Dow Drops 500 Points Today
As I mentioned in a post last night, the Wall Street financial crisis is THE major political issue facing the country right now. There are lots of complex responses to offer, involving a mix of regulation, de-regulation, streamlined regulation, bailouts, etc. I personally agree with Barack Obama’s charge that excessive de-regulation of the financial services sector over the last several years (going back to the Clinton Administration actually) is largely-responsible for this meltdown. But that doesn’t necessarily mean we need to, say, re-institute the Glass-Steagall Act. The 21st-century market requires 21st-century regulations. What are those?
What’s striking about today’s market behavior was the extent to which the Dow plunged AFTER the State of New York allowed American International Group (AIG) to borrow money from its subsidiaries. While this could have helped calm investors on Wall Street, it seems to have fed into the panic. After all, for much of the day, the market merely hovered around its 300-point drop and even hinted at a recovery. The story of the day could have been: “Wall Street shakes off Lehman woes, gains confidence from Bank of America purchase of Merrill Lynch and NY plan to help AIG.” But the last hour of trading told a different story.
Next up will be Washington Mutual. Do they survive the week? Are any other major financial institutions at risk of collapse?
More importantly, what does this mean for credit access? If the investment banks retrench, the sluggish economy will completely stall. What will give the great houses of Wall Street the confidence to invest again? And how soon will this ripple through the economy?
We’ll find out in the next few days.
19 Responses to “Dow Drops 500 Points Today”
Wow, I've long seen these problems coming (well other people saw them coming and I read it and thought they had a very strong argument) but the incompetence that is being revealed is stunning.
Let me be blunt. A lot of “good” companies might not be “good” because they made bets and used these contracts as hedges. There will most assuredly be counterparty failure (where the party that is supposed to pay out cannot) and it will almost be Russian roulette which firms are taken down and which aren't. This is why Warren Buffett said these things were “financial weapons of mass destruction.”
Today the market dropped not because much of significance happened but because the machine was finally set in motion that will test this massive and secretive system that has never been tested before. If it fails the test we're going to have many more “Black” days on par with the most famous ones.
mikkel said: “Let me be blunt. A lot of “good” companies might not be “good” because they made bets and used these contracts as hedges.”
Exactly. As far as I'm concerned, none of them are worth being called “good”. And I bet there are many more secrets in the Finance Cabal that are about to be exposed.
McCain's buddy and, until recently, top economic adviser Phil Gramm was the chief sponsor and writer of the legislation that removed some of the protections that allowed us to land where we are today. Good to know we can depend on McCain to bring in the best minds for his cabinet should he win.
http://news.yahoo.com/s/ap/20080915/ap_on_el_pr…
At least we don't have to hear anymore talk about privatizing social security.
Wow President Bush has killed more Banks than Taliban terrorists, scorecard Investment Banks =4 Osama Bin Laden= 0. Gees look at the market, lmao man. Call Bill Clinton any dirty name you want and if you run out of names email me, I'll help you with more words. Yet in all of Clinton's sleaziness we never went through such a financial collapse as we've had with a Republican as President, oh wait we did Herbert Hover GOP President of the Great Depression. So lets recap ok? The GOP loves to talk tuff , but as you can see the Middle East talks tougher than the GOP. So there went the GOP trademark of we're the party of warriors. GOP tax cuts are the least of Problems we face now. So there went the GOP's economic plans. In short tell me again why the GOP is important or even needed? If you hate the USA vote Republican.
Greed+Panic
Bush and financial disasters- a family tradition.
WIth regards to derivatives' contracts… hedges are great instruments if you use them to protect your company from exposure to markets….
The problem isn't with the instruments themselves but the misuse of those instruments and using those instruments to speculate.
Oh, I got caught up in a thread and forgot to say what I wanted to say…
I wonder if the Dow will actually end DOWN from where it was when Bush took office…
In the eight years under Clinton the Dow went up from roughly 3,400 to 10,500. Under Bush we're almost back where we started. In the next few days the markets will go up, but we won't see anywhere near the growth rate of the Dow under Bush that we saw under Clinton. Weren't Bush's policies suppose to stimulate the economy and be good for business growth? What DID bush's tax cuts accomplish other than making the super-rich become super-duper rich and leave the country with a $10 trillion debt?
