Am I the only one who thinks the crisis started with LTCM?

The Coffee Shop
1

The underlying cause of the current crisis is exactly the same as that of the S&L crisis many years ago: the USG issuing insurance to financial institutions without regard to the risks they take.

The problem with the S&Ls was that you paid the same rate regardless of the risks you took. It’s like insuring someone who walks into a casino. Since they pay the same rate no matter what, they’re going to go for the games with highest return and the highest risk.

Fast-forward to the 2000s. “But wait” you say: “the government didn’t insure Citi, AIG, and all those guys!” Well the truth is they did. In fact, when the USG intervened to rescue LTCM, they implicitly provided FREE BLANKET COUNTERPARTY INSURANCE FOR THE ENTIRE FINANCIAL INDUSTRY. From that point on, no one needed to worry about counterparty risk anymore.

If AIG issues CDS at ridiculously low prices, because they have 0 capital to back them, who cares? We know that the USG ultimately stands behind them. If you’re on the other side of a big derivatives trade from Bear Stearns, no problem. It’s ultimately backed by the full faith and credit of the USG. Why not go for the biggest returns and biggest counterparty risk?

The guys making these bets all turned out to be right. Goldman and Deutsche Bank were paid billions to cover their AIG CDSs. If there was even a little doubt after LTCM there isn’t any now…

2

The Government didnt bail out LTCM. Treasury and the Fed organized a consortium of about a dozen banks who provided private capital.

And ask anyone on the other side of Lehman if they agree there is no such thing as counterparty risk.

3

I blame LT83.

4

Rich Berg’s comments about 2:20 into the clip …
http://www.marktomarketdebate.com/2009/03/27/financial-market-regulation/

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Rich Berg’s comments about 2:20 into the clip …
http://www.marktomarketdebate.com/2009/03/27/financial-market-regulation/

Thanks Trifloyd. That’s hilarious. I feel like I’ve been channeled. :wink:

Greensneakers: whether or not they jawboned other banks into contributing is immaterial. They made it clear they would not permit failure.

6

“They made it clear they would not permit failure.”

You mean they didnt permit failure at Lehman? Can you let me know where to send the claim?

7

“They made it clear they would not permit failure.”

You mean they didnt permit failure at Lehman? Can you let me know where to send the claim?

Lehman was an anomaly. Treasury and the Fed were acting like a drug addict trying to break the habit. But they lacked the will power and returned to the addiction.

That’s moral hazard in a nutshell. Once you start, any attempts to stop will be painful. But ultimately, it’s a little pain now, or a whole lot more down the road…

8

I 100% agree with LTCM being a key turn in policy. The other major problem is the massive size and consolidation of the financial cos. They believed that size and synergy would be their salvation… If the banks were smaller, they could fail w/o bringing the whole house down. Of course now they are even bigger…

It is not capitalism that failed.

9

I’m a small govt. guy. However, I like Gary Becker’s idea of putting capital requirements on a sliding scale – the bigger a financial institution is the higher their % capital requirements are. That will limit the “too big to fail” problem somewhat.

I also think, we may have to accept the reality that nobody has the will to let really big institutions fail (I mean everybody in Treas and the Fed is saying they will never, ever do another Lehman).

So the sad alternative is we need to charge the banks for the “insurance” they’ve been getting for free. And charge them a S***load if they take any risk.

10

I’m pretty sure you can blame Gramm-Leach-Biley Act of 1999.

11

No I think it started with greed :

  • I want a big house even though I have no money.

  • I want to make more loans so that I am a bigger bank manager and can get a bigger salary

  • I want to give these guys all AAA ratings for there business/banks so that they use us again to rate them,

It only takes a few greedy people to bring the whole stack of cards down. The few greedy ones who take everything down should be banished with no monetry reward. Even Sir Fred the Shred shouldn’t get his 700,000 pounds annual retirement, he did cause that bankruptcy directly, but he bought another bank which they shouldn’t have(he wanted to be a bigger man but everyone knows otherwise).

But I think 99% of people aren’t greedy, but with no rules the 1% caused the financial meltdown to be worse than it should have been.

G.

12

Nice points but I think the problem goes back to interference in the free market. There are several elements that are at the very core of this problem yet the Fed nor the Government talk about it.

