A Short History of Meltdown Control
From The Observer (London):The biggest bet in the world
By the time G7 finance ministers met on Friday afternoon, they were staring into the abyss. In a desperate effort to restore calm to the markets, they took decisive action and came up with a five-point plan, which includes spending billions of taxpayers' money to rebuild the global banking system and reopen the flow of credit. This is how the drama unfolded ...
* Heather Stewart and Larry Elliott in New York, Ruth Sutherland and Lisa Bachelor in London
* The Observer,
* Sunday October 12 2008
It was 19 minutes to noon on Wednesday when Gordon Brown took the call from Mervyn King. With the seconds ticking away to the Prime Minister's first Question Time in the Commons since the summer break, the governor of the Bank of England had dramatic news: secret consultations between the world's most powerful central bankers had resulted in the decision to make the biggest co-ordinated cut in interest rates there had ever been.
With the world's financial system perilously close to complete meltdown, bankers were determined to show they meant business. The move was to be announced at midday in London and 7am New York time, and King was nervous that Brown might be embarrassed by a backbencher picking up the news via BlackBerry as he stood up to speak.
Brown had already been dealing with the financial crisis for more than six hours that morning, having held a 5am summit with Chancellor Alistair Darling at Number 11 to discuss details of a £50bn part-nationalisation of Britain's bombed-out banks, due to be unveiled to the stock exchange that morning.
With just 10 minutes to go before world markets heard the news, King's next call was to Darling. Both Prime Minister and Chancellor had been hoping for a rate cut for many weeks as the credit crisis began to take its toll on Britain's cash-strapped borrowers, threatening to tip the economy into a severe recession.
Just before Brown stood up to explain his drastic bail-out plan to Parliament, US Treasury Secretary Hank Paulson was appearing before reporters in Washington in an attempt to reassure American voters that their savings were safe. Asked if he planned to emulate Brown's bail-out package, Paulson was sniffy, defending his own $700bn 'troubled asset recovery plan'. Yet within little more than 48 hours, he was signing up to a promise by the G7 finance ministers to pour public cash into struggling banks, buying shares to ease the severe shortage of capital in the world's financial sector.
The reason for the volte-face was simple: Wall Street was locked into a vertiginous sell-off as terrified investors dumped stocks, commodities and the dollar, fearing that the mounting financial crisis would turn into a full-blown economic slump.
By the time the G7 finance ministers gathered in Washington on Friday afternoon, there was no doubt whatever that they were looking at disaster. The half-point rate cut, unthinkable just a few days before, was greeted with a shrug by investors who had lost their faith in governments' powers to fix the world economy. Wall Street had suffered the worst week in its history, with the Dow Jones index losing an extraordinary 18 per cent of its value, and every major stock market had plunged, day after day. On Friday alone, the Dow hurtled an eye-watering 700 points downwards, then swung up into positive territory, before settling 'only' 128 points down.
General Motors, once the proud symbol of America's car industry, was worth less by the end of the week than it was in 1929, and felt obliged to issue a statement saying it was not at risk of bankruptcy. By Saturday, it had announced talks about a merger with its rival Chrysler. Morgan Stanley was in desperate talks to save a proposed cash injection from the Japanese bank Mitsubishi, and on Wall Street the buzz was that Paulson's damascene conversion to state intervention had been triggered by the impending demise of another household name of US banking.
Thousands of miles away in Iceland, once a sleepy but prosperous example of the cautious Nordic economic model, a decade of financial excess was ending in tears. Reykjavik has been brought to the edge of national bankruptcy by its overstretched financial firms, and deposits from thousands of British savers, along with money belonging to local authorities and charities, was tied up in Icelandic banks. An IMF team was dispatched to assess its need for an emergency loan. Reports in Washington suggested that other countries were also teetering on the brink of insolvency.
