Streetwise Professor

In a show of his unbounded generosity, Timmy! (AKA Rodney Dangerfield) has agreed with Spain that Germany should lend directly to Spanish banks, thereby avoiding the untidy strings that come with a bailout of the Spanish government, a la Greece.  (Yes, the loans would come from the ESM, but we all know who is on the hook.)

The US and Spain agreed that European banks should be able to “go directly to obtain funds without any state intervention, without any conditionality”, Ms Santamaria said.

Go ahead!, sayeth Timmy! Give them the money.  No conditions!

The Schäuble smack down coming in five, four, three . . .

PS. Timmy had been on one of his extended disappearances of late.  He is the Major Major Major of the Obama administration.

Global regulators are lumbering towards announcing proposals on the margining of non-cleared swaps, though they will miss the original G-20 deadlines:

Global regulators said on Wednesday they will issue proposals in coming weeks on rules to encourage banks to put derivative trades through a central clearing house, but they won’t be ready for the G20 summit in June.

. . . .

The FSB said it will issue a consultation paper on setting globally agreed margin rules for trades that are cleared directly between two parties rather than through a central clearing house.

“Momentum on OTC derivatives has accelerated in recent months,” FSB Chairman Mark Carney said at a news conference in Hong Kong.

The FSB is expected to push for a minimum margin that banks must post on derivatives trades that aren’t processed through a central clearing house. The aim is to provide an incentive for trades to be centrally cleared, or at least ensure there is a lower risk of an uncleared trade running into difficulties.

Here we go again.  Regulators believe they know how to determine the risks of transactions, and price those risks.

This of course worked out so well with Basel II, which deemed that mortgage loans and mortgage backed securities and sovereign debt were low risk and provided incentives for financial institutions to invest in them.

How’s that working out?

The clearing proposals in particular are frightening for at least two reasons.  First, they are predicated on the view that clearing necessarily mitigates systemic risk, a highly misguided view as I’ve pointed out here for years. Second, and relatedly, the very policy of attempting to encourage the movement of transactions to CCPs will tend to increase the riskiness of CCPs by leading them to clear products that are not well-suited to clearing, thereby increasing the riskiness of CCPs.  And because these CCPs are systemically important, this creates systemic risks.

It is also interesting to note that this one regulatory effort my be undermined by another one.  The New! Improved! Basel Rules will set capital requirements for exposures to CCPs.  The prevailing belief is that this will result in low risk weights (2 percent) on exposures to CCPs.  But an analysis by JP Morgan suggests that actual risk weights are likely to be far higher:

New capital rules outlined under Basel III are designed to incentivise the use of a CCP by levying a relatively small 2% risk weight against a bank’s exposure to a clearing house. This charge is much lower than the punitive charges proposed against traditional bilateral non-cleared trades and is designed to make clearing more financially attractive.

However, in-depth research by JP Morgan analyst Kian Abouhossein and his European banks team has cast doubt on this presumption. Taking a hypothetical clearing house that is only 45% funded against its theoretical capital requirements, they argue that the move towards central clearing could in fact prove far more costly under the new rules than initially thought.

This is because the new Basel III rules are expected to require a higher risk weight for exposure to central counterparties that may be regarded as underfunded; the rules will also levy a higher charge depending on whether the ultimate counterparties to the trade are clearing members, or clients of clearing members. Banks that clear trades on behalf of clients will also be required to take credit valuation adjustment charges against those clients which represent a measure of potential loss in the event that client counterparty goes bust.

In summary, JP Morgan finds therefore that the proposed floor 2% risk weight can only be attained under specific circumstances. In reality, the bank argues, the real risk weighting could shoot up dramatically.

So on the one hand, global regulators are trying to encourage the movement of trades to CCPs, but other global regulators are devising rules that will (unintentionally) make CCP exposures extremely expensive.

I am sure this process of setting prices for counterparty risk will turn out just swell, and lead to an efficient allocation of  these risks.

All these various efforts to regulate margins and capital weighting for counterparty exposures are a species of centralized price control.  All such schemes are doomed to failure.  Doomed.  The regulators lack the information to determine the right prices, and are in fact at an information disadvantage relative to private actors, so these schemes inevitably result in substantial losses arising from adverse selection problems.  Moreover, it is grimly ironic that these schemes are touted as a means of reducing systemic risk, when in fact they are far more likely to create systemic risks.  As I’ve noted repeatedly (and as others, such as Roberta Romano have also pointed out), these regulated pricing schemes tend to encourage everyone to load up on the same risks, and it is these correlated risk exposures that create systemic risk.

