The risk, less haircut, boomerangs back to the banks.
Finally, “an ex post emergency central bank liquidity backstop for the dealer’s creditors” was examined.
Large, concentrated financed risk paper positions increase vulnerability to a fire sale.
Just because paper is normally liquid, it doesn’t always stay that way. Beyond their own potential liquidity issues (think: Reserve Primary Fund breaking the buck), the paper noted that the cash lenders, now securities owners, might not have the legal authority to own the underlying collateral or at least not as much of it.
This might be ok if the funding problem has idiosyncratic roots, but we wonder about (what amounts to) mutualization when the risk zips past the tipping point and goes systemic.
— taking on all the paper and selling at a controlled pace, perhaps in a series of auctions.
While this does control everyone running for the doors at once and the chaos that comes with that, it still does not mean the losses won’t be enormous – even if the seller can do so over time. And in the middle of all of this, decisions will have to be made about what assets are impaired and getting worse versus those that are going to bounce back.