They say history repeats itself, but usually not this quick. The United States is in going through a huge banking collapse not seen since the banking collapse that gave rise to the Great Depression.
Looking back at the first collapse provides a good education. We had lots of people building paper wealth. That market corrected very suddenly and panic ensued. People tried to get money out of the banks and banks did not have it. The collapse ensued.
The Great Depression was nothing less than a brutal period in world history. Not only did the United States go through 10 years of misery, but the world did since the ties to the US economy were strong enough to create a cause and effect situation.
It took two major events to put a stop to the economic misery. Social projects by the government created jobs for tens of millions and then World War II started. War requires goods and the war acted as the ultimate economic stimulus package.
Does all this sound a little familiar? It should. The only difference is the Great Depression was fueled by stock market gains, while we have seen housing market gains. We all hope, of course, that a World War is not necessary as well.
The world of banking and finance these days is shocking. Huge names like Merrill Lynch, Lehmans and AIG in dire straits. Freddie Mac and Fannie Mae, the backstops of the mortgage market, in government hands. It is simply shocking.
Do not be confused about Merrill, AIG, Freddie Mac and Fannie Mae. They did not file for bankruptcy, but only because they were either saved by the government or snapped up for pennies on the dollar. For all intensive purposes, they failed as entities.
Given the clear similarities, why have we not sunk into the throws of a complete banking collapse and another depression? It might still happen, but one man stands in the way. Ben Bernanke of the Federal Reserve is really earning his salary.
In 1929, the Federal Reserve was neither particularly strong nor prepared for the massive rush on banks. To the extent that is was involved in the banking process, it failed in its role. Well, not this time.
The Federal Reserve has a number of roles. The biggest is to provide liquidity to the financial system. Essentially, it loans money to banks. It is the last step before government intervention. In the current crisis, the Fed and Government have put up over 900 billion dollars to keep things running.
The Fed has become very savvy. It has started stepping in and taking over banks. To prevent panic, it arranges for a buyer of the bank by guaranteeing the transaction. It then does the transaction over the weekend when there is less focus on the news.
So, does this mean the financial crisis is under control? Not really. It should only get worse. AIG is a huge company. The Fed is mostly trying to buy time till things settle down naturally. When and how that happens is anyone’s guess.
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