These global Sorcerer’s Apprentices believe that they are preventing the next crisis.  It is more likely that they are casting the spell that will bring it about.

This long piece by Catherine Belton and Charles Clover in the FT echoes several SWP themes.  Most notably, it focuses on the role of Putin as balancer between rival clans who distributes power and resources to maintain an uneasy political equilibrium.  It also opines that the political developments since the December Duma elections have undermined Putin’s ability to perform this balancing act.

One interesting tidbit: the story reports claims that Gunvor’s Gennady Timchenko plays hockey with Putin.  Recall that (a) rumors are rife that Putin owns a big chunk of Gunvor, but (b) Putin denies any personal relationship with Timchenko.  If Timchenko is really a participant in the private sports bonding where real deals get done, that would undermine Putin’s denials, and lend credence to the rumor.

This article by Lee Smith from the Weekly Standard blog goes into gruesome detail about Obama’s deference to Putin on Syria.  The last paragraph gets it mostly right.

Moscow is simply playing the spoiler and thereby enjoying the sort of international prestige that it has not been afforded since the end of the Cold War. The Russians are not going to engineer a coup against Assad, or in any way work to resolve the issue, because it is precisely the conflict that has given them influence in Syria—the conflict, that is, and Obama, who for no good reason has handed Moscow the reins.

I say mostly right, because Putin has other reasons not to resolve the situation in Syria, including his inveterate anti-American attitude and zero sum mindset, and the economic benefits that accrue to Russia from continuing turmoil in the Middle East.

I missed this when it first came out, but apparently a modified Matrix plan to solve the European financial crisis has been bouncing around for a couple of years (h/t Tyler Cowen at Marginal Revolution).  The plan is take both the red and the blue pills.  Well almost: it is to issue both red and blue bonds.

Under the plan, “the senior ‘Blue’ tranche of up to 60 percent of GDP,would be pooled among participating countries and jointly and severally guaranteed.” In contrast, “the junior ‘Red’ tranche, would keep debt in excess of 60 percent of GDP as a purely national responsibility.”

Blue Bonds are essentially Eurobonds, which would mutualize/socialize European government spending, thereby perpetuating the illusion of fiscal bliss.  The Red Bonds are traditional sovereign debt, that require governments to face up to painful fiscal realities.

I seriously wonder if the plan’s authors, Jacques Delpla and Jakob von Weiszsacker had the Matrix in mind when they came up with these labels.

Europe is split into Red Pill and Blue Pill camps.  All the basket case countries are definitely clamoring to take only the blue pill: they want Eurobonds in the worst way.  The French, under newly elected president and alleged babe magnet Francois Hollande (h/t R), are also shouting “BLEU!” (no sacre).  The Germans, Austrians, Finns and Dutch, conversely, are definitely putting it all on red.

Germany in particular has said repeatedly in recent weeks that it will not countenance blue bonds.  Instead, it is pushing a “Six Point Plan” that focuses on structural reforms:

But Merkel is an experienced opponent. She knows that she is now on the defensive in Europe, and she is planning her counter-attack. She believes that euro bonds would enable the crisis-ridden countries to lower their borrowing costs, and that the necessary structural reforms would be postponed. This is why she now wants to counter Hollande’s proposals with a principle familiar to judo fighters: using your opponent’s momentum for your own attack.

. . . .

After Hollande’s statements on Wednesday, Merkel is now presenting her opposing concept. In a six-point plan, she calls for deep-seated structural reforms for Europe. Under the plan, government-owned businesses are to be sold off, protections against wrongful dismissal relaxed and obstructive regulations for companies removed. There is also talk of special economic zones and privatization agencies based on the model of Germany’s Treuhand trust, created at the time of reunification to sell off most of former East Germany’s state-owned enterprises. In short, the Mediterranean region is to become more like Germany, but with better weather.

Jans Weidmann, head of the Bundesbank, is also flashing red.  His interview with Le Monde is refreshing, not least because he calls  bull on the repeated invocation of the Growth Faeries by Hollande and others:

Growth is always a good thing. But to favor growth is like supporting world peace. The real debate is which path to sustainable growth? Growth has always been a pillar of European and adjustment programs through structural reforms. Cyclical wildfire into debt does not lead to the desired growth. In fact, I wonder about that behind these discussions. Do we want to deviate from what was decided? In this case, it is dangerous. [Emphasis added.]

