2008 September 14 Sunday
Liquidity Crisis Unfolds Over Weekend
In case you have missed the scope of what is unfolding here's a list of the major Wall Street and Federal Reserve events of this weekend. The big banks are afraid of a liquidity crisis and stronger banks are banding together.
Second, to establish a collateralized borrowing facility, which ten banks (Bank of America, Barclays, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, JP Morgan, Merrill Lynch, Morgan Stanley, and UBS) have committed to fund for $7 billion each ($70 billion in total). The facility will be available to these participating institutions for liquidity up to a maximum of one third of the facility for any one bank. It is anticipated that the size of the facility may increase as other banks are permitted to join the facility.
Nouriel Roubini said on CNBC that the investment banks can not survive as independent units. So Morgan Stanley will need to tie up with a conventional bank if it is to survive. The effects of the Glass-Steagall Act (which separated investment banks from retail banks) have been almost totally reversed.
Lehman Brothers might be headed into chapter 11 bankruptcy. At the time of this writing they are trying to sell themselves to one last potential suitor.
As potential suitors walked away from a deal to rescue Lehman Brothers Holdings Inc on Sunday, it became increasingly likely that the only place the troubled investment bank has to turn is a bankruptcy court.
The biggest insurer in the United States, AIG, is fighting for its survival.
American International Group, the nation's largest insurer, plans to unveil a restructuring plan as soon as Monday morning that will include selling off part of its business to raise cash and boost investors' confidence, according to a published report.
Other big investment banks are afraid they too will find it impossible to raise capital at affordable rates. Merrill Lynch decided to cut a deal before they went up against the wall. Bank of America is to buy Merrill Lynch for $29 per share.
Bank of America has struck a $44 billion deal to buy Merrill Lynch, according to two people familiar with the negotiations, a merger that will unite the nation's largest consumer bank with one of its most celebrated investment banking firms.
Many months after Warren Buffett said we were going to have a long deep recession due to financial reasons former Fed chief Alan Greenspan is now saying we are going thru a once-in-a-century financial crisis. Er, wouldn't that make it worse than the Great Depression?
The United States is mired in a "once-in-a century" financial crisis which is now more than likely to spark a recession, former Federal Reserve chief Alan Greenspan said Sunday.
The talismanic ex-central banker said that the crisis was the worst he had seen in his career, still had a long way to go and would continue to effect home prices in the United States.
"First of all, let's recognize that this is a once-in-a-half-century, probably once-in-a-century type of event," Greenspan said on ABC's "This Week."
The Federal Reserve has just announced a broadening in the types of collateral it will accept from major banks. This is a move to allow the Fed to give more banks more very large sums of money.
The collateral eligible to be pledged at the Primary Dealer Credit Facility (PDCF) has been broadened to closely match the types of collateral that can be pledged in the tri-party repo systems of the two major clearing banks. Previously, PDCF collateral had been limited to investment-grade debt securities.
The collateral for the Term Securities Lending Facility (TSLF) also has been expanded; eligible collateral for Schedule 2 auctions will now include all investment-grade debt securities. Previously, only Treasury securities, agency securities, and AAA-rated mortgage-backed and asset-backed securities could be pledged.
These changes represent a significant broadening in the collateral accepted under both programs and should enhance the effectiveness of these facilities in supporting the liquidity of primary dealers and financial markets more generally.
The recession is going to deepen, housing prices will continue to fall, and default rates will rise on more types of credit aside from mortgages. Major financial institutions have fallen just from the mortgage crisis. So what happens to the rest of them as the bad credits start piling up in other areas?
Update: The cost of insuring against company defaults soared even for seemingly stronger firms such as Morgan Stanley and Goldman Sachs. This illustrates how deeply the market distrusts all the investment banks at this point.
Among some market participants, the wait on Sunday was excruciating. There was trading in credit default swaps — contracts that allow traders to buy or sell protection against a company defaulting on its debts, and there were few willing to sell such protection.
Instead, traders said, the cost of buying protection against defaults soared, even for financial firms that are considered to be in good shape, like such as Morgan Stanley and Goldman Sachs.
If the markets do not trust the investment banks then the other market participants will be reluctant to take the opposite side of trades with them or to let large amounts of money flow through the investment banks.
Will stock prices go through a huge decline on Monday or some other day soon?
Some even recalled the stock market crash in 1987, the biggest fall ever seen by the current generation of Wall Streeters. “This is an earth-shattering event, this is like a tectonic plate shifting event,” said Thomas Priore, chief executive of Institutional Credit Partners, a hedge fund active in credit markets. “This is welcome back to Black Monday.”
Update: What caused this debacle? Something this big requires multiple causes that all come together. First off, the East Asians bid up the dollar and drove down interest rates so that we could live beyond our means without causing consumer price inflation. This fed into the real estate bubble. Second, Democrats in Congress (with support from George W. Bush and Bill Clinton before him) pressured financial institutions to lend lots of money in sub-prime mortgages to poor blacks and Hispanics (see more here). This helped lower the quality of mortgage debt. Third, the price of oil skyrocketed and drained disposable income. This comes courtesy of Peak Oil. The problem is going to get worse.
