TELEGRAPH 16.9.08
1. Who's next after Lehman Brothers is fed to the wolves? [slightly
shortened]
By Ambrose Evans-Pritchard
One can date the onset of the Great Depression from December 1930
with the collapse of the Bank of the United States, a mid-size lender
to the Jewish community in New York.
(- - - - -) The failure set off a worldwide run on US gold deposits
(ie, the dollar), and forced the Federal Reserve to raise interest
rates into the slump. Some 4,000 lenders were ultimately driven to
the wall.
We will find out soon enough whether the decision to throw Lehman
Brothers to the wolves over the weekend was any wiser. Princeton
economist Paul Krugman has accused the US Treasury and the Fed of
playing "Russian roulette" with the financial system, warning that
the shadow banking network could disintegrate within days.
The hunting packs switched instantly to AIG yesterday, driving down
its shares by 70pc in early trading. The world's biggest insurer is
suddenly on the brink of collapse as well. The killer virus is
striking deep into a whole new sector of the financial system.
"This is a potentially very dangerous situation," said Professor Tim
Congdon from the London School of Economics.
"Banking system capital is being wiped out. The risk is that this
could lead to a contraction of credit and set off a self-reinforcing
downward spiral, leading to the sort of debt-deflation we saw in the
1930s. (- - - - - ) he said.
When creditors cut off funding to Bear Stearns in March, the Fed
reacted with dramatic speed. It invoked nuclear powers under Article
13 (3) of its charter, allowing it - in "unusual and exigent
circumstances" - to take credit liabilities on to its own books for
the first time since the Roosevelt era.
It was fiercely criticised for rescuing Wall Street from its own
folly, but the risk was a meltdown in the vast, untested market for
derivatives. Bear Stearns alone had over $13 trillion in contracts (-
- - - - - -) The Bear Stearns bail-out gave the banks an extra six
months to clean up their positions and lower exposure. (- - - - - - -)
With the tail risk of a derivatives Chernobyl out of the way, the Fed
and the Treasury at last feel safe enough to strike a blow against
moral hazard. The line has to be drawn somewhere.
Unlike mortgage giants Fannie Mae and Freddie Mac, broker dealers are
not crucial pillars of the US housing market. Lehman is an optimal
candidate for ritual sacrifice.
While the appearances of free market discipline have been upheld, the
reality of the weekend events is a further lurch towards socialism,
or state capitalism if you prefer.
The Fed's lending window has been widened, allowing all forms of
investment grade paper to be used as collateral in exchange for
taxpayer credit.
Even equities are now admitted, though under a disguised formula. (-
- - - - -) Yet the dangers remain acute, even after the move to
shield Merrill Lynch from contagion by orchestrating a shotgun
wedding with Bank of America.
The credit crunch is about to bite deeper. The interest rate on Tier
1 debt for typical banks has jumped by 125 basis points since
Friday. (- - - - - - -)
"There is a flight to quality. People are hoarding liquidity and this
is going to prove very damaging. What concerns me is that the banks
refused to take on Lehman's bad assets even at a low valuation, and
that tells you they still don't know where the clearing level is for
this mortgage debt," [said Willem Sels, credit strategist at Dresdner
Kleinwort.]
As this newspaper has long feared, the world is now faced with both a
tightening credit squeeze and a synchronised hard-landing across most
of the world economy.
The eurozone and Japan are almost certainly in recession already.
Britain will follow soon.
America is plummeting into a second downward leg as the fiscal
stimulus package fades and the exports mini-boom stalls. China cut
interest rates yesterday following a sharp fall in property prices
over the summer.
Superficially, one can blame Lehman and its ilk for the excesses that
led to this crisis.
However, the root cause lies in the actions of governments across the
Western world. They held interest rates too low for much of the past
two decades, and encouraged the debt burden to explode to
unprecedented levels.
This reckless experiment has left our societies acutely vulnerable to
a sudden reversal of debt issuance, or ''deleveraging" as it is
known. The ferocious purge now under way will come at a high human
cost. Millions in Britain, Europe, the US, and the rest of the world
will lose their jobs over the next two years, through no fault of
their own.
Having caused this crisis, it would now be remiss for governments to
pursue a policy of strict debt liquidation in the name of capitalist
purity.
As the bankruptcies mount, the state will have an obligation to step
in to preserve social stability. If that means the temporary
nationalisation of large chunks of the Western economy, so be it.
