The Shadow Banking System is Unravelling
Roubini Column in the Financial Times. Such demise confirmed by Morgan and Goldman now being converted into banks

Nouriel Roubini | Sep 21, 2008



The Financial Times published in its Monday edition my Op-Ed column “The Shadow Banking System is Unravelling”. The column was written and posted on their web site a few hours before the sudden announcement of the end of major independent broker dealers with the Fed announcement that Morgan Stanley and Goldman Sachs will become bank holding companies and will be thus regulated as banks. This is the additional step in the demise of Wall Street as we know it and the unraveling and demise of the “shadow banking system” that I described in my Financial Times Op-Ed column.


Here is the text of my Op-Ed column:


Financial Times Published: September 21 2008 17:57 | Last updated: September 21 2008 17:57




Last week saw the demise of the shadow banking system that has been created over the past 20 years. Because of a greater regulation of banks, most financial intermediation in the past two decades has grown within this shadow system whose members are broker-dealers, hedge funds, private equity groups, structured investment vehicles and conduits, money market funds and non-bank mortgage lenders.

Like banks, most members of this system borrow very short-term and in liquid ways, are more highly leveraged than banks (the exception being money market funds) and lend and invest into more illiquid and long-term instruments. Like banks, they carry the risk that an otherwise solvent but liquid institution may be subject to a self-fulfilling and destructive run on its liquid liabilities.

But unlike banks, which are sheltered from the risk of a run – via deposit insurance and central banks’ lender-of-last-resort liquidity – most members of the shadow system did not have access to these firewalls that prevent runs.

A generalised run on these shadow banks started when the deleveraging after the asset bubble bust led to uncertainty about which institutions were solvent. The first stage was the collapse of the entire SIVs/conduits system once investors realised the toxicity of its investments and its very short-term funding seized up.

The next step was the run on the big US broker-dealers: first Bear Stearns lost its liquidity in days. The Federal Reserve then extended its lender-of-last-resort support to systemically important broker-dealers. But even this did not prevent a run on the other broker-dealers given concerns about solvency: it was the turn of Lehman Brothers to collapse. Merrill Lynch would have faced the same fate had it not been sold. The pressure moved to Morgan Stanley and Goldman Sachs: both would be well advised to merge – like Merrill – with a large bank that has a stable base of insured deposits.

The third stage was the collapse of other leveraged institutions that were both illiquid and most likely insolvent given their reckless lending: Fannie Mae and Freddie Mac, AIG and more than 300 mortgage lenders.

The fourth stage was panic in the money markets. Funds were competing aggressively for assets and, in order to provide higher returns to attract investors, some of them invested in illiquid instruments. Once these investments went bust, panic ensued among investors, leading to a massive run on such funds. This would have been disastrous; so, in another radical departure, the US extended deposit insurance to the funds.

The next stage will be a run on thousands of highly leveraged hedge funds. After a brief lock-up period, investors in such funds can redeem their investments on a quarterly basis; thus a bank-like run on hedge funds is highly possible. Hundreds of smaller, younger funds that have taken excessive risks with high leverage and are poorly managed may collapse. A massive shake-out of the bloated hedge fund industry is likely in the next two years.

Even private equity firms and their reckless, highly leveraged buy-outs will not be spared. The private equity bubble led to more than $1,000bn of LBOs that should never have occurred. The run on these LBOs is slowed by the existence of “convenant-lite” clauses, which do not include traditional default triggers, and “payment-in-kind toggles”, which allow borrowers to defer cash interest payments and accrue more debt, but these only delay the eventual refinancing crisis and will make uglier the bankruptcy that will follow. Even the largest LBOs, such as GMAC and Chrysler, are now at risk.

We are observing an accelerated run on the shadow banking system that is leading to its unravelling. If lender-of-last-resort support and deposit insurance are extended to more of its members, these institutions will have to be regulated like banks, to avoid moral hazard. Of course this severe financial crisis is also taking its toll on traditional banks: hundreds are insolvent and will have to close.

The real economic side of this financial crisis will be a severe US recession. Financial contagion, the strong euro, falling US imports, the bursting of European housing bubbles, high oil prices and a hawkish European Central Bank will lead to a recession in the eurozone, the UK and most advanced economies.


European financial institutions are at risk of sharp losses because of the toxic US securitised products sold to them; the massive increase in leverage following aggressive risk-taking and domestic securitisation; a severe liquidity crunch exacerbated by a dollar shortage and a credit crunch; the bursting of domestic housing bubbles; household and corporate defaults in the recession; losses ****** by regulatory forbearance; the exposure of Swedish, Austrian and Italian banks to the Baltic states, Iceland and southern Europe where housing and credit bubbles financed in foreign currency are leading to hard landings.

