Let the Financial Reforms Games Begin!

As financial reform finally gets moving, the debate is heating up. Here is the case of the House Financial Services Committee for how its legistlation addresses the “. . . Problems Raise By Lehman Failure.”

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Lehman’s Window Dressing

The story today about Lehman’s accounting manipulations can only be described as shocking. The details are to be found in  the “Lehman Brothers Holdings Inc. Chapter 11 Proceedings Examiner’s Report”. I am not an accountant, and based on a quick look at FAS 140 I do not understand why Lehman thought it could do what it did. But it seems to me that  this case is a poster child for a change in accounting rules.

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Financial Reform Continues

Money market funds and the commercial paper markets were at the heart of the financial crisis. In the fall of 2008, money market funds experienced massive withdrawals after one fund (the Reserve Primary Fund) reduced the value of depositors’ accounts after getting caught as Lehman went under holding significant amounts of Lehman short-term debt (other money market funds also lost money but were bailed out by their institutional sponsors). In response to this drain on funds for investing in short-term commercial paper, the Federal Reserve stepped forward and insured all money market funds.

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US house prices and economic recovery

Recent commentators have suggested that house prices have a ways yet to fall, and that these further declines will lead to a further collapse in US output, potentially lengthening and deepening an already severe global downturn.  But while this US recession was kicked off by the sub-prime crisis, even the large declines in housing wealth that we have seen are not enough by themselves to explain the severity of the current downturn.  Let me explain why.

First, my comments are prompted by the following somewhat alarming figure (via Chad Jones):

Note: By nearly any measure, the appreciation of home prices between 2000 and 2006 was quite unusual. Source: Robert Shiller, Historical housing market data (Click on graph to get the Excel file)

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The Week of Living Dangerously

We seem to have entered a new phase of the credit crisis. We spent a number of months learning just how much house prices would fall and which institutions had exposure to mortgage loans. Now, as credit problems cascade and liquidity remains scarce, events seem to have moved beyond mortgages. Now we are concerned, for example, about which firms are exposed to other firms via credit default swaps.

In this entry I will make some observations about a few of the extraordinary events of the last week, specifically about money market funds, short sales, and the need for centralized clearing of financial products.

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