If a dealer submitted a very large amount of a certain kind of paper, he might not want that exposed (for instance, most of the AAA CDOs held by Merrill and Citi is paper they issued; if the Fed put up a big amount to test the price for a comparable lot size, the market would be able to guess who was posting the collateral and that might have repercussions. Plus there might not be any bids on a large amount.

Smaller lots (in the single digit millions) probably would attract bids but would have limited use in evaluating the prices of much larger trades (hundreds of millions). But prices of small lots would certainly be higher than those for large amounts, so if they resulted in lower prices than the clearing banks’ marks, it would force the banks into more, ahem, candor.

That’s a long winded way of saying it could be useful but you need to recognize the limitations.

Primary dealer submits collateral and its value (separate submissions for each type of collateral).

An auction for the collateral is conducted; the submitting dealer is excluded.

The submitting dealer obtains a put option at the winning price. This prevents bidders from propping up the price – they just might be stuck with the collateral.

If the winning bid is less than the submitted value, the winner receives a call option for the collateral at the winning price. This prevents submitters from overvaluing the collateral – they just may be required to sell at actual value (and mark the remainder of this asset type to market since it has just been established).

The submitter is delivered the lesser of its submitted value and the winning bid (if one of the options is exercised, that amount is delivered and the collateral goes to the winner).

AND, OF COURSE, THIS IS ALL BEING DONE WITH U.S. TAXPAYER MONEY, now and for future claims.

I am a professional investor, trying to do my best in uncharted waters for my clients. And what do I see?: First, the monoline insurance companies should be downgraded big-time, but S&P and Moody’s NEVER get around to it, because THEY DO NOT WANT TO BE THE CATALYST FOR THE END OF “MODERN” FINANCE… Yves has done a great job of spotlighting the monoline’s situation, and I have spent many hours analyzing the situation — which rationally suggested big-time trouble for the financial markets — but NO, the big monolines were never downgraded (clearly, the rating agencies didn’t want to take the heat).

And now we have not only the Federal Home Loan Banks giving huge amounts of money to their member banks in return for lousy collateral, but the Fed has rapidly progressed through a series of moves to the point where it accepts collateral that NOBODY ELSE WILL TOUCH, AND AT THE VALUATION OF THE SWAPPER! According to the Fed’s latest statements, this includes “third-party” stuff that will be shifted to the Fed from hedge funds via the prime brokers that now have straight-line access to the Fed’s coffers.

Consequently, the Fed is now the willing recipient of all the toxic waste held in the private sector, one way or another.

AND THIS IS EVEN BEFORE CONSIDERING THE REALITY THAT THE TREASURY, UNDER EITHER A REPUBLICAN OR A DEMOCRAT, WILL BE EAGERLY DEVISING PROGRAMS TO BUY UNDERWATER MORTGAGES, ETC, ETC, IN ORDER TO PROP UP THE HOUSING SECTOR AT PRICES THAT ARE AT LEAST 20 PERCENT ABOVE CLEARING PRICES, BASED UPON THE CUSTOMARY METRICS OF PRICE-TO-HOUSEHOLD EARNINGS, ETC.

AND MOST IMPORTANTLY, THE FINANCIAL MEDIA DOESN’T HAVE A CLUE — THEY TRULY HAVE NO UNDERSTANDING OF WHAT’S GOING ON. AS ONE EXAMPLE, LOOK TO TODAY’S NEW YORK TIMES ARTICLES ON HOUSING, ETC.

So where am I now? — totally frustrated. It is hard to accept the course that is clearly inevitable – the BIG BAILOUT FOR ALL THOSE WHO SHOULD BE GETTING THEIR JUST HARD DUES. But that’s clearly the trajectory, and we all are going to pay taxpayer money for it — BIG TIME.

MF

It’s somewhat ironic that the same people who say liquidity has disappeared can in the same sentence say that oil prices will come down because all the recent runup is due to speculators creating another bubble. Either there’s enough money available for investing / speculating, or there isn’t. If people are dropping billions into the commodity market and taking it out of the mortgage market, that’s because they feel they can get a better return in commodities. Price mortgage debt competitively and you’ll get plenty of liquidity flooding back.

But of course, that wouldn’t achieve the larger goal of socializing the losses of our dear banks, now would it?

Collateral eligible for pledge under the PDCF includes all collateral eligible for pledge in open market operations, plus investment grade corporate securities, municipal securities, mortgage-backed securities, and asset-backed securities.

This arrangement is an invitation to the primary dealers and their clearers to collude to rip off the Fed by overvaluing the collateral, including using false markets and/or arbitrary internal pricing models as part of their ‘..range of pricing services’ (what are pricing services anyway?). They can then split the difference. If the Fed wants to be mugged, why not let the primary dealers themselves price the collateral they offer the Fed?”

“Three hits and three misses for the Fed”

http://blogs.ft.com/maverecon/2008/03/three-hits-and-three-misses-for-the-fed/

But in reality, they are all bankrupt; merrill, lehman, ubs, countrywide (and therefore BofA; yes it’s that bad), wamu, national city… the gamut.

And we haven’t even started with the option-ARM recastings yet!!!