Thus the financial crisis of the century will also envelop European financial institutions.





The writer, chairman of Roubini Global Economics (RGE Monitor), is professor of economics at the Stern School of Business, New York University

Let me now elaborate in more details on the arguments of this column also in light of the just announced decision to convert Morgan Stanley and Goldman Sachs into banks that will be regulated like banks...

Iniciado por Fraga II

Por cierto, una lástima no poder leer el artículo "La peor crisis financiera desde la Gran Depresión". Normalmente con pegar un par de líneas de texto, seguido de "Roubini", aparecían varios Blogs sobre coÑomía con el artículo íntegro, pero el truquillo esta vez no me ha resultado.

La propuesta del gobierno es una "estafa"
09/29/08

¿Comprar $700 mil millones de activos tóxicos es el mejor camino para recapitalizar el sistema financiero? ¡No! Es más bien una desgracia y un timo que sólo beneficia a los accionistas y acreedores no asegurados de los bancos.

..
Nouriel Roubini*






En cualquier crisis sistémica bancaria, existe la necesidad de recapitalizar el sistema financiero bancario para evitar una contracción excesiva y destructiva del crédito. Pero comprar activos no líquidos / tóxicos del sistema financiero no es la forma más efectiva y eficiente para hacerlo. Tal recapitalización —vía el uso de recursos públicos— puede ocurrir en otras formas alternativas: La compra de malos activos /préstamos; La inyección de gobierno a acciones preferidas; La inyección del gobierno a acciones comunes; La compra del gobierno de deuda subordinada; La emisión de bonos del gobierno a ser colocados en los balances de los bancos; La inyección del gobierno con dinero en efectivo; Líneas de crédito del gobierno extendidas a los bancos; La presunción del gobierno de adeudos del gobierno; etc.

Un estudio reciente del FMI (Fondo Monetario Internacional) de 42 crisis sistémicas bancarias a través del mundo, dan evidencias de cómo diferentes crisis fueron resueltas. Ante todo, sólo en 32 de los 42 casos hubo intervención financiera del gobierno de algún tipo; En 10 casos se resolvió sin la intervención financiera el gobierno. De los 32 casos donde el gobierno recapitalizó el sistema bancario, sólo siete incluyeron un programa de compra de malos activos /préstamos (como el propuesto por el Secretario del Tesoro estadounidense). En 25 otros casos no hubo compra del gobierno de tales activos tóxicos. En 6 casos el gobierno compró acciones preferenciales; En 4 casos el gobierno compró acciones comunes; En 11 casos el gobierno compró deuda subordinada; En 12 casos el gobierno inyectó dinero en efectivo a los bancos; En 2 casos se extendió crédito a los bancos; Y en 3 casos el gobierno asumió las deudas bancarias. Aun en los casos dónde los malos activos fueron comprados —como en Chile— los dividendos fueron suspendidos y todas las ganancias y recuperaciones fueron usados para volver a comprar los malos activos. Por supuesto, en la mayoría de los casos el gobierno uso múltiples formas de recapitalización bncaria.

Pero la compra de gobierno de malos activos fue la excepción en vez de la regla. Esto fue usado sólo en México, Japón, Bolivia, República Checa, Jamaica, Malasia, y Paraguay. Incluso en seis de estos siete casos, donde la recapitalización de bancos ocurrió vía la compra de malos activos por parte del gobierno, la recapitalización fue una combinación de compra de malos activos junto con otras formas de recapitalización (como la compra de acciones preferidas o deuda subordinada).

En el caso de la crisis de la banca escandinava (Suecia, Noruega, Finlandia) que son un modelo de cómo debería resolverse una crisis bancaria, no hubo compra del gobierno de malos activos; La mayor parte de la recapitalización ocurrió a través de diversas inyecciones directas de capital público en el sistema bancario. En lugar de eso, la compra de activos tóxicos —en los casos que ocurrió— hizo que el costo fiscal de la crisis fuera mucho más alta y costosa (como en Japón y México).

Así, el reclamo que hacen la Reserva Federal y el Tesoro, de que gastar $700 mil millones del dinero público es la mejor forma para recapitalizar bancos, no tiene justificación o base objetiva. Esta forma de recapitalizar las instituciones financieras es un timo total que, en su mayor parte, beneficiará —con un gasto enorme para el contribuyente estadounidense— a los accionistas comunes y preferenciales, e incluso a los acreedores no asegurados de los bancos. Incluso, la última garantía de que el gobierno pondrá a cambio una inyección masiva de dinero público, es sólo una hoja de parra cosmética de dudoso valor, dado que la forma y el tamaño de tales garantías son completamente ambiguas y borrosas.