G7 ministers were keen to avoid the policy paralysis that had been so evident when Nicolas Sarkozy gathered the leaders of Europe's big four economies in Paris a week earlier. Then, declarations of solidarity were swiftly belied by Germany's unilateral decision to guarantee all bank deposits, an example of the beggar-my-neighbour behaviour that had helped to deepen the Great Depression. The world's financial markets had delivered a clear message about the costs of indecision and disarray.
The strain of wrestling with the crisis was clearly visible on the faces of the finance ministers. France's Christine Lagarde, Washington's Hank Paulson and Alistair Darling all looked as if they had been burning the midnight oil - which they had. It didn't help that on Saturday, they all had to be at the White House by 6.45am to get security clearance for their breakfast meeting with George Bush.
The President has repeated his mantra that if they work together, the West's biggest economies would get through the crisis. For the first time since the turmoil entered a new and dangerous phase, Bush's remarks did not send share prices tumbling - but only because the market was closed for the weekend.
Darling's morning continued with a bilateral with Paulson, and talks with the new chairman of the Financial Services Authority, Lord Turner, over the plans for recapitalising some of Britain's biggest banks, details of which will be announced tomorrow.
Around the table at the US Treasury, Darling argued forcefully that recapitalising banks with public cash was the only viable solution to the worldwide crisis. Japanese delegates, rarely the most vehement contributors to G7 debates, argued passionately that the lesson from their country's own catastrophic banking crisis in the 1990s was that taxpayer-backed bail-outs of financial institutions should be carried out without delay. So keen was King to push home the importance of unblocking the credit markets, he summoned up the ghost of Elvis Presley, saying, 'as the King would say - a little less conversation, a little more action'.
It was not Elvis but the desperate need to restore calm to the markets that really prodded the G7 into action, however. When civil servants presented a first draft of the communique, several pages long and packed with waffle, finance ministers said they wouldn't sign it - because it wouldn't work.
Italian finance minister Giulio Tremonti even went public, saying 'the current draft is too weak', and wouldn't, at first, put his name to anything more than a page long. When the meeting ended, what emerged was a five-point plan, including a promise to buy up stakes in banks, on the British model.
Governments also pledged to prevent the failure of 'systemically important' banks, in a bid to avoid unleashing another financial domino effect like the one that followed the collapse of Lehman Brothers; take 'all necessary steps to unfreeze credit and money markets'; ensure that consumers around the world can have confidence in the safety of their savings; and take action to kick-start stalled markets in the mortgage-backed assets and other securities that banks use to help fund their lending.
In other words, governments of the world's richest countries will unleash every weapon they have, including billions of pounds of taxpayers' money, to rebuild the global banking system and reopen the flow of credit to consumers and households. Paulson called it 'aggressive,' but that was an understatement - it is financial 'shock and awe'.
There are high hopes in Washington that this much concentrated firepower, perhaps combined with more drastic rate cuts from central banks, must eventually work - though European Central Bank governor Jean-Claude Trichet said it might still take time for the markets to respond positively. If this plan does succeed, finance ministers can stop worrying about the risk of total collapse of the world's financial system - and start worrying about the long, grinding recession that most believe will follow this month of extraordinary drama.
When Paulson was drafted into Washington from Goldman Sachs in 2006, with his action man demeanour and impeccable Wall Street pedigree he seemed the ideal personification of America's economic invincibility. Two years on, he, and the swashbuckling model of capitalism he represents look like a busted flush. Even even his friends on Wall Street have dramatically lost faith in his power to halt the financial storm.
For 50 years, America has been the global economy's uncontested superpower, preaching open markets, financial liberalisation and free trade. Washington confidently believed it had the answer to the world's economic problems, if only the unconverted would listen. But last week showed that the US has no magic recipe to assuage the violent fear that had seized Wall Street, let alone offer a blueprint for other governments to follow.
Every time delegates from developing countries thumbed through a newspaper, or glanced at a TV screen, they saw bleak red graphs of plunging stock markets or footage of an earnest-looking Bush using an emergency briefing in the White House rose garden to reassure shell-shocked American voters.
The US public are bailing out of mutual funds in their droves and discussing where the hard-earned cash they have saved for retirement or their kids' college funds will be least at risk. Safe-makers are reporting rising sales as a growing number of Americans resort to the old-fashioned method of withdrawing their dollars and locking them up at home.
At every press conference within the tight ring of security that surrounds the IMF's HQ, a forest of hands shot up, as journalists from Brazil, the Philippines, Russia, China and a host of other countries asked urgently what impact the crisis would have on their home countries.
For the past decade, World Bank and IMF meetings have been dominated by the problems of the world's poorest countries. The crash of 2008 has followed the longest sustained boom in the global economy since the late 1960s and early 1970s, breeding the complacent belief that the only real issue was how to help poverty-stricken countries in Africa catch up. This year, the mood had changed: Africa barely merited a mention, as the West concentrated exclusively on preventing its home-grown crisis dragging the entire world into a slump.
The problem is twofold: in the short term, the vital need is to stop the financial virus from infecting every country in the world and having an even bigger impact on global growth. In the longer term it is how to rebuild a world financial system that has so comprehensively failed in the past 14 months.
In 12 months' time, when the IMF gathers for its next annual meeting in Istanbul, the world may look very different. There is a palpable sense in Washington that even if the downturn is shorter and sharper than the IMF predicts, the domino effect that began in America's housing market and has rippled throughout the world, is leaving in its wake a powerful momentum for reform.
Dominique Strauss-Kahn, the IMF's managing director, stressed that there must be no return to 'business as usual' when the worst of the crisis is over. At the very least, there will be reforms to what the experts call the 'global financial architecture' - in other words, the rules will be tightened.
Credit ratings agencies, which assess how likely borrowers are to repay their debts, will find their activities reined in; regulators monitoring the behaviour of international banks across different jurisdictions will be forced to work more closely together; and the IMF is likely to be given stronger powers to issue warnings about the build-up of dangerous financial bubbles in the years ahead.
Central bankers who have contented themselves for the past decade with focusing on inflation, may well also be asked to take into account the risk that by cutting interest rates to keep economies out of recession they may be pumping up an unsustainable boom. Alan Greenspan, the former US Federal Reserve chairman, was once lionised as an economic 'maestro', but now appears to be a major architect of the crisis. The IMF said the world economy had been allowed to run above its 'speed limit' for too long.
The banks, which have been forced to beg for public cash to prevent their business model imploding, will find themselves under severe scrutiny from their new shareholder, the taxpayer. In return for rescuing them, governments will insist on limits on bonus payouts and curbs on dividends to shareholders.
There are broader changes afoot, too. Robert Zoellick, president of the World Bank and a veteran of the US Treasury, called for seven major emerging economies to join the traditional G7 club of rich countries to provide a better reflection of the new power balance in the world economy. Bringing Brazil, China, India, Mexico, Russia, Saudi Arabia and South Africa on board would create a powerful 'steering group,' representing 70 per cent of the world's GDP and 56 per cent of its population. Zoellick's pointed call for change underlines the mood for reform unleashed by the crisis.
Iceland may yet be forced to turn to the IMF for an emergency loan, but the fact that it was given direct financial support first by the Russian government underlines the power that countries which have built up huge financial surpluses - including Russia, but also China and many Middle Eastern economies - could wield in the years ahead.
How deep the changes go may depend on how badly the shortage of credit affects the global economy. The IMF believes that, after a grim year, with recessions in most major countries, the green shoots of recovery will be visible beneath the frost.
Olivier Blanchard, the IMF's chief economist, insisted that with the right concerted action from governments, the risk that the financial crisis would give way to a full-blown depression on the scale of the 1930s was 'almost nil'. Yet he was also quoted warning that share prices could have another 20 per cent to fall before calm is restored: hardly the sort of thing to reassure investors in the current environment.
