BusinessWeek on the recent financial meltdown dynamics...
A bigger question is how the bailout and forced sale will play on Wall Street. Overnight, the Asian markets sold off sharply and the plunge is continuing in the European markets. U.S. markets are also in for a turbulent day as investors ponder the thought of how a seemingly secure investment bank could evaporate literally overnight. Wall Street now will begin wondering which firm may be next to go the way of Bear Stearns, and many people are pointing fingers at Lehman Brothers (LEH).
It would have been highly risky for other Wall Street firms if Bear Stearns had been allowed to go under because they are tightly interconnected with Bear as both borrowers and lenders. Any firms that are owed a lot of money by Bear would have fallen under suspicion, on grounds that they might not be able to pay their own debts if Bear failed to pay them. That could have triggered a dangerous wave of defaults. The rescue by JPMorgan Chase gives the financial system breathing room to pay off Bear's debts gradually.
If you don't think we're in for a bumpy ride for a while, incidentally, you might also want to check out Alan Greenspan in today's Financial Times -- his first paragraph:
The current financial crisis in the US is likely to be judged in retrospect as the most wrenching since the end of the second world war. It will end eventually when home prices stabilise and with them the value of equity in homes supporting troubled mortgage securities.
A key theme later in the Greenspan article:
But these models do not fully capture what I believe has been, to date, only a peripheral addendum to business-cycle and financial modelling – the innate human responses that result in swings between euphoria and fear that repeat themselves generation after generation with little evidence of a learning curve. Asset-price bubbles build and burst today as they have since the early 18th century, when modern competitive markets evolved. To be sure, we tend to label such behavioural responses as non-rational. But forecasters’ concerns should be not whether human response is rational or irrational, only that it is observable and systematic.
I encourage you to visit Amazon and purchase a copy of Galbraith's classic A Short History of Financial Euphoria if you find the previous paragraph hard to believe. You might also want to check out his 2004 book, The Economics of Innocent Fraud.
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