This is too grave a crisis for ideological preening and free market
infantilism. May those calling for debt liquidation ''a l'outrance"
be the first in line to lose their jobs.
==================
2.Capitalism - it's painful, but it works
By Jeff Randall
After a year of grim financial news, it would be easy to dismiss the
collapse of Lehman Brothers as just another bad day at the office.
Easy, but wrong.
This is a rare defining moment, when regulators call the bluff of
those who say that the demise of such an important bank will ruin our
economic infrastructure. It is the day of reckoning.
In throwing Lehman to the dogs, US Treasury Secretary Hank Paulson is
betting heavily that dire warnings of "contagion", "systemic risk"
and "domino effect" are little more than special pleading from
hitherto Masters of the Universe who would like the taxpayer to save
their over-priced skins. It is quite a punt.
Soon enough we will discover if the core of Western finance is just
an elaborate Ponzi scheme, underpinned only by new waves of suckers,
or an imperfect but flexible machinery that, despite its flaws, has
the capacity to withstand shocks.
Either way, it seems to me, Paulson was right to turn off the tap. If
the system is rotten, why shore it up? If it's not, then it will -
somehow - survive without more state aid.
The next test may not be far away. Right behind Lehman, in the
departure lounge of life, is AIG, the giant insurance group, that
lost $18.5 billion in the first nine months of this year.
Forget covering conventional risks such as hurricanes and floods, AIG
was beguiled by the complexity of "credit default swaps" and is in
urgent need of many billions to shore up its balance sheet. Yesterday
the insurance regulator threw it a lifeline, but it remains on the
critical list.
Lehman got what it deserved: to be the test case for a Darwinian
shake-out. I fail to see why garbage collectors in Gloomsville should
pay taxes so that $1,000-an-hour bankers can retain their seats at
the Wall Street casino. They had their fun and they lost their chips.
Correction, they lost other people's chips.
All right, so directors' share options are no longer worth anything,
but all those jackpot bonuses have been banked - and they're not
coming back. Lehman provides the latest egregious example of reward
for failure.
Were it not so serious, the role reversal would be hilarious. For
years, US governments have called in titans of finance for advice on
how to run federal affairs more effectively.
Now, those clever clogs who were once deemed to have all the answers
are asking difficult questions, like: "May we have some help, please,
we appear to have burned through our shareholders' reserves?"
What little faith I had in financial wizardry was blown away 10 years
ago when Long Term Capital Management, a hedge fund set up by a
couple of economists with Nobel Prizes in the cupboard, went pop.
Lehman, I'm afraid, went the same way: bamboozling itself.
Over lunch at its Canary Wharf offices, you could feel the heat from
all those first-class brains, working out how to make billions from
financial products that only an expert in nuclear fusion could
comprehend. I didn't have a clue what they were talking about. The
trouble is, it turns out, neither did they.
As a former Goldman Sachs executive, Paulson understands that the
unravelling of Lehman is not a sign, per se, that free markets are
failing. Quite the reverse. They work best when driving out weak and
inefficient operators. Creation and destruction are part of the game.
Nobody said that capitalism was devised to provide soft landings for
hopeless losers. Sending a message that all sinners will be saved
only encourages reckless behaviour.
Meddling politicians often find this impossible to accept. They would
rather pay a stricken company's ransom than face the wrath of voters
whose interests are linked to a business about to go bust.
Which explains Gordon Brown's willingness to jet-hose a relative
tiddler like Northern Rock with Treasury largesse, instead of
allowing the bank to take its chances in administration. The Rock's
nationalisation was not about saving the banking system from
oblivion. It was a cynical and unduly expensive exercise in electoral
engineering failed to instill confidence in other UK mortgage lenders
(shares in wobbly Halifax Bank of Scotland fell by more than 15 per
cent yesterday).
By contrast, in America, Fannie Mae and Freddie Mac were special
cases. Not because they are inextricably linked to the US housing
market - although that is true ($5.4 trillion of liabilities) - but
because from the outset they were "government-sponsored" private
companies.
As quasi state bodies, their implicit guarantee was that Washington
stood behind them. Had they gone under, it would have told the world
that Uncle Sam was happy to renege on his promises.
While unbothered by the wiping out of shareholders in Fannie and
Freddie, the US Treasury was determined to preserve value for their
bondholders. The reason was that these bonds are held in vast
quantities by foreign governments, notably China's, whose confidence
Washington is desperate not to lose.
