Crisis on Wall Street: Lehman to file for bankruptcy protection, Merrill Is Sold

[brendan]

Myths about the Financial Crisis of 2008
http://www.minneapolisfed.org/research/WP/WP666.pdf

[brendan]

How to Restore Confidence in Our Markets
By ARTHUR LEVITT
Mr. Levitt was chairman of the Securities and Exchange Commission from 1993 to 2001.
http://online.wsj.com/article/SB122463316333956653.html

This Bailout Doesn’t Pay Dividends
By DAVID S. SCHARFSTEIN and JEREMY C. STEIN
David S. Scharfstein is a professor of finance at Harvard Business School.
Jeremy C. Stein is a professor of economics at Harvard.
http://www.nytimes.com/2008/10/21/opinion/21stein.html?_r=1&partner=permalink&exprod=permalink&oref=slogin

[brendan]

The Fund must be a global asset manager

By Michael Bordo and Harold James

Published: October 20 2008 18:43 | Last updated: October 20 2008 18:43

The chaotic, costly and ineffective international response to the current financial disorder has prompted French president Nicolas Sarkozy, British prime minister Gordon Brown and German president Horst Köhler, a former head of the International Monetary Fund, to call for a new Bretton Woods conference to design a new global financial system.

This is the first big crisis since the Bretton Woods conference in 1944, when the IMF was created, when the Fund has stood on the sidelines. Yet the origins of the crisis lie in some of the areas where it has a direct mandate – in particular, the large current account imbalances – as well as in the areas where it has recently been extending its mandate to cover financial stability.

The core IMF function should be multilateral surveillance. But at present this often means just talking. This is quite different from past visions. The IMF originally supervised the rules of the system of the par value of currencies under the Bretton Woods order, which disintegrated in 1971. The effectiveness of multilateral surveillance as it developed in the 1960s was linked to the IMF’s presence as a significant financial intermediary. It is this role that needs to be rethought.

In the past, the ability to give powerful advice to the systemically important countries, such as the UK, was enhanced by the dependence of those countries on IMF resources. It was the financial power of the IMF that gave it its bite, and that power was enhanced by its borrowing – at first from the Group of 10 nations that constituted the General Arrangements to Borrow.

In the years after the collapse of Bretton Woods, the IMF reinvented it­self as a vehicle for the management of the surpluses of the time. It borrowed from the new surplus countries, which as a consequence in part managed their new assets through the intermediation of the IMF. It was then able to lend to those countries that suffered shocks as a result of the increase in petroleum prices.

A very large financial actor can have a stabilising role. In the more distant past, market expectations were stabilised during panics by the counter-cyclical behaviour of very large private institutions. The multinational house of Rothschild made the first half of the 19th century stable. In the great panics of 1895-96 and 1907, the US economy was calmed by JPMorgan. At the time of the Great Depression in the 1930s, there was no house of equivalent power.

The IMF could be a powerful stabiliser in global markets if it managed a significant part of the reserve assets of the new surplus countries. It would be in a strong position to take bets against speculators, potentially in regard to speculative attacks on both countries and on financial institutions.

The stabilising action would benefit both the world economy and the interests of the owners of the reserve assets, which have (simply by the fact of the accumulation of the surpluses) a similar interest in world economic and financial stability. At the same time, the management of reserve assets by an internationally controlled asset manager would remove suspicions and doubts about the use of assets for strategic political purposes.

In order to carry out this new task, the IMF would need to regain the trust of its members. The rise in reserves in many Asian countries was a deliberate response to the 1997 Asia crisis, in which there was substantial disillusionment with the IMF. A precondition for acting as a global reserve manager would be governance reform in which the new surplus countries were able to exercise substantive influence through the IMF and feel secure that they were not being politically manipulated.

In particular, if the IMF were to be in a position of an asset manager that could shift assets from one market to another, it would need to be at greater distance from US influence and attempts at control: otherwise, it might be seen as a device for propping up the dollar or particular financial institutions for political economic reasons.

In a revised approach, votes in the IMF would be allocated or “bought” to a large extent through the assets held at the IMF. The proportion of votes determined in this way might be as high as 50 per cent, while the rest would be allocated in the traditional way. There is an analogy to this double determination of voting power in the US constitution, according to which all states have an equal share of Senate votes but very different numbers of seats in the House of Representatives, reflecting population differences.

Making a substantial part of Fund voting a reflection of the reserve positions held in the IMF would allow quick adjustments to new international realities. It would make the IMF more of a market institution, much like the ownership of joint-stock companies can change quickly and noiselessly.

A new version of the Fund could be a substantial contributor to stabilising market expectations. The IMF was conceived in 1944 in a world without major private capital flows, in which states would undertake all international transactions. Extending its mission to include some private sector rescues would be a recognition of the preponderant role markets now play. At the same time, the involvement of a rule-bound international agency would minimise the political poison associated with bank recapitalisations as well as currency interventions.

