It supposedly began with a bubble. Just another bubble like the one I described on The South Sea Company (or how Sir Isaac Newton spurned the dismal science). The bubble was fuelled by an excess of liquidity. It had to end someday. We learned the word subprimes. We knew it had to mean trouble.
Liquidity injections were administered and succeeded. But they were just patches for a bigger problem. And then they asymmetrised the risk: there were institutions willing to provide liquidity when needed, to reward higher risks, to stimulate the economy further up and away from reality. Until the moral hazard was too huge.
And then it ended too abruptly. The wells of money simply drained and, those whose business was to ensure the efficient distribution of liquidity between the different players just became inefficient. From excess to world wide scarcity, even for sound projects. It became a financial crises.
Few crises have been so focused on the financial system like this one. Because that’s what’s really in trouble here, the whole financial system. I began in the UK with Northern Rock, now nationalised thanks to Alistair Darling. In the meantime Daniel Bouton from Societe Generale didn’t know what was happening in his bank until he lost more than his reputation. And the Swiss face value is also in an all-time-low: just take a look at UBS and Credit Suisse (also First Boston).
But where really is too darn hot is in the US. Bearn Sterns is in flames, expiring his final breath. Bought by $270 million, it was valued about $20.000 million one year ago. A 85-year-old Wall Street institution simply died.
And those that bought companies using leveraging, namely private equity, now see the liabilities piling on top of the roof. Take a look at Blackstone: their profit for the last quarter was less than a half of what was expected, and dropping. Of course its value is dropping too.
We gave it complete freedom. They took it. They invested again and again in the same risky assets, albeit chopped and transformed so they didn’t look like they were the same: collateralised debt, mortgage insurances, mortgage reinsurances, credit swaps and all kinds of derivatives that were the same dog, different collar.
And when the system was in trouble: more liquidity. Await for some more in the next days. New bolts and flashes from the Fed to try to contain it all. But no regulations… in any case it would be too late for that. And always paying a huge price in inflation… until that game is not longer possible.
The dollar’s dropping. The safe heaven for savings all over the world that financed the US debt has ended. If you add up the soaring energy prices, and the huge public deficits, the US credibility is under minimum. The country risk is dangerously rising… no more overspending, no more cheap financing, the party is over.