Hear damn hear.

Weidmann damns the blue pill:

A belief that the Eurobonds will solve the current crisis is an illusion. This can only be the culmination of a long process which requires, among other things change the constitution in several states, changse the treaties, to implement a more unified budgett … You do not trust you credit card to someone if you do not have the ability to control his spending.Mutualized debt is can be one face of a coin whose other side is federalism. Governments who support federalism lose elections. Even in countries where governments are demanding Eurobonds, as in France , I see no public debate or public support for the transfer of sovereignty to the support . But it is precisely this debate that we must have.

Weidmann also argues forcefully that growth requires substantive structural reforms, not more leftover Keynesian crack:

But is Keynesian stimulus is an adequate response? Apart from a lack of competitiveness in some countries, the main problem of European countries remains the debt of states and should not be run in a new round of spending. Countries must first regain market confidence, regain credibility: he must set out the announced reforms and not delay the time.

If growth is the true objective, I am foursquare behind the Germans.  Long term growth requires thorough structural reforms that permit resources to flow to their highest value uses; encourage competition; reduce rent seeking; and permit creative destruction.  I understand that big cuts in government spending in the short run (cuts which have not occurred for the most part in Europe, despite all the howling about austerity, as former colleague Russell Roberts has pointed out) are counterproductive.  This suggests that the appropriate policy would be to combine structural reforms that encourage real growth with longer term strategies to reduce government spending to restore fiscal balance.

But that is exactly the problem.  It’s like the old joke: I know where you’re going, but you can’t get there from here.  There is no credible way in democratic countries to commit to these policies.

And this brings us back to the fundamental point, which I’ve made several times previously: Europe’s problems are fundamentally political ones, not economic.  I am a Europessimist precisely because I see no path to addressing these political problems, either at the level of individual nations or at the level of Europe as a whole.

The political clamor in Europe is clearly in favor of taking the blue pill. Germany and Merkel are under tremendous pressure to submit to these demands. Germany is currently struggling with intense internal conflicts, between the desire to be Good Europeans who will not do anything to destroy Europe for the third time (a desire manipulated by France and others playing guilt trips on Germany), and the understanding (well expressed by Weidmann) that socializing European fiscal problems will not solve anything, and eventually make things worse.

How will this turn out? I have no idea how it will play out in the short run: that hinges on this internal struggle in Germany, and I have no idea which of the conflicting impulses will prevail.  Eventually, however, I think that the whole thing will fall apart.  Whether Europe takes the red pill or the blue pill in 2012 or 2013 will only affect when the collapse occurs, and the distribution of the damage.

The banks in Spain continue to swirl down the drain, and more rapidly:

Spain will make an emergency €19bn investment in Bankia, the stricken savings bank, in a bold bid to restore confidence in the stability of the country’s financial sector.

Madrid’s biggest bank nationalisation will take the total amount of state aid pumped into Bankia to €23.5bn, and will give the government as much as 90 per cent control of Spain’s second-largest bank by domestic deposits.

This represents an approximate four-fold increase in the amount of assistance this month. And who says this is the end?

And it’s not just the banks.  Regional governments are demanding bailouts:

Financial markets were further rattled by comments from Artur Mas, president of Catalonia, which forms a fifth of Spain’s economy and is larger than Portugal by output, that the region was running out of options to refinance its debts, and wanted backing from Madrid to borrow.

The Alfred E. Newman crowd often points to Spain’s relatively low debt-GDP ratio to downplay concerns that the country may turn into Greece on steroids.  But the developments with the banks and the regions is misleading.  There are massive contingent liabilities that should be added to the Spanish balance sheet when evaluating the country’s fiscal position.

What is transpiring there reminds me of the banks that set up off balance sheet SPVs, and then brought them back on balance sheet at the height of the crisis.  Creating the SPVs made the banks look less riskier and better capitalized than they were in fact.  Spain is now in the process of bringing its own equivalents of SPVs-its big banks and big regions-onto its balance sheet.  The results are unlikely to be pretty.

Apropos my Russia-as-a-high-beta-economy theme, consider this Russophobic jeremiad:

Vladimir Putin faces the risk of Russia’s political stability being shaken if Greece leaves the euro area, triggering a global crisis and sinking the price of oil, according to the Center for Strategic Studies in Moscow.