Así, este plan de rescate es una enorme y masiva fianza para salvar a los accionistas y los acreedores no asegurados de las firmas financieras (no solo de los bancos sino también de las instituciones financieras no bancarias); Con $700 mil millones, del dinero de los contribuyentes, los banqueros imprudentes y los inversionistas se harán más gordos, bajo el falso argumento de que pagar la fianza de Wall Street es necesario para rescatar a los pequeños empresarios y a la población de una severa recesión. En lugar de eso, la restauración de la salud financiera de las angustiadas firmas financieras pudo lograrse con un uso más barato y eficiente del dinero público.

Ciertamente, el plan tampoco se ocupa de la necesidad de recapitalizar a las instituciones financieras que están severamente infracapitalizadas: Esto pudo haberse logrado usando una parte de los $700 mil millones, para inyectar fondos públicos en otras formas más efectivas que comprar activos tóxicos: Con inyecciones públicas a las acciones preferidas de estas firmas; Con inyecciones de capital que exijan a los actuales accionistas asumir las pérdidas de primera fila ante la recapitalización pública; Vía suspensión de pagos de dividendos; O por la conversión de una parte de la deuda no asegurada en patrimonios netos (un trueque de la deuda por patrimonios).

Todas estas acciones habrían implicado un costo fiscal muy inferior para el gobierno, a la vez que hubiera obligado a los accionistas y los acreedores de los bancos a contribuir a la recapitalización de los bancos. Así, menos de $700 mil millones del dinero público se pudo haber gastado si los accionistas privados y los acreedores se hubieran visto forzados a contribuir a la recapitalización; Y sea cual fuere el tamaño de la contribución pública a ser distribuida entre las compras de malos activos y formas más eficientes de recapitalización (acciones preferenciales, acciones comunes, sub deudas), hubiera sido diferente.

Por ejemplo, si el sector privado hubiera cumplido con su parte sólo se hubiera usado $350 mil millones del dinero público; Y de esa suma la mitad pudo haberse usado en la compra de malos activos y la otra mitad a través de una inyección de capital público en estas instituciones financieras. Así, en lugar de adquirir —probablemente a un precio excesivo— $700 mil millones de activos tóxicos, el gobierno pudo haber logrado el mismo resultado —o uno mejor recapitalizando los bancos— gastando $175 mil millones en la compra directa de activos tóxicos.

Y aun después de que el gobierno derroche $700 mil millones activos tóxicos, muchos bancos que aún no han hecho provisiones para perdidas/retiros estarán aún más infracapitalizados. De modo que este plan ni siquiera logra el objetivo básico: recapitalizar bancos infracapitalizados. El plan del Tesoro tampoco incluye explícitamente un programa estilo-HOLC (Home Owners' Loan Corporation) para reducir la carga de la deuda al sector angustiado de las viviendas; Sin tal componente la deuda de los propietarios de viviendas continuará deprimiendo el consumo y exacerbará la contracción económica actual.

Así, el plan del Secretario del Tesoro es una desgracia: Un rescate de banqueros imprudentes, prestamistas e inversionistas, que provee poco alivio a los grupos familiares agobiados financieramente por las deudas hipotecarias y se convertirá en un costo muy alto para el contribuyente estadounidense. Y el plan tampoco hace nada para resolver la severa depresión en los mercados de valores, y los mercados inter-bancarios que ahora están próximos a un colapso sistémico. Es patético que el Congreso no haya consultado con cualquier de los muchos economistas profesionales que han presentado —como muchos los han hecho en el foro del blog RGE Monitor Financian— planes alternativos que hubieran sido más justos, eficientes y menos costos para resolver esta crisis. Otra vez, éste es un caso de privatizar las ganancias y socializar las pérdidas; Un rescate y un socialismo para los ricos, los bien relacionados y Wall Street. E incluso es un escándalo de que el Congreso Demócrata haya caído en esta estafa del Tesoro Público, que hace poco por resolver la deuda de millones de afligidos dueños de casas.








* Nouriel Roubini es profesor de la escuela de negocios Stern de Nueva York, uno de los pocos que, desde su blog Global EconoMonitor (RGE - Nouriel Roubini's Global EconoMonitor), predijo la actual crisis económica.


