Fundamentally insolvent

Marshall Auerback here.

Equity investors, perhaps unlike credit investors, don’t get the fundamental insolvency of the financial sector, an artifact of mega-leverage.

This is a culture that responds to visual clues and marketing jingles. Substance is at best a second thought, and seriously, there is not time in these markets for second thoughts. It’s all about maximal distraction and info flow. ADD is ingrained.

They will fall out of bed when they figure out no RTC can bail out a $600 trillion OTC derivatives market — a market that never could clear given that even netted, it is a multiple of global money stock, global money income, and the value of the global capital stock that was put at stake.

Treasury Secretary Paulson has proposed that the federal government remove unspecified illiquid assets from unspecified financial institutions. The BIS estimates the notional value of OTC derivatives is $600 trillion – that’s t for trillion. Looking at Lehman’s balance sheet, it would appear off balance sheet exposures were quite large relative to Lehman’s known borrowings.

In the off balance sheet exposures depicted in the CLSA excerpt below, you will notice derivative contracts represent the bulk of the exposures. When Congress figures out that Treasury Secretary Paulson has placed a gun on their temple to do, might they balk?

Source
CLSA (CLSA stock strategist Christopher Wood is well known for his book “The Bubble Economy,” about Japan’s Credit Bubble during the 1980s.)