How one thing led to another
Anatole Kaletsky in the London Times asked: “What suddenly transformed the familiar credit crunch, quietly grinding away in the background of the world economy since last August, into a catastrophic crisis?” His answer:
The financial diseases caused by lax mortgage lending and misconceived financial trading have been around for over a year. But two weeks ago they suddenly moved from chronic to critical.
What triggered this change was the US Government’s “rescue” of the Fannie Mae and Freddie Mac mortgage companies. This rescue was actually more of an expropriation. Fannie and Freddie shareholders had their investments suddenly and unexpectedly wiped out by Henry Paulson, the US Treasury Secretary, who was intent on avoiding accusations of using taxpayer money to bail out banks. The “rescue” signalled to shareholders in other US banks that they, too, would lose everything if they ever required government help.
The debacle also encouraged short-sellers — stock market speculators who profit from falling share prices — who concluded that any bank they temporarily destabilised to the point where it needed government intervention would suffer a Fannie-type “rescue”. Mr Paulson’s terms would slash the share price almost to zero and short-sellers would be richly rewarded, while long-term shareholders would be wiped out.
This is exactly what happened to Lehman Brothers and AIG this week. By Wednesday it was the turn of HBOS in Britain — and almost every other bank seemed vulnerable to similar attack. Mr Paulson had built a financial doomsday machine and then handed short-sellers the key.
We’ll have to think about this a bit, but Mr. Kaletsky’s analysis seems to make a good deal of sense on first reading. It certainly causes us to consider the AIG bailout in a different light. It was a great deal for the government, but that massive transfer of wealth away from shareholders clearly created an almost risk-free strategy for short sellers of financial institution stocks, a “Doomsday Machine,” according to Mr. Kaletsky.
September 21st, 2008 at 11:34 am
It seems to me that the eeeeevil shortseller is getting a bad rap in this Wall Street crisis. If these companies weren’t leveraging themselves at 30/40:1, they wouldn’t be vulnerable to a sustained short selling attack. My banker starts sweating if I approach 2:1 leverage. So my question is, instead of restricting short selling, why not set limits on how hard a company may leverage itself? This excess leveraging makes me do a slow burn. Execs leverage the you-know-what out of a company, meet earnings targets and collect huges bonuses. Then the company is wrecked when the market realizes they are over extended and the share price collapses. Execs walk scot free with millions in compensation. Shareholders and Uncle Sam left holding the bag. There it is. Ignorance sounding off.