There’s a more than 50 percent chance of a Greek exit, which would lead to more countries pulling out of the currency union, Mikhail Dmitriev [what a clever disguise!], the research institute’s head, said in an interview yesterday. Russia’s main risks are a worsening economy, which would swell anti-Putin sentiment, and increased political repression, according to a study published today by the institute, which advises the government.

“If these trends continue, we will see the escalation of political violence and repression on one hand, and the worst economic crisis on the other,” said Dmitriev, a deputy economy minister from 2000 to 2004. “This may lead to Putin losing control and a chaotic political transformation.”

The article goes on in a familiar vein, linking Russia’s economic fortunes to the price of oil, and the price of oil to the impending train wreck in Europe.  Nothing you haven’t read here, if you’ve been reading here.

Moreover, Dmitriev echoes another long-standing SWP theme.  Namely, that in the present political environment, a sufficiently severed adverse economic shock could threaten Putin’s brittle political system:

“The political crisis could quickly become acute if it’s aggravated by a fresh economic crisis,” it said. “This is highly likely to provoke a rapid loss of political control and an accelerated change in the political system.”

Dmitriev predicts that in the event, Putin will respond with repressive measures.   Indeed, one can see the new law imposing huge fines on demonstrators as a preparation for such an eventuality.

No, pointing out that  (a) Russia is hostage to international economic conditions, and (b) Russia’s brittle polity is in turn vulnerable to economic shocks is not Russophobic.  It is a very reasonable appraisal of reality, and many Russians viewing the situation objectively, like Mikhail Dmitriev and the Center for Strategic Studies, arrive at the same conclusion.

Francois Hollande took the high speed train from Paris to Brussels for the latest EU summit.  He might as well have stayed home.  As the FT headline put it, “European Leaders Put Off Key Decisions.” Whoa.  That’s never happened before. Ever.

In inimitable Euro fashion, they promise-promise-to do something at their next meeting in June. Like what’s the hurry?

Although Hollande’s train trip was apparently an affected display of frugality, my initial thought on reading the headline was that it was an environmental gesture, an attempt to reduce his carbon footprint.  But that’s nothing: the Euros’ biggest contribution to a low carbon future will be that their policy paralysis will lead to a serious economic contraction that will put far more of a dent into emissions than any cap and trade scheme could ever hope to achieve: and that’s true even if Athens and Madrid and Rome-and even Paris-burn.

The Clash on Fridays – "Train in Vain" by Timmy_Ramone

The G8-perhaps with the conspicuous exception of Angela Merkel-apparently believe that if you say growth enough, like a mantra, it will magically appear.  Obama and Hollande and Monti and even Osborne (who seems a great candidate for the Upper Class Twit of the Year Contest: Jeez how British conservatism has devolved) appear convinced that some sort of stimulus funded by more debt is just the ticket to pull Europe out of the morass:

In an interview with CNN to be broadcast on Sunday morning, Mr Monti said: “We link back to the notion of demand … I think we should regard it more positively than the most conservative European authorities do.” [Yeah, he’s looking at YOU, Angela.]

But reflecting German resistance to authorise monetary easing from the ECB, Mr Monti added: “On the other hand, if it is an across-the-board crusade for more demand, then I believe that the German reluctance to that is not entirely unfounded.”

Obama is of course desperate for anything that pushes the inevitable reckoning beyond the first Tuesday in November.

Although the Seven Dwarves are importuning Merkel to give in and put German taxpayers to work supporting 55 year old Greek retirees and French bureaucrats, she will give them short shrift (and good for her!) and respond to the German electorate.   Obama doesn’t cast a vote in Thuringia or Bavaria, and she will base her calculations on those who do.

Germans are being pulled in opposite directions by years of indoctrination about the necessity of being Good Europeans on the one hand and deep-seated German aversion to profligacy on the other, so it is difficult to predict exactly how her electorate will react.  My sense is that ultimately Germans will recognize that shouldering the entire burden of funding Europe will be throwing good money after bad, and that Germany will not take one for the Euro team.  Though I would not be surprised if the ultimate decision comes next year, unless events force a decision earlier-which may well be the case.

