Merrill, Lehman, Bank of America: Financial Chaos?

September 15, 2008 · Posted in Barack Obama, Bush Administration, Domestic Policy, Election 2008, Foreign Policy, Iraq 

With the news of Lehman’s frenzied courting of Barclay’s for a shotgun marriage, and the elopement of Merrill and Bank of America, everyone is nervous. On the Twitter stream, the buzz is that the end of America is nigh, that maybe even the end of the world is upon us.

This was not entirely unexpected. The ball was put in motion at the end of March when the subprime crisis finally burst into the public consciousness in a big way, Bear Stearns failed, and Lehman teetered on the edge.

Last week’s bailout of FreddieMac and FannieMae simply brought the next round of illiquid financial institutions to the fore.

Hear this: We have a situation, brought on by a national addiction to credit on an individual, corporate and governmental level. It’s not going to go away anytime soon. It’s not going to get easier.

As long as our government continues to finance the Iraq War with abandon, credit will be tighter, financial institutions will be as squeezed as the individual, and our nation will leverage the future of our children in the name of “national security”. Just as a reminder, the architect of the blueprint for the failure of these financial institutions can be laid directly at the feet of Phil Gramm, John McCain’s chief economic adviser. McCain continues to try to tell Americans he will not raise taxes and will extend the Bush tax cuts, but he does not admit that what he proposes is impossible.

This is important, because it goes straight to the heart of our faltering economy. There is no question that the debt we’re racking up in Iraq (last tally it was 3 TRILLION). Despite the Bush Administration promise that Iraqis would help foot the bill, the facts say otherwise. They have not contributed one penny to the debt the US has accumulated during our occupation of their country. Why should they? It’s not as if we were invited in, and asked to stay.

The continued shakiness of our financial institutions and Federal bailout responses are cause for concern, but not cause for panic. It is not time to make a run on the bank. It IS time to be smart about how your money is banked. Make sure you’ve got cash in FDIC-backed institutions, be prudent and get rid of as much personal debt as possible. (I have more suggestions here).

As a third-party pension administrator, I admit to having concern about how 401(k) investors are going to react to today’s news. As the single largest cash investor in US markets, it’s really important that participants in 401(k) plans react with caution, rather than on impulse. Retirement plans are long-term investments, and investors have an opportunity to buy at bargain-basement prices while the markets react to the Lehman/Merrill news. This is not a time to pull funds out of the market; it’s an opportunity to leverage the state of the market for future growth.

But on a higher level, all of us need to ask how much bleaker this economy will get before we’re staring down a full-fledged depression. While McCain and Bush try to tell us it’s in our heads, facts remain facts.

Paul Krugman:

To understand the problem, you need to know that the old world of banking, in which institutions housed in big marble buildings accepted deposits and lent the money out to long-term clients, has largely vanished, replaced by what is widely called the “shadow banking system.” Depository banks, the guys in the marble buildings, now play only a minor role in channeling funds from savers to borrowers; most of the business of finance is carried out through complex deals arranged by “nondepository” institutions, institutions like the late lamented Bear Stearns — and Lehman.

The new system was supposed to do a better job of spreading and reducing risk. But in the aftermath of the housing bust and the resulting mortgage crisis, it seems apparent that risk wasn’t so much reduced as hidden: all too many investors had no idea how exposed they were.

This is the problem in a nutshell. The twisty passages of current banking and securities law have done a wildly effective job of hiding vulnerabilities until it’s far too late to correct without drastic measures. The best solution is going to be a steady diet of transparency, mandatory disclosures, belt-tightening, and putting an end to the bleeding of our resources into Iraq.

Areas to watch: Insurance companies, who typically invest heavily in the mortgage markets but usually have lower liquidity needs than brokerage houses and banks, and the larger institutions like Bank of America and Citibank. As they consolidate and bring the troubled securities children under their corporate umbrella, there should be concern that they are not putting us at greater risk by concentrating exposure in one place.

Oh, and listen carefully to what John McCain has to say about this latest shakeout. My guess is that he will try to brush it off as less than it is or write it off to market adjustment. Don’t believe him. I cannot say this loudly enough. Attention should and must be paid to this. That doesn’t mean panic, it means heads-up, stay alert, and watch your back.

Someone should ask Sarah Palin how she’d handle this too. I’d love to hear her very detailed and experienced answer.

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Comments

  • KyleSellers

    I think the point to take away here is that Lehman, most significantly, is paying the price of poor greed-driven decision making. They were an early backer of sub-prime loans and for a few years were doing quite well with these loans, but it was short sighted.

    In a free market, companies should be allowed to fail–and not be bailed out. These failures should be like a lighthouse on a rocky shore, warning other ships of the danger of risky decisions. It will also be a warning to investors, employees, etc. to better research the companies they invest in, work for, and do business with. I believe that the root of the problem was that many people got caught up in a bubble and their judgment was clouded by dollar signs.

    Let failing companies fail, and struggling companies fight through the tough times without gov't assistance. Hopefully, present troubles result in future caution.

  • http://www.drumsnwhistles.com/ Karoli

    I have no disagreement with you on the indictment of greed and hubris on Lehman's part. But when assessing damage (and in particular with respect to AIG), weight has to be given to the ripple effect across the economy of allowing failures.

    This is why, after the depression, federally insured deposits came into being — to make sure that the failure of an institution does not fan out so far as to undercut the economy and possibilities for growth further.

    One thing that cannot be ignored: these companies have been given a ticket to a free ride for far too many years. It's time for them to be accountable and transparent.

  • KyleSellers

    I have to say, I am upset by the Fed bailing out AIG. I disagree with it on principle.

    Hopefully, as soon as things settle down funding will come along and someone will by the 80% stake back from the government… thus bringing it back into the free market before another Fannie Mae/Freddie Mac situation develops. As bad as the AIG situation is, allowing it to remain (even partially) in the governments hands would be disastrous.

  • http://www.drumsnwhistles.com/ Karoli

    I agree. I'm not all that pleased about it either, and can't help wondering if there's a backstory that is yet to be told.

  • LuisMcduffie6

    Cant access my pc much here, at work right now will surely give a fair comment latter this evening.

    Have a nice day
    jenny yully
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