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Since the wheels started coming off the stock market last summer, investors have looked to at least seven white knights to end the distress with a bold stroke.
Yet each, including Federal Reserve Chairman Ben Bernanke and U.S. superinvestor Warren Buffett, has failed to lift investors' spirits for more than a couple of weeks, ultimately leaving stocks to tumble ever lower. Why?
The fundamental problem in the world economy is that it grew over the past two decades to be incredibly reliant on optimistic risk takers' willingness to accept increasingly complex IOUs from companies, banks and government institutions as investments instead of real assets. Now we are seeing the same movie play back in reverse, as massive investor losses in debts once believed to be safe have led to falling confidence, rising pessimism and extreme risk avoidance.
In a gentler era, debt was important but not as vital to world finance. In recent years, debt became the oxygen of the world financial system, along with a fanciful means of transferring its risks from borrowers and issuers to investors. To the extent that neither debt nor its conveyances are now trusted, even from organizations once considered rock-solid, the entire global banking system is asphyxiating before our eyes.
The first symptoms appeared in subprime-mortgage debts and seemed to be confined to the faltering U.S. home-construction industry. Then we learned that mortgages had been "securitized" and thus had become a problem for brokerages that issued and traded them. Next it turned out that banks held warehouses full of these securities and would suffer large losses.
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Then it turned out that these damaged credits had been used as collateral for further bank loans, amplifying losses as margin calls demanded selling at deteriorating prices. Then we learned that not just banks but also corporations, states and cities had created and traded their own versions of the convoluted debt instruments and risk-transfer mechanisms that once seemed so promising. And in turn we learned about the troubled $45 trillion market for insurance on all of these credits.
The threat of the obscure
Now, with our antennae up, virtually every week we discover a new large but obscure corner of the U.S. and world financial system that -- unknown to all but a few practitioners -- depends on the confidence of debt buyers in order to survive. And they are all today gasping for breath.Take, for instance, the obscure tender-option-bond programs or auction-rate securities that I wrote about in my past two columns. These lightly regulated, trillion-dollar financing programs underpin our civic infrastructure, and their possible failure seriously threatens the health of our cities, hospitals and transportation networks.
We are not quite talking about a terminal illness here, but close enough. This slow-motion asphyxiation is worse than a flu or pneumonia, and it's more resistant to treatment than cancer. And that's why the problems besetting the market are not solvable by conventional fiscal or monetary policy changes, political gestures or mere tens of billions of dollars in new investments.
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Is a recession under way?Standard & Poor's Sam Stovall thinks we're already in a recession, and he expects much lower housing prices and a classic bear market this year.
To breathe a meaningful amount of new oxygen into the financial system, and thus effect a lasting reversal in the fortunes of major banks and stocks, experts now believe will require hundreds of billions of dollars just as a baseline. Plus we'll need to see a restoration of confidence in dishonored regulatory bodies, bank execs and ratings agencies, and quite possibly wholesale changes in the way financial companies are governed and managed worldwide. For all that, add the most precious commodity of all: time.
Until U.S., European and Asian central banks, investors and governments can coordinate a solution on an unprecedented scale, all interim white knights are doomed to fail. With them will go every minor stock market rally such as the one that kicked off at the start of this week.
Continued: Everyone wants to play the hero
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