In the meantime, Merkel might want to circulate this paper by Valerie Ramey to the members of the Anti-Austerity Cult:

This paper asks whether increases in government spending stimulate private activity. The first part of the paper studies private spending. Using a variety of identification methods and samples, I find that in most cases private spending falls
significantly in response to an increase in government spending. These results imply that the average GDP multiplier lies below unity. In order to determine whether concurrent increases in tax rates dampen the spending multiplier, I use
two different methods to adjust for tax effects. Neither method suggests significant effects of current tax rate changes on the spending multiplier. In the second part of the paper, I explore the effects of government spending on labor markets. I find
that increases in government spending lower unemployment. Most specifications and samples imply, however, that virtually all of the effect is through an increase in government employment, not private employment. I thus conclude that on balance government spending does not appear to stimulate private activity.

In other words, “stimulus” via government spending does not translate into growth.  Indeed, the Ramey analysis suggests quite the opposite.

Not that it will matter to the Dwarves, but their growth mantra-which presumes that more spending by already nearly bankrupt states will magically reverse Europe’s economic problems-is based on a highly dubious theory for which empirical evidence is either lacking, or in the case of the Ramey paper, empirical evidence utterly contradicts.  Will Merkel-and the German electorate-have the courage of their convictions and oppose the Dwarves? I am not certain, but when push comes to shove, I believe that she-and they-will do just that.

Russia has been notably obstreperous on two foreign policy issues: American missile defense plans and Syria. In each instance, members of the leadership have threatened direct military confrontation if Russia’s will is thwarted.  Ironically, the more veiled of these threats-Medvedev’s with respect to Syria-led to a bigger blowback on Russia.

A little over two weeks ago, Chief of the General Staff of the Armed Forces of Russia and First Deputy Minister of Defense Nikolai Makarov stated that Russia might launch a preemptive attack against US antimissile systems based in Europe if “the situation worsened.” Makarov would not make such a statement unless it was approved at the highest levels-meaning Putin.

Makarov’s warning was paired with a presentation of a computer simulation in which a diabolical US system shot down a barrage of Soviet I mean Russian ICBMs headed for the US.

It is flattering, I guess, that the Russians believe that US ABM systems are so capable, or will be in less than a decade’s time.  But if they actually believe this, they are delusional.  The particular installations in Europe against which Makarov vented, and threatened to attack, are of no use whatsoever against a Russian ICBM launch against the US.  They are not on the path of outgoing land based Russian missiles (which would take a polar trajectory), of no use whatsoever against SLBMs, and are laughably few in number.  US systems based in North America are also very limited in number and coverage.

Indeed, even the Russians themselves can’t tell a consistent story. They tout the evasive capabilities of their new ICBMs and the difficulty of ABM systems in dealing with large numbers of decoys.  Rogozin the Ridiculous tweeted:

If someone tried 2 build MD system right under our noses, it’d only give’m illusion of defense. We’ll pierce that fence

The mixed messages, and the underlying unreality of the characterization of the threat, make it rather difficult to interpret exactly what Putin et al are thinking.  Any reasonable interpretation does not give comfort.  Paranoid and panicky vs. using missile defense as a pretext to attempt to cow the Europeans and split them from the US.  Or both.  Oh joy.

An even higher authority-at least de jure-uttered the other apocalyptic threat.  Dmitri Medvedev obliquely raised the threat of nuclear war in remarks on Syria:

In his comments at a conference for lawyers in St. Petersburg, Mr. Medvedev started out by ruminating on the unintended outcomes of military campaigns. That is a theme often taken up by Russian officials as a line of criticism for what they see as America’s interventionist policies in the Middle East.

“The recent, hasty military operations inside foreign states usually end with the arrival of radicals in power,” Mr. Medvedev said shortly before 1 p.m. on Thursday.

He went on to add that: “At some moment, such actions, which undermine sovereignty, can end with a full-fledged regional war, or even, and I don’t want to scare anybody, the use of nuclear weapons.”

Russia has been shrill in its defense of its client and big arms buyer, the murderous Assad regime, and was outraged at the demise of another client (and big arms customer), the Khaddafy regime.  It has made it clear that it will not abide a repeat of what transpired in Tripoli and Benghazi in Damascus and Homs.  In this context, raising the possibility of the use of nuclear weapons can only be interpreted as a threat by Medvedev (which again would not be made without Putin’s approval) to employ nuclear weapons in response to NATO/US efforts to overthrow Assad.

Is the threat credible? Unlikely, but who is taking chances? Certainly not the markets:

An unusually candid reference to nuclear war by Russia’s prime minister prompted a sell-off in the nation’s stock market this week, underscoring how nervous traders here have become about worsening relations with the West, a street protest movement in Moscow and an overall slump in emerging markets.

. . . .

