|
September 17, 2008
Paul Krugman in The New York Times makes a good point about the way the global financial system has changed. In doing so he pinpoints how the regulatory regime of the US financial system has failed.
Ingam Pinn
Krugman says:
To understand the problem, you need to know that the old world of banking, in which institutions housed in big marble buildings accepted deposits 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.
What evolved was the brave new US financial system----what Krugman calls the “shadow banking system” and it is this which is melting away before our eyes.
Krugman adds:
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.
He adds that the defenses set up to prevent a return of those bank runs, mainly deposit insurance and access to credit lines with the Federal Reserve, only protect the guys in the marble buildings, who aren’t at the heart of the current crisis.
Yesterday, Peter Costello in his National Press Club address rightly raised the issue of regulation pointing out that the US has bad regulation and Australia has good regulation. Bad regulation of the US sub prime mortgage market was the cause of the problem, and Australia's good regulation was due to his time in Treasury. Costello, in making this point, was referring to the old world of banking, in which institutions housed in big marble buildings accepted deposits and lent the money out to long-term client, not the “nondepository” institutions-- like Bear Stearns and Lehman-- or the shadow banking system institutions. However, as Krugman points out the guys in the marble buildings aren't at the heart of the crisis.
Krugman concurs about the lack of regulation in the US as the cause of the problem --- but he is referring to the shadow banking system institutions:
The real answer to the current problem would, of course, have been to take preventive action before we reached this point. Even leaving aside the obvious need to regulate the shadow banking system — if institutions need to be rescued like banks, they should be regulated like banks — why were we so unprepared for this latest shock? When Bear went under, many people talked about the need for a mechanism for “orderly liquidation” of failing investment banks. Well, that was six months ago. Where’s the mechanism?
Costello knows this. At the National Press Club he was talking up the Australian financial system and selling or big noting himself vis-a-vis the Rudd Government. To his credit Costello did highlight the significance of the global financial system to a Canberra Press Gallery that was obsessed with Liberal leadership, and which has little understanding that this will turn out to be the worst financial crisis since the Great Depression and the worst US recession in decades. Presumably this is just too large for the Canberra Gallery hacks to cope with. It wasn't denial on their faces, it was incomprehension.
What Costello didn't say----and he should have since he talking truth to power-- was that the ability of US policy authorities to prop financial markets is rapidly eroding as market participants perceive that policy makers are desperate and running out of options. He did say that the US was a now debtor nation not a creditor.What he didn't say was that the US government cannot afford to provide the subsidy as the moral hazard problems are becoming severe. and that the real danger is the run on most of the shadow banking system, especially the other major independent broker dealers Morgan Stanley, Goldman Sachs now that Lehman and Merrill Lynch have gone down the tube.
|
The fallout in Australia can be seen with Babcock and Brown.Shares of Babcock & Brown 35% to $1.03 in afternoon trading, cutting the firm's market value to $357 million. The stock has tumbled 96% this year.
The effect of global credit markets seizing up is that they are cutting off access to cheap loans to finance acquisitions of ports, power stations and airports, which Babcock bundles into funds it manages.
Investors and banks are now shunning highly leveraged companies.