from Follow the Money

The world is changing, fast

September 14, 2008

Blog Post
Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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After Argentina was -- at the end of a long, drawn out process -- denied financial support from the IMF and left with no choice other than default and devaluation, the US Treasury encouraged the IMF to provide a large backstop to both Brazil and Uruguay. That strikes me as the right metaphor for tonight. But rather than worrying about the rest of the world, the US authorities now are worried about the health of the United States’ own financial system.

Lehman failed, at least in part because the Treasury and Fed were not willing to put taxpayer money on the line to help Lehman.

Merrill accepted Bank of America’s offer. And one assumes -- based on Yves Smith’s analysis - that the Fed was quite happy that Bank of America was willing to bid for Merrill.

AIG is on the ropes and needs cash, which could imply that the type of institutions with access to the Fed’s liquidity window keeps expanding.

The Fed certainly is going to accept a broad range of collateral to try to avert John Jansen’s worst fears.

Felix is hoping that the deal for Merrill -- together with the expansion of the Fed’s liquidity facility -- saves the day. He defines short-term success as a fall in the equity market of less than 5%:

If AIG hasn’t collapsed after New York markets open and the broader stock market is down less than 5%, all that will mean is that there hasn’t been a systemic meltdown yet. It’s going to take a long time to liquidate Lehman and unwind all of its positions, and nobody has a clue how that’s going to play out.

I personally would pay more attention to the credit markets than the equity market. Partially that is because I understand credit markets better than equity markets. But that is also where it would seem, at least to me, the real shock may lie. Lehman’s likely liquidation implies, I suspect, that some of Lehman’s creditors won’t get paid in full or on time.*

The US banks need to rollover a lot of debt over the next few months. Debt was was issued two years ago, back when the market was driven by greed rather than fear, is now coming due. The bankruptcy of Lehman could be more of a surprise to the debt market than the equity market; after Bear, the risks of holding equity in a major US bank were pretty clear. Up until now, though, unsecured creditors of large financial institutions generally have been protected from losses.

Back when the New York Times Magazine profile of my former boss/ co-author of "Bail-ins and Bailouts" came out, I said, more or less, that I would think the current crisis was over when it was clear that Nouriel Roubini was too pessimistic. Right now, though, things are still playing out far too close to his script for comfort.

* If this is wrong, do let me know -- I am not at all an expert on how this will all unfold, and who exactly will be taking losses.

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