The Russian Micex index, a gauge of large blue chips traded on the domestic market, fell sharply. By the market closing, the index had lost 3.5 percent and ended the day at its lowest level in seven months. Some large Russian companies tumbled even further. Sberbank, the country’s largest lender, dropped 7 percent.

Yes, there were other bearish developments, notably a drop in oil prices, but the market drop appears to large to be explained by these other developments alone.

Why the reaction? One explanation is that they highlight the political risk of investing in Russia. They emphasize the importance of geopolitical objectives to the Russian leadership, and that they are not all that interested about comity with the west.  Such a confrontational posture will almost certainly create risks for foreign investments in Russia, and the Russian economy generally.

Here is another interpretation.  Yes, the remarks did coincide with a selloff in oil.  And that may be exactly why Medvedev uttered them.  The Russian economy and the Russian fisc are highly dependent on the price of oil.  Oil prices are currently below the level necessary to balance the Russian budget, which is not a good thing given the tumult in European capital markets. Brent is now trading at about $107/bbl.  Given current spending, Russia needs a price in the $115-$120/bbl range to balance the budget, and around $150/bbl to fund Putin’s elaborate election promises.

As my friend Sergei Guriev notes, Russia’s vulnerability is acute:

“It’s very hard to overestimate how vulnerable the Russian economy is to external pressures” from the oil price, Sergei Guriev, the rector of the New Economic School in Moscow, said in a telephone interview. “That vulnerability is huge, which is why Russia must be very vigilant. The spending is a risk.”

That vulnerability is huge.  No lie. That Sergei must be another one of those damned Russophobes.

Given this huge vulnerability, perhaps it is not surprising that Medvedev rattled the nuclear saber in the midst of a sharp selloff of oil: what better way to goose the price of oil than a threat of nuclear Armageddon in the Middle East?  Under that interpretation, his remarks would betray a certain, shall we say, anxiety about the current economic situation.  Which would help explain the sharp selloff in Russian stocks, or perhaps even suggest that the selloff was underdone.

Dogs chase cars.  Investors chase yields.  Especially in low yield environments.  And the consequences of “succeeding” in the chase is often the same for dogs and investors: they get crushed.

Many financial disasters occur in low yield environments, as investors despairing of finding the kinds of returns they expect in low risk instruments, pile into higher risk ones-especially ones with a lot of embedded short options.  Orange County and Gibson Greetings are two examples from the early-to-mid-1990s.

And we may be seeing a similar phenomenon in the Morgan loss.  Many big banks are swimming in deposits, and looking for places to invest the money.  That’s what Morgan’s CIO was doing:

The unit made a deliberate move out of safer assets such as US Treasuries in 2009 in an effort to increase returns and diversify investments. The CIO’s “non-vanilla” portfolio is now over $150bn in size.

Moreover, this is apparently an issue with all major banks (though you might want to take this statement with a grain of salt, coming as it does from Dimon, who, er, has something of a stake in the matter):

JPMorgan Chief Executive Officer Jamie Dimon said on a conference call with analysts on May 10 after announcing the loss that all banks have “these fairly large portfolios” that invest excess cash. Dimon had encouraged the unit to boost earnings by buying higher-yielding assets, including structured credit, equities and derivatives, ex-employees said in April.

But have no fear! The Fed is studying the problem:

JPMorgan Chase & Co. (JPM)’s $2 billion trading loss has prompted the Federal Reserve Bank of New York to examine how banks in its district are managing cash after receiving a flood of deposits since the credit crisis, according to a person familiar with the matter.

New York-based JPMorgan’s trading loss, announced last week, occurred in its chief investment office, which oversees about $360 billion, the difference between deposits and what the bank lends. The New York Fed is reviewing the structure of investment units and similar businesses at other banks it regulates, said the person, who wasn’t authorized to discuss the matter publicly and declined to be identified.

This pegs the irony meter.  Hell, it breaks it.  This problem is a consequence-unintended, surely, but still a consequence-of deliberate Fed policy to flood the market with liquidity.  You can defend that policy, but the Fed has to live with the reality that yield chasing is the inevitable consequence of ZIRP.  Indeed, it has long wanted to rejuvenate the mortgage and securitization markets, and that necessarily entails risk. The Fed appears to be doing its best Captain Renault impersonation here, expressing Shock! that banks are taking on risk in a low interest rate environment deliberately created by the Fed.

So, one wonders if in its “study”, the Fed will realize that the underlying fault is not in the banks, but in itself.