Lehman Brothers: when confidence runs out
The crisis on Wall Street shows that a risk-averse outlook - not foolish financiers - is the biggest threat to the economy.
The southern English town of Lewes has just introduced its own currency. The Lewes Pound, which features a portrait of Tom Paine, officially trades one-for-one with plain old boring sterling. The idea is to encourage local people to shop with the small businesses that accept the new notes, keeping Lewes money ‘local’.
Of course, the Lewes Pound could just be a useless piece of paper. The fact that it is not – for now – is because of an agreement to treat it as if it was as good as the British Pound. As long as everyone agrees to take part in this elaborate game of ‘Let’s Pretend’, people will be able to buy goods from the butcher, the baker and the artisan candlestick maker.
In the case of Lehman Brothers, the game of ‘Let’s Pretend’ – also known as ‘market confidence’ – came to a shuddering halt on Monday with the news that the investment bank had filed for bankruptcy protection. Like any other bank, Lehman Brothers only had a fraction of the capital on hand to cover the mind-boggling amount of money it owed to its creditors – some $613billion. The value of the assets that were collateral for the loans Lehman had made had simply fallen too far for the business to remain viable.
Too many of those assets were mortgage-backed securities. In the fallout from the huge losses from sub-prime mortgages, the value of the ‘securitised’ assets held by Lehman Brothers (and, indeed, by many other financial institutions) is now lower than when they were purchased. The real problem is that no one knows just how much lower – so few institutions are prepared to lend against them.
It is this uncertainty that underpins the whole financial crisis. Those mortgages, and the property they are based on, are clearly worth something; their value has not entirely disappeared overnight. But the process of writing down that value to its new worth is proving horrendously complicated because it is not simply some cowboy operators that have made dodgy deals on property debts gone bad – every major financial institution has bought into these assets to some extent.
Other big investment banks including Bear Stearns and Merrill Lynch have been similarly affected, but both these companies accepted their losses and were sold for way below their previous market values. The board of Lehman Brothers had a similar opportunity in August – the chance to sell half its capital to a Korean state-owned bank for a fraction of its former value – but prevaricated. The Koreans, it seemed, got cold feet and pulled out.
The machinations of financial institutions undergoing an overdue reality check might be of little concern to the rest of us if we could be sure they would have no impact on our day-to-day lives. But where once commentators felt the ‘real’ economy could ride the storm, pessimism now prevails.
One optimist, Anatole Kaletsky of The Times (London) notes today: ‘The risk of a disastrous divergence between the worlds of finance and economics, with the financial system spinning completely out of control despite an otherwise decent outlook for the US and world economies, is much greater today than two weeks ago.’ Kaletsky blames US treasury secretary Henry Paulson for his decision to nationalise the US mortgage agencies Fannie Mae and Freddie Mac, and his refusal to bail-out Lehman Brothers, in such a manner that shareholders were left with nothing: ‘Mr Paulson has sent the clearest possible message to investors around the world: do not buy shares in any bank or insurance company that could, under any conceivable circumstances, run short of capital and need to ask for government help’.
Like Kaletsky, Larry Elliott of the Guardian was dismissive of UK chancellor Alastair Darling’s recent pronouncment that conditions in the world economy were ‘arguably the worst they’ve been for 60 years’. However, writing today, Elliott’s optimism is rather tempered: ‘This is without doubt the most serious financial shock since 1929, and while talk of a 1930s-style depression is still conjecture, so are the predictions that failing banks and a bankrupt financial system will have minimal impact on the “real economy”.’
There is a distinct possibility of a vicious circle of credit drying up, leading to a fall in asset values, forcing institutions with previously watertight balance sheets into trouble, leading to even greater unwillingness to lend. This really is starting to have an impact on the real economy as companies find it harder to refinance their previous lending. For example, the US motor industry, ever lurching from one crisis to another, is now faced with the task of finding new sources of credit at a time when lenders are increasingly hard to find. Fritz Henderson, president and chief operating officer of US automaker General Motors, told a Reuters event on Monday: ‘Capital markets have been quite difficult, and this is just going to make it more so.’
There has been a tendency to blame a reckless, risk-taking outlook for the current problems. Lehman Brothers boss Dick Fuld has been particularly vilified in the last day or two for a series of gambles that have gone wrong. But it would be more accurate to emphasise the risk-averse outlook in finance and government that has led to the current situation.
After all, the ‘contagion’ of bad debt that has called into question so many institutions is precisely a product of wanting both to share in the quick bucks that appeared to be coming from the sub-prime mortgage market and the desire to ‘hedge’ that risk by repackaging assets and selling them on. While there has been a tsunami of cash floating around in recent years looking for a profitable outlet, very little of that has gone into solving the problems in the real world of restructuring and modernising the productive base of society in the USA or Britain. Investors have been happy to keep coining it in from ever-more complex financial instruments rather than worry about how that capital could produce value in the real world.
Equally, governments have been happy to take the (easy) credit for growing economies, particularly in Britain, based substantially on consumer spending paid for by borrowing against the rising value of property. Gordon Brown, having proclaimed himself some kind of wizard for presiding over these developments as chancellor of the exchequer, has become prime minister just in time to take the flak as the financial and property markets go pear-shaped.
Yet, the outlook for the ‘real economy’ seems nothing like as gloomy as the financial crisis might suggest. There may, technically, be a recession in the UK – defined as two quarters of negative growth – but forecasts still suggest it should be relatively mild. Oil prices have slumped in the last couple of months, with prices having fallen from a brief peak around $145 per barrel in July to just $96 per barrel today. Gas prices, which are heavily linked to oil prices, should start to come down significantly, too, so overall energy costs should come down substantially. With food commodity prices also down, and interest rates likely to fall as inflation fears ease, the future actually looks brighter in some respects than it did two or three months ago.
That the financial system should have been allowed to get into such a parlous state in the first place is an indictment of the chaotic nature of capitalism and its inability to reliably provide for the needs of society. But even given that rider, talk of recession – even a new Great Depression – should be misplaced. However, if the mistrust and loss of nerve typified by the make-it-up-as-you-go response to the sub-prime mortgage crisis is anything to go by, it is not beyond the ability of financiers, regulators and government to snatch depression from the jaws of recovery. As Mick Hume noted last week on spiked, once fear – rather than political or economic principle – becomes the guiding light of policy, anything is possible.
Meanwhile, back in Lewes, the new currency is going from strength to strength. Notes are apparently changing hands for up to 25 times their face value on eBay – all for the novelty value. It turns out that the Lewes Pound is worth more as a piece of paper. The staff at Lehman Brothers must be wishing the same could be said for the company’s investments.
Rob Lyons is deputy editor of spiked.
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Mick Hume argued that risk-aversion rather than reckless neo-liberalism lies behind the current financial crisis, and that the real depression is in political outlook. Daniel Ben-Ami looked at Alistair Darling’s split personality, and described how even free marketeers have lost faith in capitalism. Neil Davenport attacked the green recession-mongers. Sean Collins explained how discussion of recession is based on the economics of fear. Or read more at spiked issue Economy.
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