Michael Bordo is professor of economics at Rutgers University; Harold James is professor of history and international affairs at Princeton University and Marie Curie Professor at the European University Institute

[Noblesse]

Sigh, time for my super in depth analysis of the Dow Jones activity during the night: It sucked.


From punditkitchen.com

[AppleXY]

Sigh, time for my super in depth analysis of the Dow Jones activity during the night: It sucked.

(Image removed from quote.)
From punditkitchen.com

LOL.

[AppleXY]

Well obviously the ASX 200 will be a bear market today. I'm speculating it will decrease ~4%.

[brendan]

What the financial crisis means for you - if you are a prostitue.
http://www.slate.com/id/2200640/pagenum/all/

Bailouts Are Inevitable, Even Desirable
Tim Harford
http://www.slate.com/id/2201343/

How the Bailout Auction Should Work
Steven E. Landsburg
http://www.slate.com/id/2202182/pagenum/all/

[brendan]

http://gregmankiw.blogspot.com/2008/10/may-you-live-in-interesting-times.html

[brendan]

[Noblesse]

Here is an awesome blog with pictures and captions from trading floors around the world.

http://sadguysontradingfloors.tumblr.com/

Bookmarked

[rh]

http://wallstreetfacepalm.blogspot.com/

[brendan]

http://www.ft.com/cms/s/0/d775399a-a38e-11dd-942c-000077b07658.html

The pendulum swings towards regulation

By Lawrence Summers, Charles W. Eliot university professor at Harvard University

Published: October 26 2008 18:56 | Last updated: October 26 2008 18:56

Events as well as ideas shape policy choices in democracies. Who would have predicted a year ago that a Republican ad­ministration would demand that Congress make the largest set of investments in public companies in US peacetime history? Would anyone have supposed that President George W. Bush would convene a global effort to renew Bretton Woods through strengthened international financial regulation? It reminds us that in the economic sphere, as in the national security sphere, dramatic events can make the inconceivable become inevitable.

Discussions of the policy implications of the crisis have primarily focused on the immediate economic demands. The need to ensure the capital adequacy of financial institutions, maintain important credit flows, support the housing sector and the real economy, contain international spill­overs and reform regulation to prevent any recurrence of the crisis have rightly been the priority. In all these areas there will be many crucial policy choices to make in the months ahead.

However, policies that contain the crisis, support the economy and generate recovery are not sufficient to meet the historic challenge of this moment. Even with the best conceivable fiscal, monetary, financial and regulatory policies, economic performance depends on deeper and more structural policy choices. Nations cannot fine tune their way to delivering a prosperity that is more broadly based. In important ways, then, the crisis creates space to address longer standing problems. Just as patients hear advice regarding diet and exercise differently after a heart attack, so recent events should make it possible for the next US administration to accomplish more than might previously have been thought possible.

These broader goals depend on achieving the rapid and sustained growth that restores business confidence and generates the resources for investment. Economists do not understand what drives productivity growth very well. However, we know these facts: productivity grew rapidly after the second world war and then sometime between the late 1960s and mid-1970s it slowed dramatically only to re-accelerate to record levels in the mid-1990s. Unfortunately, even before the downturn, underlying productivity growth appeared to be slowing.

The most plausible explanation is that an array of transforming investments and technologies – the interstate highway system, widespread air travel and the expansion of electronics – were spurs to growth during the postwar period. Eventually their impact dissipated and, as energy costs rose, growth slowed until the information technology revolution kicked in during the 1990s. Unfortunately, the IT supply shock that powered the economy in the 1990s and early part of this decade appears to be diminishing.

So there is a need to ensure that the pressure to increase spending is directed at areas where it will have the most transformational impact. We need to identify those investments that stimulate demand in the short run and have a positive impact on productivity. These include renewable energy technologies and the infrastructure to support them, the broader application of biotechnologies and expanding broadband connectivity, an area where the US has fallen behind.

The crisis has also reminded us of the lessons of the technology bubble, Japan’s experience in the 1990s and of the US Great Depression – that finance-led growth is problematic. The wealth and income gains from the easy availability of credit were highly concentrated in the hands of a fortunate few. The benefits also proved temporary. In retrospect, the fact that 40 per cent of American corporate profits in 2006 went to the financial sector, and the closely related outcome – a doubling of the share of income going to the top 1 per cent of the population – should have been signs something was amiss.

Therefore we need to reform tax incentives that encourage financial risk taking, regulate leverage and prevent government policies that give rise to a toxic combination of privatised gains and socialised losses. This offers the prospect of a prosperity that is more firmly grounded and more inclusive. More fundamentally, short and longer-term imperatives come together with respect to policies that seek to ensure that any future prosperity is inclusive. The policies that are most effective in helping to support demand are those that help households struggling either because of low incomes or because they have recently lost part of their income. Recent events also remind us that individuals can become impoverished or lose health insurance through no fault of their own. This reinforces the need for people to have basic health and re- tirement security protection regardless of what happens to their employers.

