Meeting on CDS and Mortgage Market Reforms

Monday, November 10, 2008
George Shultz Conference Room, Herbert Hoover Memorial Building


John Taylor, George Shultz, Andrew Crockett (JP Morgan), Joe Grundfest, John Gunn, Kenneth Scott, Darrell Duffie, John Shoven, Michael Boskin, John Ciorciari, and Matthew Gunn.


  • Recent Market Trends – John Taylor began by reviewing some key recent trends in the markets. He noted that the spread of 3-month LIBOR over the Fed funds overnight rate has fallen considerably since its dramatic increase in early October. Participants noted the possible roles of recent policy moves, including the Fed’s new Commercial Paper Funding Facility, the extension of the Troubled Asset Relief Program (TARP) to equities, and the FDIC’s Temporary Liquidity Guarantee Program. Taylor then presented data on continuing woes in major U.S. housing markets. After touching on some methodological challenges in assessing the weakness of housing markets, participants moved briefly to a discussion of broader macroeconomic trends. Michael Boskin and others put the economic contraction in historical perspective, noting the severity of the current recession and the continuing challenges facing financial markets.

  • Credit Default Swap (CDS) Markets – Darrell Duffie then gave a presentation on developments in the critical area of CDS markets. He emphasized that most large CDS dealers intermediate between buyers and sellers and have nearly offsetting positions. He presented data to show that many large dealers have net positions equal to roughly 10% of their gross outstanding notional positions. Duffie argued that a central ―clearing counterparty‖ for credit derivatives is long overdue. By effectively netting dealers’ positions, a clearing mechanism would help eliminate large, unnecessary exposures among dealers in the event of default. Duffie noted that intellectual property and liquidity concerns have been obstacles to establishing a clearing counterparty to date. However, he argued that the Fed needs to act promptly and noted some key issues—such as standards on collateral—that will need to be addressed. Duffie also argued that disclosure needs to be improved, particularly so regulators have better information on large exposures among key market players and potential conflicts of interest.

  • Mortgage Markets – The group next turned to a discussion of mortgage markets, with Ken Scott presenting. Scott argued that the SEC should require regular web disclosure on holdings of mortgage-backed securities (MBS) to help markets and regulators assess counterparty risks. He also proposed consolidating data on MBS so that the Treasury and other prospective buyers can assess the value of MBS more accurately. He noted that thousands of pools of mortgages were created before MBS were created and sold. The trustees of original mortgage pools prepare reports for investors, and rating agencies used such reports to rate the MBS. Scott argued that Treasury should fund the data consolidation effort before purchasing large volumes of MBS. The group briefly discussed the feasibility of the plan and possible reactions of key actors, including the rating agencies and the SEC.

  • Areas for Further Research - During and after the presentations, George Shultz and other Working Group members raised a number of critical questions for further inquiry:

    • Effects of ad hoc policy responses – Participants drew attention to critiques that the Fed and other U.S. policymakers have responded in an ad hoc and sometimes inconsistent fashion to the crisis. The group discussed ways to analyze the effects of particular policy actions, perhaps by establishing a chronology of Fed and Treasury behavior and tracking contemporaneous developments in the markets.

    • Role of the Fed – A related question concerns the role of the Fed. Participants noted that the Fed has expanded well beyond its normal range of action and agreed on the need for further research on the possible consequences of the Fed’s changing role.

    • International dimensions of the crisis – The group also highlighted the importance of a coordinated international response to the crisis. Andrew Crockett of J.P. Morgan offered some observations about the upcoming G-20 summit in Washington. Participants stressed that the leaders of major economies and the IMF will need both a sound understanding of the causes of the crisis and an appropriate set of guiding principles as they respond.

John Taylor concluded the meeting by noting that the themes above will be analyzed in greater detail at the Working Group’s next meeting on December 3.

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