Adumbration

Interesting.

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Taibbi describes many events of the preceding months, weeks, and days that showed BS was closer and closer to the brink.  Given what was apparently known, quite broadly in that industry, about the fragile state of Bear Stearns, to me it's surprising that more people were not betting against it.   Given all that, it seems inappropriate to use the term "blindsided" to describe the effect on BS of the eventual avalanche of creditors trying avoid being buried themselves.  Given the broad recognition that it was over leveraged and its creditors were dropping them, is it surprising that large numbers of people would try to short the stock?  I'll bet the options market showed a lot of puts as well.  Even in the absence of the apparent fraud (or at least inadequate transparency) associated with the "naked" short selling, BS was hugely leveraged in the housing bubble.

Also interesting is his example of counterfeiting about half way down - it's one of currency inflation that the US government (and most others) have been pursuing off and on for years.  There is a problem with the conclusion to that example, however.  Taibbi says "Before long, the cash you've churned out floods the market, and the currency's value plummets. Do this long enough and you'll crack the currency entirely; the loaf of bread that cost the equivalent of one American dollar the day you arrived now costs less than a cent"  The currency that his character counterfeits is not the dollar, but the "Island Ruble";  the value of bread remains the same in terms of the currency that is not inflated, so the loaf of bread still costs a dollar, even though it may cost a godzillion Island Rubles.  For the same reasons, the character can not buy the island with a few dollars.

Continuing that thought, ... The similarity of counterfeit stocks to currency inflation is more subtle.  When the US government cheapens currency by lowering interest rates or just printing it up, the beneficiaries are those who first receive the new funds.  Those people use their new dollars and are effectively able to bid up the prices of goods and services that they first choose. Those recipients have it almost as good, as only a few things have grown in price, but eventually it all spreads out and everyone has prices to pay that are higher than they would otherwise be.  Just one more way that financial manipulations transfer wealth to the privileged.  Counterfeit stocks will (of course) depress valuations to the benefit of the counterfeiters and their cronies.  When people lose similar confidence in the dollar then we will be surely up shit creek.

BS is among the most egregious examples, but the fundamental problems with leverage were (and probably still are) systemic.  Why?  At least in part it is because the creditors of such institutions are not held accountable for their risky bets in lending in to such proceedings.  Why?  because the problem institutions are "too big to fail", and the bailouts focus on the creditors.  The stock holders may take it in the shorts, but the creditors get paid by taxpayers, following up on 25 years of bailouts.

In a very related matter, the last week or so I listened to this podcast:

William Cohan, author of House of Cards: A Tale of Hubris and Wretched Excess on Wall Steet, talks with EconTalk host Russ Roberts about the life and death of Bear Stearns. The discussion starts with how Bear Stearns and other Wall Street firms made money and how they financed their operations. The conversation then turns to the collapse of Bear Stearns's hedge funds in the summer of 2007 and how that collapse and the firm's investments in subprime mortgages led to the death of the firm in March of 2008. Cohan explains the role of borrowed money in the financial crisis and Bear Stearns in particular. The conversation concludes with the incentives facing Wall Street executives and the price they paid or didn't pay for the gambles they made with other people's money.

For a bit more on the preceding 25 years of bank bailouts and consequent moral hazard problems, consider this discussion:

Gary Stern, former President of the Minneapolis Federal Reserve Bank, talks with EconTalk host Russ Roberts about Stern's book, Too Big To Fail (co-authored with Ron Feldman), a prescient warning of the moral hazard created when government rescues creditors of financial institutions from the consequences of bankruptcy. Stern traces the origins of "too big to fail" to the rescue of Continental Illinois in 1984 and then follows more recent rescues including those of the current crisis. The conversation explores the incentive effects of such rescues on the decision-making by executives in large financial institutions. The discussion concludes with Stern's ideas for alternative ways to deal with large, troubled financial institutions.

To extract one possibly hopeful remark - "from the bailouts, the American people will realize that they have paid hundreds of billions of dollars to some of the richest people on the planet"

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