A Primer On the Causes of the Global Credit Crisis

[azraelle]

The question that remains unanswered, though, is what happens when MANY banks threaten to go into default--to attempt to bail them all out would have the effect of causing a global meltdown in the confidence in the dollar by such governments as the Chinese, who hold many billions of dollars in government backed investment bonds. What happens then??

[Gibbous Moon]

It’s not great.

If bank or banks present themselves to the Uncle Sam looking for crisis support beyond the governments willingness (or worse ability) to provide funds what I think happens is

1) We stop lending to banks and banks stop lending to each other and to us. The whole financial system gums up. Otherwise sound businesses go bust through lack of financing or through financial distress to their customers or suppliers. The US economy shrinks.
2) There is a fire sale of US finance houses. Likely buyers are Asian capitalists as they have lots of cash as their economies are growing quickly and they seem less affected by the sub-prime issues so far.
3) People start withdrawing their dollars from the US and turning them back into other currencies. This will cause the dollar to fall but also as the US public sector debt is large will cause significant liquidity issues for the Government.
4) Because of 3 taxes will rise or public spending will fall
5) Because of all of the above Americans and America are poorer and a significant recession takes place in the US
6) This probably spreads to other parts of the world, affecting those economies closely linked to the US’s (the EU probably, especially as we have our own sub-prime issues). The exciting question is whether China is affected by a slow down in the US and EU. If we stop buying their cheap manufactured goods do they have another market or do they have a recession too.

Think 1929 with bells on.

I’ll see you all down at the soup kitchen and we can be glad that our countries are at least self sufficient for food and can be for energy.

GM

[myron myron]

I'm well aware that many Citibank and JP Morgan have investment banking activities/subsidiaries, but I don't agree with the general premise that commercial and investment banks are the same animal. A major investment bank like say Goldman Sachs is not afraid of say Bank of America as an investment banking rival. Even in the couple of exceptions where the giant banks have somewhat respectable investment banking arms, the activities and personnel are separate enough so that the bankruptcy of one sub doesn't necessarily mean the bankruptcy of the other.

Commercial banks not only rival but have surpassed investment banks in investment banking (underwriting securities).

Here is the Thomson Financial League Table for the first quarter of 2008 ranking of underwriters of Global Debt, Equity and Equity-related (on page 3):

1. JP Morgan
2. Citi
3. Deutsche Bank AG
4. Barclays Capital
5. Merrill Lynch
6. Goldman Sachs & Co.
7. Morgan Stanley
8. Credit Suisse
9. UBS
10. RBS

And here is the ranking of underwriters of Global Debt, Equity and Equity-related based on Imputed fees:

1. Citi
2. JP Morgan
3. Banc of America Securities LLC
4. Goldman Sachs & Co.
5. Merrill Lynch
6. Deutsche Bank AG
7. UBS
8. Morgan Stanley
9. Credit Suisse
10. Lehman Brothers

Citigroup wrote down $18.1 billion in losses related to asset backed securities (ABS) and collateralized debt obligations (CDOs) in the last quarter of 2007 and is expected to write down about $12 billion in the first quarter of 2008.

[Big Ben]

Fair enough point on the league tables, but the real point is that bailing out Citibank's commercial bank and bailing out Morgan Stanley the investment bank are different animals. Bailing out JP Morgan the commercial bank and bailing out JP Morgan's investment banking arm are different animals. Look at the balance sheets of commercial banks and investment banks. I'm saying the US government is treading on tricky ice if it is going to systematically bail out investment banks/subsidiaries as well as commercial banks/subsidiaries.

[myron myron]

From 1935 to 1999, U.S. federal law prohibited the same financial institution from accepting deposits and underwriting securities. As a result, commercial banks and investment banks were totally segregated. There were no parent-subsidiary or other machinations. When the prohibition was repealed in 1999, commercial banks began underwriting securities.

Citigroup was formed in 1998 from the merger of Citicorp, a commercial bank, and Travelers Group, an insurance company (the insurance arm was later spun off). As of the end of 2007, Citigroup was the world's largest company in terms of sales, market value, assets and profits.

Although Citigroup acquired two investment banks, Salomon Brothers and Smith Barney, it did not keep them separate or distinct. They were absorbed into Citigroup.

Citigroup is structured such that there is no segregation between investment banking and commercial banking, i.e., they are "business groups" within Citigroup. As indicated in the Thomson Financial League Tables, Citigroup underwrites securities as "Citi," which is the name of the commercial bank. The profits and losses from commercial banking and investment banking are incorporated into the financial statement of Citigroup

As I noted in my previous post, Citigroup wrote off $18.1 billion in CDO and ABS related losses for the last quarter of 2007 and is expected to write off another $12 billion in losses for the first quarter of 2008. If Citigroup goes under as a result of its investment banking losses, the commercial bank will necessarily go under as well.

[azraelle]

... If Citigroup goes under as a result of its investment banking losses, the commercial bank will necessarily go under as well.

As a former customer of Citibank, may I say ... GOOD! Couldn't happen to a NICER banking corporation, may they rot and burn in Hell!

[Big Ben]

Many entities put part of their business in bankruptcy and have the other part out of bankruptcy. But the main point is that an entity like Bear Stearns, which does not have a commercial bank is a different animal than bailing out a commercial bank.