When I was in Davos in January, moderating workshops and panels on innovation, there was a deep undercurrent of anger at “financial innovation.” People were grumbling, “thanks for all that innovation, Bruce,” as the credit markets imploded and the economy tanked.
They were right, of course. Innovation in the financial markets created a highly-levered credit market model that was unregulated by anyone and proved to be poorly designed when stress-tested. Alan Greenspan, ex-head of the Federal Reserve and father of this credit system that is now failing, now admits that the innovative financial model isn’t working.
Now, beneath all the shouting about bailouts of Wall Street investment house Bear Stearns and a plunging stock market, we are seeing yet another round of financial innovation—in regulation. In fact, we are seeing the creation of an entirely new global credit system model that will effect all of us. For the first time, the US central bank, the Federal Reserve, is reaching out to help—and regulate, investment banks and their portfolio of securities, including mortgages on your house. In the past, the Fed only regulated banks—and your savings. Since we, as a nation, pretty much stopped saving in banks about a decade ago and began to “save” by investing in houses and other assets, this kind of makes sense.
Wall Street took our assets (and asset-based economy), designed new financial innovations that leveraged them to the sky, and built an economy based on debt. Indeed, New York and London built a global economy based on highly-levered debt. Unlike the old economy built on savings in banks, this new economy built on leveraged debt went totally unsupervised.
The Americans and Brits told the Continental Europeans, the Asians and the Middle Eastern folks not to worry. “Leave it to the markets.” Well, that translated into leaving the global economy in the hands of a few hundred private equity and hedge fund players who screwed it up royally.
So we are now in the process of designing a new global economy. As far as innovations go, this is a biggie. Soon, all the central banks in Europe and Asia will be joining the US Fed in redesigning the global credit system. The International Monetary Fund, usually active only in troubled “Third World” countries, may well come in as well to help the US and the rest of the globe. In a flash, the US appears to be a helpless giant, needing all the help it can get.
Now here are a couple of things to REALLY WORRY ABOUT. The US central bank, the Federal Reserve is “nationalizing” or taking onto its books, huge obligations that could go sour. Most of mortgage-backed securities that Bear Stearns and other the investment banks can’t currently sell. It could seriously hurt the Fed—and the dollar—if the recession gets much worse.
Add to that this—imagine what a financial crisis in China would do?
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