Basically the Chinese, Japanese and all the other east Asians have got all the money - That in a nutshell is all you need to know about the current debacle, all other words are wasted.
So much then for 'free-trade', and gosh, aren't 'mercantilists' stupid and deluded, not like the 'clever' people at the WSJ and 'The Economist'.
"Tell me, Mr. Greenspan, aren't you in part to blame for the current banking mess, since you were chairman of the Federal Reserve Board for so many years?" Alas, too often government officials are mere servants of the current administration, sock puppets to do the bidding of George Bush.
dchamil: no, Greenspan's not to blame. Two other scoundrels are: FDR and Nixon, who serially disembowelled our gold-standard. Our fiat currency was then supported by dollar hegemony. And this non-convertible currency allowed massive trade deficits and government overspending via borrowing. And this led to Kenelm Digby's lament that foreign powers hold all our over-printed dollars (after decades of citizens living beyond their means). That, in a nutshell, is the whole horrid tale, except for the central bankers, who thumbed their nose at God (and His gold and silver), engineering the whole debacle to enrich themselves over nine decades. They need hanged for treason.
The gold standard would not have made a difference. Currency manipulations are simply price manipulations. Under the gold standard, China and other Asian countries would have manipulated the price of $US by manipulating the price of gold. Same outcome/No difference.
As for Greenspan, he has been making noises that the over-valuation of the $US and the trade deficit was unsustainable for ages and ages. Blaming Greenspan requires profoundly willful ignorance. It's not like he could have unilaterally put an end to it without plunging the world into a financial crisis and global depression.
Gold doesn't necessarily provide a stable store of value any way. Read about the Price Revolution, when gold lost a lot of value in an era long before central banking and fiat money:
Here's who I blame. Clinton and Bush and Democrats and ethnic "leaders" wanted minorities and immigrants to have their own houses no matter how little income they had. So the government gave quotas to banks and to Fannie Mae and Freddy Mac. The banks, etc., did not dare object for fear of being called bigoted or racist ... racism of low expectations ... I'm sure you remember that phrase. So there were plenty of no-doc loans to those folks. No blame to them for taking the opportunity.
Then, on top of this fragile foundation, were layers of con-artists who figured they could take commissions all the way up the chain; and who figured that they would be out of it by the time the Ponzi scheme collapsed (if they understood that possibility) when, naturally the poor folk couldn't make the payments; and couldn't get renegotiation because the bubble finally broke. Or the poor suckers who bought the final mathematically related bonds for their retirement would take the fall.
Many of those con men really did make out like bandits, I bet. Even if they lost their jobs eventually.
The minorities and immigrants really did not do too badly. They never had much capital in the houses and got to live way above their means, for a while at least. Now they will have to go back to rentals; just many friends of my parents did all their lives in the respectable middle class.
No doubt; but which of these subprime holders are defaulting? Presumably the highest proportion are the "no-doc" folks. In addition, the upper-income folks were granted these faulty mortgages because ... how could they be refused when the less worthy borrowers were being granted loans?
The rot spread from the political top down to the sociological bottom and then back up to the middle class. It was aggravated by the creation of fancy financial instruments which could be passed off as safe to the conservative investor.
There are real bad actors. You can call them scapegoats but who is to blame? I don't suppose you believe no one is to blame. PC is the ultimate cause of our current disaster.
Robert, if the assertions of a race based correlation are correct then we're essentially saying that a major financial meltdown can be caused by the defaults of some small fraction of the 7% low-income group. That conclusion just isn't supportable - the financial system is much more resilient than that. Also keep in mind that that the dollar value of the mortgages held by the low income groups is smaller in absolute dollar terms when compared to high income groups.
What we're seeing is the bursting of a bubble. The financial sector (you know, those flag waving free-marketeers) pocketed fortunes as the bubble inflated and now they're busily sucking on the tax payers teat when the bubble bursts. I say let the blame fall where it may - I'm all in favour of moral hazard. That's why I'm against the taxpayer having to foot the bill.
I know the following is going to sound a bit odd...
When I think about the structure and exercise of political power in the liberal democracies (eg UK, US, Australia, Canada and New Zealand), I have great trouble seeing the monied classes at the peak of that structure making a decision to protect blacks from financial loss etc, but I have little trouble seeing them making decisions to protect themselves under the guise of rescuing the financial system.
I agree with Bob. We had a similar debt situation as the proximate cause of The Great Depression and were on a gold standard at the time. Eliminating the gold standard has nothing to do with the situation we find ourselves in today. If you do not understand it, Steve Randy Waldman on his blog Interfluidity has one of the most elegant pieces I have read describing what is happening today titled Credit Crunch for Kindergardeners http://www.interfluidity.com/posts/1205997488.shtml
And FYI, this problem started WAY before Clinton. Though there is really no 'one person' or 'one party' or 'one group' we can blame (we are ALL responsible for the current situation in our failure to come to a cooperative resolution of our spending-funding-debt issues as a society), IF there is any one period in history that our current debt cycle started to dramatically grow from, it would have to be the early 1980's when Ronald Regan was president. He (and his party) made the amazing discovery that the economy could grow IF the US governement both borrowed heavily AND spent heavily at the same time. And since any debt re-payment would not crop up until long after his/congress' retirements/deaths, what did it really matter? It was only future generational competitiveness with foreign nationalities that was being mortgaged away... and worrying about the future is so (well) 'tomorrow'.
