In times of market crisis, the safest course for any one market participant may be the riskiest course for the entire market.
In past financial crises, it has fallen to someone — regulators, investment banks or even a single banker — to organize collective action and avert disaster.
Such moves involved persuading people to take steps that seemed to go against their own private interests. Buy stocks when everyone wants to sell? Lend money to a bank in danger of failing, when your own bank might need the money tomorrow? It goes against the basic principle of markets, that your job is to look out for yourself.
In 1907, Morgan demanded that presidents of New York trust companies — then a type of second-class bank — act together to save one of their own, the Trust Company of America, from a bank run.
Morgan, then the dominant figure in American finance, called the presidents to a Saturday meeting in his library — and locked the door. Not until dawn Sunday did he let them out, after they had committed the needed cash.
In 1987, on Tuesday, Oct. 20, it appeared that the crash of the previous day was going to get worse. Market makers had little capital and less appetite to risk it, and one by one trading in the shares of major companies was halted because there were no buyers.
That changed when two major brokerage firms — Goldman Sachs and Salomon Brothers — sent word to the New York Stock Exchange floor that they would buy any stock in the Standard & Poor’s 500 if their orders were needed to keep the shares trading. Just after that word was sent, the market turned around.
In 1998, when a possible hedge fund failure seemed to threaten the financial system, it was the Federal Reserve Bank of New York that called in all the major financial institutions and organized a bailout.
But efforts to organize concerted action this time have been limited. Treasury Secretary Henry M. Paulson Jr. has sought to get agreements in two areas — renegotiating mortgages and putting together a fund to deal with structured investment vehicles.
In part, that may reflect the slow realization of what is at stake. For many months, we called it the subprime mortgage crisis, because that was where the problem first became apparent. But that label is far too narrow, and serves to obscure what is at stake.
“The principal cause for concern today is the paralysis of the credit markets,” said Martin Feldstein, a Harvard economist.
The latest area of crisis is one that Morgan would have recognized in 1907. The major Wall Street houses refused to commit capital to the auction-rate market.Now many auctions are failing.
When the crisis storms gathered in late 2007, much of the problem was with complicated securities — collateralized debt obligations. The big banks were unable or unwilling to either buy the securities or find customers to buy them.That lack of action has damaged the reputation of each of the houses. Bosses are no longer are sure just how adequate their capital is, and they are afraid to commit it while the financial crisis swirls around them.
It is not clear what the Fed or the Treasury could, or should, do now. The players can no longer be gathered into a single room, and they are regulated in different countries around the world, if they are regulated at all. Things are far more difficult because many of these markets are unregulated, making it difficult to gauge who is at risk and for how much.
But it is hard to see this ending until something is done to, in Mr. Feldstein’s words, assure “that necessary extension of credit.” Lowering interest rates will not, by itself, do that so long as the banks and investors are too scared to lend money at any rate.
In their book on the Panic of 1907, published last year before the crisis began, Mr. Bruner and Mr. Carr hailed Morgan’s actions, as well as the Fed’s 1998 move to salvage the hedge fund. But they warned, presciently as it turned out, that the current environment might hamper similar efforts in a new crisis.
“In a globally complex financial system, will such collective action be possible if the crisis is triggered beyond the reach of any of today’s regulators?” they asked.
So far, it appears the answer is no.
In past financial crises, it has fallen to someone — regulators, investment banks or even a single banker — to organize collective action and avert disaster.
Such moves involved persuading people to take steps that seemed to go against their own private interests. Buy stocks when everyone wants to sell? Lend money to a bank in danger of failing, when your own bank might need the money tomorrow? It goes against the basic principle of markets, that your job is to look out for yourself.
In 1907, Morgan demanded that presidents of New York trust companies — then a type of second-class bank — act together to save one of their own, the Trust Company of America, from a bank run.
Morgan, then the dominant figure in American finance, called the presidents to a Saturday meeting in his library — and locked the door. Not until dawn Sunday did he let them out, after they had committed the needed cash.
In 1987, on Tuesday, Oct. 20, it appeared that the crash of the previous day was going to get worse. Market makers had little capital and less appetite to risk it, and one by one trading in the shares of major companies was halted because there were no buyers.
That changed when two major brokerage firms — Goldman Sachs and Salomon Brothers — sent word to the New York Stock Exchange floor that they would buy any stock in the Standard & Poor’s 500 if their orders were needed to keep the shares trading. Just after that word was sent, the market turned around.
In 1998, when a possible hedge fund failure seemed to threaten the financial system, it was the Federal Reserve Bank of New York that called in all the major financial institutions and organized a bailout.
But efforts to organize concerted action this time have been limited. Treasury Secretary Henry M. Paulson Jr. has sought to get agreements in two areas — renegotiating mortgages and putting together a fund to deal with structured investment vehicles.
In part, that may reflect the slow realization of what is at stake. For many months, we called it the subprime mortgage crisis, because that was where the problem first became apparent. But that label is far too narrow, and serves to obscure what is at stake.
“The principal cause for concern today is the paralysis of the credit markets,” said Martin Feldstein, a Harvard economist.
The latest area of crisis is one that Morgan would have recognized in 1907. The major Wall Street houses refused to commit capital to the auction-rate market.Now many auctions are failing.
When the crisis storms gathered in late 2007, much of the problem was with complicated securities — collateralized debt obligations. The big banks were unable or unwilling to either buy the securities or find customers to buy them.That lack of action has damaged the reputation of each of the houses. Bosses are no longer are sure just how adequate their capital is, and they are afraid to commit it while the financial crisis swirls around them.
It is not clear what the Fed or the Treasury could, or should, do now. The players can no longer be gathered into a single room, and they are regulated in different countries around the world, if they are regulated at all. Things are far more difficult because many of these markets are unregulated, making it difficult to gauge who is at risk and for how much.
But it is hard to see this ending until something is done to, in Mr. Feldstein’s words, assure “that necessary extension of credit.” Lowering interest rates will not, by itself, do that so long as the banks and investors are too scared to lend money at any rate.
In their book on the Panic of 1907, published last year before the crisis began, Mr. Bruner and Mr. Carr hailed Morgan’s actions, as well as the Fed’s 1998 move to salvage the hedge fund. But they warned, presciently as it turned out, that the current environment might hamper similar efforts in a new crisis.
“In a globally complex financial system, will such collective action be possible if the crisis is triggered beyond the reach of any of today’s regulators?” they asked.
So far, it appears the answer is no.
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