  1. The Federal Reserve System. That problem goes back to 1913 and wouldn’t it be for the quasi-private Fed that interferes with the interest rates, rates could never be at historic low rates when the savings rate in the country is negative like it was/is. Also, everybody recognizes that it was the lose lending standards that contributed to this mess, yet few ask the question where the money came from. The Fed flooeded the market with excessive credit and the result was an imbalance in supply and demand. To “balance” that and get the demand up, institutions simply lowered the standards. But the core of that problem goes back to the Fed and its monetary policies.

  2. Interference in the free market (that doesn’t exist here) by our Government. GSE’s like Fannie and Freddie backed loans and therefore made borrowing cheaper. They made the American dream possible for those that should just be dreaming about it. To make matters worse, not only did they back those loans, but stupid Congress voted several times to raise those conventional limits during the credit/housing bubble, allowing the bubble to further expand.

It’s not the first, nor will it be the last time that “somebody” causes a bubble only to profit from its consequences by becoming more wealthy, increasing their power, or both.

HR 1207 already has 39 co-sponsors!
http://www.govtrack.us/congress/bill.xpd?bill=h111-1207
http://www.youtube.com/watch?v=bW4YZ6R53yA&eurl=http://www.dailypaul.com/node/88565&feature=player_embedded

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But I think 99% of people aren’t greedy, but with no rules the 1% caused the financial meltdown to be worse than it should have been.

G.

Very, very few people work for the betterment of all humanity.

The baker doesn’t bake bread, the doctor doesn’t treat patients, the plumber doesn’t plumb because they want to serve humanity selflessly. They all want to secure the best possible standard of living for themselves and their families.

So, in a sense, we’re all “greedy.” That has not changed for thousands of years. So it’s not a sufficient cause for the current epic crisis.

Instead you have to look to some other confluence of policy or events that are substantively different in the current era. I say “moral hazard” is what’s different (that and absurdly loose money from '01 to '04).

14

But ultimately, it’s a little pain now, or a whole lot more down the road…

A couple of points. First, if there was moral hazard, it was participated in by all. The assumption of excessive risk was systemic - that is pervasive from individuals, intermediate brokers, small banks, large banks, regulators, government, and ratings agencies. Everyone participated. No single segment of the system was crying foul in the good years. There were a few lone voices, but that’s about it. You might argue that some elite executive management types were committing more egregious moral hazard by withholding information that others didn’t know. There’s just not much evidence of it. There was plenty of information all along that pointed to exactly what happened. No one was hiding it. The classic bubble signs were hiding in plain sight.

I’d be careful with the “a little pain” part. Be careful what you wish for. The worst-case scenario in a banking failure is complete systemic failure - full-on run on the entire banking system. Which, with AIG being a huge global player - means the global banking system. This isn’t just banks failing, but a rippling effect of capital and credit vaporizing from all sectors of finance and business. Historically such losses incur an average loss of 20% of GDP for the first four years of the crisis. And that’s average, not worse-case.

Compare that to our 4th quarter GDP annual contraction rate of 6.3%. Imagine tripling that. I would argue that what we’re doing now is accepting a little pain for a long time instead of a hell of a lot of pain all at once.

Now some people, particularly in this forum, claim that we were nowhere near a full on systemic failure, and it was self-serving fear mongering by various bank lobbyists and corrupt government officials. I suppose it’s possible. But, if you look back, it looks an awful like the run had already started in earnest until our government acted really, really quickly to construct some massive firewalls and bring the whole thing back from going over the cliff. What they did was rash and fraught with all sorts of the nasty, unintended consequences of market intervention. But that doesn’t necessarily mean it was the wrong decision given the situation at the time.

Now maybe we should have let it go to “reboot” the whole system. But don’t call it “a little pain.” It would have ranged somewhere from “a lot of pain” all the way to “unimaginable bloodbath.”

Personally, I’d rather suffer a 10% reduced standard of living for the next 20 years than an 80% reduced one right now.

15

I agree - the interference by the Fed, the US government and other GSE’s led to our current crisis, and also created situations like S&L and LTCM.

Anyone blaming the current situation on 8 years of deregulation under Bush is simply not paying attention.

Historically, you would have to go back to at least 1913 (pre-Fed) to get to anything close to a free market in the US.

16

“When Genius Failed” should be required reading for anyone investing money with anyone who claims they are smarter than the rest of the finance guys. A lot of lessons were learned when LTCM failed, and yet all of smart guys forgot them and repeated the same mistakes.

