The Credit Crisis of 2008
STELZER, IRWIN M.
The Credit Crisis of 2008 As was the case a century ago, it’s good to have a J.P. Morgan when you need one. BY IRWIN M. STELZER The really bad news about the debt crisis is that it is sowing...
...So long as they keep falling, which almost all experts expect them to do, the value of the mortgages held by the banks will fall...
...Paulson wants them to stop paying dividends and retain those funds as new capital...
...As more and more loans are being written off, the asset sides of banks’ balance sheets are dropping...
...It seems that the Knickerbocker Trust Company had backed speculators seeking to corner the market in shares of a copper company...
...The March 18 cut in the so-called Fed funds rate, lowering it to 2.25 percent (a negative interest rate, when infl ation is factored in) was only the latest in a three-percentage point cut since September of last year...
...No longer: They have taken on professional managers, and are also reserving a bit more of their wealth for internal development, as a glance at the skylines of many Middle Eastern cities makes abundantly clear...
...Except that longterm rates, which are most relevant to businesses seeking to expand and consumers considering purchasing a car or a house, remain stubbornly high, diluting the stimulating effect of the Fed’s actions...
...That puts taxpayers at risk...
...In for a penny, in for a pound, as British bankers say—although lately they have been willing to be in for neither...
...That’s why runs on a bank can happen: If depositors or institutions that have lent the banks money on the basis of being able to get it back on demand decide en masse to show up at the teller’s window with withdrawal slips in hand (it’s done rather differently now, but many readers might fi nd this description more comprehensible), there isn’t enough cash on hand to satisfy the demand for it...
...For one thing, it is good to have a J.P...
...No wonder...
...Bernanke came on stage to show that Woodrow Wilson’s decision to establish the Fed half a decade later was a good idea...
...They also worry that the imported laborers who do the work that their native populations fi nd offensive are restive: The dollars these workers send home to their families are buying less and less...
...Paulson now fi nds that the intervention game he has learned to play might be more than the one-inning affair he had hoped...
...Morgan around...
...That’s the term used to describe the sound when the owners walk away from their house and mail the keys to whoever is responsible for collecting their monthly payments of interest and principal...
...Which tells us something more about what future researchers will fi nd: The era of free-market, no-governmentintervention purists is over, if indeed it ever existed...
...This, the boards of most banks do not want to do, lest shareholders, many now holding onto their shares because dividends seem so generous, rise up in indignation...
...the precise nature of Bear’s assets and liabilities is unknown to the Fed, which had no time to do anything resembling due diligence if it was to complete the deal before Asian markets opened on Monday morning...
...Other than those certainties, we can expect an inconclusive duel to the death of bored audiences by competing econometric models...
...Sovereign wealth funds have watched the value of their investments in American banks wither under the dual blows of falling share prices and a declining dollar...
...I mention this only because when Long Term Capital Management went under in 1998, and Alan Greenspan organized a rescue effort by major banks in order to ease strains on the fi nancial system, only Bear Stearns refused to help...
...In a mere 100 hours, shares in the 75-year-old investment bank, trading, and brokerage fi rm fell from $70 to $2, the price at which it was picked up by Morgan...
...It’s an increasingly tough call, as the dissent by 2 of the 12 members of the Fed’s monetary policy committee to the last rate cut demonstrates...
...My own guess is that we will see a combination of dividend cuts, the emergence of “bottom fi shers” (investors who at some point decide bank shares are under-valued), and a call on taxpayers to swallow hard and ante up to rescue the banking system, even if that means also coming to the aid of bleating bankers...
...That reduces the banks’ ability to take on liabilities, i.e., to make loans...
...As every economist knows, or thought he did, such a reduction in short-term rates will bring long-term rates, set in the market, down with them...
...Bear Stearns is no more...
...So, too, will former Fed chairman Alan Green span, whose fondness for free markets will prompt the academics to blame much of the problem of 2007-2008 on his 18-year tenure as manager-inchief of U.S...
...Bush and Paulson have been leading the “no bailout” contingent, at least when it comes to poor, overextended homeowners trying to cope with suddenly higher payments as the teaser rates on their mortgages are reset...
...They failed and so did the bank...
...Not a new role: After all, the savings and loan crisis of the 1980s and 1990s came to an end only when the government tossed about $125 billion of taxpayer money at the problem...
...All exacerbated by the path of the dollar, which has been spiraling down...
...But Bernanke has had to choose: shore up the fi nancial system by pumping dollars into it in such amounts that the banks will start lending again or fi ght infl ation by keeping interest rates high...
...Which is what happened in 1907, and why J.P...
...If the assets prove dicey, taxpayers will have to cover the loss...
...Democrats believe that government should insure mortgages that have been written down to current value (Barney Frank), send money to the states for the relief of homeowners facing foreclosure (Hillary Clinton), or provide those home owners with help of a vague and unspecifi ed sort (Barack Obama...
...True, the decline in the value of the dollars that oil producers are getting for their crude causes them to raise the price in order to protect their ability to purchase arms and baubles in the world’s poshest shops...
...Enter J.P...
...Now that the Fed has decided that investment banks and brokers are too intimately interconnected with all the other players in the fi nancial system to be allowed to fail—to the traditional “too big to fail” add “too interconnected to fail”—the taxpayer has become a key player...
...The vaults of his country’s central bank are overfl owing with stacks of fi nancially deteriorating green paper adorned with pictures of American presidents...
...But to clear the way for Dimon to swallow Bear, the president and the Treasury secretary agreed to have the taxpayers guarantee $30 billion of Bear’s diffi culttovalue assets...
