Friday, September 19, 2008
What is going on with the federal bail outs and banks all over the world participating in the bail outs of United States financial institutions? The short answer is preservation of access to capital for world markets.
The world economy is predicated on fast and reasonably easy access to capital markets. Without it we are in the same boat as a third world country with lots of natural resources but no money.
Examples abound in South American and African countries. Peasant farmers and merchants may own their land or business but their lack of recorded deeds and business instruments makes their claim on assets undefined and of little or no value with respect to getting any loans or access to capital to expand their operations. They have no proof of ownership, eventhough the assets may have been in their families for generations. Recorded deeds and solid proof of ownership are not the norm in third world countries.
Right now we have a "frozen credit market" with banks unwilling to loan any money to anyone for any reason for fear they will have a run on their capital reserves. Banks can loan out many times the amounts of money they have on deposit in savings and demand deposits (aka checking accounts). The multiple is dictated by the Federal Reserve. It gets a lot more complicated than what I have presented here but cash, currency and coins in the economy represent a small fraction of the actual "money" flying around the world markets. It is for the most part debt secured by an equity position in some type of asset.
Financial markets are by defintion predicated on the belief that lender's will get repaid and borrower's will perform on the debts they have taken from the system. When the belief in the system gets toxic and debtors can't repay all hell breaks loose. Investments in non-liquid assets creates "technical insolvency". Fire sales of companies and their assets create a feeding frenzy in the economy.
With defaults in the housing market and other commercial paper assets, equity positions of those seeking credit is suspect to lenders. Financial markets granting credit have tightened requirements for loans and access to credit. Without access to capital via credit the economy comes to a grinding halt. Jobs, and demand for consumer products come to a screeching halt. Faith in the ability of creditors to pay back loans becomes suspect by lenders. Assets instead of appreciating in value, declining in value. Banks are not confident in loan to value ratios.
This may end up as the GREAT DEPRESSION of the modern era. However, the allways suspect government has acted quickly to stop the bleeding. Banks may have the toxic assets off their balance sheets but they still lack money and reserves. It will take some time for them to restore themselves to a position where credit is easily obtainable. Money market certificates may be a great investment after the election.
This is why the Western World Banks have come to the rescue of the United States Financial System. If we go down the tube the world economy falls with us. It will be interesting to see how long it takes for the credit market to un-freeze. Meantime, a lot of stocks and bonds are at fire sale prices and those with cash are going to make a lot of money out of all this misery.
This is a basic outline of the problem and time will tell if the fixes have resolved the issues with access to capital.
Posted by Paul Alldredge at 11:56 AM