The governments of the world's largest economies think they've done enough to avert disaster. This week, they will be watching anxiously watching to see if the markets agree.
A year of rescues
14 September 2007
Bank of England steps in with emergency funding to support Northern Rock.
17 March 2008
Federal Reserve organises the rescue of Bear Stearns.
7 September
US government seizes control of mortgage lenders Fannie Mae and Freddie Mac.
17 September
US rescues insurer AIG.
26 September
US government takes control of Washington Mutual in the largest-ever American bank failure.
29 September
UK government nationalises Bradford & Bingley's loan book.
30 September
Ireland guarantees the deposits of all savers.
3 October
Biggest ever US government bail-out plan - worth $700bn - clears House of Representatives after being rejected a week earlier.
7 October
Iceland asks Russia for €4bn loan to avoid financial meltdown.
8 October
Chancellor Alistair Darling announces £450bn rescue plan for Britain's ailing banks. Bank of England cuts interest rates by half a percentage point.
10 October
G7 meeting in Washington agrees global rescue plan
* guardian.co.uk © Guardian News and Media Limited 2008
The Other Financial Crisis
From the BBC:Nature loss 'dwarfs bank crisis'
By Richard Black
Environment correspondent, BBC News website, Barcelona
The global economy is losing more money from the disappearance of forests than through the current banking crisis, according to an EU-commissioned study.
It puts the annual cost of forest loss at between $2 trillion and $5 trillion.
The figure comes from adding the value of the various services that forests perform, such as providing clean water and absorbing carbon dioxide.
The study, headed by a Deutsche Bank economist, parallels the Stern Review into the economics of climate change.
It has been discussed during many sessions here at the World Conservation Congress.
Some conservationists see it as a new way of persuading policymakers to fund nature protection rather than allowing the decline in ecosystems and species, highlighted in the release on Monday of the Red List of Threatened Species, to continue.
Capital losses
Speaking to BBC News on the fringes of the congress, study leader Pavan Sukhdev emphasised that the cost of natural decline dwarfs losses on the financial markets.
"It's not only greater but it's also continuous, it's been happening every year, year after year," he told BBC News.
"So whereas Wall Street by various calculations has to date lost, within the financial sector, $1-$1.5 trillion, the reality is that at today's rate we are losing natural capital at least between $2-$5 trillion every year."
The review that Mr Sukhdev leads, The Economics of Ecosystems and Biodiversity (Teeb), was initiated by Germany under its recent EU presidency, with the European Commission providing funding.
The first phase concluded in May when the team released its finding that forest decline could be costing about 7% of global GDP. The second phase will expand the scope to other natural systems.
Read the rest of the article.
Labels: BBC, Environment, financial crisis
It's Going To Be A Fateful Weekend
This posting is from D&S collective member and frequent blogger Larry Peterson. To see more of his posts, click here.My apologies for the earlier, aborted pre-New York market opening comment: I write some of these posts a bit under pressure, and I pasted material unrelated to the intended post on the site by mistake. My apologies. As I write at nearly 1 pm Eastern Standard time, US markets continue to follow European and British closes downward.
The gist of the matter is this: the co-ordinated Central Bank actions and attempts to shore up banking systems in several countries have failed miserably, and equity markets worlwdwide are adding significant losses to horrific and even record losses from yesterday (and from the last two weeks: the Dow was down some 20% in the last ten days--and that was yesterday; so a significant amount of pension fund money has been wiped away as a consequence in very little time). Meanwhile, potential lenders of increasingly scarce capital are paralyzed with fear, worldwide. Hence: look to governments to do something drastic this weekend, especially with all the mandarins gathered in Washington for the annual meeting of the IMF anyway. And, even then, don't expect a quick reversal: too much economic damage has been added to what was already there before the run on commercial paper, and there's still too much inherent uncertainty concering the time and means necessary to begin to sort out the bad investments from the good and get markets to find a floor, and buyers, again.
