Risk Drifts From Banks to Governments to You, Me: Mark Gilbert

Commentary by Mark Gilbert

Oct. 16 (Bloomberg) -- Anyone who lost money in the collapse of Lehman Brothers Holdings Inc. should probably be reaching for their lawyers about now.

Our money -- yours and mine -- is now keeping the global financial system afloat. In a capitulation that beggars belief, governments all around the world have pledged our money -- yours and mine -- to fund a ``No Bank Left Behind'' program. And no matter what the politicians say, that means our money -- yours and mine -- is now at risk in the casino.

So the decision to let Lehman go to the wall last month looks increasingly like (a) an experiment in brinkmanship gone wrong (b) a worthless sacrifice to the angry gods of moral hazard (c) the biggest mistake that the authorities have made during the current crisis (d) all of the above.

The U.S. Treasury's theory that the demise of Bear Stearns Cos. was rapid and unforeseen, whereas traders and investors had sufficient time to brace themselves for the collapse of Lehman, is undone by the chaos and panic seen in recent weeks as trading desks rush to untangle the mess of unraveling deals. Listen to any of the recent comments from European Central Bank policy makers on the topic of Lehman, and you can hear the undercurrent of puzzled anger at the decision.

Hoarding Carrots

It's way, way too early to gauge the effectiveness of U.S. Treasury Secretary Henry Paulson's plan to cure the financial crisis by spending $250 billion making Uncle Sam a shareholder in thousands of financial companies, guaranteeing bank debt and buying commercial paper.

What is clear, though, is that however many carrots the U.S. gives to Wall Street, the government doesn't have much of a stick to flagellate the banks into replanting those vegetables on Main Street, where the real economy is facing starvation.

``Leaving businesses and consumers without access to financing is totally unacceptable,'' Paulson said this week when he revealed his latest bailout for the banks. ``When you give them a stronger capital position and you also provide a certain amount of government backstop to their funding sources, it's incumbent upon them to go out and continue to lend,'' said assistant U.S. Treasury Secretary David Nason.

I disagree. If the alternative is lending money to businesses that are about to go bust and consumers who are about to lose their jobs, then restricting credit seems not just acceptable, it is downright prudent.

No Credit

``Will banks turn on the lending taps and will corporates fall over themselves for the liquidity? We don't think so,'' Suki Mann, a credit strategist at Societe Generale SA in London, wrote in a research note this week. ``Deleveraging won't stop overnight. The cost of credit will remain high.''

The global effort by central banks to shore up the precarious capital position of the financial industry using our money -- yours and mine -- is a direct consequence of the earlier decision to let Lehman hang.


The failure to prevent Lehman's collapse -- sandwiched between the shotgun marriage of Bear Stearns to JPMorgan Chase & Co. and the gazillion-dollar loan to keep American International Group Inc. from going pop -- sapped whatever remaining confidence banks had in each other. It removed any yardstick to judge which institutions would be deemed too important to fail.

Far from being a panacea, the accelerated effort to funnel our money -- mine and yours -- to plug the yawning holes in bank balance sheets, hasn't alleviated any of the dangers. Risk has just been reallocated.

Goldman Default

So the cost of buying credit-default swaps to insure against Goldman Sachs Group Inc. defaulting on its bonds plummeted to about 234 basis points this week from as high as 543 basis points last week. The benchmark default-swap on U.S. government debt, meantime, has jumped to about 37 basis points from 19 basis points two months ago.

In the U.K., Royal Bank of Scotland Group Plc default swaps cost about 85 basis points, down from almost 300 basis points last week. U.K. government debt, though, is deemed twice as risky as it was two months ago in the credit-derivatives market.

``With country after country guaranteeing deposits and senior creditors, and also doing everything they can to protect the financial system as we know it, senior financial risks should migrate closer toward sovereign risk,'' Jim Reid, a credit strategist at Deutsche Bank AG in London, wrote in a report this week.

Pension Pain

It doesn't stop there. The crisis of confidence has destroyed about $27 trillion of value in the global stock market in the past year. That isn't a typographical error. The combined market capitalization of the world's publicly traded companies is down to about $36 trillion, from a high of $63 trillion reached a year ago, according to data compiled by Bloomberg.

So anyone who has diligently socked money away into a pension plan has seen the value of those contributions destroyed. Put another way, risk has been transferred down the food chain. It started in the banks, filtered through the governments, and now it is infecting our pensions -- yours and mine.

You can guess what is coming next in this crisis. Regulators will call for centralized oversight of financial markets. Some bright spark will suggest that what the world needs is a global central bank, within the environs of the Bank for International Settlements.

And an ex-partner of Goldman will humbly agree to run the show. Rearrange the words ``stable door,'' ``shutting the,'' and ``after the horse has bolted'' to form a well-known phrase.

(Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Mark Gilbert in London at magilbert@bloomberg.net