There's a bogeyman in American political circles, but he's also brilliant - at least, more brilliant than most of us around here. Do you all remember that batty diary a couple of days ago about how we were five hours away from societal collapse last September 18th? Well, here's how the Bogeyman explains it:
On Monday September 15, Lehman Brothers, the US investment bank, was allowed to go into bankruptcy without proper preparation. [...] The price of credit default swaps, a form of insurance against companies defaulting on debt, went through the roof as investors took cover. AIG, the insurance giant, was carrying a large short position in CDS and faced imminent default. By the next day Hank Paulson, then US Treasury secretary, had to reverse himself and come to the rescue of AIG.
But worse was to come. Lehman was one of the main market-makers in commercial paper and a large issuer of these short-term obligations to boot. Reserve Primary, an independent money market fund, held Lehman paper and, since it had no deep pocket to turn to, it had to “break the buck” – stop redeeming its shares at par. That caused panic among depositors: by Thursday a run on money market funds was in full swing.
Interesting, huh? It wasn't a shadowy Arabic hand that pulled trillions of dollars out of our system all at once. It was herd behavior. But how could this happen?
More from the bogeyman, after explaining exactly how the makeup of the CDS instruments create demand for pushing the financial system out of whack:
[...]Lehman, AIG and other financial institutions were destroyed by bear raids in which the shorting of stocks and buying of CDS amplified and reinforced each other. Unlimited shorting was made possible by the 2007 abolition of the uptick rule (which hindered bear raids by allowing short-selling only when prices were rising). The unlimited selling of bonds was facilitated by the CDS market. Together, the two made a lethal combination.
The bogeyman then goes further. He has a pronouncement about how we (and Barack Obama) can avoid a Depression:
It can be done – by creating money to offset the contraction of credit, recapitalising the banking system and writing off or down the accumulated debt in an orderly manner. They require radical and unorthodox policy measures. For best results, the three processes should be combined.
[...]
To prevent the US economy from sliding into a depression, Mr Obama must implement a radical and comprehensive set of policies. Alongside the well-advanced fiscal stimulus package, these should include a system-wide and compulsory recapitalisation of the banking system and a thorough overhaul of the mortgage system – reducing the cost of mortgages and foreclosures.
[...]
Alternative energy and developments that produce energy savings could serve as a new motor, but only if the price of conventional fuels is kept high enough to justify investing in those activities. That would involve putting a floor under the price of fossil fuels by imposing a price on carbon emissions and import duties on oil to keep the domestic price above, say, $70 per barrel.
Sounds like the fiscal stimulus package is underway, and Geithner/Obama's plan has something that sounds a lot like recapitalisation. We can hope that more work on mortgages and foreclosures comes next.
So, who is this smart bogeyman? Well, it's George Soros. Go read his full article here.