This is the last post I'll make before next week (I'm planning a longer piece for the website, not the blog, that I'd like to see appear early next week, which will concern the historic events since the nationalization of Fannie Mae and Freddie Mac). We'll still be posting newsworthy items from other sources, though, so keep referencing this site during what promises to be an unusual weekend.
General Motors In a Ditch
GM shares plunged to their lowest price since 1949 before recovering slightly, reports the Washington Post. Analysts are concerned that the global auto industry is on the verge of "outright collapse." Standard & Poor said on Thursday that it is considering cutting the rating of both GM and Ford to "junk" status, which would sharply increase their cost of borrowing.Both domestic and imported car sales have been plummeting in the wake of the financial market meltdown.
According to a company statement
"Clearly we face unprecedented challenges related to uncertainty in the financial markets globally and weakening economic fundamentals in many key markets," GM said in a statement on Friday.
"But bankruptcy protection is not an option GM is considering," it said. "Bankruptcy would not be in the interests of our employees, stockholders, suppliers or customers."
Somehow this doesn't inspire a lot of confidence.
Labels: auto industry, financial crisis, financial crisis bailout, General Motors, GM, Washington Post
Dow Drops 680--Under 8600
From the Wall Street Journal online:By PETER A. MCKAY | OCTOBER 9, 2008, 5:10 P.M. ET
The stock market's collapse accelerated Thursday as bank lending remained stubbornly clogged and investors remained unwilling to hold anything except cash and government debt, no matter how tiny the returns for doing so.
The Dow Jones Industrial Average declined for a seventh straight day, plunging 678.91 points, or 7.3%, to 8579.19. Blue chips last dipped below the 9000 level five years ago. Thursday's fall was the Dow's third-worst all time in point terms and 11th worst in percentage terms. During its recent losing run, blue chips have fallen by a startling 20.9% and are down 39.4% from their record high, which was hit exactly one year ago.
"This is indiscriminate selling," said trader Todd Salamone, of Schaeffer's Investment Research, an analysis and asset-management firm in Cincinnati. "Not until there are massive improvements in the credit markets are we likely to see this really end."
Among the Dow's components, General Motors shares plunged 31% after the auto maker's credit ratings and those of its financing unit were put on watch for downgrade by Standard & Poor's. The Dow's financial components suffered as well, with Citigroup dropping 10% and Bank of America falling 11.2%. Exxon Mobil shares fell 11.7% after the front-month crude-oil futures contract settled at $86.59, the lowest settlement since Oct. 23, 2007. Investors worry economic aftershocks from the credit crisis will curb demand for fuel.
Investors are generally skeptical that the vast sums of government money that are being pumped into the financial system will do much to unfreeze the credit markets. Economists fear that with companies frozen out of short-term funding sources, a severe recession could result. Markets are beginning to price in such a scenario, analysts say.
Read the rest of the article.
Labels: Dow Jones Industrial Average, financial crisis, Wall Street
Hard New Look at Greenspan Legacy (NYT)
From today's New York Times, an interesting piece about Alan Greenspan's attitude toward derivatives.By PETER S. GOODMAN
Published: October 8, 2008
“Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.” —Alan Greenspan in 2004
George Soros, the prominent financier, avoids using the financial contracts known as derivatives “because we don’t really understand how they work.” Felix G. Rohatyn, the investment banker who saved New York from financial catastrophe in the 1970s, described derivatives as potential “hydrogen bombs.”
