Robert Stein 1924-2014

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Monday, September 15, 2008

Money Under the Mattress?

Childhood nightmares of the 1930s Depression are back today with the fall of Lehman Brothers and Merrill Lynch as the unthinkable becomes the possibly avoidable in a national economic meltdown.

"Will the U.S. financial system collapse today," asks economist Paul Krugman, "or maybe over the next few days? I don’t think so--but I’m nowhere near certain."

As a small-account holder at Merrill Lynch, my antennae went up after a phone call from someone there this weekend trying to sell me a certificate of deposit--an unprecedented pitch for cash to bail out the huge investment house.

Where did all the money go? "To understand the problem," Krugman writes, "you need to know that the old world of banking...has largely vanished, replaced by what is widely called the 'shadow banking system'...(M)ost of the business of finance is carried out through complex deals arranged by 'nondepository' institutions, institutions like the late lamented Bear Stearns--and Lehman.

"The new system was supposed to do a better job of spreading and reducing risk. But in the aftermath of the housing bust and the resulting mortgage crisis, it seems apparent that risk wasn’t so much reduced as hidden: all too many investors had no idea how exposed they were."

So do we withdraw whatever money we have and put it in The First Bank of Sealy Posturepedic and start looking forward to former stockbrokers selling apples on street corners?

Not quite yet, but extreme caution is in the air. Krugman says "the system has been experiencing postmodern bank runs. These don’t look like the old-fashioned version: with few exceptions, we’re not talking about mobs of distraught depositors pounding on closed bank doors. Instead, we’re talking about frantic phone calls and mouse clicks, as financial players pull credit lines and try to unwind counterparty risk. But the economic effects--a freezing up of credit, a downward spiral in asset values--are the same as those of the great bank runs of the 1930s."

To put it in terms of the presidential election campaign: Are you feeling better off than you did eight years ago?

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