With more than $1 trillion of foreign-exchange reserves, China is
equally anxious that America's economy, and with it the dollar, does
not get flushed away.
As Paulson was blocking state aid to Lehman, Merrill Lynch sold
itself to Bank of America in what looks like a panic-stricken dash
for the lifeboats while they still exist. Founded in 1914, Merrill's
corporate logo is a raging bull.
Who could have imagined that by charging about in the china shop of
sub-prime mortgages, the bank's hubristic management would smash 94
years of independence? The Thundering Herd, as Merrill is known,
looks more like The Blundering Nerd.
That said, the price Bank of America is paying is a hefty premium to
Merrill's recent share price - and none of the money is from US
Treasury coffers.
Add Lehman and Merrill to Bear Stearns, which fell into the arms of
JP Morgan at a knockdown price earlier this year, and it becomes
clear that investment banking has changed forever. Never again, at
least not until the next time, will they be allowed such free rein.
After this mess is over - perhaps even before then - there will be a
regulatory backlash. Everything from credit risk and lending ratios
to salaries and share issues will come under fiercer scrutiny.
The high-water mark of US financial hegemony was passed several years
ago, when both government and consumers became addicted to cheap debt
to pay bills they could not afford. The problem was, too few seemed
to notice.
The richest nation on earth carried on borrowing and spending until
the fantasy morphed into madness: Ninja debtors - No Income, Jobs or
Assets - were lent money by wannabe alchemists to buy homes at
unfathomable valuations.
A couple of years ago, Steve Forbes, the former US presidential
candidate and business publisher, told me he thought the American car
industry was going bust. He said it was only a matter of time before
Detroit's finest turned up in Washington looking for a comprehensive
bail-out, costing tens if not hundreds of billions of dollars.
What's more, he predicted, they would get the money.
Had Lehman been handed a get-out-of-jail card, demands for similar
treatment from other beleaguered businesses would have poured on to
Paulson's desk. There are plenty of them. General Motors and Ford
have made pre-emptive strikes.
Remarkable, isn't it, how those who champion the survival of the
fittest are quickly converted into supporters of lame ducks when they
become one. Banks that deprecated state intervention while sloshing
about in easy money are calling for the creation of government
agencies to "facilitate the consolidation of the financial sector".
The trouble with inviting in governments is that they don't know when
to leave.
As the world's buyer of last resort, the American shopper is
exhausted. Having drained all credit, he can barely keep up with
mortgage payments and is scared stiff that his job is about to be
axed. The world's locomotive of consumption is leaking oil.
Not since the Wall Street Crash of nearly 80 years ago has the
financial system that supports Joe Sixpack's lifestyle been so
severely stretched. Lehman has gone, others seem sure to follow.
There will be no quick fix
==================
3.Back to the future: the return of monolithic 'risk-averse' banks
By Damian Reece
After Meltdown Monday, I'm beginning to feel more like an apologist
than a proud defender of free markets. Like my colleagues I've been
busy justifying why it was right for Hank Paulson to refuse Lehman
Brothers state aid and let it go bust.
If we want the benefits of capitalism on the upside (rising wealth,
growth and taxes) then we have to be prepared for the cyclical
lurches down (recession, unemployment, social and political unrest).
Capitalism is a two steps forward one back sort of system, but you
end up making progress in the long term. I can sense those sceptical
eyebrows arching by the word.
The dual demise of Lehmans and Merrill Lynch (taken over by Bank of
America) proves that the cruel machismo of markets has not been lost.
One goes bust wiping out shareholders, exposing creditors to losses
and placing thousands on the jobless list while the other is saved
and life goes on.
The death of Lehmans reassures us diehards but in truth it also
horrifies us. Our beloved system is brittle. Our masters of the
universe fallible and weak. Our loud applause at the merciless
slaying of Lehmans is to drown out the sound of the cynics perched on
our shoulders calling time on what's been the biggest party in living
memory.
If we can't show that our financial system can absorb the likes of
Lehmans, find a solution for AIG and a saviour for Merrill Lynch,
then intervention from government and regulators is inevitable. Even
though capitalism is indeed consuming its weakest, its creditability
is taking such a pounding that it faces inevitable constraints. The
power structures within Wall Street and the City shifted permanently
yesterday.
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