hiredgun

Roach, I wouldn't quite make the leap that you seem to want to make from all of this - that the startling and significant implosion in the financials somehow indicates the need for a paradigm shift away from capitalism itself.

I will say that this compellingly demonstrates a couple of things: one, the foolhardiness of the ideology of complete financial deregulation. What we have had for the past decade is a system of financial institutions that were highly leveraged enough, and interconnected enough, to become vital in the sense that they were 'too big to fail'. Implicit in all of this was a government guarantee, that in a crisis, taxpayer money would be used to prevent a failure - kind of like how the FDIC guarantees deposits. And yet this banking system was not made to accept the flipside of that guarantee - some kind of regulation to control risk. As roachboy alluded, it was assumed that the private sector could manage risk well enough on its own, that capital was equivalent to rationality. This has been proven disastrously, demonstrably untrue.

A word on 'too big to fail'. I understand the impulse, echoed by some here and no doubt motivated by some sense of capitalistic justice, to simply cheer as Lehman burns and the other financials retrench. Unfortunately, the world we live in doesn't work this way. The amounts of money at stake are so enormous that the impact on Lehman's counterparties (other financial institutions with exposure to Lehman's debt), to take just one example, would reach most of the way to a trillion dollars. There is a serious risk of a cascade of bank failures to follow, as other banks' assets disappear from their balance sheets each time another bank goes belly-up, defaulting on its debts. Even without a cascade, what we would see - will see, in the coming days - is a severe contraction of credit that is going to choke the economy for some time to come. You can't invest in new economic growth without credit. So as much as we like to see the economy as in most cases self-correcting, there is a limit to what any economy can absorb without complete collapse, and I think some here are underestimating the impact of what a total collapse of the credit system would do to the US economy - and the world economy, for that matter. (Bailouts aren't a great solution - those who mention moral hazard are absolutely right. The idea is not to get here in the first place. But the phenomenal levels of risk taken by private enterprise have brought us to this juncture and left us to choose from among pretty terrible options.)

So yes, some regulatory safeguards need to be put in place, and no, it's not really all that hard to imagine what some of those might be. We cannot, as a system, be so cavalier about manipulating assets whose worth is almost impossible to value. And we cannot then trade those assets at absurd levels of leverage - I think I read that the average gearing was something like 14 to 1 - don't remember if that was the industry, or Lehman particularly.

Anyway, the second thing demonstrated by the crisis is that our economy, boosted by both a housing stock and a financial sector that were vastly overvalued, has been far weaker than we imagined. I'm afraid the financials are just the canary in the coal mine, and that we are going to see a lot of spillover into the 'real' economy, and soon. Expect things to get worse before they get better.