Wednesday, December 24, 2008

The Debts of the Spenders: Lehman Bros - The Road to Hyper Deflation

When Paulson let LEH go bankrupt I was very surprised. Didn't he realize that LEH was a critical counter-party to many OTC derivative trades? Didn't he know that LEH was a primary dealer intimately connected to the world banking system? Didn't he know that LEH had clients all over the world?

For whatever reason(s), Paulson made a move that led to hyper-deflation this fall and early winter. LEH's collapse wiped out dozens of counterparties - starting with AIG - that has since rippled around the world. The first few cracks were visible and easily contained (AIG and the shorting ban).

BUT, like throwing a stone at a glass window, the cracks spread in a spider web pattern and branched out into dozens, then scores, and now possibly hundreds of smaller branches throughout the global economy. Even those institutions and individuals not directly exposed to LEH's trades became affected. The massive amount of debt destruction was reflected in the record TED spread and impending collapse of the money markets back in October.

Emerging markets were also another victim, then commercial real estate, then commodities, and now retail.

Credit or debt (depending on your viewpoint) is THE lifeblood of the modern economy. Debt allows borrowers to leverage their returns. It grants the small business and average person the ability to achieve in years what took their ancestors generations to achieve - the attainment of wealth (or at least its trappings). Just look at student loans for example. For larger institutions, the returns were phenomenal. Several hundred or even thousand percent returns in months and even weeks were possible (at least on paper).

I am not repeating anything that most readers here already know. I think it's just necessary sometimes to take a step back and analyze the trees from the forest. We get caught up in day-day market movements instead of looking at the bigger picture.

And for the inflation watchers...don't worry, I haven't forgotten you. My next article is called, "Obama: The Road to Hyper-Inflation."


Blog Archive