Texto Original:

http://www.rgemonitor.com/roubini-mo...of_banks/print



Traducción: Luis Aguilar

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Financial and Corporate System is in Cardiac Arrest: The Risk of the Mother of All Bank Runs
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Nouriel Roubini | Oct 3, 2008




It is now clear that the US financial system - and now even the system of financing of the corporate sector - is now in cardiac arrest and at a risk of a systemic financial meltdown. I don’t use these words lightly but at this point we have reached the final 12th step of my February paper on “The Risk of a Systemic Financial Meltdown: 12 Steps to a Financial Disaster” (Step 9 or the collapse of the major broker dealers has already widely occurred).



Yesterday Thursday a senior market practitioner in a major financial institution wrote to me the following:

Situation Report: So far as I can tell by working the telephones this morning:


* LIBOR bid only, no offer.
* Commercial paper market shut down, little trading and no issuance.
* Corporations have no access to long or short term credit markets -- hence they face massive rollover problems.
* Brokers are increasingly not dealing with each other.
* Even the inter-bank market is ceasing up.




This cannot continue for more than a few days. This is the economic equivalent to cardiac arrest. Then we debated what is necessary to restart the system.


I believe that the government will do another Hail Mary pass, with massive guarantees to the short-term commercial credit system and wide open short-term lending by the Fed (2 or 3 times expansion of the Fed balance sheet). If done on a sufficient scale this action will probably work for a while. But none of these financial measures affects the accelerating recession -- which will in turn place more pressure on the financial sector.

Another senior professional in a major global financial institution wrote to me:

Today, in our trading room, I could see the manifestations of a lending freeze, and the funding hiatus for banks and companies, with libor bid only, the commercial paper market closed in effect, and a scramble for cash - really really scary.

Do you think this is treatable without a) a massive coordinated liquidity boost and easing of monetary policy and b) widespread nationalisation of some banks, gtess to others AND a good bank/bad bank policy where some get wiped along with their investors? The Treasury Tarp plan is an irrelevance if we are at a major funding crisis.

And to confirm the near systemic collapse of the system of financing of both financial firms and corporate firms Warren Buffett declared yesterday, as reported by Bloomberg:

the U.S. economy is ``flat on the floor'' after a cardiac arrest as companies struggle to secure funding and unemployment increases.

``In my adult lifetime I don't think I've ever seen people as fearful, economically, as they are now,'' Buffett said today in an interview with Charlie Rose to be broadcast tonight on PBS. ``The economy is going to be getting worse for a while.' …The credit freeze is ``sucking blood'' from the U.S. economy, Buffett said.

We are indeed at the cardiac arrest stage and at risk of the mother of all bank and non-ban runs as:

- The run on the shadow banking system is accelerating as: even the surviving major broker dealers (Morgan Stanley and Goldman Sachs) are under severe pressure (Morgan losing over a third of its hedge funds clients); the run on hedge funds is accelerating via massive redemptions and a roll-off of their overnight repo lines; the money market funds are experiencing further withdrawals in spite of government blanket guarantee.



- A silent run on the commercial banks is underway. In Q2 of 2008 the FDIC reported $4462bn insured domestic deposits out of $7036bn total domestic deposits; thus, only 63% of domestic deposits are insured. Thus $ 2574bn of deposits were not insured. Given the risk that many banks – small, regional and national – may go bust (as even large ones such as WaMu and Wachovia went recently bust) there is now a silent run on parts of the banking system. Deposit insurance formally covers only deposits up to $100000. Thus any individual, small or large business and/or foreign investor or financial institution with more than $100000 in a FDIC insured bank is now legitimately concerned about the safety of its deposits. Even if as likely the deposit insurance limit will be temporarily raised to $250000 by Congress there will still be a whopping $1.9 trillion of uninsured deposits (or 73% of total deposits); thus, a huge mass of uninsured deposits will remain at risk as even small businesses have usually more than $250K of cash while medium sized and large firms as well as any domestic and foreign financial institution or investor with exposure to US banks has average exposure in the millions of dollars. Particularly at risk are the cross border mostly short term interbank lines of US banks with their foreign counterparties that are estimated to be close to $800 billion.


