FAILURES OF FINANCIAL INSTITUTIONS

Failures Of Financial Institutions



Failures Of Financial Institutions

Introduction

In September 2008, after many months of declines in U.S. housing, mortgage securities, and currency markets, the U.S. banking and financial system suffered what was referred to as a financial heart attack. Credit markets froze, from interbank lending to bond markets and mortgage markets. The response by the Federal Reserve was a swift expansion in credit facilities to commercial banks, primary bond dealers, investment banks, and even one of the world's largest insurance companies, as well as guarantees for interbank lending, money markets and commercial paper. The Federal Deposit Insurance Corporation expanded its support for commercial banks and guarantees for deposit insurance. Congress passed the Troubled Asset Relief Program (TARP) authorizing $700 billion in emergency support for financial institutions and markets.

The origins of subprime mortgages and predatory lending can be traced back to such financial innovations, sanctioned through deregulation, as variable-rate loans and loans of shorter maturity that soon shifted the risks of rising interest rates from lenders to borrowers. Keynes himself wrote of the need for margin requirements (minimum down payment requirements) to limit systematic risk for the financial system.38 For some period of time, particularly during World War Two and the early post-war period, margin requirements were imposed as a tool by the Federal Reserve on loans for housing, consumer, and stock purchases. But such "selective credit controls" came to be seen as unwarranted intrusions by government in the marketplace. At the end of 2007 roughly 11,000 essentially unregulated, mainly unaudited, and largely off-shore domiciled hedge funds worldwide controlled about7 $2,250 billion in assets. Even if the results had been otherwise, namely that a strong statistical relationship had been demonstrated, this would not be valid evidence that economic value measures are better, indeed even appropriate, for management planning and control. (Miller 1987:235-265)

Discussion

Consumption goods are valued on benefits to be immediately received, financial assets are valued on disparate (heterogeneous) expectations about the future whose content is never wholly predictable. Despite this characteristic of financial markets, Young (2006) states that: “[b]y closely reading the stock market, managers can find out whether proposed strategies will be effective” (Young 2006:579-600) (emphasis added). But notions of valuation which neglect uncertainty imply no novelty, no effects of human reflexivity, and therefore no surprises. Miller (1987) calls the denial of uncertainty in financial markets “absurd” (Miller 1987:235-265). Lehman (2005) observes that: “contingency or 'chance' is an unanalyzable fact of nature” (Lehman 2005:975-992). John Maynard Keynes states that: “our knowledge of the factors which will govern the yield of an investment some years hence is usually very slight and often negligible” (1936, p. 149). In the real world “forecasting is difficult if it really is about the future” (Chwastiak 2005:533-552). Only in romanticized or fantasy notions of financial markets can this unavoidable and incorrigible condition be by-passed. Uncertainty cannot be analyzed away. Choices made in real time are never made with complete information. Extensive and often significant unpredictable and unanticipated events ...