All of these considerations suggest that the pendulum will swing – and should swing – towards an enhanced role for government in saving the market system from its excesses and inadequacies. Policymakers need to be attentive to potential government flaws as well. For example, they need to recognise that, even as events compel larger deficits in the short run, they reinforce the need for longer-term measures to keep government finances on a sound footing. They must also be wary of measures that have a short-term superficial appeal, yet have adverse long-term consequences.

It is said in all presidential election years that the choices made by the next president are uniquely important. This time the cliché is true. The gravity of our situation is matched only by the opportunity it presents.

[brendan]

[bubble sunglasses]

 "...when the shock waves have died down, politicians and regulators should draw at least one lesson from history.
They should force fundamental changes to the way in which financial institutions charge for their services and remunerate their staff."
  Latrobe VC Prof Paul Johnson
 http://www.latrobe.edu.au/news/opinions-2008/opinion-oct2808.html

[brendan]

Globalisation is not our enemy

By Alberto Alesina and Francesco Giavazzi

A “new Bretton Woods” is the name given to a summit next month of leaders of the world’s top economies to map out a response to the global financial crisis.

The New York meeting received this label because it aims to reconsider the structure and the role of international economic institutions such as the G7, the International Monetary Fund and the Financial Stability Forum.

The goal of this meeting should be to redesign the institutions that supervise and regulate international capital flows and world financial markets, not to write new rules for these markets.

One of the lessons learned from the experience of independent central banks is that policies improve when politicians delegate technical decision, such as interest rate setting, or financial supervision, to independent bodies.

When politicians meddle with those decisions or, worse, are captured by financial industry lobbing, things can go wrong. In this particular case, allowing politicians such as French president Nicolas Sarkozy, who some claim are engaged in an anti-market,  anti-globalisation drive, to rewrite rules could be disastrous.

The IMF, conceived in 1944 when western leaders met in Bretton Woods and set out a new financial order, the G7, the FSF and even the European Central Bank need to be reformed, and the crisis has provided an opportunity to focus on how such measures should be designed.

The IMF’s role, as the watchdog against irresponsible macroeconomic policies and against the possibility that capital flows are mishandled, should be enhanced. The ECB should have a larger role as financial supervisor in Europe, taking over responsibilities from national governments.

As the effects of the crisis reverberate to central Europe and to Latin America, the membership of the FSF appears to be out of step with its mandate, which is to “assess vulnerabilities affecting the international financial system, identify and oversee action needed to address them and improve co-ordination and information exchange among the various authorities responsible for financial stability”. The current FSF membership can hardly deal with central Europe and Latin America since it is limited to the G-7 plus Australia, Switzerland, Singapore and Hong Kong.

Meanwhile, some international economic institutions still bear the imprint of the second world war. Why are large countries such as China, India, Mexico and Brazil not members of the G7, while others such as Italy are?  Shouldn’t the euro area countries have only one, heavyweight representative in international economic summits?

Instead, President Sarkozy, as well as other participants in the meeting, such as Italy’s prime minister, Silvio Berlusconi, look at it as an occasion to redesign not the institutions but the rules governing international financial markets with an anti-globalisation bend.

This is a worrisome prospect because some politicians misunderstand the reasons for the crisis.

Take global imbalances. Politicians often suggest that they are the culprit of the crisis. And since global imbalances are the result of globalisation, the latter is our enemy. This is wrong and it would be dangerous if this view were to inspire the design of new rules.

Global imbalances, the excess of savings in some parts of the world, matched by a lack of savings elsewhere, have been a feature of the world economy for a long time.

At the end of the 19th century Britain ran a current account deficit financed by savings elsewhere in the Commonwealth.

After world war two, negative savings in the US were financed first by excess savings coming from Germany, later from Japan: today is the turn of China. The geographical separation of savings from investment, made possible by free capital movements, is one of the engines of world growth. It allows a country to invest its savings where returns are highest, rather than being constrained to invest at home where returns may be lower.

Failure to understand this could easily result in proposals to limit the international mobility of capital. The consequence on the world economy could be as serious as the mistakes made in the 1930s by US President Hoover, who introduced barriers to trade in goods and by doing this transformed a serious recession into the Great Depression.

Sure, when imbalances are especially large, as they were in the years leading up to the crisis, badly regulated financial markets are especially dangerous. Since global imbalances are likely to persist, regulatory reforms are needed - but not vendettas.

Another dangerous mistake are efforts to outlaw some market activities, such as short selling, or some institutions, such as hedge funds.

These proposals demonstrate a lack of understanding of how markets work. By short-selling a stock or a currency, an investor brings to the market valuable information: he signals that the price of that asset is out of line with its fundamental value.

Outlawing short selling means preventing such information from getting to the market. And hedge funds are the investors who bring it to the market, for instance by building an arbitrage between the shares of two companies belonging to the same industry.

The finance industry has made serious mistakes in the past few years, often because of its intermingling with politicians. But the financial sector has also been an engine of growth. Allowing politicians to redesign rules with a punitive spirit would be a cure worse than the disease.

Alberto Alesina is the Nathaniel Ropes professor of political economy at Harvard University. Francesco Giavazzi is professor of economics at Bocconi university in Milan