Summary:
Allen Sloan describing how the current economic slowdown is fundamentally from others (except one) and what the implications are. Difference lies in that normally the economy slows down first, creating financial problems. This time, it's the markets bringing down the economy. Only other time this has happened was 1929. Fed's attempts to reassure markets by cutting rates isn't working. Inter-bank credit markets have dried up due to fear, losses and uncertainty. Commercial banks, not investment banks are Fed's responsibility, but can let the financial system fail. Difference in ethos between commercial banks and investment banks. Fed attempting to bail out investment banks with tax payers' money. Low interest rates, weakening dollar, rescue packages and emergency loans for banks, ... Wall Street enablers of the mortgage mess and other financial excesses are able to escape the full cost of their folly, while the public picks up the cost. US financial institutions will emerge from this episode weakened compared with those in the rest of the world. (Published: 31/03/08)
Notes:
- current slowdown different from other slowdowns
- it is the markets slowing down the economy
- normally, the economy goes bad first, which then creates financial problems
- crucial distinctions, because markets are harder to fix than the economy
- Alan Meltzer: it is an unusual situation, but not unprecedented
- precedent: 1929
- was followed by the Great Depression
- 25% unemployment, social unrest, mass hunger, millions of people's savings wiped out in bank collapses
- Great Depression is not going to happen this time
- 1929 slowdown morphed into a Great Depression in large part because the Fed tightened credit rather tan loosening it
- is why Bernanke's Fed is cutting rates rapidly and throwing everything but the kitchen sink at today's problems
- However: Bernanke's rate cutting isn't working
- markets where the financial institutions borrow, lend and trade among themselves have been paralysed by losses, fear and uncertainty
- you can't get rid of losses, fear and uncertainty by cutting rates!
- the giant institutions are feared to death
- had to come back time after time and report additional losses on their securities holdings after telling the market that they had cleaned everything up
- "it's whack-a-mole finance - the problems keep appearing in unexpected places"
- had problems with MBS, CDOs, CLOs, financial insurers, SIVs, asset-backed commercial paper, auction rate securities, liquidity puts, ...
- they realise that if you don't know what's in your own portfolio, how can you know what's in the portfolio of people who want to borrow from you?
- in addition, big firms are short of capital because of their losses and are afraid of not being able to borrow enough short-term money to fund their obligations
- conclusion: credit has dried up
- investment banks vs. commercial banks
- commercial banks are obliged to take the long term view
- mess up and you have no reputation, no bank, no job
- heavily supervised by the Fed
- investment banks
- different ethos prevails
- if you take big, even reckless bets and win, you have a great year and get a great bonus
- if you lose money, you lose your investor's money rather than your own
- and you don't have to give back last year's bonus
- loosely supervised by the SEC
- Fed trying to reassure the markets by inventing new ways to inundate the financial system with staggering amounts of short-term money
- much of this money is available not only to commercial banks (Fed's responsibility), but also the investment banks
- normally aren't allowed to borrow from the Fed
- tax payer is paying for all this
- e.g. Fed extends $500b of emergency loans to firms in need of short-term money
- they're paying around 2.5% interest to Fed
- is way below what they'd pay to borrow in the open market, if they could borrow
- difference between the open-market price and the 2.5% is paid by the tax-payer
- is better than letting the system collapse
- but it's a serious subsidy to outfits that made a lot of money on the way up and are now whining about the losses
- private profits, socialized losses
- has a blackmail kind of feel to it
- economy held hostage by investment banks
- Fed has fronted $29b to Bear Stearns, which in turn offloaded $30b of its financial toxic waste into a fund run on the Fed's behalf
- those securities aren't worth $29b, otherwise JP Morgan wouldn't have needed the Fed's money
- Fed - i.e. taxpayer - is paying the difference between $29b and whatever the stuff is worth
- Wall Street enablers of the mortgage mess and other financial excesses are able to escape the full cost of their folly, while the public picks up the cost
- good news: sooner or later all this money thrown at the debt markets will stabilize thngs
- but cost will be steep
- "those of us who have been prudent, lived within our means, and didn't overborrow are paying a huge price for this."
- income on Treasury bills, money funds and cash deposits has dropped sharply owing to the Fed's rate cuts
- wealth has eroded relative to foreign currencies and commodities
- loss of faith in the dollar by foreign creditors is direct result of the Fed cutting short-term rates
- has helped run up the price of commodities that are priced in dollars
- may in turn be stirring up inflation
- will get harder and harder to finance country's trade and federal budget deficits
- with falling dollar carrying such low interest rates
- US financial institutions will emerge from this episode weakened compared with those in the rest of the world
