Can world fix Humpty Dumpty markets?
TERRY SAVAGE email@example.com Oct 13, 2008
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Updated: May 3, 2013 12:14PM
Humpty Dumpty had a great fall. All the king's horses and all the king's men couldn't put Humpty together again!
As the stock market struggles to find a bottom, I'm reminded of that old nursery rhyme. Leaders of the world's industrialized countries are struggling to find a solution that will put the system together again. But the cracks are too great.
What they should be working toward is a new global financial system, based on transparency of transactions and a centralized structure for matching and measuring freely made transactions.
Until the global market participants can trust each other, the system will remain frozen. The stock market is only a symbol of the world's financial problems.
And those problems are not unique to this day and age. If you're a student of history, you read about "Tulip-mania" in Holland, where one rare tulip bulb was viewed as worth an entire farm and its livestock. It lasted until the last person into the mania tried to sell and found no buyers, and then the bubble burst.
Human nature, with all of its emotions, and especially fear and greed, cannot be changed. That's what we're seeing at work here. But the excesses of this bubble are buried far below the markets for stocks.
All bubbles occur because of human greed. But this time, the greed factor was not quite as obvious because it occurred behind the scenes -- in the trading rooms of the investment banks that created a huge, unseen network of banking contracts with institutions around the world.
Sure, many individuals were greedy to buy homes they couldn't afford, or to earn commissions selling mortgages that were not likely to be repaid. But at the root of it all was the ability to "structure" those mortgages into securities that were endorsed by the rating agencies (who were paid to do so) and then distributed around the world into the financial system greedy to get high yields on "safe" investments.
Turning those bad mortgages into highly rated securities represents the 21st century version of ALCHEMY -- the ancient hope that you could turn base metals into gold!
And what's really going on around the world is an attempt to revalue all of those securities sitting on the books of global financial institutions, hedged by derivative contracts that were supposed to represent "insurance" against the failure of the underlying mortgage holders to keep paying on their homes.
When Lehman Brothers failed, and AIG came close, the banking insiders knew they had a huge problem with these derivatives, estimated to be worth more than $67 trillion. (No, there weren't that many American mortgages; it was the "tulip bulb" leverage that boosted the "value" of these contracts as they were sold, and re-sold, to financial institutions.)
Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke misjudged the importance of Lehman Brothers, and the derivatives on its balance sheet, to spark the conflagration. History will judge that to be the linchpin of this downward spiral. Ever since, global regulators have been trying furiously to get ahead of the collapse -- and failing miserably.
Since each bank knows it has these securities in its portfolio, it suspects that others do, too. Better the devil you know than the one you don't. So they won't lend to each other, won't make contracts with each other -- and with ordinary businesses, no matter how much money central banks pump into their coffers.
In effect, world business is grinding to a halt. And the efforts to "print" money and "guarantee debt and deposits" will only leave us with a huge collapse in the value of paper money (inflation) down the road.
Stocks: 'collateral damage'
In that context, the stock market decline is only "collateral damage" -- the reflection of the frozen banking system. We see the stock market headlines and the numbers, but that is the only visible sign of the real, underlying problem -- the credit crisis.
Of course, as credit remains frozen, there is a very real impact on the global economy. That means earnings of companies will fall, and that always leads to lower stock prices. But the sharp decline of last week wasn't based on realistic economic assessments; it was based on fear that the entire global financial system would come crashing down.
Since stocks themselves are not at the center of the problem, it is even more difficult to predict the market's future. If "all the king's men" can make the right decisions and work together, the global economy can recover once it has purged itself of these excesses. There is still real value to the businesses that drive our real economies around the world.
That's what's going on behind the scenes -- a frantic attempt to put Humpty together again, to restore confidence. It will work if two things happen.
First, the leaders must allow the markets to "clear" -- to set a price determined by buyers and sellers of assets. That started Friday afternoon, when an auction set the value of Lehman's derivative guarantees.
Second, they must set up a system that will alleviate these hidden bank-to-bank transactions and bring them to light, so values can be discovered and priced on a daily basis.
I have every hope, but no special insight, into whether such a system will be enacted.
All I can recommend to you in my role as personal finance adviser is hold tight, plan to live on your safe, "chicken money," add to your gold holdings in case of future inflation, and be a voice of calm and reason when your friends and family are panicking. Our most important task is to bring America through this without destroying our values along with our investments. And that's The Savage Truth.
Terry Savage is a registered investment adviser. Distributed by Creators Syndicate. Copyright Terry Savage Productions Ltd.