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But I think 99% of people aren’t greedy, but with no rules the 1% caused the financial meltdown to be worse than it should have been.

I think you have your numbers reveresed. 99% of the people ARE greedy, in fact capitalism depends on it. The problem comes in when “Greed” has no consequences which is exactly what the OP is talking about.

Everyone is greedy. If there were NO consequences I would walk into the nearest bank right now and rob the place blind. The fact of the matter is that there are consequences to that “Greedy” action.

It all boils down to exactly what the OP is talking about and that is everyone from the home buyer to the financial sector was operating on the mentality that “It won’t fail, and if it does the government has my back”…guess what they were wrong, and then right.

The only “Tempering” for greed you need is to allow these individuals and corporations to FAIL. If we don’t which we aren’t, they be right back here in 5, 10 whatever number of years and everyone will be wondering “How did this happen”?

~Matt

18

Firstly the point I was making is that it only requires a smal percentage of greedy people to ‘bring the stack of cards down’.

Well I have to disagree that 99% are greedy. For a start I don’t come across many greedy woman; there focus in the work place is more about improving the work conditions(9am-3pm workday etc…), and enjoyment. Otherwise there focus is related to family which is also fair enough.
Even if all us guys are somewhat greedy there is only a small percent to really be in the position to take it to its full extent. I don’t think many people who do a lot of triathlon type sports are greedy or lots of people who work for others.

It is like the people who have responded to me saying all the top pros use PEDs; that is they are one eyed for some reason.
C. Wellington isn’t using PEDs but is somehow in a different league(unreal really).

Alot of people outside of the USA do see that country as being a bit greedy. I actually liked the very confident nature of the USa folk until it started knocking on the door. The first wealthy of my folks neighbours in NZ to take the banks for millions were a couple of American families; decent folk by all accounts but their dreams were not with reality. It has a knock on effect to all the young people in NZ because it artificailly inflates the prices.

I am definitely not anti-American but it is pretty clear from the outside what is going wrong. September 11 is very wrong and it was a strike on the free market democratic world(look a the target that sticks in everyones minds). So even in NZ, UK it is indirectly an attack on us also, or thats how I feel.

Your guy Bernanke of course knows what has happened; I think he mentioned indirectly the change whereby your competition(eg China), are producing the same goods for cheaper and said it started before 2000.

My definition of greed is not people who want more than the ‘Jones family next door’, but more the type who are fraudulent in their bussiness dealings and not realistic. I am sure that has happened(well madoff for one).

I agree with what you said,

This recession(downturn), will be prolonged I am sure of it. Governments bailing them out is not allowing the democratic free market to work as it should.

I will go against what many world leaders are saying(no protectionism), and say that ‘you need to look after yourselves somewhat, eg buying USA made where the quality/price is right’. You still have to have competition in your country for that to work though.

There is more to it, but it can be simplified. What the goverments and the world is really after is slow steady growth and that is what the mathematical equations used by financial people are based on. We had a boom(not slow growth), and now a bust. Mind you there is still 8% growth in China today which is still a boom. Plus there is some fraud in the system. I applaud the goverments for naming and shaming the tax havens.

The world is not an equal playing field and I don’t see it being that way in my lifetime.

G.

By the way is the following accurate?

http://en.wikipedia.org/wiki/Long-Term_Capital_Management

If so it sounds like some individuals fraud is to blame. You have very low mortgage rates in the USA right now but i don’t think it will cause another house price bubble like the last 6 years. Regulation is required, for example people must prove they can save and come up with a 20% deposit for a house. Regulataion(rules) are also required for the banks, especially the ones the governments now hold a decent share of or those which choose to have any sort of governement guarantee in hard times. I believe in the ‘free market’ but not for anything where the government is involved. Some rules for private companies will probably help them getting into to the worst type of scenarios though.

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10-4. Add “The Creature From Jekyll Island” for some insight on the formation of the Fed.

20

“Nice points but I think the problem goes back to interference in the free market…”

I agree completely with your analysis, but I also think that the actions described by the OP, which created the moral-hazard situation, have also been part of that same pattern of market interference.

I should also point out that it is not longer appropriate, and has not been appropriate for many years, to use the phrase “interference in the free market.” After all, you can’t interfere with something that no longer exists. Today we should more accurately term it merely “interference in the market.”