aardvarkcola

A historic week on Wall Street

Posted on: September 20, 2008

One mayor of a municipality I covered for a small newspaper told me that no one new on council ever asked questions about the budget. Budgets for the municipality were under $30 million. Sure enough, budget time rolled around and the new councillors looked thoughtful, listened to the debate, but asked no questions.

Why?

There really is too much to ask. When you have volumes of pages of budget line items in binders on your desk and it’s the first time you’ve dealt with these matters, you have so many basic questions that diving into details more complex is a few episodes ahead. So you sit on your hands and try to learn. The learning curve is steep.

The same thing may be happening in the United States. Americans are faced with landmark financial institutions that have been wiped out overnight, face mergers or have been propped up by their federal government. Reportedly $900 billion has been spent in all including direct buyouts and that figure may include the January prime-the-pump cheques to Americans to spend.

Now the U.S. government has a plan to spend $700 billion more in a single plan to remove the bad debt from the system. It’s necessary and an auction should have been set up months ago to do it.

The media has a job to do in explaining this issue to Americans who have never in their lives wondered about a day in the life of Wall Street brokers. It will be a steep learning curve.

The subprime crisis was on the radar for a while.

Subprime lending refers to borrowers who were not “prime”, that is, not ideal. A glitch in their credit history could get them turned away from traditional loans from the local bank. But if they couldn’t afford a car or a house or credit card, there were avenues to take that were outside the traditional lending practice guidelines. The initial rates may have been attractive. But the fine print in subprime lending tightens if you are late in a payment, interest rates can skyrocket. But the rising prices in the real estate market – a bull boom from 2000 to 2006- made it tempting to get into the market for many with these available mortgages.

Already there were problems in subprime. The United States had a spike in credit card defaults in 2002. That could have raised alarm bells.

The subprime market is foreign here. Canada doesn’t have it. That’s why our banks are relatively unaffected by the American banking crisis. We do have some of this subprime market, though. Look at some of those advertisments for cars in the Sun newspaper chain. Bad credit history? No problem. Buy a car from us anyway. That’s subprime. You’ll pay through the nose in interest because you have risky credit.

Money brokers need a boom and the American home buying binge was certainly one. Even we saw the ads late at night. Buy a house with no money down, flip it, buy another. It seemed the U.S. had gone crazy over house purchasing. Sure, it was all a risk for average men and women, but if it’s a chance to own that nice house, why not?

The problem isn’t with Mr. and Mrs. Average American. The problem was with the money brokers.

The mind-boggling issue in all of this is not that warning signals for upcoming trouble were not heeded, it’s more than that. They were actually ignored as investment banks leveraged themselves into serious debt to lend even more because profits were so good in the subprime market.

I’ve written about this before- some investment banks were lending over $30 in borrowed money for each dollar of shareholders money. It’s no wonder when the crunch came that it all became a house of cards. There was no money anywhere.

That’s why the United States Federal Reserve, the Treasury department and the Congress are now considering the biggest bailout in history, that could cost a trillion dollars to prime the money-starved banks and separate the bad debt from the system.

Investment bank Bear Sterns was first. It’s history included weathering the crash of 1929 when it was just a six-year-old trading house. By 2007 it had over 15,000 employees, $350 billion in assets. In July 2007 two subprime hedge funds evaporated and the company then had to face over $1 billion in write-downs. The loss of confidence in the investment banking giant was swift and caused a melt-down in its stock price from a high of $172 in 2007 to just $2 by March, 2008. J.P. Morgan Chase swallowed Bear Sterns whole for $10 a share, bumping up its offer from $2 to add the worth of its newly-built New York office tower.

But it was this past week that was history making.

To begin last week the news was already surprising and grim with the federal government takeover of two corporations, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) that backed five to six trillion dollars worth of the $10 to $12 trillion mortgages in the United States.

On Monday, September 15, Lehman brothers, founded in 1850, and with assets of $639 billion, filed for bankruptcy under crushing debt. By Wednesday the prized LEH stock offering was taken off the roster of stocks traded on the New York stock exchange. Barclays bought the Lehman building and much of its trading operations. There is no choice about the bankruptcy as it is made clear there will be no bailout by the federal government. Bank of America buys Merrill Lynch.

On Tuesday, with Wall Street reeling from the news of the Lehman Brothers bankruptcy, more hard news followed. AIG, the 18th largest corporation in the world, faced a similar fate. The company had underwritten much of the subprime mortgage affair. It now needed tens of billions to continue operating. Deemed too big to fail, a federal loan bailed it out, but at the cost of 80 per cent control of the company.

Wednesday. Treasury bills paid almost zero as the flight of capital sought safety as the Wall Street everyone knew seemed to be crumbling.

Thursday. The rate banks lend money to each other at is relatively high, indicating there is little trust or willingness between banks to lend money. The U.S. Federal Reserve, helped by foreign banks, pump billions into the system to thaw frozen capital. The rate comes down.

On Friday the U.S. Treasury Department announces a plan to buy up all the bad debt out of the system. The rescue plan is estimated to cost $700 billion.

The U.S. Congress about to debate the measure. The clock is ticking. The debate will be interesting. There will be members of Congress who will be learning as they go. They will not ask questions. They will give the proper sound bites, say they are studying the issue, in meetings over it, but like that mayor I spoke to said, some issues are so complex you don’t want to look stupid, even if you are the one voting on the measure. Expect the matter to pass spiced with just the right amount of sound bite grumbles on behalf of the American taxpayer who is going to have to pay for the whole thing.

Thank you for reading Aardvarkcola

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  • wordbeeps: No, he doesn't deserve an apology. Who tweets during a funeral? If you do, expect feedback. I didn't say the mourners were faking it. I think they we
  • Holly Stick: Look you fuckwit, are you too stupid to realise that Ghomeshi was an actual friend of Layton's, when you tweeted to him that the mourners were faking
  • aardvarkcola: Thank you. I see the rest of your message now. i'm honoured to to have your words on my blog. That alone is a delight. Lawrence

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