Everything I know about the global financial system comes from cartoon stick figures. Still, this doesn’t sound good. (Via, via.)
Nouriel Roubini | Sep 13, 2008
It is now clear that we are again – as we were in mid- March at the time of the Bear Stearns collapse – an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). If Lehman does not find a buyer over the weekend and the counterparties of Lehman withdraw their credit lines on Monday (as they all will in the absence of a deal) you will have not only a collapse of Lehman but also the beginning of a run on the other independent broker dealers (Merrill Lynch first but also in sequence Goldman Sachs and Morgan Stanley and possibly even those broker dealers that are part of a larger commercial bank, I.e. JP Morgan and Citigroup). Then this run would lead to a massive systemic meltdown of the financial system. That is the reason why the Fed has convened in emergency meetings the heads of all major Wall Street firms on Friday and again today to convince them not to pull the plug on Lehman and maintain their exposure to this distressed broker dealer.
The Fed doesn’t want to simply bail out Lehman Brothers, as they did Bear Stearns, for a bunch of reasons — including, it appears, that it doesn’t set a good precedent to keep failing out banks that take crazy risks and then fail. Also because Lehman is in worse shape than Bear — insolvent, not just illiquid.
So will anyone step in and save Lehman? Signs point to no.
Unable to find a savior, the troubled investment bank Lehman Brothers appeared headed toward liquidation on Sunday, in what would be one of the biggest failures in Wall Street history.
Should we be surprised to learn that many of Lehman’s problems stem from worthless mortgage-related assets, known colorfully as “toxic waste”? Probably not.
Lehman put itself on the block earlier last week. Bad bets on real-estate holdings — which have factored into bank failures and caused other financial companies to founder — have thrust the firm in peril. It has been dogged by growing doubts about whether other financial institutions would continue to do business with it.
Everything is connected, which is why we can’t just let bad banks fail and to hell with them. My cartoon-based knowledge of the economy doesn’t accurately predict what will happen if banks start falling like dominoes, but it can’t be good, right?
We all suffer in this, it affects all of our retirement portfolios, it hurts the dollar, and will lead to much tighter credit and money. That can only stifle economic growth. There are more failures to come, and I am glad to see that the Feds are standing back more than they did with Bear Stears and Fannie/Freddie. But a total global meltdown is still not impossible.
The blame for all this goes squarely on the free wheeling deregulation of the financial industry spearheaded by Phil Gramm in 1999. This is the architect of McCain’s economic policy program (assuming he still has one – we haven’t heard much in the way of specifics for several months…)
Retirement portfolios? Hah, hah! So all those skills I’ve learned from years and years of poverty now come into their own. Life is looking good at last. Learn the hard way, suckers. I’m going to join the guy drinking that fine wine – which I’m sure my country won’t stop producing.
A question and a comment:
(a) Roubini wrote “…other major independent broker dealers…”. Dumb question: independent from what?
(b) “Everything is connected, which is why we can’t just let bad banks fail and to hell with them…” Ok, but if this is the case, why do we accept the goverment’s over-hyped praise of the free- market? It is hypocritical (the goverment’s praise, I mean).
changcho:
Let me give your questions a crack:
(a) Independent broker/dealers, such as Leyman Brothers and others I listed, are strictly speaking not banks. Experts call them shadow banks. They do not accept deposits and they don’t have retail operations. As such they are not regulated by banking laws, have no access to the Federal Reserve’s various ‘facilities’, and have no insurance by the FDIC. They make their money by trading financial stuff. Thus they are independent from the normal banking system.
(b) Everything is not that connected. As I said, independent broker/dealers are not connected to the normal (FDIC insured) banking system. And that is why the bailout of Bear Stearns by the Federal Reserve using $29B of taxpayer’s money (Bear Stearns not even a member bank) is such a profound corruption. The government (mostly the Bush administration executives) implementation of a free-wheeling no-regulation ideology under the guise of ‘free market’ eventually led to Wall Street broker/dealers running their businesses, and your money, like a casino. The FDIC banks, strictly regulated by banking laws, dared not go to the same extent for fear of criminal implications.
changcho:
I think the main problem is that there isn’t a voice for any of this. The US government’s (I assume you’re American) blind priase of free market capitalism comes from the fact that there are very few politicians willing to stand up and say that Ronald Reagan was wrong, that Reagannomics set us down this road of spiraling deficits, credit crunches, low savings, a massively expanded military industrial complex and bank bailouts.
Until someone is willing to directly say that Reagan was wrong, and that his economic policies have lead to nothing but ruin, we’re just going to repeat this over and over. Perhaps, if Obama wins big, we might get something like that. I’m not holding my breath.
Who Can You Trust ?
An alternative for theoretical physicists would be to start their own businesses. Who could be better suited to be entrepeneurs than the smartest people with the best and longest education?
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An alternative for theoretical physicists would be to start their own businesses. Who could be better suited to be entrepeneurs than the smartest people with the best and longest education?
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Oh, dear.