...Bernanke is betting that the economic slowdown will lower infl ationary pressures, and that if he has uncorked the infl ation genie he will be able to bottle it up again by raising interest rates once the current credit crisis has run its course...
...Factor in the $1.2 billion at which Bear Stearns’s Midtown Manhattan headquarters offi ce building is valued, and Dimon got Bear for Irwin M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London...
...A cheap dollar makes our goods less expensive abroad, stimulating exports and thus adding signifi cant growth to a slowing economy...
...Which might explain why the fi rm, famous for its macho, cigar-chomping, go-it-alone style found itself friendless just when it needed more than a few friends...
...Students of history will remember that almost exactly 100 years ago, in 1907 to be exact, one J.P...
...Citigroup, which 10 years ago fi red Dimon, has to maintain a dividend yield of over 6 percent to get anyone to hold its shares...
...Not that we have not already learned a great deal about crisis containment...
...Morgan was forced to round up a group of men willing to put up their own money to prevent a run—some contributing “under penalty . . . of lacking assistance when the pinch should come home to them,” as Carl Hovey put it in his 1911 biography of Morgan...
...And when a house is worth less than the mortgage, the circumstance in which an estimated 8 million homeowners now fi nd themselves, and 14 million soon might, we get the phenomenon known as “jingle mail...
...First, house prices have to bottom out...
...And by a large multiple since banks typically lend many multiples of their assets, and for long periods...
...You know, the guys who were so generous to you when you came around for help without so much collateral that you didn’t really need any help at all...
...All of this is being played out against a background of longerterm problems in the banking system...
...Second, banks will have to raise more capital...
...nothing...
...Other banks grew nervous, refused to clear with Knickerbocker, and tightened credit to the point where credit-worthy borrowers such as New York City, Boston, and Westinghouse could not sell their IOUs...
...BY IRWIN M. STELZER The really bad news about the debt crisis is that it is sowing the seeds from which will bloom, if that is the right word, hundreds of doctoral dissertations fi ve or so years hence...
...In the case of defaults, the banks are lucky to get half of the face value of the mortgage...
...Bernanke and the current head of JPMorgan Chase, Jamie Dimon, managed a similar feat in two days...
...True, too, that the falling dollar has the Chinese very nervous...
...Future researchers are also going to have to sort out the relationship between the Fed’s monetary policy, the rate of infl ation, the value of the dollar, the trade balance, and a host of other economic drivers...
...monetary policy...
...Bank presidents are making pilgrimages to the Middle East to meet with managers of sovereign wealth funds, which are attractive sources of capital from the point of view of bank executives for two reasons...
...Paulson might insist that he allowed the government to take on billions in risk only to save the system, rather than any one company, but if it looks like a bailout, and smells like a bailout, it probably is a bailout, certainly of the Bear Stearns bondholders, although employees, many of whom have been partly paid in shares in recent years, will prefer the term “wipe-out...
...But once burned, twice shy...
...At one time these foreigners were seen as a source of “dumb money,” which they earned merely by watching oil fl ow from the ground...
...Two things have to happen before we put paid to the current problems...
...The risk-takers are us...
...In this drama, Dimon played old J.P., and Hank Paulson played George Cortelyou, Roosevelt’s Treasury secretary...
...These funds—the surplus revenues of oil-rich governments—are in for the long haul, and they are passive investors rather than the sort who complain when bank executives mess up...
...Economic model builders, unchastened by the fact that their predecessors’ models failed to anticipate, indeed, contributed to the great crisis of 2008, will concoct elaborate equations designed to reveal whether it was the Fed’s interest rate cuts, or its pumping of hundreds of billions into the credit markets, or the JPMorgan Chase-led takeover of Bear Stearns, or Hank Paulson doing whatever it is Treasury secretaries do in these circumstances, or the calming words of George W. Bush that brought the credit crunch to an end...
...So they raise the price of their money—the interest rate that they charge for its use...
...The rescue took about two weeks...
...Given the political bent of most university economic departments, it is a safe bet that President Bush will be found to be on the cause-side of the balance sheet, not the cure-side...
...What concerns me now is the continuous depreciation of the dollar,” says Prime Minister Wen Jiabao...
...How the banks will solve their need for capital no one can predict...
...Many lenders believe that the Fed is playing too fast and loose with the money supply, and that the resultant infl ation will drive down the value of the dollars with which they will be repaid...
...He cobbled together a consortium including John D. Rockefeller and other elite members of the rich-and-famous club to put up tens of millions, the Treasury added $25 million of taxpayer money (a half billion in today’s dollars), and trust-busting President Theodore Roosevelt told his attorney general, “I felt it no public duty of mine to interpose any objection” to the complicated rescue scheme...
...The last thing the rulers of Arab nations want is an uprising by foreign workers who in many cases outnumber the native population...
...Despite singing that old tune, “American interests are served by a strong dollar,” the administration is humming under its breath something like “down and down it goes, in a spin, and we are loving the spin it’s in...
...Morgan rode to the rescue of a fi nancial system on the verge of collapse—if one can imagine someone with the girth of the great 70-year-old banker riding to anything...
...Stuck with unmarketable securities it had accepted as collateral (cf.today’s subprime mortgages and other securitized paper), it had insuffi cient cash to meet depositors’ demands...
...It seems that the infl ation-wary have guessed right: Prices of food, energy, and just about everything that is not an electronic gadget have risen, and with them inflationary expectations...
Vol. 13 • March 2008 • No. 28
