Banking System Collapse - Could it Happen?
After rescuing Bear Sterns, Freddie Mac and Fannie Mae, the American government decided that it had to draw the line somewhere and not use public funds to rescue Lehman brothers. The effect is that the big investment bank, Lehman Brothers has gone bankrupt leading to almost 20,000 job losses. However, although this is a high personal cost to those concerned, the repercussions could spread far across the banking and financial system.
It shows a year after the credit crunch started, we are far from reaching the bottom.
Lehman brothers were part of the ’shadow banking system’ - The banking system that doesn’t rely on deposits to fund loans. Instead Lehman brothers helped to sell on debt from other banks (including the notorious subprime loans). They were also heavily involved in derivative trading. Yesterday, as stock markets plummeted, traders tried to unwind $700bn worth of derivatives - a scale never seen before. Wall street admits that derivatives trading has grown so fast, that there is hardly any regulation of this trading.
What does the Future Hold?
The fact another big bank has gone under will send shock waves throughout the financial system. There are real concerns that the problem could spread. In the US, Ken Lewis, head of Bank of America, said he thought that up to half of the country’s 9,000 banks would ultimately go under or be taken over.
The danger is that the collapse of Lehman brothers will trigger a fall in confidence. Combined with the long standing shortage of funds, we could see higher interest rates (the libor interbank rate rose 0.5% yesterday alone) and the possibility of the credit crunch getting worse, pushing the economy further into recession.
A recession would only exacerbate the current problems. A recession would lead to more mortgage defaults - the last thing banks need at the moment. If home repossessions continue to rise and house prices fall; the losses of banks could grow even higher.
Economists such as Paul Krugman fear the worse, saying the collapse of Lehman Brothers reminds him of Russian Roulette
AIG a big insurance firm is the next finanicial institution that is in the firing line.
Original post by Tejvan R Pettinger