Are You Understanding the Global Economy Now?

In the last week, three massive European banks needed to be rescued.  I know, I know….the MSM is not covering what is happening in the global financial markets.  So what is new there?  The problems with the US housing market are effecting all the global markets, and now we have our government pumping money into Morgan Stanley and Goldman Sachs in hopes of keeping them alive. If you thought Wachovia was the last to go, think again.

According to Nouriel Roubini, an economist that writes a weekly column for Forbes, we are headed for rough times.  His column is clear, concise and precise.  Next: The Mother Of All Bank Runs?

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–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 (nyse: MS news people ) and Goldman Sachs (nyse: GS news people ).

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 (nyse: BAC news people ), 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 (other-otc: MSBHY.PK news people ) and a bunch of Japanese life insurers can take over Morgan.

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

Don’t panic…..get prepared.


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