.Joe and helicopter that is in the picture. I remember them fondly, and wish somehow I could go back to my 8 year old self and say, “Protect these. They will be worth _money_ one day.”

David Hillary April 17, 2008 at 5:35 pm

Loans to banks backed by the security of super-senior mortgage backed securities are very safe investments.

The probability of bank failure of a BBB rated bank is about 0.2% p.a. (most banks are sitting around AA with a probability of default (PD) of about 0.03% p.a.). The loss given default (LGD) depends on how much the collateral falls in value at the same time as the default, i.e. within a very short time. Normally the collateral will be liquidated for more than its haircut reduced amount, i.e. normally the lender can expect to fully recover the amount lent by liquidating the collateral, and the lender’s collateral policies (and haircuts imposed) are calibrated to this end. When doing this they probably use a 99th percentile confidence level over a 5 or 10 day horizon, so that they can be, say, 99% sure that the collateral will cover the loan in the event of default. However, suppose that in 10% of cases only 80% of the lent value can be recovered this way. This gives a probability of loss (PL) of 0.02% p.a.

In that case where a loss is realised from default and subsequent liquidation of the collateral asset, the loss depends on the recovery rate for unsecured creditors. Normally this is well above 50% in the case of a failed bank, but we can use 50% as our measure. This leaves the lender with a loss of 10% of the amount lent.

So, the expected loss (EL) is just 0.002% p.a. on this type of transaction, which in financial market terms is not materially different from zero (AAA rated securities have a PD of about 0.02% p.a.).

For some reason central banks generally avoid credit risk like the plague. While commercial banks lend to commercial borrowers with a PD of 1.3% p.a. and LGD of 45% (the benchmark for 100% risk weight), central banks lend to investment rated banks on the security of high quality marketable financial assets. The result is that commercial banks bear probably at least 1000 times the total credit risk of central banks. Central banks have similar capital ratios to commercial banks, except the latter have average risk weights of something like 70% while the latter have average risk weights of 0-2%.

Liquidity is not about credit risk, something William Anderson appears to understand about as well as he does lending to banks on the security of marketable financial assets.

The structural function of today’s central banks is to turn government bonds (the lowest risk and most liquid asset available today) into cash — in the form of paper bank notes and balances with the central bank. To do this central banks primarily lend or invest in government bonds (or repurchase agreements on them), and primarily issue bank notes and balances used to settle inter-bank obligations. Stated simply, central banks monetise government debt, and issue forms of money used for final settlement between banks and for the retail trade. They can also monetise other assets, and doing so does not change their structure or function. So long as their risk levels remain trivial, their function does not include bearing any significant share of the credit risk on total loans made in the banking sector.

The reason central banks are offering to accept AAA rated super senior mortgage backed securities as collateral for loans is in an attempt to improve the liquidity of these instruments. Such an attempt may be misguided and/or a poor way to improve the liquidity of banks, however it probably will improve the liquidity of those instruments.

Bruce Koerber April 17, 2008 at 5:44 pm

I wonder what monetary event, what specific act of intervention, will generate the whirlpool that will transform the recession into a depression.

Bernanke is flying in his helicopter above the sea oblivious of the mounting currents. That is one of the problems with the insularity created by chronic interventionism. These charlatans cannot perceive the destructiveness of their actions.

But since all interventionists are ego-driven Bernanke’s helicopter will crash when he is reviled as one of the chief perpetrators.

The suffering of everyone, the depression, is avoidable! The answer is non-interventionism and a return to a Constitutional Republic in America.

David April 17, 2008 at 6:00 pm


The Daily Reckoning has a bigger version of the picture.


Mike Sproul April 17, 2008 at 7:32 pm

David Hillary:

Amen! It’s good to hear an intelligent comment above the noise.

Ben April 18, 2008 at 6:55 am

If you don’t believe in conspiracies, as with Rush Limbaugh, who calls anyone discussing conspiracies, “kook,”

I don’t have to be Rush Limbaugh to think you’re a kook.

hjmaiere April 18, 2008 at 8:31 am

David Hillary: “Loans to banks backed by the security of super-senior mortgage backed securities are very safe investments.”

Especially if it allows you to get away with disguising a bank seizure as a bank bailout.

Deacon April 18, 2008 at 9:05 am


Attn: Ben

If I’m a kook, then you’re a fool:

Okay, Ben, let’s call it an IN-YOUR-FACE, WELL-EXPOSED, OPEN PLAN by elite movers and shakers who wish to usurp the WILL OF THE PEOPLE in this purported democratic republic, for the purpose of establishing ONE-WORLD GOVERNMENT, under what this scribbler has coined as “GLOBAL ECONOMIC SOCIALISM; that is, the Ford Foundation, Trilateral Commission, CFR, Kennedy Round Table and various U.N. organizations have published in-house documents that relate what I’ve MISTAKENLY termed “CONSPIRACY,” and which documents found in the charters and meeting-minutes and published articles of said organizations REVEAL a plan to effect the above stated goal.

If you’d just study my “Planned Destruction…” essay – and Google any of the terms related to said PLAN – I believe you’d change your mind about this on-going financial collapse of the West being merely a product of mismanagement.

Planned Destruction of America


Paul Marks April 19, 2008 at 7:06 am

In Britain the powers-that-be are handing out government bonds in return for bank mortgage debt – but the bonds will not appear in statistics for the government budget deficit or the national debt.

I can not think about these “clever” government fraudsters without curse words popping into my mind.

mikey April 19, 2008 at 5:13 pm

David Hillary, I’d be interested in your opinion the following-TIA, mikey.


Joe Stoutenburg April 21, 2008 at 11:15 am

David Hillary,

I have a quantitative finance background and so recognize the terminology that you use. I have also read into the defaults of some high rated, supposedly safe sub-prime assets. The problem is that assets are being packaged and repackaged. Collateralized debt is itself chopped up and its pieces sold again. When you follow the twisted trail of the prospectuses of these wrecked assets, you eventually find massive amounts of leverage with drastically less seniority than you thought you had. It only takes one piece of the scheme to go into distress to bring the whole thing down.

I have seen AAA rated assets be written down to zero. So much for your LGD numbers. Blind reliance upon such models as those you preach has brought down more than a few hedge funds with brilliant people who couldn’t see outside of their models. If you have anything to do with this stuff professionally, I sincerely recommend that you employ caution when considering popular credit models. As I’ve often heard said, all models are wrong. Some are just more useful than others.

Regarding your comments about liquidity, if you think about it, liquidity is simply the inability to sell an asset at the price you want. Lower your price, and you’ll find you asset quite liquid. If these assets being accepted by the Fed are “illiquid”, one must question why market participants are unwilling to bid for them.

mikey April 21, 2008 at 8:15 pm

To see what some of these debt instruments are actually trading at-


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