ECB Worries About Liquidity Schemes, Fed Worries About Bubbles

According to the Financial Times, the European Central Bank is growing concerned that banks are taking advantage of its generosity. In an effort to alleviate frozen credit markets, the ECB began allowing banks to swap illiquid mortgage and other securities for treasuries on a temporary basis three weeks ago. In that short period of time, banks have created approximately $175 billion worth of bonds out of formerly unusable loans in order to provide collateral to the ECB to increase their liquidity. The ECB was apparently taken by surprise by the frantic securitization efforts and is now highly concerned that the banks are taking advantage of its leniency with the type of collateral it will take. In fact, the ECB is "looking very hard at whether there is not a specific deterioration of collateral."
Meanwhile, across the pond, the Fed is beginning to look at attempting to prevent asset bubbles in the future. The Fed also began allowing dealers to submit extremely illiquid collateral in exchange for treasuries through the TSLF two months ago to alleviate the panic in the credit markets. Now the Fed is studying how it can prevent asset bubbles? Perhaps it can start by not accepting collateral it doesn't understand and can't price, thus encouraging further speculation from dealers. Maybe the Fed and the ECB don't fully understand what is going on behind the scenes within the dealer community right now as they attempt to craft ever new and creative securities to shovel into the eager central bank liquidity machines. But K10 has been behind the scenes. It probably looks something like this:

Repo Trader: I can't get bleepin' financed. Nobody will lend us any bleepin' money!

CFO: What's the problem?

Repo Trader: I'm not sure. But there's some rumor floating around about us not being able to get financed.

CFO: Can't you just give something to the Fed and get some treasuries?

Repo Trader: All I've got is these bleepin' loans! Fed will only take AAA rated securities.

CFO: Oh, why didn't you say so? We can cook up some of those by the end of the day. (yells to securitization desk) Hey Jones! Can we bundle some of this crap and make some AAA's by the end of the day?

Frank: Um, you fired Jones last week.

CFO: Oh. What about you? Can you make some AAA's?

Frank: Yeah, I don't really do that.

CFO: Anyone there who does?

Frank: Nope. All gone. The whole department was laid off last week.

CFO. Who the hell are you? And who are all those people with you?

Frank: We're the clean up crew.

CFO: Ok. No problem. This should be easy. I was the head of securitization two years ago when we were having a banner year before I got promoted to CFO. I can do it, but I'll need your help.

Frank: Yeah, we're not really experienced.

CFO: Don't worry about it. Hey repo guy! Does the Fed care what's in the securities?

Repo Trader: Nah. They have no idea. As long as somebody says its AAA.

CFO: Excellent. Ok gang, grab all the mops, buckets, shoes and coats you can find. Repo guy, call the Fed! We have some collateral.

Repo Trader: I have a name, you know.

CFO: Shut up! You still have a job.