Sobering comments about the bungling of the world financial system

Mohamed El-Erian of Pimco is a fellow who usually knows what he’s talking about. FT:

History books will document that the global economy experienced a sudden stop after September 15. In accentuating long-standing structural weaknesses, the manner in which Lehman Brothers failed disrupted the trust that underpins the smooth functioning of market economies. As a result, virtually every indicator of economic and financial relationships exhibits characteristics of cardiac arrest.

The situation will get worse before it gets better and it will only get better if there is a shift in thinking in both the private and public sectors: away from comforting yet unrealistic notions of a return to “business as usual” and towards the more nasty reality of a volatile journey to a different destination. The implications are far-reaching as they speak to more market accidents, disorderly sectoral realignments and additional shifts in policy.

Up to September 15, debate focused on moral hazard, or the extent to which government bail-outs encourage irresponsible behaviour. The need to signal the government’s seriousness about market discipline partly drove the decision to let Lehman fail. What was less well understood was that it matters a great deal how an institution’s failure affects the capital structure.

The way Lehman failed disrupted payments and settlements. Around the world, market participants stepped back in mass from what, up to then, were standardised, routine, predictable transactions. Not surprisingly, all main indicators are now violently heading south. It is not just about consumption, investment and employment in the US, which will result in a 4 per cent plus contraction in gross domestic product in this quarter alone. It is also about pressures on production in Brazil, China, Japan and Russia, as well as the slowdown in construction in the Gulf. What we are witnessing goes well beyond a cyclical economic shock and a consolidation of the financial sector.

We have said that letting Lehman fail was a big, possibly calamitous mistake. It does not help matters that the Fed Chairman continues to obfuscate this situation. Much of the financial world pretty much ceased functioning 80 days ago, and banking is like a river that brings life to the modern world of commerce. This needs to be fixed, and fast, but unfortunately this is probably a situation that can’t be remediated in short order.

2 Responses to “Sobering comments about the bungling of the world financial system”

  1. dan Says:

    the energy bubble was a major contributing factor to the recession.
    and so was greenspan’s 17 rate increases from 2004-2007.
    had energy prices not reached ridiculous heights and had greenspan not raised rates there would have been no real estate collapse.
    and the structural problems underlying fannie mae and their derivatives might have been dealt with in a less expensive manner.

    square one was the cra and sub-prime and alt-a loans. this led to bad paper being created by FM bought – in good faith by banking institutions globally. to the tune of 6 TRILLION.

    this paper was fine until the real estate bubble burst.
    the real estate bubble burst because of greenspan’s fed, opec, and hedge funds using oil as a hedge.

    the underlying error which led greenspan and the hedge funds to raise rates and put billions into oil/oil futures was FEAR OF INFLATION.

    unbased fear (of inflation) and socialism (cra/fannie mae).

    a fatal mix.

    unbased fear of AGW and the green socialist boondogle the left is promising us will be just as damaging to the global economy.

  2. Rick Says:

    Loss of trust was absolutely the key to this mess, but Lehman’s failure wasn’t the catalyst OR the cause. The lack of trust came about as people in the financial world began to realize they had been LIED TO about the general safety of the mortgage backed securities and attendant credit swaps. There was a tremendous imbalance in place between these, creating massive opportunities for gain with the swap holders, and massive losses with those who held the actual securities.

    Add to this a tacit promise on the part of the government to “back up” any failures and you had a situation that was ripe for failure – trust was bound to dissipate as everyone knew “free money” was available if they all took the most elaborate risk.

    Sadly, there is no free money. All money from the gov’t comes from somewhere, even if it eventually just winds up being printed (thus hyperinflationary). There is a cost to this money. At this stage the cost is, without a doubt, the loss of private capital as public spending pushes private initiative to the side.

    Where are our corporate raiders today? Men who, with the brashness and boldness of fearsome knights went forth and made fortunes to “remake” the economy? They are all hiding with their billions behind the skirt of the government. The few who are willing to step out – Carl Icahn, T Boone Pickens – are doing so tepidly. In T Boone’s case, he is seeking the government to use Eminent Domain FOR HIS ADVANTAGE. At this stage Icahn remains one of the few using his own cash to push for change.

    The billions these men made should come showering forth NOW – TODAY. Warren Buffett famously remade Goldman Sachs – he should do so again. There was a day when men of money and stature stepped forth to PREVENT government intervention and taxpayer loss. Why? Because in the long run it erodes their gains, though this happens as a mirage, slowly and almost invisibly….
    Today, these men believe (TRULY BELIEVE) the government CAN HELP. They fail to recognize the massive losses THEY will suffer over time…but if they suffer large losses today, these men can create great gains for themselves by pushing the government aside. This is as it SHOULD BE.
    Sadly, these men are content to ride out the remainder of their glory days as pundits sitting on billions telling us how the government should do this or that. They are using Socialism to preserve their stature. They have turned into leeches, sucklings on the public teat – George Soros has won – he has his socialism. He got his man elected, he convinced many others like him to support the “cause” and now we are suffering.

    Ayn Rand’s stories are all coming true…and people still laugh at her “naivete”.

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