"U.S. Receives Margin Call"
–Wall Street Journal, March 15
You may recall those old black-and-white movies where bickering, contentious earth dwellers were forced to rally together when they discovered that massive hurtling asteroids were on a collision course with our planet. (Earthlings, in the end, always came through and saved themselves).
Well, figurative asteroids are on the way but, thus far, rallying is hard to find.
The "mortgage crisis" – mainly, a classic speculative bubble in the housing industry – has spread throughout the financial system and now poses a systemic threat. In the meantime, the previously inspiring Obama-Clinton contest for the Democratic presidential nomination has deteriorated into down-on-all-fours debate centered around race and gender issues. Here in our Emerald City theme park, we appear most agitated by the fact that Gov. Chris Gregoire and state legislators failed last week to come up on short notice with a few hundred million in public money to keep that smarmiest of professional sports leagues, the National Basketball Association, operating in our midst.
It was truly big news Friday, March 14, when the Federal Reserve and JPMorgan Chase announced a 28-day emergency funding loan to keep Bear Stearns afloat. A depression-era law had to be invoked to get it done. The Fed pushed the action through with extraordinary speed and without Fed governors having in advance the usual data required for consideration of such a major step. (Update, 2008-03-16: JPMorgan will buy Bear Stears.
Of local interest, Moody's Investors Service announced Friday that Washington Mutual's credit rating had been downgraded to near-junk status and that WaMu needed another $4 billion to cover its bad mortgages this year.
Both Bear Stearns and Seattle-based WaMu, predictably, took big hits to their stock prices. A couple days earlier, one of Carlyle Group's major hedge funds folded when its creditors ran out of patience. Other major firms have been kept afloat recently only after massive infusions of offshore money – including money from sovereign (state) investors thus taking a big stake in vital U.S. financial institutions.
What is happening now is what happens after the bursting of a tulip, high-tech, or any speculative bubble. It is discovered that establishmantarian, respected institutions – well outside the specific sector involved (in this case, the housing sector) – have exposed themselves and their shareholders to unjustified risk. A scramble takes place to keep them alive. Governments become involved in large or small ways. In the end, some fail altogether. In this instance, in the the housing sector alone, millions will lose their homes; mortgage companies will go under; big banks, investment houses, and hedge funds will have to do writedowns. Taxpayers, in the end, will be stuck with much of the bill. In time, the bubble will subside. New government regulations will preclude future risky lending. We will vow not to let it happen again.
Please watch closely what happens over the 28-day grace period which Bear Stearns has been given. Will it attract fresh capital? Will it be able to sell itself to another institution? Will its stock value plunge to zero before either can happen? The same questions can be asked about WaMu, although its situation is not presently as dire as Bear Stearns'. The closest recent parallels to the present situation, it seems to me, lie with the 1990s Mexican peso and Asian financial crises. The U.S. and other major economic players knew that Mexican and Asian distress lay principally with the irresponsible actions of local political, financial, and business leaders. But the risk of domino effects, and a general collapse, was so great that the U.S. and other western countries intervened directly. It was by no means certain that their interventions would work. But they had no choice but to do what was necessary to stem the bleeding.
For some 11 years (1986-97), while in Washington, D.C., I ran an advisory service for institutional investors which kept them informed on public policy trends which impacted them. I developed great confidence in asset managers and decisionmakers at some of my institutional-investor clients. But I also observed that the industry was just as subject to herd instincts and rumor as any other. I also saw the disproportionate influence in the sector of traders and speculators basically unconcerned with the broader consequences of their short-term actions.
Wall Streeters like things put in terms of probabilities. Thus I will make it 60-40 that Bear Stearns, WaMu, and other threatened entities do not go down in the immediate future and that we will make it through the present travail with the loss of a point in GDP and with damage being relatively contained. But even a 40 percent chance of calamity is far too high.
For a road map, look back to the New Deal era. The Bear Stearns rescue was the first undertaken since that time under the relevant law. It is not far fetched to imagine President George W. Bush, as President Franklin Roosevelt before him, taking to the airwaves to announce a brief financial-sector "holiday" in which there would be no transactions and in which financial transfusions could be undertaken to strengthen institutions vital to the country.