At the End of the World...

With stocks down seven percent in Europe and the United States today, it looks like the end of the world, and maybe it is.

But maybe it is just a problem of too many people borrowing too much against too little in assets. Or setting up their lives without any thought for the downside.

There’s a simple fact about borrowing a ton of money. Things better work out for you, otherwise you’ll be wiped out.

From time immemorial financial intermediaries like banks have operated in a highly leveraged way, borrowing and lending a lot of money. Problem is that when the assets securing the loans start to go south then so does the bank. And that is what we are seeing now.

The problem right now is that market participants lack confidence that the other party to their transaction is going to be there next week. So they are reluctant to lend to them. The central banks are running around hosing everyone with money but so far this hasn’t solved the problem. There are still a lot of people with assets securing loans that are worth a lot less than they were last week, last month, or last year.

The solution is fairly simple. All these folks who are leveraged up to the gills and beyond are going to have to be rescued by companies that aren’t leveraged up to the gills. That’s what J.P. Morgan did in 1907. He took the questionable assets of a highly leveraged broker and swapped them with the gold bonds of much-less-leveraged US Steel. All of a sudden the broker’s loans were secured by an asset that everyone could trust, and US Steel had an asset that turned out to be worth a lot more that people feared.

Unfortunately this time around our genius leaders haven’t yet decided how to do this. We must hope that they hurry up and figure it out. It’s their job to do stuff like this, after all.