.
October 13th, 2008
03:15 PM ET

Why there's a crisis – and how to stop it

David Smick
Chief Executive, Johnson Smick International

At this point in the credit crisis, at least one thing is certain: most policymakers lack a clue of what is really at stake. Those with some knowledge are driving policy looking through the rearview mirror.

Begin with the U.S. Treasury's $700 billion bailout package. This was presented as some magic pill which, if gulped down, would quickly restore financial stability.

The "shock and awe" of the sheer size of the taxpayer-funded bailout would somehow restore confidence. Instead, stock markets collapsed and credit markets remained frozen.

This is because the credit crisis reflects something more fundamental than a serious problem of mortgage defaults. Global investors, now on the sidelines, have declared a buyers' strike against the sophisticated paper assets of securitization that financial institutions use to measure and offload risk.

In recent years, our banks, borrowing to maximize the leverage of their assets at unheard-of levels, produced mountains of financial paper instruments (called asset-backed securities) with little means of measuring their value. Incredibly, these paper instruments were insured by more dubious paper instruments.

Therefore, the housing crisis was a mere trigger for a collapse of trust in paper, followed by a de-leveraging of the entire global financial system. As a result, we are experiencing the painful downward reappraisal of the value of virtually every asset in the world.

So what are these paper instruments, these asset-backed or mortgage-backed securities?

Read more...

Editor's Note: David Smick, a global strategic adviser, is author of the new book, "The World Is Curved: Hidden Dangers to the Global Economy" (Penguin Portfolio). He is chief executive of Johnson Smick International, a financial market advisory firm based in Washington. It publishes "The International Economy" magazine.


Filed under: 360° Radar • Bailout Turmoil • Economy
soundoff (8 Responses)
  1. Terra Hoskins

    Thanks for the big picture on this. I've been trying to understand how it all fits together...

    I guess it doen't matter now, but I really wonder how the market would have responded without the drama of Congress passing the bailout. What would have happened if the government hadn't intervened? What if the banks had declared bankruptcy? I know it would be a bad scenario any way you look at it, but would the market have corrected faster on its own?

    Seems to me that policymakers are making this worse. But I don't know - governments around the world are pumping money into banks. Where is this money coming from? Is that going to make the situation worse? What does it all mean?

    October 13, 2008 at 6:09 pm |
  2. Maureen O. From Apple Valley, California

    I think the problem all started when people used credit like free money and not for an emergency. Then banks gave people loans for houses,cars,college,etc. to people that can no way of paying the loan back. By the world trying to live to out beat the Jones' they have just committed financial suicide.

    October 13, 2008 at 5:59 pm |
  3. xtina, chicago IL

    The mistake was a liberal Congress forcing banks to give loans to people who can't pay them back. Looks like our country needs to be alot more conservative in establishing our lending criteria.

    October 13, 2008 at 5:47 pm |
  4. Rainer Oberndorfinger, Coral Springs

    Oh yeah...they don't have financial problems...

    October 13, 2008 at 5:33 pm |
  5. Rainer Oberndorfinger, Coral Springs

    Anderson,

    I know that most Americans are scared s@#%less by the word 'socialism' and some Republicans (and Democrates) in Congress have stated that very clearly over the past few weeks. Look what happened. When the government stepped in here in the U.S., people got scared even more, the markets (almost) crashed, and the media fueled panic. Over the weekend, the Europeans got together, stepped in, people STOPPED being scared, and the markets recovered. It's a matter of trust in the ability of the governmental system to take care of a problem that affects the PEOPLE. Here it has neither been honest about its motives nor about its national responsibility. Patriotism is like a religon. The common believer is dedicated, humble, and honest. The one in power uses it as a tool...and he and she fool themselves. How do they still sleep at night?

    October 13, 2008 at 5:29 pm |
  6. earle,provincetown

    Just go back ,and look at the "Fab Four",yes sir, I'm referencing,the"Den of Theives",(Boesky,Milken,Freeman ,and Siegal &Co.). They did their bidding in the," Hi Yield Junk Bond Market 's",and that my friend is all about Commercial Paper. This is the only reason for the bailout,because I believe Boesky's been doing his thing in Europe(Germany/Russia)since his bannishment from the U.S. Markets,thus teaching them all the tricks of the "Trade"(for a fee) ! Secondly, the Brainiac himself Michael(The Professor) Milken, has a select group of geniuses from around the world as his premier student's enrolled in his "Charity of Venture Capitalist School", developing,and mentoring all of them in what they can,and can't do (raising cash/deriviative incubation),during the past Decade,or so! The seeds were planted, and sown . I personally believe their unscrupulous (Boesky/Milken,etc)meddling in the world's market has a, "Great Deal" to-do- about why were here? Today's 1,000 pt. Dow gain is just a dead cat bounce for more sucker's, created by a massive short squeeze . I apologize for my cynicsism, but it's only my grain of salt melting away. Thanks for listening....

    October 13, 2008 at 4:42 pm |
  7. JC- Los Angeles

    The culture of corruption that swept post 9/11 America is what needs to be addressed if our nation is to reclaim its once lofty position.

    Today, hard work, sacrifice, honesty and integrity are traits that are all too uncommon; operating in the gray, cutting corners, chasing a buck and ego-centric behavior have become the norm.

    I thought we implemented Sarbanes-Oxley so accurate corporate reporting would become the norm; how are restatements and writedowns not violations? hasn't everyone violated this law?

    Right is right and wrong is wrong; laws are to be followed and not exploited; loop holes are to be closed and criminals punished.

    Our leaders better act fast or we'll need another $700 billion to address universal healthcare fraud.

    October 13, 2008 at 4:26 pm |
  8. Clarence Albuquerque

    Whatever the paper instruments are meant to forstall or cure, it seems that many other nations are doing the same thing.... someone has to know what is all about. Sometimes the technical language seems to loose some of the message. Is there any way to report in more down to earth language? I have a feeling there will be a lot more technical dialogue before it "trickles down" to the common folk.

    October 13, 2008 at 3:40 pm |