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Events are moving so rapidly it's hard to keep up. But a few vaguely connected thoughts about what we're seeing:
First, the Federal Reserve now seems to be the lender of last resort for the entire U.S. market system. The Securities and Exchange Commission is invisible (not that it's a lender at all); the other bank regulators have effectively disappeared; the Treasury, the White House and Congress seem to be on the sidelines, wringing their hands. The Fed's aggressive role in the Bear Stearns affair, its willingness to take risk off J.P. Morgan Chase, and its apparent readiness to open the discount window to Wall Street firms is both significant and precedential. What's interesting here is that Ben Bernanke is not an elected official, and the Fed is technically independent-- though at times it's hard to discern. Still, Bernanke is gambling big time, and if this blows up on him, the institution will get creamed by all those forces out there that believe they can manage the economy more effectively. (Even if it works, the Fed could emerge with such power that the political crowd may feel tempted to grab it.) Bernanke now finds himself in the same position as Alistair Darling, the U.K.'s Chancellor of the Exchequer who engineered the takeover of Northern Rock only to discover that it was stuck with the damn thing. Shuffling off Bear to J.P. Morgan so quickly may have temporarily sidestepped that problem, but the Fed is accumulating a ton of poorly performing mortgage-backed securities. And what if the takeover doesn't go through? There is a strange paradox to Bear's plight. On one hand, Bear expired because lots of folks yanked back their liquidity. On the other hand, we can't let Bear go down because of all the folks who were unable, or unwilling, to get out. Is this a Katrina situation? We refuse to leave! The amount of damage that Bear would wreak if it failed remains something of a mystery. And how much time would it take for the market to naturally render Bear a harmless shell? Second, there's the issue of size. Investment and commercial bank consolidation helped blow away Glass-Steagall and was viewed for years as an element of systemic safety. The banks are so big, and look how much capital they have! Well, now we realize that jumbo size means jumbo risk (just as risk management enables a proportional increase in risk). We also realize that, beneath the surface, all banks are sort of alike--at least, in the sense that they are all market creatures that tend to swim in the same direction. And, with bailouts in the air, we look around and discover that there aren't many institutions that can save a Bear or, say, Lehman Brothers (not that we're predicting anything), particularly if the saviors have to be Fed-regulated commercial banks. And finally--this is obvious--we have recreated the problem of moral hazard and too-big-to-fail in a much wider, if still thinly populated, basis. Third, is there a bailout on the way, much like the S&L crisis' Resolution Trust Corp.? That's an eventuality Paul Krugman mentioned in The New York Times. Perhaps, but it's hard to imagine the Bush administration and the current Congress getting together to pull that off. And folks forget how successful, after some early fumbling, the RTC was in clearing the market of a ton of bad S&L real estate. But the real question is more immediate: How much damage to the financial system takes place while we wait for a bailout that may or may not come with a new administration? Fourth, there is a hall of mirrors sense to this crisis that goes back to the spooky and changeable realities of mark-to-market accounting. (An aside: The definition of naivete is anyone who tries to make moral and ethical judgments based on marks that dance like Madonna.) Bear Stearns may now be effectively bankrupt because of the enormous black hole created by those MBSs. Those very same securities, however, could dramatically improve in a year or two, much as Wall Street in the Long-Term Capital Management bailout profited by simply holding many of LTCM's positions. Could that happen here? Maybe. But that doesn't do Bear shareholders any good today; they're screwed. The bottom line here is that we've built this enormously complex system that's fueled by incredible piles of abstraction--models, software, indexes. Not only do we fail to fully understand how this all works together, we really have lost any tangible idea of underlying value. The political forces here seem to think that if we can alleviate the foreclosure problem way down the chain where reality lives (poorly), everything else will work itself out. Could be. But this is where John Maynard Keynes' famous line has the greatest bite: In the long run, we'll all be dead. Just ask Bear Stearns shareholders. -- Robert Teitelman
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BRAVO!!! A very insightful view of exactly where we (US economy and people) are in this whole mess. Oversight has failed, leverage is again the culprit. One of the last potential meltdowns of the free market system was Long Term Credit, who was rescued by negotitations with all the top tier banks and the Fed. The leverage used by Long Term Capital was in excess of 100 to 1. The only group who refused cooperation??? Bear Stearns! An ugly reminder of Karma. Your article was well thought out and well written.