I think I’ll just post daily here instead of starting a new thread every time things are horrible in the finance markets.

Today’s summary: Things are so bad they’re funny again! Highlights:

- A flight to quality; everyone wants their money in a safe place. Gold is up 8% today. The TED spread (the difference in interest rate between LIBOR (the rate at which banks lend to one another) and the 90-day T-bill (considered a “safe” investment)) increased by something like 40%, which is unheard of. T-bill effective rates dropped to something like 0.01% at one point, which means the the Federal Government is competing with the bottom side of your mattress.

- The last two remaining independent investment banks started to drop precipitously. Goldman Sachs (GS) down 18%, Morgan Stanley (MS) down 25%.

- Here’s the funny part. Washington Mutual (WM), down 50% in the last week, hired Goldman Sachs to help find a buyer. Morgan Stanley is rumored to be considering a merger with the probably-failing bank Wachovia. That’s crazy, you might say! That’s like two drowning men trying to scramble on top of one another to safety! They’ll just drown more quickly!

Crazy? Crazy like a fox. When you combine two Too Big To Fail firms you get a Too Bigger To Fail firm and your safety is assured by a Federal bailout.

The contents of this post are my personal views and in no way reflect the views or policy of the Federal Reserve Bank of Richmond.

http://faculty.chicagogsb.edu/luigi.zingales/Why_Paulson_is_wrong.pdf

I’m very angry after reading this piece, by a professor at the Chicago Graduate School of Business. You might be too. Let me give you a brief overview of Secretary Paulson’s plan.

The government would create a new agency responsible for buying bad assets (mortgage- backed securities and so on) from corporations in an attempt to increase confidence and encourage these companies to start lending to one another again. This puts hundreds of billions of public money on the line. Here is Doc Zingales on why an alternative solution with no bailout was probably not considered:

As during the Great Depression and in many debt restructurings, it makes sense in the current contingency to mandate a partial debt forgiveness or a debt-for-equity swap in the financial sector. It has the benefit of being a well-tested strategy in the private sector and it leaves the taxpayers out of the picture. But if it is so simple, why no expert has mentioned it?

The major players in the financial sector do not like it. It is much more appealing for the financial industry to be bailed out at taxpayers’ expense than to bear their share of pain. Forcing a debt-for-equity swap or a debt forgiveness would be no greater a violation of private property rights than a massive bailout, but it faces much stronger political opposition. The appeal of the Paulson solution is that it taxes the many and benefits the few. Since the many (we, the taxpayers) are dispersed, we cannot put up a good fight in Capitol Hill; while the financial industry is well represented at all the levels. It is enough to say that for 6 of the last 13 years, the Secretary of Treasury was a Goldman Sachs alumnus. But, as financial experts, this silence is also our responsibility. Just as it is difficult to find a doctor willing to testify against another doctor in a malpractice suit, no matter how egregious the case, finance experts in both political parties are too friendly to the industry they study and work in.

The decisions that will be made this weekend matter not just to the prospects of the U.S. economy in the year to come; they will shape the type of capitalism we will live in for the next fifty years. Do we want to live in a system where profits are private, but losses are socialized? Where taxpayer money is used to prop up failed firms? Or do we want to live in a system where people are held responsible for their decisions, where imprudent behavior is penalized and prudent behavior rewarded? For somebody like me who believes strongly in the free market system, the most serious risk of the current situation is that the interest of few financiers will undermine the fundamental workings of the capitalist system. The time has come to save capitalism from the capitalists.

Meanwhile, I have been congratulated by a French minister. I feel an intense need to shower.

“Today the actions of American policy makers illustrate the need for economic patriotism,” said Bernard Carayon, a lawmaker of President Nicolas Sarkozy’s center-right governing party, UMP. “I congratulate them.”

http://www.nytimes.com/2008/09/18/business/worldbusiness/18rescue.html?_r=2&hp&oref=slogin&oref=slogin

Post updated by sam on 2008/09/20 04:29

Among other things, I hope this view convinces you that I am not a shill for capitalists (only for capitalism) :P

Yeah, wow. That makes me angry too.

How do you even go about fighting a system that entrenched? I mean, by the time you could realistically do something about anything, it’s too late…

Very, very, very, very (etc) troubling article:

http://www.voxeu.org/index.php?q=node/1669

Main points:

1. Many European banks are highly leveraged (ie, they are betting with 30-60 times more money than they actually have). The real problem: they are both too big to fail (as discussed elsewhere; their collapse would lead to a systematic collapse) and too big to bail (their liabilities are often greater than the GDP of their resident country). For example,

The key problem on this side of the Atlantic is that the largest European banks have become not only too big to fail but also too big to be saved. For example, the total liabilities of Deutsche Bank (leverage ratio over 50!) amount to around 2,000 billion euro, (more than Fannie Mai [sic]) or over 80 % of the GDP of Germany. This is simply too much for the Bundesbank or even the German state to contemplate, given that the German budget is bound by the rules of the Stability pact and the German government cannot order (unlike the US Treasury) its central bank to issue more currency. The total liabilities of Barclays of around 1,300 billion pounds (leverage ratio over 60!) surpasses Britain’s GDP. Fortis bank, which has been in the news recently, has a leverage ratio of “only” 33, but its liabilities are several times larger than the GDP of its home country (Belgium).

2. Apparently the Fed has so many toxic, worthless assets on its balance sheet that it may be becoming insolvent:

But at the same time the balance sheet of the Federal Reserve has now been loaded with so many assets of dubious value that the Fed itself may soon no longer be solvent; hence the Fed’s request for a recapitalisation by the Treasury. This means that the US Central Bank has lost its independence, since it now survives on a life-line from the US government.

Bad news for me. Bad news for you too, but especially bad news for me.

So, what would a systemic bank collapse actually look like, given that it’s starting to seem like a real possibility?

So, what would a systemic bank collapse actually look like, given that it’s starting to seem like a real possibility?

No one really knows, I guess. Key aspects:

1. It would be global, since so many European and Asian banks have assets tied up in US assets

2. It would be very fast

3. Policymakers would really have no way of stopping it. Notice that the US has barely been able to digest an insurance company and an investment bank (alongside the assets of some semi-solvent pseudo-agencies, I suppose). If many larger commercial banks started to tank, the feds would be unable to do more than issue orders for people to stop withdrawing funds. I’m not sure if they could do this.

4. There would be lots of panic everywhere.

The more I describe this the worse it sounds. Jesus. Well, let’s hope this doesn’t happen.

If the world ends please come back to Minnesota. I know of a farm where we can winter and live off the land as a sort of Randian commune.

It seems like Minnesota would be a bad place to be when the world ends… it’s really, really cold. And heat takes energy.

This is why I advocate gun ownership! You know who’s sad when it comes time to fight over food? The guy without the gun.

It’s 100% true. I’ve thought about getting a license for this reason.

I think people underestimate the odds of the world ending.