When the Levee Breaks

A now tired and dog-eared phrase is "When the United States sneezes, the rest of the world catches a cold." This may be true, but disease and illness tends to only affect those with already weakened immune systems, be that due to stress, an already present underlying illness or just being run down in general. Thanks to the massive interbank network the slightest sniffle could be transmitted with ease.

As the pandemic spread there were a lot of fatalities and injuries along the way. 

RBS, IKB, Sachsen LB, Bear Sterns, Countrywide Financial, Northern Rock, Merrill Lynch, IndyMac, were victims of the crash either experiencing runs, being nationalised, being bailed out or sold off to other banks. Washington Mutual was sold to J.P. Morgan Chase, Wachovia was sold to Wells Fargo. Goldman Sachs & Morgan Stanley decided to become bank holding companies, although their hand was forced in this case, the collapse of Lehman Brothers had weakend their position. By becoming bank holding companies it allowed them access to the lender of last resort facility. 

The list above is not even the tip of the iceberg. This link allows you to view a list of failed banks going back as far as 2005 and the image below shows who has acquired who.

AIG was hit hard by Lehman's fall, resulting in a life boat being sent out carrying $85billion. This escalated to $180 billion to keep it afloat. Governments promised to insure debt of their banks which calmed the bank run. Central banks were giving money and saving both the good and bad banks. Not a move that Bagehot would have approved of, even though Mervyn King said "We are certainly not going to protect people from unwise lending decisions' in 2007.

It wasn't just banks the crisis affected. Many emerging economies were affected by the virus spreading from the epicentre. What started in the U.S. spread. As Rothschild once said "The whole world has become a city"; a phrase that is as apt today as it first was in 1875.

Take for example China. China relies on exports as a massive source of income. The United States bought a lot of these exports, which meant Chinese growth depended upon the United States. When the United States slipped into a recession, it affected China, which in turn affected everyone else on the supply chain.

A shakeup in regulation soon followed. Basel III, Dodd-Frank 2010 which is currently at 848 pages long with many questions still left unanswered (http://www.economist.com/node/21547789). At this stage somebody should probably take a look at the credit rating agencies, a move towards eliminating the conflict of interest would probably be for the best. 


But perhaps most telling is those economies that weren't disrupted by the crisis. India survived. Although you could turn around and argue that maybe it is just slower to react. There may not be panic yet, but that doesn't mean there won't be. On the basis of my first point maybe we should look to them for guidance when it comes to regulation in the future.

Many countries in the Middle East had to bail out various different banks through preferred shares i.e. Citigroup obtained $7.5 billion from Abu Dhabi. Abu Dhabi also bailed out Dubai, resulting in Burj Dubai being renamed Burj Khalifa.

The levee had most certainly broke when the crisis reached its full force. The effects were felt around the world and left many people picking up the pieces of a system torn apart. Regulators were left scratching their heads wondering what to do next. Credit Rating agencies were left red faced.