And Warren E. Buffett presciently observed five years ago that derivatives were “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”
One prominent financial figure, however, has long thought otherwise. And his views held the greatest sway in debates about the regulation and use of derivatives — exotic contracts that promised to protect investors from losses, thereby stimulating riskier practices that led to the financial crisis. For more than a decade, the former Federal Reserve Chairman Alan Greenspan has fiercely objected whenever derivatives have come under scrutiny in Congress or on Wall Street. “What we have found over the years in the marketplace is that derivatives have been an extraordinarily useful vehicle to transfer risk from those who shouldn’t be taking it to those who are willing to and are capable of doing so,” Mr. Greenspan told the Senate Banking Committee in 2003. “We think it would be a mistake” to more deeply regulate the contracts, he added.
Read the rest of the article.
Labels: Alan Greenspan, derivatives, financial crisis
October Surprise
This posting is from D&S collective member and frequent blogger Larry Peterson. To see more of his posts, click here.The race is on. And it's going to be a short, but intense race. Central banks throughout the world (including the People's Bank of China) implemented co-ordinated interest-rate hikes today, while huge swathes of banking systems in a number of key countries have been reinforced with large injections of public funds and the extension of deposit insurance guarantees, or even semi-nationalized. But the most important--and timely--development concerned the $1.6 trillion (but falling fast) commercial paper market, that weird little corner of the financial world which regular companies (not banks, or even "shadow-banks") worldwide have been increasingly tapping in the last few decades to meet their everyday expenses, and even payrolls. The Federal Reserve, in conjunction with the Treasury Department, is establishing a fund to buy up these very short-term bonds, in an attempt to breathe some life back into this clinically-dead market. This is unprecedented: it means the Fed will be pretty much lending money directly to private companies. Still, equity prices continued to fall all over the world (though Tokyo's Nikkei has just opened in positive territory, after sustaining major losses over the last few days), in spite of these huge, even historic interventions. But the variable everyone is looking at, the cost of commercial paper, reacted favorably only for overnight transactions: for anything longer-term, it has continued its relentless rise. As did interbank lending rates (though this looks like it's beginning to change, too).
So this is where we are: because the commercial paper and interbank markets are dormant, companies are desperately pursuing other funding options: those lucky enough to have (generally when times were very good) been extended emergency credit lines by their banks are taking the banks up on their offers, at a time when the banks are scrambling to conserve capital. But as lending costs increase, and despite interest rate cuts and massive monetary injections (precisely because banks are hoarding the money that gets pumped into the system), the banks are chasing a moving target. This is all the more the case when one remembers that many of the banks started the race well behind the starting line, if you consider the quality of capital they were allowed to book as reserves by regulatory regimes dedicated to, well, deregulation, and that the banks didn't provision properly for much of the bad debt that's coming due now in the lead up to the crisis (in fact, many banks stashed money away in Structured Investment Vehicles--SIVs--to get around reserve provisioning altogether, and when the underlying loans went bad, they had to, as is the case now with the emergency credit lines, take such loans back on their books).
And the situation cascades through the whole economy: suppliers, customers, you name it: at virtually every point, short-term but essential funding is something that can no longer be taken for granted. This, on top of expected economic weakness, has contributed to a universal flight from risk. And that means the desperate hoarding of capital, prohibitively higher lending costs, and significantly less equity finance. This is especially destructive for the banks: they have to compensate for falls--sometimes dramatic ones, like Bank of America's, which has lost a third of its value in the last two days--in share prices, but interbank borrowing costs (not to mention insurance against default) rise as equity prices decline: it's a vicious cycle. And that's the cycle governments are trying to break, with all the means they can conjure up at this point. But something has to give, soon. If, somehow, the commercial bank and interbank markets don't stabilize by the end of the month, expect governments to take extremely (even beyond the scope of the historic ones we've seen already) drastic measures. And expect economic damage to expand exponentially for every few weeks this situation isn't resolved.
It feels good to be an insurance exec too!
Executives at insurance behemoth AIG must have been really stressed after getting an $85 billion bailout from the government. That seems to be the logical explanation for why executives at the failed company held a week-long retreat at the luxury St. Regis Resort in Monarch Beach, CA right after the Treasury agreed to stop the company from imploding.Congress's chief curmudgeon, Henry Waxman (D-CA), chided the executives for running up a tab including $200,000 for rooms, $150,000 for meals, and $23,000 for the spa. News reports did not indicate whether anyone took advantage of the resort's "Pamper Your Pooch" package.
