 |
Midday Open Thread: Bailing Out the Bear (Stearns) |
 |
The effects of the the bail-out of Bear Stearnes are starting to rear their hydra heads. Markets across the world are starting their trading at large losses today.
Central banks are trying to aid the credit crisis, the Fed dropping interests rates by a quarter of a percent and looking to drop them another 1% tomorrow. However, analysis by Robert Peston from the BBC that the central banks don’t have much influence and are actually encouraging the process:
Well in a way our own government has actually been encouraging deleveraging, by supporting the plan of Northern Rock - the nationalised bank - to shrink its balance sheet by around £60bn.
The impact of that is to cut the amount of mortgage finance available in the UK by up to a fifth.
As for central banks, they increasingly look not like supermen but seven-stone weaklings.
They’ve been reducing official interest rates, but that’s done little to cut the cost of credit for most of us or increase its availability, because banks have taken the opportunity to rebuild their profit margins.
What should be government’s role in regulating how the credit industry in light of the Bear Stearns buyout? Why do we continue to see crisis after
crisis?
Ugh, this kind of thing makes me sick, and not really in an outraged way. This is bad…recession or depression just might be real…
We continue to see crisis after crisis for three primary reasons:
1. Bailouts - while they may alleviate the risk of drastic change in the financial system, they are in effect halting capitalistic evolution. Institutions who cannot perform adequate risk-management deserve to go under. Those left after the dust settles are the ones who took prudent risks and did their due diligence - and that’s who I want managing my money.
2. Non-disclosure - whether by individual traders to their firm, or by institutions to their clients, disclosures should be made in a timely fashion of risks or losses generated by trading activity. Withholding of such information leads to poor risk-management by the firms or investors, which can lead to crashes when asset depreciation sparks a sell-off.
3. Human psychology - countless psychological studies have found that humans over- or under-estimate risks or probabilities based upon emotional interference. This leads to poor financial decisions, and market inefficiency.
In the case of the sub-prime debacle, all three are present. The whole crisis started as a non-disclosure problem - the high-risk jumbo sub-prime loans were marked as AAA or AA CDOs by rating agencies. Had their risk been properly disclosed and their papers been marked B or lower as probably should have been, investors of all sizes would not have snapped them up as quickly as they did. Had investors investigated these CDOs more careully, however, they might have discovered their high risk; the blame does not fall solely on the disingenuous asset-raters.
Of course now the Fed is bailing out lenders and investors who made poor decisions, effectively allowing them to stay solvent and continue their poor risk-management. These investors fell prey to a common psychological tenet - confirmation bias. They did not investigate their assets closely, simply relying on the implication that they were good debt by the rating agencies to confirm their desire for excess reward. This hype and subsequent fear of loss lead to massive sell-offs as the sub-prime loans went into foreclosure.
Were the markets properly informed, evolved over generations of selective inheritance, and more rational, this crisis would be much less likely to occur.
Your suggestion seems to me to be that markets opened down because Bear Stearns was bailed out. But in reality the situation would have been a whole lot worse had it been allowed to fail! Although it is tempting to just say “let the fuckers fall” the interconnectedness of banking and means that allowing one large financial institution to fail may well tear down other banks as well which would have a massive knock on effect in the real economy as well.