8
A primer on the financial crisis
People walk under a ticker sign announcing Lehman Brothers financial losses.
To view this content, Javascript must be enabled and Adobe Flash Player must be installed.
TEXT OF INTERVIEW
Scott Jagow: I've been getting a lot of e-mails about this financial crisis, especially from people trying to understand exactly what's going on in the credit markets. This morning, we're going to do a little primer because it is difficult to understand. We're joined by consultant Peter Cohan. Peter, first question is why do banks need to lend to each other? Don't they have money already?
Peter Cohan: Oh, they do have a lot of money already, but the complicated thing about it is they usually use very short-term financing -- that is money that they borrow for one day, and at the end of the day they get a new loan and just roll it over. That's the way it normally works. And the reason that banks do that is because it's among the lowest-cost ways that you can get money.
Jagow: But it's not cheap right now, and that's exactly the issue here -- the rate that the banks charge each other has gone up so much just in the last few weeks.
Cohan: Ah Yes, and what it basically boils down to is that banks don't want to lend to each other. They saw what happened when they lent to Bear Stearns, when they lent to Lehman Brothers. And what's happening is instead of banks lending to each other, the Federal Reserve is stepping in and they're doing all the lending, because they are basically the lender of last resort, and the banks aren't lending to each other so all the banks are going to the Fed.
Jagow: OK, but what is happening to that money?
Cohan: The banks are hoarding the money, because they don't have enough capital. This is the fundamental cause of all this distress. You know, the Fed has been ordering and the Treasury's been ordering them to go out and raise more capital, and they tried earlier in the year to get the money from the sovereign wealth funds over in China and the Middle East. And they made some investments, lost their money. So they're basically stuck, they can't get capital from anywhere else. So here they are, going to the Fed, borrowing the money and hoarding it, and just hope that it keeps them from being wiped out.
Jagow: You could probably imagine how a lot of people feel about this is they made their bed, and now they have to lay in it.
Cohan: Absolutely, and it would be great if they had been responsible enough to have enough protection for what might happen if things went wrong. But unfortunately, by borrowing more and more money, they have put the entire global system at risk. So unfortunately, we have a situation where we have private profits and socialized loses.
Jagow: How do we know that this threat to our economy is not being oversold, that it's not being exaggerated?
Cohan: We don't, and I think we have reason to be suspicious. Because of what happened back in early 2003, when we were sort of pushed into a war in Iraq. And frankly, there's a lot of people in Congress who don't understand this either, and I think most Americans are hungry for more information, so they really know what they're talking about instead of all this fear mongering.
Jagow: Well Peter, this was a very good explainer and I really appreciate your time. Thank you so much.
Cohan: Thank you, Scott.
Some (non-rhetorical) questions:
(1) Why are banks and credit card companies permitted to charge interest rates that were once considered usurous?
(2) Why are banks and credit card companies allowed to, essentially, change the terms of their contracts, including interest rates charged lenders and/or other customers, unilaterally?
(3) Why, when corporations declare bankruptcy, do their employee contracts not stand at or near the front of the lienholder line (while "the deciders" walk away with golden parachutes)?
(4) Why are corporations, with or without declaring bankruptcy, permitted to unilaterally change the terms of retirement benefits, including pensions and health benefits to pensioners? Were not these people previously employed persuant to either an explicit or implicit contract that included these benefits?
(5) What has happened to honesty and integrity in our country? As these qualities appear to be preconditions to "trust," how do we recover them?
I thought this NPR article was also very helpful (The Week Americas Economy Almost Died- http://www.npr.org/templates/story/story.php?storyId=95099470&sc=emaf&sc...
It really shows how the credit crunch effects businesses, and how "good credit" doesn't really matter if no one is lending.
It seems to me that any individual or small business that has a good credit history will be able to able to get loans or other secured credit. The biggest risk is that we'll have widespread financial panic, which is what causes the stock market to nosedive an people to pull their money out of banks. Unfortunately, we haven't learned the important lessons from the Great Depression, such as how to minimize waste and use credit wisely. In the past, taking unwise risks with other people's money was considered at least unethical, if not criminal behavior. Today, instead of pouring their personal fortunes back into their banks or investment companies, the average taxpayer is being asked to help out the multi-millionare executives and investors.
Those who resist the temptation to panic and who have managed their money well, should be OK.
Thank God somebody thought we needed a primer! In a hurry to cover all the events that are unfolding at an unprecedented rate, the media and the people have become sort of scatter-brained and one of things we all seem to be neglecting is correctness. We have economists, politicians, and newscasters using words very loosely. For example, someone who voted for the bailout says "the economy will collapse" and another guy who voted against it says "the economy will just experience a mild recession". Without they defining what they mean by a "collapse" and a "mild recession", how on Earth can anyone make sense of what they are saying?!?
Please be as precise as possible (use quantitative terms wherever possible instead of vague/subjective ones) and help us get our minds around this mess!
Peter Cohan's explanation of the current financial crisis is the clearest I have heard so far--how the banks got into this mess is not as important as the notion that they made risky and ultimately bad bets on the housing industry, desperately made more bad bets, lost more money and now many financial institutions have gone out of business, need to be rescued or are at grave risk--and won't lend money to each other because its too risky. The phrase that struck me the most was "we have private profits and socialized losses." In other words, lots of individuals have made lots of money during this process but now taxpayers have to bail these institutions out due to risky and ultimately flawed bets and short-sighted management. Irksome. I would like some of these individuals to explain to my children, ages 21 and 17, why their financial future is much less secure than it was even last year.
How can banks be "hoarding money?" Is this like Uncle Scrooge's Money Bin? We've all seen "It's a Wonderful Life" haven't we? -- Jimmy Stewart stopping a run on the bank by telling the crowd "the bank doesn't have your money; it's out on loan to (and then he names a bunch of local borrowers)." So where is the money today? It's out in the economy somewhere, doing something. Questions are where? and what?