The package consists of an overnight stay in a Resort view guestroom, a personalized welcome letter to the pet, the exclusive St. Regis doggy bed, pet amenities including “Sniffany & Co.”, “Bark Jacobs”, “Dog Perignon”, or “Jimmy Chew” toys, personalized silver food and water bowls, an array of treats, biscuits, and bones, along with an issue of Hollywood Dog! Pricing for this package begins at $545 per night. (two-night minimum required)
As they did yesterday with ex-Lehman Brothers CEO Richard S. Fuld Jr., Waxman and others (seemingly in need of some R&R themselves) taking a careful look at thousands of documents from the failed insurer and raising concerns about what appear to be hastily-crafted golden parachutes for top company executives while the company was in freefall:
According to the Washington Post:
Those documents show that as the company's risky investments began to implode, the company altered its generous executive pay plan to pay out regardless of such losses.
AIG lost over $5 billion in the last quarter of 2007 due its risky financial products division, Waxman said. Yet in March 2008, when the company's compensation committee met to award bonuses, Chief Executive Martin Sullivan urged the committee to ignore those losses, which should have slashed bonuses.
But the board agreed to ignore the losses from the financial products division and gave Sullivan a cash bonus of over $5 million. The board also approved a new compensation contract for Sullivan that gave him a golden parachute of $15 million, Waxman said.
Joseph Cassano, the executive in charge of the company's troubled financial products division, received more than $280 million over the last eight years, Waxman said. Even after he was terminated in February as his investments turned sour, the company allowed him to keep up to $34 million in unvested bonuses and put him on a $1 million-a-month retainer. He continues to receive $1 million a month, Waxman said.
Labels: AIG, bailout, financial crisis bailout, Golden Parachutes, Henry Waxman, Lehman Brothers, Richard Fuld Jr, St. Regis Resort, Washington Post
Damn It Feels Good to Be a Banksta!
Hat-tip to Jordan Hayes on lbo-talk for this gem.
See the whole cartoon.
Labels: bailout, financial crisis
Why Fed Policy is Failing (Tom Palley)
The Federal Reserve and U.S. Treasury continue to fail in their attempts to stabilize the U.S. financial system. That is due to failure to grasp the nature of the problem, which concerns the parallel banking system. Rescue policy remains stuck in the past, focused on the traditional banking system while ignoring the parallel unregulated system that was permitted to develop over the past twenty-five years.This parallel banking system financed vast amounts of real estate lending and consumer borrowing. The system (which included the likes of Thornburg Mortgage, Bear Stearns and Lehman Brothers) made loans but had no deposit base. Instead, it relied on roll-over funding obtained through money markets. Additionally, it operated with little capital and extremely high leverage ratios, which was critical to its tremendous profitability. Finally, loans were often securitized and traded among financial firms.
Read the rest of the article.
Labels: bailout, financial crisis, The Fed, Thomas Palley
Perdition Postponed
This posting is from D&S collective member and frequent blogger Larry Peterson. To see more of his posts, click here.Stocks worldwide suffered huge losses again Monday, after the worst week for US shares since September of 2001. The Dow fell below the psychologically-significant level of 10,000 (as did the Nikkei in Japan), but the final number was a vast improvement on the 700 odd point loss the index showed earlier in the day, with the index closing a mere 389 points down. And it was probably only the prospect that the Fed would be forced to cut interest rates perhaps by half a percentage point in an emergency (i.e. before the scheduled meeting of the Federal Reserve Board of Governors late in the month) that prevented the slide from eclipsing a record slide--which it did only last week. In addition, oil dropped to about $85 a barrel, a level unseen for a year. Clearly the markets are not impressed by the passage of the Treasury plan, passed on Friday, to buy the toxic assets on the books of the banks: instead, they fear worldwide recession, one thing (amongst many) the Treasury plan is singularly ill-equipped to deal with.
