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Paul Krugman: Financial Russian Roulette - SPIEGEL ONLINE - News - International

If institutions need to be rescued like banks, they should be regulated like banks -- why were we so unprepared for this latest shock?

 Can the Fed do anything to stop the continuing series of collapses of major financial institutions? Will the US financial system collapse today, or maybe over the next few days? I don't think so -- but I'm nowhere near certain. You see, Lehman Brothers, a major investment bank, is apparently about to go under. And nobody knows what will happen next.

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.

by Fran on Mon Sep 15th, 2008 at 06:18:22 AM EST
Well, when there's something that serious people find fitting to call "the shadow banking system", you have a problem of regulation, don't you?

Nouriel Roubini via Angry Bear: If Lehman collapses expect a run on all of the other broker dealers and the collapse of the shadow banking system (September 13, 2008)

It is now clear that we are again - as we were in mid- March at the time of the Bear Stearns collapse - an epsilon away from a generalized run on most of the shadow banking system, especially the other major independent broker dealers (Lehman, Merrill Lynch, Morgan Stanley, Goldman Sachs). ...


... Thus, a collapse of Lehman would trigger a panic and a potential run on all sort of other broker dealers and also on other distressed financial institutions like banks (WaMu) and insurance companies (AIG) and smaller member of the shadow financial system (distressed and highly leveraged hedge funds, etc.).


What we are facing now if the beginning of the unraveling and collapse of the entire shadow financial system, a system of institutions (broker dealers, hedge funds, private equity funds, SIVs, conduits, etc.) that look like banks (as they borrow short, are highly leveraged and lend and invest long and in illiquid ways) and thus are highly vulnerable to bank like runs; but unlike banks they are not properly regulated and supervised, they don't have access to deposit insurance and don't have access to the lender of last resort support of the central bank (with now only a small group of them having access to the limited and conditional and thus fragile support of the Fed). So no wonder that this shadow banking system is now collapsing. The entire conduits/SIV system has already collapsed with the roll-off of their ABCP financing; next is the collapse of the broker dealers (Bear, Lehman and soon enough the other ones) that rely mostly on unstable overnight repos and other very short term funding for their financing; next will be hundreds of poorly managed hedge funds that will face a tsunami of redemptions; and finally runs on money market funds that are not supported by a large financial institutions or other smaller member of the shadow banking system as well as highly leveraged and distressed private equity funds cannot be ruled out either.


A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
by Migeru (migeru at eurotrib dot com) on Mon Sep 15th, 2008 at 07:08:02 AM EST
[ Parent ]
Well one thing that would save the old independent investment bank would be to reinstate Glass-Seagall. After all, the business world needs the functions they traditionally perform, and if by law they have to be independent of other financial institutions, they'll keep on existing.
by MarekNYC on Tue Sep 16th, 2008 at 12:55:10 AM EST
[ Parent ]
At least according to McCain.

TPM Election Central | Talking Points Memo | McCain This Morning: "The Fundamentals Of Our Economy Are Strong"

Here's the full quote:

"You know that there's been tremendous turmoil in our financial markets and Wall St. And it is -- people are frightened by these events. Our economy, I think still -- the fundamentals of our economy are strong. But these are very, very difficult times."

McCain did refer to the big Wall Street events of here, so it isn't like this was an unintentional gaffe; this is what he wanted to say. Arguably, of course, that could make this worse. Not cutting this line out on this morning, of all mornings, is a serious mistake.

by Fran on Mon Sep 15th, 2008 at 12:15:09 PM EST
[ Parent ]


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