Tuesday, August 21, 2012

Part of the revisionist history of the financial crisis that is driving me nuts is the Lehman Brothers bankruptcy. If you listen to the media, the financial crisis was caused by somebody buying a home in Detroit they couldn't afford and Lehman declaring bankruptcy. The financial meltdown in 2008 was the result of reckless behavior by everybody; big spending fiscal policy, incredibly bad monetary policy, reckless borrowers and lenders and incompetent regulators all compounded by Wall Street greed. It was a lethal brew. The Government could have just as easily let Morgan Stanley or Goldman Sachs go out of business as opposed to Lehman. I am not defending Lehman in any way and I believed they deserved to go under. It was the way they were allowed to close that created the subsequent problems in the market especially for commercial paper. By the time Lehman went belly up, Bear Stearns was long gone, Countrywide and Merrill had been absorbed by Bank of America, Fannie Mae and Freddie Mac had been nationalized because of insolvency, IndyMac Bank had been closed, the US Treasury was pumping money into AIG like it was a second job, and Washington Mutual and Wachovia would be gone in the next two weeks. Everyone of these institutions were guilty of too much leverage with a rapidly declining balance sheet. Lehman was the poster child for this problem but it was not an orphan.

Decisions matter. Because this is a presidential election year there is concentrated focus on economic issues. As the public debate rages I think it is important to remember that the country is facing choices in its fiscal policy and these choices will matter. The next administration will be faced with the choice of stimulating the economy or cutting the deficit. It is important to note that not only the policy direction but the implementation of the policy is important. If the policy is to reduce the deficit, it does no good to cut social programs if you concurrently increase defense spending. If you wish to stimulate the economy through tax cuts it matters which segment of the population gets the tax cut. The financial meltdown of 2008 was the direct result of bad choices, it did not have to happen. Hopefully the country will learn from past mistakes, certainly there is no evidence that Wall Street has learned anything i.e. JP Morgan, MF Global, and Knight Capital.

Monday, August 6, 2012

Knight Capital now takes its place in the long line of Wall Street failures. If you think that Washington, the SEC, FINRA, the Federal Reserve, or the banking industry have learned anything from the 2008 meltdown, you must be in a parallel universe. One would think that after Lehman Brothers, Bear Stearns, Wachovia, Washington Mutual, Merrill Lynch etc. went out of business and the world wide banking system was a heartbeat away from total collapse that the survivors would be more careful in their actions. Instead we have had in quick succession MF Global, JP Morgan and now Knight Capital. The common theme is the boys have no idea what they are dealing with in terms of risk. Stop the madness!!

Just to recap
MF Global allows the head of the firm (who is in fact the risk control officer's boss) to trade an enormous position. Who is going to tell him to stop?

JP Morgan loses 5 Billion dollars in a department that the senior management encouraged to take huge positions. The bank's position is" we are big and we can absorb the loss easily". The loss is still 5 BILLION  DOLLARS.

Knight Capital in a rush to meet a deadline introduces an automated trading interface with the NYSE without proper safeguards. The system cannot handle the trading and they lose 400 million in about an hour.

We will now witness the usual Congressional inquiry, the usual SEC promise to do something and the usual talking heads on TV huff and puff about how this never should have happened.

All this begs the question "What's next"? It is illogical given recent history to not expect there are other events already set in motion that will wreak havoc in the future. There is absolutely no evidence that anything has changed since 2008. In fact the recent events are all the more egregious because with a little analysis they are all preventable. Keep your helmet on, the next preventable financial disaster is lurking.