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September 15, 2008

Comments

Dipper

crisis of ownership and principal agent risk is exactly correct Chris. The shareholders failed to exercise proper control over the senior management.

Blissex

«2-3 years ago, lots of experts claimed that hedge funds were a big source of systemic risk. They seem to have been wrong (so far!)»

One of the differences is that hedge funds are not quoted, and anyhow have mostly a long lockin period. Until another fund as big as Amaranth etc. blows up, who knows what's happening inside those privately held, closed-end funds?

«stock prices not so much as the discounted value of future cash flows, but rather as the probability-weighted price of a bundle of state-contingent securities»

That's one of the most obvious explanations for the so called stock risk premium.

Along with my favourite one: that talking of expected value of discounted cash flows makes no sense because of the lower zero boundary. Once a company has run out of cash, it closes, so survivorship bias.

Cheesy Monkey

My question would be how would Lehman's collapse and an apparent US financial services meltdown affect the UK, considering how much of the British economy is tied into the financial/banking sector?

A supplimentary thought: I have long believed that one of the main (if not, the main reasonings behind the widescale deregulations of the 1980s was to force the British economy to become reliant on the whims and wishes of multinational corporations and the banks and effectively give them the power to financially undermine any 'unfriendly' Government to a greater degree than was previously possible (after all, every Labour government prior to 1997 came up against some form of financial crisis after gaining power). Is this the case, even partially? Would this explain (in part) New Labour's craven supinity when it comes to big business?

Patrick

This is also a huge failure of regulation.

If a financial institution is small enough to be allowed to fail then this is, indeed, only a matter for shareholders and management.

But many banks are too big to fail - as that would pose severe systemic risk. (Imagine the Halifax going under!).

Where governments have even an implicit obligation to step in in the event of insolvency or illiquidity then I for one feel that governements have rights over the way such institutions work.

I used to work for a failed investment bank (Barings). The key problem is that traders can make fortunes by gambling massively with their employers capital. SO they have a giant upside. If they screw up (legally but just incompetently) then the worst they face is the sack. So no giant downside.

Management cannot and will not control this as they are the chief beneficiaries. If I was Chancellor I'd impose tight regulations on profit driven bonuses that did were not specifically adjusted for risk (beta) inherent in the underlying trades. This would, of course, kill the trading floor risky behaviour, much profitability and make trading only a service for clients. NO bad thing.

I work now in the finance function of Shell. Shell treasury policy basically says that treasury only transacts for the needs of its operating companies - no 'for profit' purely financial trades at all and almost no use of derivatives. Very sound!

anotherplanet

I would be less sanguine about the prospects of hedge funds. Ownership might be less divorced from control, but they're still gambling with other people's money for short-term gain. They are also less constrained by the accounting procedures and reporting restrictions applicable to the banks -and can 'lock' their investors in when things start to go pear-shaped.

Looking back at the collapse of Long Term Capital Management, it's quite a nostalgia trip to remember who bailed them out:
Bankers Trust, Barclays, Chase, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, Merrill Lynch, J.P.Morgan, Morgan Stanley, Salomon Smith Barney, UBS, Société Générale, Paribus and ... er ... Lehman Brothers.

Rick

But Lehmans was 30% employee owned - quite a high proportion for a large corporation.

Many of those who made the decisions that killed the bank were people that owned a stake in it.

So much for ownership and control.

ad

What fraction of their personal assets was tied up in the bank?

"a once-in-a-century type of financial crisis"

Is it my imagination, or do we have one of these every decade or so?

Letters From A Tory

To be fair, Lehman has been on its last legs for months. The collapse yesterday was only because a potential buyer pulled out - the bank was in trouble well before yesterday.

Think Money

Barclays pulling out? What happened to the other two buyers, and could they not wait another couple of days before pulling the plug completely...?

Luis Enrique

What is the difference between believing the probability of a catastrophe hasn’t increased much, and believing that the present value of expected earnings hasn't decreased much? Earnings expectations are state contingent aren't they?

What do you make of the argument, being made here and there, that these failures show that the market did spread risks like it oughta, and the failures are happening to those who could best bear the risk?

What decides the question? How do we tell the difference between risks being spread as the ought, and risks being magnified and pooled in the wrong places? What pattern of failures in the crisis ought we expect in each case?

Matthew

Kaletsky is now quite pessimistic.

Frank Miller

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