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October 03, 2008

Cardiac Arrest Economy

Nouriel Roubini, the NYU economist who predicted in detail pretty much everything we're seeing transpire in the financial system, writes today:

It is now clear that the US financial system - and now even the system of financing of the corporate sector - is now in cardiac arrest and at a risk of a systemic financial meltdown. I don’t use these words lightly but at this point we have reached the final 12th step of my February paper on The Risk of a Systemic Financial Meltdown: 12 Steps to a Financial Disaster (Step 9 or the collapse of the major broker dealers has already widely occurred).

Yesterday Thursday a senior market practitioner in a major financial institution wrote to me the following:

Situation Report: So far as I can tell by working the telephones this morning:

  • LIBOR bid only, no offer.
  • Commercial paper market shut down, little trading and no issuance.
  • Corporations have no access to long or short term credit markets -- hence they face massive rollover problems.
  • Brokers are increasingly not dealing with each other.
  • Even the inter-bank market is seizing up.

    This cannot continue for more than a few days. This is the economic equivalent to cardiac arrest. Then we debated what is necessary to restart the system.

    I believe that the government will do another Hail Mary pass, with massive guarantees to the short-term commercial credit system and wide open short-term lending by the Fed (2 or 3 times expansion of the Fed balance sheet). If done on a sufficient scale this action will probably work for a while. But none of these financial measures affects the accelerating recession -- which will in turn place more pressure on the financial sector.

  • Another senior professional in a major global financial institution wrote to me:

    Today, in our trading room, I could see the manifestations of a lending freeze, and the funding hiatus for banks and companies, with LIBOR bid only, the commercial paper market closed in effect, and a scramble for cash - really really scary.

    Do you think this is treatable without a) a massive coordinated liquidity boost and easing of monetary policy and b) widespread nationalisation of some banks, gtess to others AND a good bank/bad bank policy where some get wiped along with their investors? The Treasury TARP plan is an irrelevance if we are at a major funding crisis.

    And to confirm the near systemic collapse of the system of financing of both financial firms and corporate firms Warren Buffet declared yesterday, as reported by Bloomberg:

    the U.S. economy is "flat on the floor" after a cardiac arrest as companies struggle to secure funding and unemployment increases.

    "In my adult lifetime I don't think I've ever seen people as fearful, economically, as they are now," Buffett said today in an interview with Charlie Rose to be broadcast tonight on PBS. "The economy is going to be getting worse for a while." ...The credit freeze is "sucking blood" from the U.S. economy, Buffett said.

    We are indeed at the cardiac arrest stage and at risk of the mother of all bank and non-bank runs...

    There's a lot more in his paper, including suggested actions. Read it.

    The problem now is that nobody knows which banks, brokerage houses, hedge funds, etc., are insolvent because of toxic mortgage-related assets and which are not. (Non-bank entities — the so-called "shadow banking system" — are relatively unregulated, thanks to Republican policies, and so have minimal transparency, and many of the mortgage-related assets on their balance sheets are grossly overvalued. If they were marked down to their true market value, many more of these entities would be found to be insolvent. But because of the lack of transparency, nobody knows which ones are insolvent or which dominoes will knock down which other dominoes.) Roubini likens it to walking blind through a mine field. As a result, nobody wants to lend money to anyone else. The Fed and the Treasury can pump liquidity into the system, but it does no good because banks are hoarding whatever cash they can get their hands on. The American economy has been living on credit for some time. Now the credit window has slammed shut, so the economy is grinding to a halt. It's a self-reinforcing feedback loop, because the more things seize up the more scared people get, so the less willing they are to lend or invest, which makes things seize up even more.

    Don't think the House/Senate plan will fix this. It won't.

    Posted by Jonathan at October 3, 2008 11:12 AM  del.icio.us digg NewsVine Reddit YahooMyWeb