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...a blog by Richard Flowers

Thursday, March 20, 2008

Day 2633: Bear (Sterns) Market

Monday:


Bear Sterns was Wall Street's fifth largest bank and, a year ago, it was worth eighteen BILLION dollars. Which is a LOT even in devalued dollars.

This week it was sold for one-quarter of a billion dollars and a promise of a lot of love from the Federal Reserve.

Quite simply, the bank ran out of cash.

They had invested heavily in the distinctly dodgy "capital instruments" that supposedly turned sub-prime mortgages into Triple-A quality assets. Their depositors no longer trusted them, wanted their money back and that, as they say, was that.

Does any of this sound familiar?

Yes, it's the Northern Rock saga all over again. At least it'll stop young Master Gideon braying that "only Britain has had a run on a major bank" as though he knows ANYTHING about money.

Just as in the case of Northern Rock, the so-called "credit crunch", which means banks are no longer willing to lend money to each other, meant that Bear Sterns didn't have access to enough ready funds – and when they had to go and ask the government for an emergency loan to bail them out, it immediately panicked everyone else with money deposited there.

In fact, Bear Sterns' losses of $3 billion are CHICKEN FEED compared to the amount of money that America's biggest banks, Citigroup and Merrill Lynch, have had to write off - $18 billion and £14 billion respectively.

But once a RUMOUR had taken flight that they were sinking, the rats could not have been quicker in grabbing any CHEESE they could and trading it in for a GOLDEN life raft.

The only difference is that the American central bank cut its (or rather Bear Sterns') losses, nationalised the worthless debt and found a new private buyer without all of that shilly-shallying that Mr Frown and Sooty have done leaving the British public as joint owners of a bank.


The underlying problem remains the same.

The Monkey-in-Chief went on a massive spending spree subsidised by cheap loans from abroad and a whole load of not-very-well-off Americans were persuaded to do likewise. The banks thought that they had the magic formula for never losing and as money kept rolling in they congratulated themselves with triple bonuses all round. But as with all good things it had to come to an end and, one nasty oil shock later, end the good times did. (And conducting a WAR on top of a third of the World's oil reserves is hardly a good way to keep the oil price stable!) Suddenly the Chinese want to spend their money on oil and wheat for their own economy rather than funding America's ongoing CAVALCADE of WHIMSY and – ooh dear – borrowing gets just that little bit more sticky and – oops – all of those "sub-prime" mortgages that are coming up for refinancing are now out of reach of the people living in those homes. Welcome to default city.

And now people who've GOT money don't trust the banks. People don't trust their investments – they don't put their money into stocks or deposit it – instead they are buying commodities (oil, gold, orange juice and the like). So there is less money in the banks, but that money – or LIQUIDITY – is the LUBRICATION that keeps the economy going: banks loan it out to people to buy houses, (which means that there are jobs in building and in making furnishings and paint and stuff) or to businesses to fund expansion (which means that there are more jobs doing whatever it is that the business does, or making the machinery or producing the raw materials that they want to buy). No money keeping the wheels turning: no new jobs, homes, businesses, etc.

Basically, the US economy is tanking.

The Monkey-in-Chief's Treasury Secretary has admitted as much saying that they now face a "sharp decline" but that he is hopeful of recovery before the year is out.

Translation: I'm hoping that I learn to fly before I have to learn to bounce.

Speaking of bounces, the Fed cut interest rates again to cheer up the economy and indeed the Dow Jones bounced back from earlier losses.

Not a CLASSIC "dead cat-monster bounce" (based on the principle that even a dead cat-monster will bounce if it crashes HARD ENOUGH!) since this was a response to intervention. But there is only so much further that the Fed CAN cut interest – they're down to 2¼% now which obviously leaves them less and less room for manoeuvre.

Not that WE'RE so much better off. Our interest rates are higher here in Great Britain, but that's nothing to gloat about: our mortgages and borrowing cost us more but it doesn't necessarily give the Bank of England more freedom to act. For us, high interest rates are a bulwark against rising inflation; the bank won't want to cut them as they'd risk losing the battle to hold inflation under the Prime Monster's 2% target. Well, actually they've ALREADY lost that battle, but they'd REALLY be giving up if they let low interest loans fuel yet another consumer spending boom.

What CAN we do?

It often seems that we are POWERLESS in the face of these huge global economic events. Chancellor Sooty certainly seems to think so, and it might be worth REMEMBERING that next time you come to vote for who is supposedly in charge of the country's cashbox. But we are NOT.
  • Try to spend just a little bit less and save just a little bit more – every penny in a savings account is just that little bit more liquidity for the banking system and we'll be that little bit closer to getting through this.
  • Now might be the time to see how much money you can save by taking some Green economy measures around the house – check out your insulation and your low energy light bulbs.
  • And if you think your finances are in trouble, try to get some help – the fewer people there are in difficulty the sounder the economy will be.
It is the old Liberal adage "Think Global; Act Local" in action. It may be that you can only give a little bit of help, but if lots of us do it then it really does add up.

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