On Market Panics.
After I wrote about market crashes I came across this piece on panics & the new proposed regulations put forth by the Obama Administration. It's by Robert Samuelson in the Washington Post. I'll excerpt it for you with a link at the end.
Since its earliest days, the United States has suffered periodic financial crises. The first dates to 1792...... Now we're in the midst of another crisis. It would be reassuring to think that the Obama administration's financial "reforms" -- or, indeed, any conceivable alternative -- would prevent these collapses for all time. Dream on.
Every financial crisis originates in a failure of imagination. It's not that, before the crisis, no one foresees problems, "excesses" and losses. There are usually warnings. But what's routinely overlooked are the fatal interconnections that transform problems into panic. People panic because the future goes dark. They don't know what to expect, so they expect the worst. Markets cascade uncontrollably downward.
The current crisis did not occur merely because "subprime" mortgages experienced unexpectedly large losses or even because many of these loans were "securitized" in complex bonds, argues Yale economist Gary Gorton. The crux of the matter, he says, was the failure of the "repo" market. The term comes from "repurchase agreements" -- short-term loans (usually overnight) that require the borrower to pledge collateral (usually bonds) in return for cash; the collateral is then "repurchased" by repayment of the loan.
No one knows the size of the repo market; Gorton thinks perhaps $10 trillion at any moment. Banks relied heavily on repo loans, which were routinely renewed. But when doubts arose about banks' subprime securities, the repo market panicked......Deprived of credit, Bear Stearns and Lehman Brothers failed; other institutions were vulnerable. Hardly anyone expected the panic; once it happened, large -- but bearable -- losses became a crisis.
In a crisis, government is the last bulwark against a complete financial collapse.....Just because all crises can't be prevented doesn't mean that some can't. Though complex, the Obama plan would essentially broaden regulation in three ways.
First, it would empower the Federal Reserve to designate some financial institutions.....as so important that their failure would "pose a threat to financial stability." These institutions would face stiffer capital requirements -- capital being mainly shareholders' investment. More capital would provide a larger buffer against losses and a crisis.
Second, it would create a Consumer Financial Protection Agency to police unethical lending practices and to ensure that loan documents for mortgages, auto loans and other types of consumer credit are understandable. (The Securities and Exchange Commission would retain power over stock markets.)
Third, it would change some rules of financial markets. For example, financial firms issuing securitized bonds -- bundles of mortgages, auto loans and other credits -- would be required to hold 5 percent of the bonds themselves. Because they would have to keep some bonds, it's argued, sellers would scrutinize the underlying loans more carefully.......
{R}egulation isn't a panacea against future crises. The idea of "enlightened regulators" who are vastly more perceptive than the bankers, traders and money managers they regulate is a fiction. Even in early 2007, when the problems of subprime mortgages had emerged, few regulators or economists foresaw a wider financial meltdown. They didn't see the impending chain reaction. The problem wasn't a lack of regulation; it was a lack of imagination.
So the next crisis could come from anywhere -- perhaps the follies of government, not finance. Between now and 2019, the U.S. federal debt could rise to $11 trillion , projects the Congressional Budget Office. U.S. Treasury bonds are the bedrock of the global financial system; they're considered safe and reliable. What if a glut of bonds causes investors to lose faith? What are the implications? Good questions. The seeds of the next crisis almost certainly won't be found in the debris of the last.
Every financial crisis originates in a failure of imagination. It's not that, before the crisis, no one foresees problems, "excesses" and losses. There are usually warnings. But what's routinely overlooked are the fatal interconnections that transform problems into panic. People panic because the future goes dark. They don't know what to expect, so they expect the worst. Markets cascade uncontrollably downward.
The current crisis did not occur merely because "subprime" mortgages experienced unexpectedly large losses or even because many of these loans were "securitized" in complex bonds, argues Yale economist Gary Gorton. The crux of the matter, he says, was the failure of the "repo" market. The term comes from "repurchase agreements" -- short-term loans (usually overnight) that require the borrower to pledge collateral (usually bonds) in return for cash; the collateral is then "repurchased" by repayment of the loan.
No one knows the size of the repo market; Gorton thinks perhaps $10 trillion at any moment. Banks relied heavily on repo loans, which were routinely renewed. But when doubts arose about banks' subprime securities, the repo market panicked......Deprived of credit, Bear Stearns and Lehman Brothers failed; other institutions were vulnerable. Hardly anyone expected the panic; once it happened, large -- but bearable -- losses became a crisis.
In a crisis, government is the last bulwark against a complete financial collapse.....Just because all crises can't be prevented doesn't mean that some can't. Though complex, the Obama plan would essentially broaden regulation in three ways.
First, it would empower the Federal Reserve to designate some financial institutions.....as so important that their failure would "pose a threat to financial stability." These institutions would face stiffer capital requirements -- capital being mainly shareholders' investment. More capital would provide a larger buffer against losses and a crisis.
Second, it would create a Consumer Financial Protection Agency to police unethical lending practices and to ensure that loan documents for mortgages, auto loans and other types of consumer credit are understandable. (The Securities and Exchange Commission would retain power over stock markets.)
Third, it would change some rules of financial markets. For example, financial firms issuing securitized bonds -- bundles of mortgages, auto loans and other credits -- would be required to hold 5 percent of the bonds themselves. Because they would have to keep some bonds, it's argued, sellers would scrutinize the underlying loans more carefully.......
{R}egulation isn't a panacea against future crises. The idea of "enlightened regulators" who are vastly more perceptive than the bankers, traders and money managers they regulate is a fiction. Even in early 2007, when the problems of subprime mortgages had emerged, few regulators or economists foresaw a wider financial meltdown. They didn't see the impending chain reaction. The problem wasn't a lack of regulation; it was a lack of imagination.
So the next crisis could come from anywhere -- perhaps the follies of government, not finance. Between now and 2019, the U.S. federal debt could rise to $11 trillion , projects the Congressional Budget Office. U.S. Treasury bonds are the bedrock of the global financial system; they're considered safe and reliable. What if a glut of bonds causes investors to lose faith? What are the implications? Good questions. The seeds of the next crisis almost certainly won't be found in the debris of the last.
posted by CR English at 6:46 AM
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