You could think of the situation as credit availability to that sector diminishing, which could have feedback effects on price. That’s the risk.

It’s not that markets won’t work. It’s just the economics of originating subprime loans and selling them into the market would no longer work. In other words, at some point, if the actual capital markets are not willing to accept those subprime mortgages at the right price ...

It’s quite a bit smaller share of total outstanding because the average life of the subprime mortgage loan, I’m told, is only two or three years. In other words, if your credit quality improves, you will refinance out of your subprime mortgage into a higher quality mortgage. So ...

As you know, this topic is undergoing a lot of further research. The academic literature that I’ve surveyed has yet to uncover a strong causal relationship between a climb in speculative open interest and the effect on price. One reason that is hard to imagine happening to a powerful ...

I think that is definitely part of the story. Another part of the story is that in some countries, especially emerging market countries, the oil was heavily subsidized, and some of those subsidies are now coming off because continuing to subsidize as the oil price climbs entails a rather heavy ...

Thank you. In terms of market developments, I would like to focus on three major topics. First is the sharp adjustment in market expectations concerning monetary policy since the last FOMC meeting. Second, I will talk about the persistence of high risk appetites in credit markets, with a focus on ...

Thank you. [Applause]

I’ll give you an example—the VIX has never been this elevated this long since the Great Depression.

I think we would consider it. The real issue is the Treasury’s willingness to use TARP money. We can’t do any of this without the Treasury’s commitment, so we’re somewhat constrained in our ability to broaden it in the dimensions that we might want to broaden ...

Well, I’m sympathetic with your view that broader is better than narrower because of all the boundary issues that one creates. I think we all are sympathetic with that.

The Treasury has basically committed $20 billion of TARP, and we think that’s going to fund a program of roughly $200 billion of credit cards and auto loans and so on.

Also how you go through the cycle and what the loss experiences on these securities are going to be are hugely important. If this is the worst recession in 30 years, that’s going to be a very interesting data point in terms of what the credit losses on the ...

We’re bridging—exactly.

The way I look at it, President Lacker, is that the deleveraging process is happening at a very rapid rate, and that speed can cause quite a bit of damage to financial conditions and, therefore, to the real economy. To the extent that we intervene and slow down the pace ...

I think we’re in disequilibrium. We’re in a disequilibrium in which the dealers and banks that used to do this lending are in the process of dramatically shrinking their balance sheets. Goldman announced their fourth quarter today. They shrank their balance sheet by 18 percent from the end ...

I don’t think so—not that I’m aware of.

Well, there is in this program, in that we’re trying to figure out the right way of restricting it to U.S. investors.

The issuers have to basically conform with the TARP executive comp restrictions.

Yes, we’re still working on—

May I add just one thing to that? It’s also not clear to me that the private sector won’t be clever enough to take these things and package them into securities that have the equity and the leverage embedded in them and sell them to people who want ...

I don’t think this program addresses the nonleveraged, but I think there’s not much nonleveraged interest in this sector at this point.

You can figure out the economics better once you know how much you have to pay for that 75 percent of the capital structure.

Okay. On the AAA—it is really for specific classes. I think we’ve heard that somehow the AAA would not be sufficient mostly from the auto loan area. It’s hard to judge how credible that is, given that the AAA is the big bulk of the capital structure ...

Cash bonds versus derivatives, for example.

The other thing that we should talk a bit about is credit risk to the Fed in all of this. I think the important thing to recognize here is that the credit risk to the Fed is quite low because the Federal Reserve is protected by two things. One, it ...

Well, I think the idea would be that the window for this program would not be three years. It would be a shorter period of time. So the program would come to an end by the end of 2009 perhaps, but the loans that we had made during that period ...

Well, it really depends on what rate we are charging for the loan. Presumably we are going to charge for the loan at a rate that is attractive in times of extremis and somewhat expensive in normal times. So the question really is, Will the market financing improve quickly enough ...

Jeff, this is all a judgment call. We have been making lots of judgment calls.

I would be very surprised if you saw anything similar to what we are seeing today.

Yesterday we talked about AAA tranches of student loans, which are 97 percent backed by the Department of Education. They are selling at LIBOR plus 300 or LIBOR plus 400. It is hard to say that those securities are priced there because of credit risk.

If you look at AAA-rated assets, the historical credit risk on these assets is very, very low.

Well, I think the counterfactual is what the investors tell us. They tell us that that is not the case.

No, I don’t think that is quite right. We are in basically a market disequilibrium, where the traditional buyers of these securities have vanished. In a normal market environment, it would be completely reasonable to lend against these securities on a leveraged basis. But the people who would do ...

The demand is low for these securities today. It is low because of lack of leverage.

Our view is that spreads are high mainly because people can’t get leverage—that is number 1. Number 2, the traditional buyers of these AAA-rated assets either have disappeared completely, like SIVs and bank conduits, or have balance sheet constraints. So the risk capital hasn’t really been willing ...

The purpose of this facility is not to give investors profits. The purpose of this facility is to address the fact that lending spreads on AAA-rated securities are extremely wide right now and the securitization market is closed. The idea is that, if you offer more- attractive terms than those ...

Yes.

Yes.

Three years gets you far enough along that reasonable people will believe that three years from now you might actually be able to get private-sector financing for this stuff.

It is better than the time I found out I had to discuss a Stiglitz paper in grad school about 12 hours ahead of time. That was harder. I read the Stiglitz paper three times, and then I started to understand it. [Laughter] What I thought I would do, if ...

I said substantively we’re not going to conduct policy any differently, but the market will be more confused about A than about B in terms of having to process what this means. Now, it will get to the right answer eventually, but it will be more confused in terms ...

For what it’s worth, Mr. Chairman, I agree with you. I think the market will be more confused about alternative A than alternative B. If that’s important, then that should be part of the decision.

I don’t know how quickly we could pull it back down. Look. I don’t think that this is going to happen under almost any conceivable circumstance, but if it were to happen, we would basically add reserves to protest what we’re seeing. Time would pass. We’d ...

Well, I guess we would stop doing reverse repos to signal our protesting of the fact that the fed funds rate is trading soft to its targets. That’s the first thing we’d do. I have to say that I think the probability of this happening is extremely remote ...

How about once every couple of weeks?

We can do it, but we’re under a strain. As long as we don’t start until sometime in January, I think we could manage, as long as you don’t ask us to do it every day.

No. But I think the issue is that, because we have open facilities, we just can’t guarantee what their take-up is going to be relative to what they are today. The swap lines are roughly $600 billion; those could come down.

Or “likely to.”

I think the real issue is what happens to the CPFF, what happens to the swap programs, and the take-up of the TAF. Those are the three big elements, and they conceivably could run down in the first quarter.

I think we wouldn’t do things differently to any meaningful degree.