Meanwhile, bond yields are falling, but, as cash continues to be hoarded by banks, borrowing costs continue their relentless upward advance. It is clear that markets are no longer anywhere near as concerned about the toxic assets on the books of the banks as they are about the possibility--which increases by the day, so long as the crisis remains in its seemingly terminal phase--that bank and even shadow-bank counterparties may go bust before they can meet their short-term obligations. The banks, faced with rapidly increasing costs of capital (and insurance against default), shareholder flight, and paying off agreed emergency credit lines of firms who can't access funds on the wholesale market (due to the jamming up of the commercial paper market), are looking more and more desperately to governments to guarantee deposits beyond the levels they already do.
This, of course, was one of the central points of the Troubled Asset Relief Program, which increased deposit insurance in the US from $100,000 to $250,000, and of regulations in the US which guaranteed money market funds, which, though considered risk-free, bore no government guarantee. In Europe, however, Ireland's move to guarantee the deposits of all depositors of its six largest banks has given rise to a kind of race to the bottom, with the initially reluctant Germans now providing a like guarantee, and the positively mortified British poised to do the same at any moment. In the end, though, it seems clearer and clearer that, only a blanket public guarantee of all financial liabilities, even those held by hedge funds and their ilk, can stop the downward spiral. But it's hard to imagine, after the drama of last week, that such an outcome will be politically feasible.
Labels: bailout, financial crisis, Larry Peterson
Lehman Execs' Golden Parachutes
In Congressional testimony today, former Lehman Brothers CEO Richard S. Fuld Jr. defended the massive salaries and last-minute payouts to himself and other LB executives.Rep. Henry Waxman, D-Calif., chairman of the House Oversight and Government Reform Committee, asked Fuld if it was true that he took home $480 million in compensation between 2000 and 2008. Fuld responded that he only pocketed $300 million, and that "We had a compensation committee that spent a tremendous amount of time making sure that the interests of the executives and the employees were aligned with shareholders."
According to the Associated Press (posted on Yahoo), Waxman read from internal company documents that detailed a request to the compensation committee that three departing executives be given $20 million in "special payments." The request was made on September 11 -- four days before the company went bankrupt.
"In other words, even as Mr. Fuld was pleading with Secretary Paulson for a federal rescue, Lehman continued to squander millions on executive compensation," Waxman said before Fuld appeared as a witness.
Waxman also read from other internal Lehman documents that described the response of one executive rejecting a suggestion from employees that top executives forgo their bonuses: "I'm not sure what's in the water."
Labels: financial crisis, financial crisis bailout, Henry Waxman, Lehman Brothers, Richard Fuld Jr
Dow Drops Below 10,000 (WSJ)
Just posted to the Wall Street Journal's website:Dow Drops Under 10000 As Bank Woes Persist
By PETER A. MCKAY | OCTOBER 6, 2008, 12:56 P.M. ET
Markets continued a fearful downward spiral Monday as investors focused on the weakened state of the global economy, looking past recent steps by government officials around the world to shore up the financial system.
The Dow Jones Industrial Average was recently down almost 536 points, or 5.2%, at 9789.83, with all 30 of its components in the red. The move marks the first time since late October 2004 that the measure has fallen below 10000 on an intraday basis. The Dow also appears poised to extend a three-day losing streak in which it had already shed 4.8% coming into Monday's session.
Investors around the world are increasingly worried that a deep global economic slowdown is taking hold despite measures like last week's bailout of Wall Street and moves by the Federal Reserve prior to Monday's opening bell to further encourage bank lending.
Read the rest of the article.
Labels: Dow Jones Industrial Average, financial crisis, Wall Street, Wall Street Journal