From pubs in London to bars in New York, everyone is asking the same question: Why is this financial crisis different? The answer is simple albeit not sexy. The rot has set in.
The world’s investment banks are basically houses built on pillars of money. Sometimes those pillars are cash, often bonds; these days pillars are made up of derivatives, swaps, options and other frighteningly complex instruments.
But these pillars are the strength that supports not only the bank itself, but also its debts and liabilities. Under technical rules the pillars have to be transparent and of a certain quality, so that investors know just how well propped up the bank is. In layman’s terms — everyone can tell “the bank is safe!” If the pillars remain strong — the bank stays standing.
What has happened is that the rot has got into the pillars and no-one noticed. If they were wooden it would be worms. The very financial instruments that make up the core of the banks are questionable.
They have been questionable for over a decade. And people did notice.
A certain portion of government and legislators were bribed and “influenced” by lobbyists. Some of the remainder were so-called deregulators like John McCain who refused to institute licensing and regulations for storefront mortgages – which became, by the way, what everyone terms sub-prime.
And the rest were simply ignorant gits.
No-one can say for certain how much these instruments are worth, if anything. No-one knows if counterparties to deals are financially secure and will be around tomorrow. The very structure upon which banks like Lehman depended became doubtful.
If this was happening to just one or two banks then it would be a “nasty business.” But it is happening to all the banks — at once. The major names have all been taking on these dodgy instruments and are all now seeking better quality investments and cash. And of course those with the cash want to keep it to themselves, in case they need it — hence the term credit crunch.
Overnight lending, bank-to-bank – an essential of doing business – has ceased. Either a big bank tells a smaller one that all their capital has been taken for the day or they’re offering a usurious LIBOR interest rate to squash the transaction.
Oh – and Countrywide – they served their purpose. Now, they’re merged into BankAmerica.