Wall Street Bank Run

David Ignatius
Washington Post
Saturday, February 23, 2008

It doesn't look like an old-fashioned bank run because it involves the biggest financial institutions trading paper assets so complicated that even top executives don't fully understand the transactions. But that's what it is -- a spreading fear among financial institutions that their brethren can't be trusted to honor their obligations.

Frightened financiers are pulling back from credit markets -- going on strike, if you will -- to escape the unraveling daisy chain of securitized assets and promissory notes that binds the global financial system. As each financier tries to protect against the next one's mistakes, the whole system begins to sag. That's what we're seeing now, as credit market troubles spread from bundles of subprime residential mortgages to bundles of other kinds of debt -- from student loans to retailers' receivables to municipal bonds.

Investors are nervous because they aren't sure how to value these bundles of securitized assets. So buyers stay away, prices fall further, and the damage spreads.

The public, fortunately, doesn't understand how bad the situation is. If it did, we might have a real panic on our hands. And there would be more pressure for bad policies -- ones that try to freeze the damage, rather than letting prices fall to levels where buyers will return and the markets will clear. Hillary Clinton's proposed moratorium on home foreclosures, in that respect, is one of the truly bad ideas of our time. It would make the situation worse by increasing even more the illiquidity and inflexibility of the housing market.

The answer to Wall Street's bank run may be a version of what saved Main Street banks during the Great Depression. President Franklin Roosevelt created the Federal Deposit Insurance Corporation in 1933 to reassure the public that there was an insurer of last resort for the banks -- and that people's money was safe even if they couldn't see it or touch it or put it under a mattress. Rep. Barney Frank and other congressional experts are weighing different approaches to this problem of how to backstop the markets without Clinton's misguided moratorium.

These markets are now so complicated that most of us can't begin to understand the details. So I asked the chief financial officer of a leading concern to walk me through what has been happening. The problem, he said, is that financial institutions are required to "mark to market" their tradable assets (which is a fancy term for setting a value) even when there isn't a functioning market. In many cases dealers can do little more than guess at the value -- and other investors down the line know it.

Full article here.