Lehman, AIG, Merrill: Is this December 1930?
I am writing this in Washington at 3.33 am GMT. There's been a dramatic day on Wall Street and it's not even open (actually they had to open trading this afternoon to clear the decks for tomorrow's potential meltdown). Here's what we know so far:
1. The US government has refused to put money into bailing out Lehman Brothers; Barclays Capital have pulled out of the rescue attempt, which has been orchestrated by the Treasury, the Fed and the SEC but so far failed. Lehman is set to file for bankruptcy as early as, er, around about now.
2. In a moment of contagion the massive insurer AIG, itself facing untold bad debts, is looking at selloffs or breakups, racing to save itself from collapse.
3. Bank of America just bought Merrill Lynch. For fifty billon dollars. Kersplat. Just like that.
I myself have been at the centre of the action all day: not in DC, not in Wall Street, but in the blighted inner city of Detroit. Here there are foreclosed properties, torched properties - ranging from 30k in value to 600k - and the 600k ones look like art deco mansions that would go for several million in London. This is the real epicentre of the earthquake that has just hit Wall Street: the bad lending on a massive scale that forced debt down the throats of low income people like foie down the throat of a gras.
Now, instead of writing off, oh, just a few billion here or there two major companies have had to write themselves off in their entirety. Lehman will go bust, effectively; Merrill is selling itself at half its value; AIG's predicament is right now too opaque to predict.
So what's caused this Sunday afternoon throat slitting?
First, the insistence of the US government that it would not put taxpayers money into the bailout as it did with Bear Stearns. It has just, as I am writing, issued a decree that the Fed can take all kinds of collateral against short term loans (maybe some of the Piccassos on the top floor offices of these banks, certainly their near worthless paper); but it will not bail them out.
This is a signal moment. It signalled to the banks in the worst trouble that they had no chance of being saved by the American taxpayer so instead of just one going under, three are going at once.
But don't take this at face value. It looks to me, reading the reports which are all sourced from "those close to the situation" that other banks took umbrage at the prospect of Barclays or BoA taking over Lehman at rock bottom prices and walked away. On Newsnight last week I said:
"If there is a state bailout of one of these banks then the whole blessed lifestyle of the investment bankers will have to change. The high rewards, supposedly for high risk, will have to be reined in if it turns out the taxpayer is the ultimate risk taker. The whole regulation of investment banking will have to change"
Now I do not know all these gentlemen personally, but I suspect that, given that choice, they would rather see investment bank regulation stay as it has been, asleep at the wheel during the entire Bush administration and for much of the Clinton years, allowing vast institutions to lend so profligately that they are TODAY brought down
The list of meeting participants in the battle to save Lehman reads like a who's who of Wall Street. It reminds me of the famous list of New York luminaries who attended the final meeting on 11 December 1930 which decided to let the Bank of the United States go bust, thus - and I am simplifiying several hundred PhDs here - precipitating the Great Depression, the rise of FDR, fascism and World War Two.
So what are the parameters of the financial day of reckoning that has already begun in the Far East as I write?
1. This is the necessary writedown and firesale that has been needed all along. It will, ultimately - and along with the Fannie/Freddie bailout - begin the cleansing of bad debt out of the system.
2. Most of Merrill's 50,000 and Lehman's 25,000 employees will be fighting for places in much slimmed down operations. If you add in AIG this is about half the mining jobs destroyed in Britain in the 1980s and 90s. It's a lot - and it's not over. Many are about to find - as the Detroit auto workers have found - that you can be world-class at your job but if the economic model is wrong, you are out of the door. We should be sorry for them, as many of them have excelled in the most arduous of careers; the bosses who failed to spot the errant lending? Most will walk away financially secure.
3. The world of investment banking, should it stabilise itself by tomorrow night, looks precariously over-consolidated. The big two left standing are JP Morgan and Goldman Sachs. The ecosystem is fractured and I don't know where it is going to end up. Whatever, the "capitalist communism" that many had presumed would prevail, with everyone digging in to help out poor old Lehman, has not prevailed. Instead, competitive forces have prevailed; weakest to the wall is how you could sum up today's momentous events.
4. Stock markets will tumble. It's not just because of the shock to the financial system: there are now many real-world indicators of a downturn in profitability. October was always going to see a correction: now I think it will happen this week.
5. The credit crunch? You ain't seen nothing yet! Central Banks are, once again, having to inject liquidity. But short term. This is the most tangible impact on the ordinary joes and joannas who would never get through the door of Lehman's Canary Wharf HQ. Credit will tighten: governments will have to shoulder the burden of creating the conditions to loosen it again, at some point.
6. This is the first test of the 455 trillion dollar market in Credit Default Swaps. We will only know whether that market can withstand a major default once it has withstood it. And since we have never seen a CDS crisis - indeed 99.999% of the population do not know what a CDS is - I cannot tell whether it will take weeks or seconds to find out.
Finally, to answer my own question in the headline of this posting: is this the Wall Street Crash? It does not matter - shares will go up and down. Is this the equivalent of the banking crises that destroyed US finance capitalism in the years 1930-31?
That is the best question - but I don't know the answer. There's been a massive academic debate about whether the failure of the Bank of the USA in 1930 was "exogenous" - hitting a fragile system like a meteor and wiping it out needlessly; or "endogenous" ie, part of the problem.
This can't even be a serious debate today: Lehman is part of the problem bigtime; the US Treasury's refusal to bail out is dictated by the government's previous failures to regulate and rein in. So it is, to take the Spinozist view, lawful because it is real.
It's hard to see how this would precipitate a retail banking crisis (although the American retail banks are quite exposed to Fannie/Freddie). However there is a psychological moment of realisation that the government is not going to bail out everyone; nor are the Soveriegn Wealth Funds; nor are the other Wall Street Banks.
This has to play out into a global market for credit default risk that is just unknowable. It's probably as dangerous as global warming, and equally manmade, but unlike global warming we don't know how it works, or how big a ripple there has to be to upset the whole barrel.
Tomorrow we will just see a stunned American media in full denial/do-not-understand mode, watching the spectacle of bank bosses come and go by limo as they nix their entire careers and the certainties that have sustained Wall Street for a decade.
"And hey Joe how's that affected the Nasdaq? Well Jim it's down by a sqillion basis points; investment banking? didn't that used to be great? Now it's screwed. You're watching XYZABC Network... now over to Jack with the weather, but first an advertisement for some pills you can take if you feel depressed..."
I will keep you posted.