From the March 23, 2008 Sunday Times (London)
March 26, 2008
by Irwin Stelzer
The assets making up the balance sheet of a leading bank are unmarketable. Other banks refuse to trade with it, and become so concerned about shoes yet to drop they refuse to lend to even creditworthy borrowers. Not to worry: JPMorgan rides to the rescue, and with some cash from the US Treasury thrown in, arranges a takeover of the troubled bank. And so the panic of 1907 ended.
Almost exactly 100 years later, a similar scenario plays out. Bear Stearns becomes illiquid, and is so intertwined with other big players that it threatens to bring down the financial system, or at least increase the crunchiness of credit markets. Jamie Dimon, head of JPMorgan Chase, leaves his office, walks past the old roll-top desk of the great turn-of-the-century banker, strolls across the street to the offices of Bear Stearns, recrosses the street and, backed by $30 billion (£15 billion) of government guarantees, buys Bear for $2 a share, well below the $70 price prevailing a relatively few days earlier.
As the former Yankee baseball player and home-hewn philosopher Yogi Berra would have said, “It’s déjà vu all over again.” And in more ways than one. A few years after JPMorgan and other members of the rich club combined with the government to save the banking system, Woodrow Wilson created the Federal Reserve System. Among other things, the new central bank was to prevent the sort of liquidity crisis that afflicted the nation in 1907 - a good thing, since JPMorgan was ageing, and his ability to whip his fellow financiers into line “under penalty . . . of lacking assistance when the pinch should come home to them” (as Carl Hovey put it in his 1912 biography of Morgan) declining.
Some 100 years later we are on the verge of changes in the relationship between government and the private sector every bit as important as the change that occurred when the Fed replaced old JP as the financial stabiliser - and as the reforms instituted by Franklin Roosevelt’s New Deal. Roosevelt created the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, the Federal Home Loan Bank System and various other agencies to regulate or participate in financial markets.
Now we have another crisis, and my guess is that the Bear Stearns deal will unleash a new round of financial regulations. For months President Bush and his Treasury secretary, Hank Paulson, have been what Clinton’s Treasury secretary Larry Summers calls “moral hazard absolutists”. They worry that if the government eases the pain of lenders who made funds available to borrowers too poor to maintain their mortgage payments, and bails out improvident borrowers, both culprits will become recidivists.
That position gains strength from the view of many that today’s problem was created in the 1980s and 1990s when taxpayer money to the tune of about $126 billion was used to bring the savings and loan (thrift) crisis to an end, creating the moral hazard that now haunts us. But now the fear of moral hazard paled into insignificance in the face of a possible collapse of Bear Stearns and the other brokers and bankers that trade with it. So Bush and Paulson gave their approval to a plan that put $30 billion of taxpayer money behind the JP Morgan takeover.
If federal money flows, can regulation be far behind? Not in 1907, and not now. Congressional Democrats, led by the very clever chairman of the House financial services committee, Democrat Barney Frank, are pressing for a new regulator to supervise the activities of investment banks and brokers. After all, commercial banks are regulated in part because the government could not tolerate the effects of a leading bank failure. Now that the Bear Stearns fiasco proves that many investment banks and brokers are “too interconnected” with banks to be allowed to fail, and that the government will be called upon to commit taxpayer money to their survival, surely, he argues, government must see to it that its money is not squandered.
The Bush administration will resist this expansion of regulatory powers, but in less than a year George W Bush will be clearing brush at his Crawford, Texas, ranch. Both Democratic contenders undoubtedly will support some version of Frank’s plan, and Republican candidate John McCain is no friend of Wall Street. If the government ends up doing what now seems likely, and contributes to the recapitalisation of the banking system, demand for closer supervision will become irresistible.
There’s more. A consensus is emerging that the current crisis will not end until the value of mortgages stabilises. And that won’t happen until house prices stop falling. Frank, Hillary Clinton and Barack Obama all have plans to involve the government in underpinning house prices. Frank’s is gathering support even from free-market conservatives. He would have the government insure new mortgages that reflect the new, lower value of the houses. Lenders would take a loss, but not very different from the loss they would incur if they foreclosed and tried to peddle the seized property in the already-glutted home market.
Meanwhile, the nation’s banks are finding that the silver bullet they thought would slay the credit-crunch dragon is a blank. The sovereign wealth funds, initially enthusiastic about investing in America’s banks, watched falling share prices and a depreciating dollar shrivel the value of their investments. Once burnt, twice shy, and the sovereign wealth funds are finding other uses for their enormous piles of cash.
So that’s what the future holds for America’s financial institutions: a scramble for capital, and increased government regulation. Anyone who has been maltreated by his banker is permitted a contented chuckle.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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