Maybe this will be a good contest… to guess how the Dow will perform for the rest of Bush's term…
In these hard times I might behoove people to look at that “scandanlous man” Bill Clinton and his potential for sitting at Hillary's right hand should she somehow obtain a position of influence in the Oval Office this election..
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President Clinton’s Record on the Economy: In 1992, 10 million Americans were unemployed, the country faced record deficits, and poverty and welfare rolls were growing. Family incomes were losing ground to inflation and jobs were being created at the slowest rate since the Great Depression. Today, America enjoys what may be the strongest economy ever.
Strong Economic Growth: Since President Clinton and Vice President Gore took office, economic growth has averaged 4.0 percent per year, compared to average growth of 2.8 percent during the Reagan-Bush years. The economy has grown for 116 consecutive months, the most in history.
Most New Jobs Ever Created Under a Single Administration: The economy has created more than 22.5 million jobs in less than eight years—the most jobs ever created under a single administration, and more than were created in the previous 12 years. Of the total new jobs, 20.7 million, or 92 percent, are in the private sector.
Median Family Income Up $6,000 since 1993: Economic gains have been made across the spectrum as family incomes increased for all Americans. Since 1993, real median family income has increased by $6,338, from $42,612 in 1993 to $48,950 in 1999 (in 1999 dollars).
Unemployment at Its Lowest Level in More than 30 Years: Overall unemployment has dropped to the lowest level in more than 30 years, down from 6.9 percent in 1993 to just 4.0 percent in November 2000. The unemployment rate has been below 5 percent for 40 consecutive months. Unemployment for African Americans has fallen from 14.2 percent in 1992 to 7.3 percent in October 2000, the lowest rate on record. Unemployment for Hispanics has fallen from 11.8 percent in October 1992 to 5.0 percent in October 2000, also the lowest rate on record.
Lowest Inflation since the 1960s: Inflation is at the lowest rate since the Kennedy Administration, averaging 2.5 percent, and it is down from 4.7 percent during the previous administration.
Highest Homeownership Rate on Record: The homeownership rate reached 67.7 percent for the third quarter of 2000, the highest rate on record. In contrast, the homeownership rate fell from 65.6 percent in the first quarter of 1981 to 63.7 percent in the first quarter of 1993.
7 Million Fewer Americans Living in Poverty: The poverty rate has declined from 15.1 percent in 1993 to 11.8 percent last year, the largest six-year drop in poverty in nearly 30 years. There are now 7 million fewer people in poverty than there were in 1993.
Source: http://clinton5.nara.gov/WH/Accomplishments/eig…
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Well yes of course much of the problem is that people speculated on derivatives to increase leverage instead of just using them as hedges. But hedges only work if your counterparty is good. Which creates a catch-22…in a safe environment where most people are willing to write hedges the premiums are so low that they can't help but use leverage because “nothing will go wrong.” So many counter-parties are bound to become bad simply because they take risks that assume nothing will happen…and it only takes a few bad apples to ruin the basket.
Interestingly enough it seems that risk premiums are much lower than they should be because everyone uses mathematical models with the wrong assumptions. If they used more realistic ones then we would see higher premiums and thus less leverage (and also probably lower growth rates over small time periods, but less volatility and similar mean growth).
Well the basket is really rotten now.
More bailouts will be coming down the road, that's a pretty fair bet. More of socializing the losses / privatizing the profits.
It's hard to imagine a worsening economy could be good for the McCain folks. How can they spin it? Already they strain credibility trying to distance themselves from Bush & Co.
