Global Finance a Shambles?

Today, I was contacted by half a dozen people asking for my take on what's going on in the financial world. I thought I would jot down some thoughts quickly.

Like everyone else, I have no idea how this will play out. I'm a retail investor like most of you, and, like most of you, I've been watching the value of my equity decline precipitously over the past nine months. Never gave it much thought, really, except to mutter occasionally and curse my stars.

But this past weekend, we got hit with a much more serious situation.

Our financial system--the one we grew up with, the only one we've known as Americans for the better part of 50 years--seems on the verge of collapse.

Many of our most honored and storied institutions--Merrill Lynch, Lehman Brothers, AIG, Fannie Mae, Freddie Mac, Bear Stearns--are either gone or under government administration. Many others--Washington Mutual, IndyMac, and a dozen other smaller banks--have failed or may do so shortly.

Our famed economists and investors are unsure what tomorrow will bring. Our central bankers are trying everything in their arsenal to calm markets and inject liquidity.

Our politicians seem uncertain how to respond and, worse, it's election season, which means the recriminations will fly around uselessly to try to score political points.

And globally, markets, investors, governments, and pundits are suddenly not sure whether America is really the place to park assets, whether our economic system that supposedly allocates capital most efficiently is the best system, whether we should have more regulation, whether we should just let the market take its course.

So let me take a minute to put these events in perspective--as last as I see it.

First, these financial institutions were not as prudent as they should have been. They engaged in financial innovation (good), syndicated it out by selling these innovative products to other banks and investors (also ok), but then failed to adequately understand or manage the risk inherent in those products (umm...bad). I have no sympathy for the shareholders of these banks and the management teams getting walloped. It's well deserved. (I have some sympathy for regular guys at these banks--my friends among them--who got caught in this once in a lifetime crisis. For most, it has nothing to do with them. And while our 401(k)s take a hit, they are out of a job.)

Second, credit rating agencies have to share some of the blame. They're not going under since they are privately held and small in comparison to the behemoths they rate. Our system relies too heavily on these agencies and they are not accountable to anyone. This has to change.

Third, the carnage on Wall Street reflect to a certain extent the pain being felt in other parts of the economy, notably real estate of course, but also IT and other areas. Largely ignored in the hubbub around Wall Street was HP's announcement that it's laying off 25,000 workers. Ok, part of this is the integration with EDS, but part of it reflects slowing IT spending and weaker corporate earnings. Housing prices have dropped by 10-15% in some parts of the country. The estimated cost for just the housing bust will be about $1 trillion.

Fourth, the crisis is largely a failure of regulation. The federal bailouts and the discussion about Resolution Trust Corporation redux are evidence that Congress and regulators agree that more should have been done ex ante. New government-sponsored accounting and auditing rules were supposed to provide more information to regulators and investors. Nope. The end of Glass-Steagall was supposed to keep the US financial sector competitive. Nope. The myriad financial regulatory agencies were supposed to be minding the shop. Nope.

Now, there is a global crisis of confidence in banks, as one commentator put it. From here in Beijing to Manila to Frankfurt to Tokyo to Johannesburg, Tel Aviv and Dubai, central bankers and finance ministers are working around the clock to calm their markets. So far, no luck.

In 1997, the IMF with the explicit support of the US, bailed out Korea in the face of the Asian Financial Crisis. It's not lost on anyone that Korea Development Bank was the final would-be bidder for Lehman Brothers.

In tomorrow's post: what's coming next and what it means for us.