Wednesday, September 17, 2008

Yahoo: We’re out of control!

The pandemonium that is afoot is centralized on how overly leveraged is the financial industry. With $515 billion in losses globally to date, and more expected to come, where are firms going to get the capital they need to cover financial losses? The deleveraging doomsday scenario might just come alive!

Problems today: U.S. 3-month Treasury bill selling at 0.17% as of 11:16am – NOW THAT IS NOT CHEAP! Between banks, there is ONLY A MARKET FOR TREASURIES!

This is the problem according to Bloomberg: “U.S. stocks tumbled as bank lending seized up in the wake of the government's takeover of American International Group Inc. and investors fled to the relative safety of Treasuries.”

All interbank lending is now frozen, and a doomsday scenario hinges on it remaining frozen and the freeze entering the real economy.

Today's housing market data, the stem of the entire crisis, provided yet another sign that a decided recovery is not at hand. Housing starts declined to 0.895m (6.2%); it was a broad-based decline, but interestingly, starts increased in the West to 0.206m (11%). According to the Wall Street Journal:

“Wednesday's data showed housing starts year over year in August were 33.1% below the level of construction in August 2007. Building keeps retreating because inventories of unsold homes are so high.”

This is the same old housing story – a decided stabilization in housing has not been determined. Only when housing stabilized will the financial markets be allowed to heal with the slowdown of bank losses.

But don’t forget, mortgage rates are at 5.85%. Banks, while not loaning to each other, will loan to qualified customers; that is the only way any profit will flow these days. Old-school banking is back: Out with the new (securitized industry), and in with the old (mortgage loans).

And for my favorite chart of the day: The doomsday scenario!

And can I say debt build? The above chart shows quarterly financial sectors debt measured as a ratio to GDP and a ratio to total financial assets. Financial firms are 112% overly leveraged compared to GDP and 44% leveraged compared to their assets. If firms try to sell of assets quickly in order to cover losses, we could be in real trouble here.

But we have seen deleveraging before. The above chart shows the quarterly change in the financial sectors' debt measured as a ratio to GDP and a ratio to total financial assets. Notice that 2006 and 2007 saw sharp corrections in the debt to asset ration in the financial sector.Go Bernanke! There is still a lot of global liquidity that key central banks, the European Central Bank and Bank of England, are holding on to.

Please leave comments. Rebecca Wilder


  1. Rebecca -- A very interesting post! Unfortunately economics have taught us to be skeptics. First off, I completely agree that housing must first reaffirm itself for other markets to follow. Riskier real estate and mortgage backed securities investment have sent many of the recent financial players down the tubes (Lehman, AIG).

    I loved how you mentioned "old school banking." Did you read that story in the NY Times yesterday under that same title? It talked about the same thing, banks must get back to their fundamentals, issuing mortgage loans, in order to restabilize themselves. There's nothing wrong in my mind to make borrowers fit certain criterias.

    You also mentioned if firms begin selling their assets to cover their losses we'll really be in trouble...well that's exactly what AIG is expected to do in order to pay back the Fed on time. Scary, but I guess their pretty washed up anyway.

    Great post,

  2. And, we the people own 80% of AIG. Word is that AIG's insurance side is in good shape which would be salable. Should we go back to the pre-1997(?) law that security firms could not own banks?