Friday, October 03, 2008

Still wondering if there really is a financial crisis? By way of an answer, the government of California has just announced that they need a $7 billion short term bridge loan from the Fed directly. They've been borrowing in the fall for decades to cover operating expenses until Christmas-season sales taxes and state income tax revenue start rolling in, but right now, no one can get a large loan from the private sector, even if (as with the State of California) there is no realistic prospect of a default whatever.

Still, on the subject, some worrisome quotes. First, the New York Times on the last time we had systemic shutdowns in the banking sector:

In late 1930, however, a rolling series of bank panics began. Investments made by the banks were going bad — or, in some cases, were rumored to be going bad — and nervous customers besieged bank branches to demand their money back. Hundreds of banks eventually closed.

Once a bank in a given town shut its doors, all the knowledge accumulated by the bank officers there effectively disappeared. Other banks weren’t nearly as willing to lend money to local businesses and residents because the loan officers at those banks didn’t know which borrowers were less reliable than they looked. Credit dried up.

The past is prologue: the mortgage mess arose in large part because banks and funds from out of state or overseas were willing to back up mortgages in which no one even tried to verify if the borrowers were reliable ("NINA" loans --- No Income, No Assets). And those mortgages are hard to renegotiate now because there's no way for the borrowers to arrange to renegotiate them with whatever post office box in the Cayman Islands now nominally has the legal right to do that. The current "cure" seems to be a wave of mergers; over the short term, this centralizes the banking sector and hollows out whatever local infrastructure is left.

Another, from Brad DeLong:

My belief is that if Paulson were to stay on he would treat undercapitalized banks like a Goldman-Sachs honcho treats counterparties in trouble: strip them of everything and send them naked into the blizzard to live or die on their own--that's what he and Bernanke have done to the preferred and common shareholders of Freddie, Fannie, AIG, WaMu, Wachovia, Bear-Stearns, Lehman, and to the bondholders and counterparties of Lehman...
He's right about Goldman, where Paulson made his half-billion dollar personal fortune. (Michael Lewis's memoir of his time as a bond salesman in the '80s, Liar's Poker, is illuminating here on the general ethos.) But Paulson may have divided loyalties here. It's true that shareholders in particular firms have gotten pretty rough treatment at his hands, so far. But a large part of critics' misgivings about the plan is a lingering suspicion that when push comes to shove, he'll be less ripping off Wall Street on behalf of the taxpayers, than ripping off the taxpayers on behalf of institutional Wall Street...

Correction: I'd misremembered that Lewis had been at Goldman; it was actually Salomon brothers. Ouch.

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