Friday, October 03, 2008


Doctor Doom

Next: The Mother Of All Bank Runs?

Nouriel Roubini 10.02.08, 12:01 AM ET

It's plain that the current financial crisis is worsening in spite of--or perhaps because of--the Treasury rescue plan.

The strains in financial markets are becoming more, rather than less, severe in spite of the nuclear option of a $700 billion package: Interbank spreads are widening and are at a level never seen before; credit spreads are widening to new peaks; short-term Treasury yields are going back to near-zero levels as there is flight to safety; credit default swap (CDS) spreads for financial institutions are rising to extreme levels as the ban on shorting of financial stock has moved the pressures on financial firms to the CDS market; and stock markets around the world have reacted very negatively to this rescue package.

Financial institutions in the U.S. and in advanced economies are going bust. In the U.S., the latest victims were Washington Mutual (the largest U.S. savings and loan) and Wachovia (the sixth largest U.S. bank). In the U.K., after Northern Rock and the acquisition of HBOS by Lloyds TSB, you now have the bust and rescue of Bradford & Bingley; in Belgium you had Fortis going bust and being rescued over the weekend; in Germany, Hypo Real Estate, a major financial institution near bust, has also needed rescue.

So, this is not just a U.S. financial crisis. It is a global crisis hitting institutions in the U.K., the Euro-zone and other advanced economies (Iceland, Australia, New Zealand, Canada etc.).

The strains in financial markets--especially short-term interbank markets--are becoming more severe in spite of the Fed and other central banks having injected $300 billion of liquidity in the financial system last week alone, including massive liquidity lending to Morgan Stanley and Goldman Sachs.

In a solvency and credit crisis that goes well beyond illiquidity, no one is lending to counter-parties as no one trusts any counter-party (even the safest ones), and everyone is hoarding the liquidity that is injected by central banks. And since this liquidity goes only to banks and major broker-dealers, the rest of the shadow banking system has no access to this liquidity as the credit transmission mechanisms are blocked.

After the bust of Bear and Lehman, and the merger of Merrill with Bank of America, I suggested that Morgan Stanley and Goldman Sachs should also merge with a large financial institution that has a large base of insured deposits so as to avoid a run on their overnight liabilities. Instead, Morgan and Goldman took a cosmetic approach, converting themselves into bank holding companies as a way to get further liquidity support--and regulation as banks--from the Fed and as a way to acquire safe deposits.

But neither institution can create, in a short time, a franchise of branches, and neither one has the time and resources to acquire smaller banks. And the injection of $8 billion of Japanese capital into Morgan and $5 billion of capital from Warren Buffett into Goldman is a drop in the ocean, as both institutions need much more capital.

Thus, the gambit of converting into banks while not being banks yet hasn't worked, and the run against them has accelerated in the last week: Morgan's CDS spread went through the roof on Friday to over 1200, and the firm has already lost over a third of its hedge-fund clients together with the highly profitable prime brokering business (this is really a kiss of death for Morgan). And the coming roll-off of the interbank lines to Morgan would seal its collapse. Even Goldman Sachs is under severe stress: Most of its lines of business (including trading) are now losing money.

Both institutions should stop playing for time, as delay will be destructive: They should merge now with a large foreign financial institution, as no U.S. institution is sound enough and large enough to be a solid merger partner. If John Mack and Lloyd Blankfein don't want to end up like Richard Fuld, they should do a John Thain today and merge as fast as they can with other large commercial banks. Maybe Mitsubishi and a bunch of Japanese life insurers can take over Morgan.

The only institution sound enough to swallow Goldman may be HSBC. Or maybe Nomura in Japan should make a bid for Goldman. Either way, Mack and Blankfein should sell at a major discount before they end up like Bear and are offered, in a few weeks, only a couple of bucks a share for their faltering operation. And the Fed and Treasury should tell them to hurry up, as they are both much bigger than Bear or Lehman, and their collapse would have severe systemic effects.

When investors don't trust even venerable institutions like Morgan Stanley and Goldman Sachs, you know that the financial crisis is as severe as ever. When a nuclear option of a monster $700 billion rescue plan is not even able to rally stock markets, you know this is a global crisis of confidence in the financial system.

The next step of this panic could be the mother of all bank runs, i.e. a run on the trillion dollar-plus of the cross-border short-term interbank liabilities of the U.S. banking and financial system, as foreign banks start to worry about the safety of their liquid exposures to U.S. financial institutions. A silent cross-border bank run has already started, as foreign banks are worried about the solvency of U.S. banks and are starting to reduce their exposure. And if this run accelerates--as it may now--a total meltdown of the U.S. financial system could occur.

The U.S. and foreign policy authorities seem to be clueless about what needs to be done next. Maybe they should today start with a coordinated 100 basis points reduction in policy rates in all the major economies in the world to show that they are starting to seriously recognize and address this rapidly worsening financial crisis.

Nouriel Roubini, a professor at the Stern Business School at NYU and chairman of Roubini Global Economics, is a weekly columnist for


An armed British police officer patrols Terminal Four of Heathrow airport in London
The terrorist threat in Britain has been considered severe since the arrest of the men allegedly plotting to attack transatlantic airliners in 2006 Photo: REUTERS

Bush will treat as done deals key issues only broached in Israel-Palestinian talks

DEBKAfile Exclusive Report

October 3, 2008, 10:36 PM (GMT+02:00)

A handshake behind Israel's back

A handshake behind Israel's back

US president George W. Bush went over Israel’s head last week and promised Palestinian leader Mahmoud Abbas to hand on to his successor as done deals the issues covered in the talks Israeli prime minister Ehud Olmert and foreign minister Tzipi Livni held with Palestinian leaders, DEBKAfile’s Washington sources reveal.

Olmert and Livni, who is Kadima’s nominee for prime minister, have told the Israeli public that nothing had been agreed in the series of talks they held with Abbas and senior Palestinian negotiator Ahmed Qureia from last year. No document or even working paper was signed to confirm claims by Olmert that Israel must give up East Jerusalem, withdraw from the West Bank except for once percent of the territory and accept tens of thousands of Palestinian 1948 refugees.

If agreed – which they were not - these issues are highly problematical and would need to seek approval Israel’s democratically-elected institutions.

But the US president has taken it upon himself to decide that the issues aired and left pending will henceforth be deemed by the US presidency closed between the parties. He will recommend this principle to the next administration in the belief that it will jump the Israel-Palestinian negotiating process forward toward a final accord in 2009. President Bush also promised Abbas the Palestinians would not be held accountable for the impasse reached by the talks this year.

The Palestinians are trumpeting Bush’s decision as a milestone on the road to achieving their goals. Abbas called Egyptian president Hosni Mubarak and King Abdullah of Jordan to give them the glad tidings.

It may be recalled that Bush was the first US president ever to back the Palestinian demand for independence and a “two-state solution” of the conflict.

DEBKAfile’s political sources say Bush has laid down a perilous precedent by hijacking Israel’s prerogative for accepting or rejecting Palestinian demands and trampling the authority of its elected institutions. If this precedent is applied to Israel’s indirect talks with Syria, it will be enough for Damascus to put the question of Israel’s withdrawal from the Golan on the table for it to be counted as agreed.

Secretary of state Condoleezza Rice visited Israel last month to try obtain a signed document summing up areas of accord to burnish the Bush foreign policy record before he left the White House. However, she was informed that the process had not advanced that far.

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