First of all, good news:
April 27 -- Federal Deposit Insurance Corp. Chairman Sheila Bair urged limits on the size of financial firms to help avoid forcing government actions aimed at preventing a large-scale disruption to the global banking system.
The Obama administration should abandon a “too big to fail” policy and create a federal authority to shut “systemically important” firms, Bair said today in a luncheon speech at the Economic Club of New York.
“What’s needed is a new way to unwind these big institutions,” Bair said. “We need an effective resolution mechanism, not a get-out-of-jail free card. Taxpayers should not be called on to foot the bill to support non-viable institutions because there is no orderly process for resolving them.”
Now, let's get back to the history of Wall-Street. What was the motivation for this institution to appear in the first place?
Was that efficient allocation of capital to the best investment project?
Was that beneficial risk insurance which any economy would struggle without?
No, that was plain and simple decision NOT TO TRADE with anyone outside of the closed club of Wall Street insiders.
Do you see a problem here?
Yes, the closed "circle of trust" is essential for the whole existence of Wall Street as an institution. You simply don't execute a trade with anyone you don't trust, that one of the basic axioms of any business transaction. There is absolutely nothing wrong with that, sometime later I'll explain how this model benefit economy.
However, what we see now is that the government became very much the dominating force in this club and the key question - can they (investment bankers etc) really trust the government? The circle of trust does seem to be broken, in fact we have plenty of evidence coming from victims of violated implicit Wall Street contract, be it the managers of Bears Stearns suspecting dirty play behind the scenes or Lehman Brothers employees who were punished severely by the Paulson just to "teach a lesson".
In addition, we have government issuing a multitude of highly complex securities, the simplest of those would be explicit and implicit put options given FOR FREE to preferred financial institutions. Can you imagine US government turning into one super big hedge fund? United States of LTCM, only without profit making motive? Well, you don't have to imagine, it is already here, in reality.
Or take for example, a A “Qualifying Financial Institution” (QFI) program to provide a funding for 2% of (risk weighted) assets. This funding is provided in exchange for Convertible, Redeemable, Preferred Stock. What's wrong here? Many things, for example, the banks now have the option to convert this security to equity whenever they seem fit.
Optional Conversion Convertible in whole or from time
to time in part at the Conversion Price
at the option of QFI at any time.
Usually, it is the investors who get this option, not the debtor. It is also redeemable, again whenever the bank wishes to do so. What that means is that potential upside from improving economy for taxpayers is severely limited by implicit put options embedded in those securities. The banks themselves will reap all the benefits, but taxpayers will take most of the risk if rebound of economy will never materialize.
This is important to stress, bank-stress if you will.
Anywhere you look, everywhere we have the most essential for the economy circles of trust severely broken now.
And that is indeed the most important reason for financial crisis that happened last Fall and nothing, I repeat, nothing was really fixed since then.
All of those famous economists and finance celebrities of the world were completely wrong about the real cause of the crisis, they never really anticipated what's about to happen. No, all reasons you've heard so far are only the side effects, a lot like elevated temperature signals the presence of virus. All famous economists and finance celebrities of the world are like blind elders trying to make sense of the elephant by touching different parts of the animal without having the slightest idea what the "elephant" really is.
And now, they all push their favorite theories "explaining" the crisis and shamelessly advising on how to deal with the crisis! They studied zombie banks in Japan, now they see Japan-like effects in US and advocate the cleaning the balance sheets. They studied liquidity, now they claim liquidity to be the main problem. They studied "rare events", now they talk about fat tail and better sampling strategies. They studied investor's preference, now they try to deduce somehow what caused elevated "risk aversion". They were playing the flute right before the Rome was about to burn, now they ARE advising what to do? The truth is they didn't know what was about to happen then and they still have no idea what's about to happen and how to deal with all the outcomes of policies already undertaken.
to be continued...
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