The crisis and the economic downward spiral will not stop and thing will continue to go downhill in every area as long as the people are determined to remain stupid and keep voting for republicans.
when are they going to wake up and realize that republicans do not like people who are not rich. When are they going to realize that republicans cannot govern or do they care. When are people going to wake up and realize that republicans will keep sending your jobs overseas, keep us in useless wars and want to destroy the middle class.
mikkel, “Interestingly enough it seems that risk premiums are much lower than they should be because everyone uses mathematical models with the wrong assumptions. If they used more realistic ones then we would see higher premiums and thus less leverage…”
I agree with your full comment, and as to the specific comment I'd like to add that when counterparties enter into trades with each other they more than likely require collateral if the exposure reaches a certain amount. So the risk premiums may appear low given the overall size of the hedges, but institutions consider large positions acceptable because posted collateral lowers the exposure…. if the transaction is secured then theoretically if a defaulting counterparty (i.e. Lehman) fails, then no money is lost…. But of course the hedge transactions may only be secured above a certain exposure level, market swings and the illiquidity of transactions may push exposure higher once the hedges are unwound.
mikkel, thanks for the comment. As I mentioned, I agree with you… I'm just adding my thoughts.
mikkel, p.s.: I tried giving you a point under your last (second) comment but it wasn't accepted, but I was able to give you a point on your first comment…. which I also think is good. Like you, many of us have seen this debacle coming. I usually don't mention when I give out points, but I wanted to let you know that your second comment should have another point given to it. Who knows, tomorrow you may end up with lots of points under your second comment (I tried a few times). Thanks for the dialogue.
Yeah you bring up a good point (I assume you do this for a living). But don't you think that that is the crux of the problem, that “acceptable risk” because of posted collateral falls apart when the collateral becomes worth less, and that in a compromised financial system all collateral is bound to become devalued?
Like it seems to me that “value” is highly correlated with liquidity and interest rates and other things and we're entering a deflationary environment where even the best stuff is losing value rapidly. I'm not sure that collateral will really hold up.
I'm not in financials but my day job is to do data analysis and think about which models to use and what the assumptions mean. From what I've read, almost all theory on risk management assumes independently distributed risk. If one firm goes belly up out of bad out of bad management or luck then it will hold up because asset values are ok…but if the decisions across multiple firms are highly correlated then it falls apart quickly. I'm not sure you read naked capitalism but a few months ago they had some guest posts on systems theory explain that the modern financial system was set up in a way that was inherently unstable and in actuality what the Fed said was “distributed risk” and lower chance of default was on an abstract level exactly what he would do when he wanted to make an unstable controller.
Haha thanks, I'm not even sure how to check points. I'm a bad computer scientist.
I don't think we can expect too many more bailouts, the Fed is about maxed in its bag of tricks. Possible lower interest rates coming along but it will be hard for a lot institutions to qualify with the state of their current collateral.
“But don't you think that that is the crux of the problem, that “acceptable risk” because of posted collateral falls apart when the collateral becomes worth less…”
That's a good point, too…. there are different types of collateral (cash, securities, etc.) so to the extent the posted collateral is something other than cash (and the value does go down), then that does throw another wrench into the sputtering engine… I suppose cash isn't a real problem from a valuation perspective unless the underlying transaction involves a foreign currency. As we've seen with Bear and Lehman, etc. crises (and actually why there are so many home foreclosures for the average Joe), the value of the real estate collateral (a house for an individual or something like mortgage-backed securities for institutions) has decreased to a level requiring more collateral to support the underlying transaction. And of course if the security, such as mortgage-backed securities is illiquid, then it may not even be acceptable for collateral.
As far as checking “points” next to a comment, just move your mouse over the up and down arrows next to your avatar. To the right of your name will be how many points your comment is “good for”.
You mention that you're not in financials… that may be the case but you would have surprised me… you seem very knowledgeable with good points on this. As far as what I do for a living… click on my avatar, then scroll down past the comments and go to the bottom of the pop-up window then click on “View Profile”.
Thanks-
Neither McLame nor Nobama know their fannies from a hole in the ground when it comes to economics.
For the love of God get the Clintons back in the ballgame before the park is hawked to the Chinese..
Let me add to Remember November's formula for Financial Mass Destruction:
Greed and ill-advised faith in the markets leads to political pressure on the GOP to relax standards and deregulate, which leads to more greed which leads to risky loans which leads to inaction by the Fed which leads to still more greed and even riskier loans which lead to collapse of the subprime mortgage market, which leads to foreclosures and bankruptcy in investment banking, insurance and lending institutions which leads to panic on Wall Street.