- A run on the short term liabilities of the corporate sector is also underway as the commercial paper market has effectively shut down with little trading and no issuance or rollover of such debt while corporations have no access to long or short term credit markets and they are therefore facing massive rollover problems (over $500 billion of rollover of maturing debts in the next 12 months). Indeed, the market for commercial paper plummeted $94.9 billion to $1.6 trillion for the week ended Oct. 1 (and down over $200 billion in the last three weeks). Especially banks and insurers were unable to find buyers for the short-term debt: financial paper accounted for most of the decline, plunging $64.9 billion, or 8.7 percent in the last week; but now even non-financial corporations are also experiencing a severe roll-off in the CP market. Discount rates for investment-grade non-financial commercial paper spiked to 599bp for 60 day maturities. More companies are borrowing against or tapping their revolving credit lines. This is largely due to the dislocation caused in the money markets by the failure of Lehman and the subsequent withdrawals from money market funds, which are some of the biggest providers of liquidity in the short term funding/commercial paper. Even the largest corporations are at severe stress: AT&T last week was forced to rely on overnight funding for its treasury operations, as lenders were unwilling to provide more long term financing due to fears in money market funds over investor redemption. The CEO said “It’s loosened up a bit, but it’s day-to-day right now. I mean literally it’s day-to-day in terms of what our access to the capital markets looks like,’’ Things are much worse for non-investment grade corporations and for small and medium sized businesses. As reported today by Bloomberg: Almost 100 U.S. corporate treasurers gathered for an emergency conference call yesterday to warn each other that banks are using any excuse to charge more to renew lines of credit. ``Capital is fleeing to safety,'' said Edward E. Liebert, treasurer of Rohm & Haas Co., who took part in the 90-minute call organized by the National Association of Corporate Treasurers. ``Interbank lending is not free-flowing any more,'' said Liebert, 56, chairman of the Reston, Virginia-based trade group. One bank charged a participant in the call 80 basis points to renew a routine $25 million credit line, according to Liebert, who wouldn't identify the speaker or the company. Rohm & Haas, based in Philadelphia and rated BBB by Standard & Poor's, is paying 8 basis points for a $750 million revolving line of credit provided by 13 banks, the treasurer said. A basis point is 0.01 percentage point. As the U.S. House of Representatives prepares to vote on a $700 billion bailout bill passed by the Senate, global credit markets are being squeezed by banks afraid to lend to each other and to even some investment-grade corporate clients. Treasurers are struggling to keep credit lines open so they can pay employees, fund pension benefits and purchase raw materials. ``The banks are really starting to play hardball,'' said Jeff Wallace, managing partner at Greenwich Treasury Advisors, a financial consultant in Boulder, Colorado. ``They don't want to give out any more money to people because they don't have enough capital”. Banks are demanding renegotiation of interest charges or lending terms when ``routine'' amendments are requested on lines of credit, said Thomas C. Deas Jr., treasurer of Philadelphia- based FMC Corp. and an association board member.


- The money markets and interbank markets have shut down as - despite the Senate passing the bail-out bill - yesterday USD Overnight Libor was still at 268bp after reaching an all-time high of 6.88%; the USD 3m Libor-OIS spread widened to record 270 basis points; EUR 3m LIBOR-OIS spread is at record 130bp; the TED spread is at record 360bps (TED was 11bps one month ago); Money and credit markets are dysfu.nctio.nal also in emerging markets ; and agency bond spreads are also at highs again.

So we are now facing:

- a silent run on the huge mass of uninsured deposits of the banking system and even a run on some insured deposits are small depositors are scared;

- a run on most of the shadow banking system: over 300 non bank mortgage lenders are now bust; the SIVs and conduits are now all bust; the five major brokers dealers are now bust (Bear and Lehman) or still under severe stress even after they have been converted into banks (Merrill, Morgan, Goldman); a run on money market funds restrained only by a blanket government guarantee; a serious run on hedge funds; a looming refinancing crisis for private equity firms and LBOs);

- a run on the short term liabilities of the corporate sector as the commercial paper market has totally frozen (and experiencing a roll-off) while access to medium terms and long term financings for corporations is frozen at a time when hundreds of billions of dollars of maturing debts need to be rolled over;

- a total seizure of the interbank and money markets.

This is indeed a cardiac arrest for the shadow and non-shadow banking system and for the system of financing of the corporate sector. The shutdown of financing for the corporate system is particularly scary: solvent but illiquid corporations that cannot roll over their maturing debt may now face massive defaults due to this illiquidity. And if the financing of the corporate sectors shuts down and remains shut down the risk of an economic collapse similar to the Great Depression becomes highly likely.

So what needs to be done? Even several hundreds of billion dollars in emergency liquidity support to the financial system by the Fed and other central banks in the last week alone have not been enough to stop the seizure of liquidity in interbank markets and the shut down of financing for the corporate sector as counterparty risk is now extreme (no one trusts any more in this crisis of confidence even the most reputable and trustworthy financial and corporate counterparties).

Thus, emergency times where we are at risk of a systemic meltdown require emergency measures. These include the following six ideas: