What is a Banking Meltdown and Why is it Possible?
It would be nice to think the economy isn't in such bad shape, but after reading the article below, I have my doubts that things are going to get any better before they get worse.
Wouldn't it be great to hear the opinions of those bankers (or other knowlegable finance pro's) who regularly visit this forum, and hear what hey think about how we got into such a mess with derivatives and what could/should have been done to prevent this global banking debaucle?! Where are a pair of good cement boots when one needs them!
Citigroup collapses! Banking Shutdown Possible
by Martin D. Weiss, Ph.D. 11-24-08
"What Is a Banking Meltdown And Why Is it Possible?
On October 11, 2008, a single statement hit the international wire services that provides more specific clues:
"Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown."
This statement was not the random rant of a gloom-and-doomer on the fringe of society. Nor was it excerpted from a twentieth century history book about the Great Depression. It was the serious, objective assessment announced at a Washington, D.C. press conference by the Managing Director of the International Monetary Fund (IMF).
The unmistakable implication: So many of the world's largest banks were so close to bankruptcy, the entire banking system was vulnerable to a massive collapse. The primary underlying cause:
The Mafia knows all about systemic meltdowns of gambling networks. In the numbers racket, for example, players place their bets through a bookie, who, in turn is part of an intricate network of bookies. Most of the time, the system works. But if just one big player fails to pay bookie A, that bookie might be forced to renege on bookie B, who, in turn stiffs bookie C, causing a chain reaction of payment failures.
The bookies go bankrupt. The losers lose. And even the winners get nothing. Worst of all, players counting on winnings from one side of their bets to cover losses in offsetting bets are also wiped out. The whole network crumbles" a systemic meltdown.
To avert this kind of a disaster, the Mafia henchmen know exactly what they have to do, and they do it swiftly: If a gambler fails to pay once, he could find himself with broken bones in a dark alley; twice, and he could wind up in cement boots at the bottom of the East River.
Unlike the Mafia, established stock and commodity exchanges, like the NYSE and the Chicago Board of Trade, are entirely legal. But like the Mafia, they understand these dangers and have strict enforcement procedures to prevent them. When you want to purchase 100 shares of Microsoft, for example, you never buy directly from the seller. You must always go through a brokerage firm, which, in turn is a member in good standing of the exchange. The brokerage firm must keep close tabs on all its customers, and the exchange keeps close track of all its member firms. If you can't come up with the money to pay for your shares, the broker is required to promptly liquidate your securities, literally kicking you out of the game. And if the brokerage firm as a whole runs into financial trouble, it meets a similar fate with the exchange. Very, very swiftly!
Here's the key: For the most part, the global derivatives market has no brokerage, no exchange, and no equivalent enforcement mechanism. In fact, among the $181.2 trillion in derivative bets held by U.S. banks at mid-year 2008, only $8.2 trillion, or 4.5%, was regulated by an exchange. The balance " $173.9 trillion, or 95.5% " was bets placed directly between buyer and seller (called 'over the counter'. And among the $596 trillion in global derivatives tracked by the BIS at year-end 2007, 100% were over the counter. No exchanges. No overarching enforcement mechanism.
This is not just a matter of weak or non-existent regulation. It's far worse. It's the equivalent of an undisciplined conglomeration of players gambling on the streets without even a casino to maintain order. Moreover, the data compiled by the OCC and BIS showed that the bets were so large and the gambling so far beyond the reach of regulators, all it would take was the bankruptcy of one of the lesser derivatives players'" such as Lehman Brothers " to throw the world's credit markets into paralysis."
A link that might be useful: