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by Christopher Chantrill
September 26, 2008 at 11:09 am
ON THURSDAY September 18, the Dow Industrials staged a robust recovery, soaring 5.4 percent from an intraday low of 10459.77 on news that the Feds intended to create a new Resolution Trust Corporation. The new RTC, similar to the agency that cleaned up the assets of the failed Savings and Loans back in 1989-1992, would address the illiquid assets on bank balance sheets that are at the underlying source of the current stresses in our financial institutions and markets, according to TheStreet.com. In 1989-1992 the original Resolution Trust Corporation probably saved the US from a serious recession, something that really would have been the worst economy in the last 50 years that Candidate Clinton claimed on the campaign trail.
Is this then the market bottom?
It could be. A century ago in in the Panic of 1907, the US experienced a similar crisis of confidence in its financial institutions. Back then the weak links in the chain were the so-called trust companies, most notoriously the Knickerbocker Trust, hot items offering better interest rates to depositors and more impressive facades than the regular banks. But in the credit crunch of 1907 it turned out that their assets werent of the best quality, and several of them failed. J.P. Morgan tried to get the presidents of the trust companies together to assist each other, but failed. Apparently the trust company CEOs figured that if they all hung together they would all hang.
But the turning point of the Panic of 1907 came on a swap of assets, according to Robert F. Bruner and Sean D. Carr in The Panic of 1907. On the weekend of November 3-4, 1907, it was feared that a stockbroker, Moore & Schley, would fail on Monday because the assets on which its working capital was secured, common stock in Tennessee Coal & Iron, was of questionable value. In other words, nobody knew if Moore & Schley was underwater or not.
Morgan and his associates devised a plan. They talked to the CEO of United States Steel, Elbert H. Gary, to get him buy a majority share in TC&I by exchanging stock in TC&I with a similar value in United States Steel 5 percent gold bonds. The takeover would bolster the stock of TC&I and save broker Moore & Schley. It took a bit of juggling, and an overnight trip on a private sleeper to Washington DC to get the approval of trustbuster President Theodore Roosevelt. But the deal was done before the market opened on Monday November 5, 1907. Stocks soared on the opening, and the crisis was over.
The same thing seems to have occurred with the RTC announcement on Thursday, September 18. If the Feds were willing to take the underwater loans off the market then the traders on Wall Street need no longer fear the underwater dark matter that might hole them under the water line. So stocks soared in the hope that the crisis was over.
The simple lesson to learn out of the credit crunch is that when people start to doubt the solvency of other market participants then the system starts to seize up. Obviously, the most vulnerable market participants are people who are highly leveraged. That would be Wall Stree investment firms with a reported 60 to 1 leverage ratioships sailing with roughly two percent freeboard above water. Or it would include homeowner with a 90 percent mortgage in a down market. Any decline in asset values puts these marginal players underwater and the system at risk.
But business is about more than proper collateral and sensible debt-to-equity ratios.
Congress failed to understand this when it investigated the banking business in the Pujo hearings in 1912. Here is J.P. Morgan testifying to a lawyer on character.
Mr. UNTERMYER. Is not commercial credit based primarily upon money or property?
Mr. MORGAN. No, sir; the first thing is character.
Mr. UNTERMYER. Before money or property?
Mr. MORGAN. Before money or anything else. Money cannot buy it.
And so on. Samuel Untermyer could not understand that, for Morgan, the question of collateralizing a loan was far less important that the character of the man to whom he was loaning the money. A man who is leveraged up to the eyeballs is a man saying: heads I win big, and tails you are all sunk. He is not a man you can trust.
J.P. Morgan solved the credit crunch in the Panic of 1907. The Resolution Trust Corporation solved the S&L crisis nearly 20 years ago. And we all hope that todays J.P. Morgan, Treasury Secretary Henry Paulson, has got the current crisis in hand.
So well probably muddle through this one.
But theres a bigger issue to consider. It is the question addressed by Laurence Gonzales in Deep Survival. Accidents happen. Large accidents, while rare, are normal. Efforts to prevent accidents and make systems safer often make the systems more complex and therefore more prone to accidents. Tightly coupled systems, like financial markets, in which everyone is connected to everyone else, are especially prone to systemic error.
Maybe the economy needs less complexity and more character.
Buy his Road to the Middle Class.
The incentive that impels a man to act is always some uneasiness...
But to make a man act [he must have]
the expectation that purposeful behavior has the power to remove
or at least to alleviate the felt uneasiness.
Ludwig von Mises, Human Action
But I saw a man yesterday who knows a fellow who had it from a chappie
that said that Urquhart had been dipping himself a bit recklessly off the deep end.
Dorothy L. Sayers, Strong Poison
At first, we thought [the power of the West] was because you had more powerful guns than we had. Then we thought it was because you had the best political system. Next we focused on your economic system. But in the past twenty years, we have realized that the heart of your culture is your religion: Christianity.
David Aikman, Jesus in Beijing
[In the] higher Christian churches... they saunter through the liturgy like Mohawks along a string of scaffolding who have long since forgotten their danger. If God were to blast such a service to bits, the congregation would be, I believe, genuinely shocked. But in the low churches you expect it every minute.
Annie Dillard, Holy the Firm
Civil Societya complex welter of intermediate institutions, including businesses, voluntary associations, educational institutions, clubs, unions, media, charities, and churchesbuilds, in turn, on the family, the primary instrument by which people are socialized into their culture and given the skills that allow them to live in broader society and through which the values and knowledge of that society are transmitted across the generations.
Francis Fukuyama, Trust
In England there were always two sharply opposed middle classes, the academic middle class and the commercial middle class. In the nineteenth century, the academic middle class won the battle for power and status... Then came the triumph of Margaret Thatcher... The academics lost their power and prestige and... have been gloomy ever since.
Freeman Dyson, The Scientist as Rebel
Conservatism is the philosophy of society. Its ethic is fraternity and its characteristic is authority the non-coercive social persuasion which operates in a family or a community. It says we should....
Danny Kruger, On Fraternity
What distinguishes true Conservatism from the rest, and from the Blair project, is the belief in more personal freedom and more market freedom, along with less state intervention... The true Third Way is the Holy Grail of Tory politics today - compassion and community without compulsion.
Minette Marrin, The Daily Telegraph
When we received Christ, Phil added, all of a sudden we now had a rule book to go by, and when we had problems the preacher was right there to give us the answers.
James M. Ault, Jr., Spirit and Flesh
I mean three systems in one: a predominantly market economy; a polity respectful of the rights of the individual to life, liberty, and the pursuit of happiness; and a system of cultural institutions moved by ideals of liberty and justice for all.
In short, three dynamic and converging systems functioning as one: a democratic polity, an economy based on markets and incentives, and a moral-cultural system which is plural and, in the largest sense, liberal.
Michael Novak, The Spirit of Democratic Capitalism
There was nothing new about the Frankish drive to the east... [let] us recall that the continuance of their rule depended upon regular, successful, predatory warfare.
Richard Fletcher, The Barbarian Conversion
We have met with families in which for weeks together, not an article of sustenance but potatoes had been used; yet for every child the hard-earned sum was provided to send them to school.
E. G. West, Education and the State