The subprime mortgage issues (and the bizzare immigrant-minority comments made above in reference to those same subprime mortgages) was simply the spark that lit the forest fire, nothing more. Similarly, the charlatans who committed mortgage fraud did not cause this mess either (the amount of money they 'stole' was but an infinitesimile % of the debt we have racked up as a society collectively).
FYI-- in case you all forgot, Medicare is a $55 Trillion timebomb and still ticking.
If you think this is big now (and personally I think we are only in the early innings of a 9 inning game that may go into overtime), you ain't seen nothing yet IF (IMHO) we do not get our Medicare timebomb under control
Sorry Randall, I forgot to answer your question:"what caused it"? Answer: Evolution of course. Bubbles are a sine qua non of evoluitionary systems. We were foolish enough to believe certain things as absolute (the dollar, the sanctity of the governement guarantee and regulatory capabilities, the lies of people as truths when they beleived the same lies themselves, etc...) when of course NOTHING is absolute (except of course the conservation of risk- just like the conservation of energy).This is all part of the same fractal evolutionary process that generates chaos, black swans, infinate risk, fat tail probabilities, etc...
Am I not correct in understanding that this blog is part of the blogosphere world commonly referrred to "humand biodiversity" or h-bd?
Stepehn, do you know how to get comments to forward to your personal email?
"If you think this is big now (and personally I think we are only in the early innings of a 9 inning game that may go into overtime), you ain't seen nothing yet IF (IMHO) we do not get our Medicare timebomb under control."
The only good thing that's going to come out of the U.S./global economy completely tanking is that political correctness will head straight out the window. It just won't be affordable anymore.
Thai, I don't think that facility exists.
IF political correctness is the main problem in the world then I guess I agree. I am not a proponent of political correctness, but I don't think it is the main problem. In fact, I would suggest to you the inability to admit that NOTHING is absolute is be a problem for almost everyone (indeed perhpas everyone?). I am not sure how its demise (if it happens which is a BIG IF) means we will be better off tomorrow than we are today?
Randall, can you add the email forwarding functionality to your blog? It is a real pain to keep track of the conversations. Most blogger comment pages I participate allow this. Is this site run on a blogger platform?
I'm running on MovableType, though not the latest version. Maybe later versions provide a way for visitors to subscribe? I could probably put you in to receive all comments since I subscribe myself to that. But I can't selectively subscribe you to comments on just one or two posts.
I do not think we are going to go do so far economically in the short term that political correctness will die. But maybe once oil production declines 30% or 40% that'll happen. I do not know.
I list multiple causes of the bubble and its bursting. There's an angle here I didn't fully write up: The defense of Fannie and Freddie by mostly left-leaning Congresscritters was done in order to boost mortgages for the poor folks. But this gave Fannie and Freddie the ability to grow in general and contributed to the bubble.
Also, the added housing demand from poor people pushed up prices up in higher income brackets as everyone traded up.
I think another cause of the bubble was the gradual dying off of the generation that lived thru the Great Depression. Each generation became successively more willing to take on debt.
I would add advertisements that pushed the Good Life as another cause. Ditto the spread of credit cards.
I would also reiterator that high oil prices chopped off housing demand, especially out in the exurbs. Money spent on gasoline is money not available for mortgages.
you wrote: "IF there is any one period in history that our current debt cycle started to dramatically grow from, it would have to be the early 1980's when Ronald Regan was president. He (and his party) made the amazing discovery that the economy could grow IF the US governement both borrowed heavily AND spent heavily at the same time."
I ask you, how could a gov't spend itself into a black-hole of debt if it were still constrained by a gold-standard, or by any type of convertible currency? Ans: it couldn't. The most epic gov't-constrained-by-gold anecdote was depicted by Disraeli, scrambling for funds to buy the Suez for his doting monarch. If he couldn't have found them, Her Majesty's gov't couldn't have bought it. Unimaginable in today's world, where the US gov't buys/does anything it damn well wants, from F16s to Medicare drugs to AIG bailouts, without a second thought. Don't tell me a gold-standard doesn't matter ! My numbers need revision, but overall the following is on target: http://docgrubb.wordpress.com/2008/02/26/conspiracy-theoryor-reality/
I hear you on gold. You could argue that the debt cycle MIGHT not have been as large, I agree. But I think fundamentally human nature is what caused this and it will occur again (though not for a while) even if we do get a gold standard.
And of course, the gold standard always has the problem of deflation as the economy grows disincentivizing investment in the first place. While this might not be so bad if a population is shrinking, it is a big problem if it is growing.