Who is better suited to make money than highly educated, smart people? My bet’s on the outlandish, brazen, manipulative and ruthless people who can afford lots of lawyers, and who give money to highly educated, smart people to do their bidding.
drunk,
At some level, everything is connected. Investment banks were leveraged 30 to 1, while commercial banks are leveraged 10 to 1, so at some level of loss they are all under water. Then the question is at what level the FDIC is leveraged at. I think it is at something far more than 10 to 1. After that, it’s the Treasury and after absorbing Fannie and Freddie, it is already under water. Paulson had a bazooka, but it only had one shot.
After the financial system itself, the corporate world applies the same “just in time” leveraging to its finances, as to its production models.
Then there are credit cards…..
It is all one big bubble and it popped.
Think of the subprime crisis as the planes flying into the WTC. Yesterday was when they started to collapse.
The Worst Financial Crisis Since the Great Depression
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At some level, everything is connected.
Yup. At this level:
Again, the theme: Instruments ostensibly introduced to manage and hedge against risk have become the risk, on a gargantuan scale. As economist Robert Merton said in a recent interview for Technology Review, the trouble is, when you give people an SUV instead of a compact sedan, some of them think they can take risks on the highway they never would have taken otherwise. Throw in greed, relentless selling, and free market snake oil, and here we are.
(Actually, those people didn’t just get SUVs, they got buses—full of passengers.)
PS: This just in; the Fed is providing AIG with an $85 billion bridge loan.
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Not only is the government going to own a bankrupt banking system, but they seem to be on the hook for a bankrupt insurance system. Of course, that’s where the derivatives market came from in the first place. This will be a very large tail wagging a small dog, given that the derivatives market has grown from 6 trillion in 1990 to 455 trillion today.
And here is the price we pay for Republican-preferred economic anarchy (imagine, if Social Security had been privatized and invested in the stock market.) McCain is now paying catchup concern troll:
http://news.yahoo.com/s/ap/20080916/ap_on_bi_ge/bank_deposits_safety
Federal bank insurance fund dwindling
By MARCY GORDON, AP Business Writer Tue Sep 16, 7:49 PM ET
WASHINGTON – Banks are not the only ones struggling in the growing financial crisis. The fund established to insure their deposits is also feeling the pinch, and the taxpayer may be the lender of last resort.
The Federal Deposit Insurance Corp., whose insurance fund has slipped below the minimum target level set by Congress, could be forced to tap tax dollars through a Treasury Department loan if Washington Mutual Inc., the nation’s largest thrift, or another struggling rival fails, economists and industry analysts said Tuesday.
…
Oh the irony. Look at http://biz.yahoo.com/ap/080918/wall_street.html?.v=44, “Stocks surge on report of entity for bad debt”
September 18, 3:37 pm ET, By Tim Paradis, AP Business Writer (was on Drudge literally within a few minutes.) It is telling and weird, how the stock market, the “nerve center of American capitalism”, goes up and down in rapid swings depending more than anything on whether the government is offering some way to cover for what is happening.
Indeed. Capitalism has always depended on government to protect it from itself. I guess we’re learning that all over again—the hard way. The only way capitalism could function independently of government would be if it took complete responsibility for its own systemic health and stability. That would require establishing and accepting what amounted to governmental oversight, even if it was embodied in nominally private institutions. (Credulous or corrupt bond rating agencies don’t count.)
My boss (I work in risk management at an investment bank) has postulated that the crisis of the last few days is due to the LHC. When they switched it on there was some sort of black hole created and we are now living in a hellish parallel universe created by it. 🙂
Everything is so complicated because no one knows what securities they really hold i- derivatives = toxic waste? – Trading *models* – developed by QUANTS – Same kind of over achieving – parent pleasing – non creative types. They hail from the same schools – they hang out together. make the same trades – they are arrogant – self centered – and they dont give a damn about anyone but them selves. No big Picture idea – they make 10$ someone else loses 20 – no problem!
From a reader review of Richard Bookstaber’s A Demon of Our Own Design:
Chris,
The more accurate biological example is of a population depleting its resource base and crashing, which is a matter of measured inevitability, rather than potential failure. The paper bubble was being inflated and each tear was papered over with ever thinner paper. It wasn’t a change in circumstance, but reaching the limits of the circumstance.
Neil,
The irony is delicious. After years of privatizing every possible public asset in the name of “greater efficiency,” while squeezing out every drop of profitability, the “free markets” rejoice when the mess is nationalized. Fear and greed are all that really matters.
Well, it seems a wipeout was narrowly averted (so far), at least “according to the market” – see, in this economy the stock market is “the” market. Why? Because “we the people” had the burden placed on our long-suffering shoulders, that’s why. As for what we should get in return, well here is my post from a thread in Brad DeLong’s literate and fascinating blog:
Since the public is basically bailing out “the financial system”, then: the public should, in some sense and to a substantial extent, be given “ownership” of the financial system. I don’t mean just ordinary individualized market participation (which they already have, however mangled) or just “the government” acting as a government (especially considering that the G. is largely, effectively owned by the same sort it is bailing out the most.) I mean literally “as” the public, in a communal effective way similar to what being in a genuinely employee-owned company is like. Reflect on that and hash out what it should consist of in particular, the thrust of it cannot morally be denied. The people should demand it, they will if they appreciate what happened to them and respect their interests.