The U.S. Treasury: Out of Bullets?
13 September 2008This weekend finds Lehman Bros. twisting in the wind. Guys who remember 8th grade dance class remember the feeling, as the Teutonic teacher loudly and suddenly announces the Sadie Hawkins dance, where girls get to pick boys, and there you are, still sitting along the wall. (Of course, for girls, every dance offered this delightful experience.)
Welcome to the world of Lehman.
People are fond of reciting the phrase: The darkest hour is often just before the dawn. It seems to me, on local as well as global stages, that the opposite is just as often true: the moment of greatest peril is when you think the challenge is over.
So it is for the U.S., and therefore global, financial system. And I don’t say this with any intended hubris. I doubt that any reader would argue long over the posit that a failed U.S. financial system would cast the world into complete economic chaos. In this particular and key universe, the U.S. is still in the World Series hunt, and China is a farm team.
With the rescue of Fannie and Freddie (may we make that assumption? on paper, at least), my prediction to my British friends and co-bloggers has come to pass: there was no way Secretary Paulson was going to let them fail, and he didn’t. It was never about moral hazard, it was about the complete collapse of the U.S. lending system.
But now what? Paulson has, just as wisely, met with Lehman and the leading global banks last night. While I haven’t seen any transcript of the meeting, my guess is that he has told them he will not be bailing out Lehman, that he will be glad to help with the meetings part, but the money and risk assumption will be theirs. Support, but no money.
This, too, is exactly the right move, in my opinion, but it brings up a difficult question. What if, in this game of chicken, no one blinks?
I have little doubt that Lehman is a basket case, based solely on their losses announced to date. But I have the same feeling about Merrill Lynch, one of the supposed saviors in last night’s meeting. Other than Goldman Sachs, there are a lot of “walking wounded” out there right now, who, despite all the triage and medical care, will take a couple more years to heal their balance sheets.
The Congress, and the Treasury, are probably on the same page regarding additional bank failures: let them happen. But what will be the result, if they do?
The chances of another bank failure, starting with Lehman, are, I believe, very high. When these failures occur, they will probably be like Palin’s self description: pigs with lipstick on. In this case, that probably means, for example, a sale to someone like Bank of America on such draconian terms that all equity value is effectively wiped out, the managers are fired, and huge headcount reductions follow.
Was it a sale, a fire sale, or just a fire, with B of A sweeping up the ashes?
And if it turns out to be the latter, as I expect, will the ensuing damage to the markets be manageable? Once? Twice?
I think the Treasury is essentially out of bullets in this war to save the U.S. financial system, and if so, the next few weeks and months will be those of greatest peril, even as many on the Street are heaving sighs of relief and writing about how the danger has already passed.
5 Responses to “The U.S. Treasury: Out of Bullets?”
September 13th, 2008 at 4:06 pm
Endgame in the banking sector
EXTRACT [Final para] The disappearance of a large number of banks, including, on both sides of the Atlantic, some household names, will boost the profitability of the survivors and is likely to produce a more speedy resumption of normal lending and funding activities than an equal sharing of pain, of the kind that was attempted in Japan following the collapse of its asset price bubble. With a bit of luck the endgame for the banking sector will be short and the financial players will be able to start another game – with a rather different set of rules, I would hope.
http://blogs.ft.com/maverecon/2008/09/endgame-in-the-banking-sector/
Mark,
This article by Willem Buiter reads like a draft obituary but is it for the western financial system or just some useless institutions? Lets hope it is just a necessary cull so that the fear of interbank lending amongst the survivors is reduced and more normal service resumes. Perpetuating the present state of affairs by yet more taxpayer supported bailouts is not an option, never was. Those that gained like bandits is this bubble will come back to play once the prices are right.
There are much bigger problems looming than worrying about Wall Street.
Tim
September 15th, 2008 at 1:13 am
I just finished reading “The Great Contraction 1929-1933″ by Milton Friedman and Anna Schwartz on a flight from San Francisco to London.
I got off the plane to read the news on Lehman and Merrill. Friedman and Schwartz’ analysis of what happened during the Depression basically concludes that the then Federal Reserve System failed to address the monetary issues and in doing so made things much worse than they needed to be.
Interestingly the book includes an afterword consisting of Ben Bernanke’s remarks on the occasion of Milton Friedman’s 90th birthday in November 2002. The remarks end “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” Let’s all hope so!
–Mark
September 15th, 2008 at 8:17 am
[...] global financial industry fall down like lifeless flies. Clearly, this mess is far from over. See Mark Anderson’s commentary. He has been pointing what is unfolding in front of us for a long [...]
September 15th, 2008 at 11:54 am
Mark. All we can think is “let’s hope so.” I also read a good book by John Assaraf titled “The Answer.” While it wasn’t a finance heavy book, it really maintains a ton of solid business fundamental values that have been discarded in recent years by wallstreet firms… http://www.readtheanswer.com/index.php?RTA=web2
September 18th, 2008 at 6:05 am
How SEC Regulatory Exemptions Helped Lead to Collapse
from The Big Picture by Barry Ritholtz
The losses incurred by Bear Stearns and other large broker-dealers were not caused by “rumors” or a “crisis of confidence,” but rather by inadequate net capital and the lack of constraints on the incurring of debt.
–Lee Pickard, former director, SEC trading and markets division.
http://feedproxy.google.com/~r/TheBigPicture/~3/Bi0HXQG3YaQ/regulatory-exem.html