Financial Markets in Trouble – Who’s to Blame?
April 1, 2008
The markets are dragging down the economy …. Giant institutions are, to use the technical term, scared to death.
I wish it was an April Fools joke but unfortunately it’s all too real. Alan Sloan from Fortune magazine has a good overview of how the current financial mess came about and what the impacts might be on you and I.
“We’re suffering the aftereffects of the collapse of a Tinker Bell financial market, one that depended heavily on borrowed money that has now vanished like pixie dust. “
Hedge funds and investment banks broke one of the vital rules of investing; don’t put your money into an investment unless you understand how it works. According to Sloan, “ they created, bought, and sold, for huge profits, securities that almost no one understood”. These institutions were repackaging and reselling debt multiple times over which made it difficult to understand how much risk there really was.
I remember reading a book several years ago, How to Profit from the Coming Real Estate Bust, that described how investment banks would buy a bunch of questionable auto loans, bundle them up, slap a quality credit rating on them and sell them as AA debt. Of course, I’m simplifying the process but that’s what it amounted to. The author of the book, John Rubino, stressed the danger of the practice and foretold a huge financial mess. Sounds like he was right.
Sloan then goes on to talk about the government’s role in bailing out these banks, why they’re doing it, and who will pay for it.
“Say the Fed extends $500 billion of emergency loans to firms in need of short-term money. They’re paying around 2.5% interest to Uncle Ben (or Uncle Sam, if you prefer). That rate is way below what they’d pay to borrow in the open market, if they could borrow. The difference between the open-market price and 2.5% is a gift from us, the taxpayers.”
He thinks the markets will eventually stabilize but the costs of the financial mess will be long lasting and far reaching:
- income on our Treasury bills, money market funds, and CDs has dropped sharply
- our wealth has eroded relative to foreign currencies and commodities
- a loss of faith in the dollar by our foreign creditors
- run up the price of commodities that are priced in dollars
- our financial institutions will emerge from this episode weakened
The bottom line is that this economic mess is not going away any time soon and those of us that have been responsible with our own personal finances are going to suffer for it.
“It’s going to take years to work out our country’s excess borrowings, with lenders and borrowers – and quite likely American taxpayers all bearing the cost.”
Doesn’t it make you feel great about paying your taxes here in the next few weeks? Too bad we can’t earmark our income tax payments as “not to be used to bail out the rich, irresponsible investment bankers”.
All posts by Ben Edwards