ramblings of an aimless mind

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Lemon brothers…

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The newspapers, the BBC and pretty much any other media I have happened to glance at in the last 48 hours are full of stories about the meltdown in financial circles. I guess people did not really expect that Lehman Brothers will be allowed to go bust or the Merill Lynch will go up for sale but the coverage has been amazing.

For a long time my relationship with the banking industry has been confined to me, my chequebook, my debit card in later years and the occassional visit to deposit/withdraw money. Only recently have I been trying to learn a bit more about what goes on in these circles and very often I find myself in awe at how the system works. It’s the ultimate in value addition and trading. It is the kind of thing that takes a sheet of paper normally worth a few pennies(or less) and makes it worth hundreds, thousands or even millions simply by printing a share certificate of the right company at the right time. This humble sheet of paper, now worth such a bloody lot can probably be used as security to get a loan to buy a house and the person who gave the loan can then “sell” the loan (I never even imagined such a thing could be possible) to someone else.

The problem of course arises when the humble sheet of paper turns out to be of a company which has a Lehman brothers style fate and goes back to being worth a few pennies. Unfortunately someone has risked a loan on this piece of paper, and if things like this happen on a large enough scale, we get what is being reported in the media nowadays.

The amount of “notional” value attached to anything in the financial industry is mind boggling. So it the flexibility that comes from being so dependent on notional values. I can’t imagine any other industry where people can sell what they do not own(as some short selling Hedge funds may do), or try to buy things that are not produced(people speculating on next years rice harvest). Everything is a number, once it was in a book, nowadays its probably on a screen.

The heavy dependence on the notional is probably what makes financial firms so vulnerable to common rumours. The CEO of a company that actually manufactures something has it easy, if he hears any rumours that his firm is on the verge of collapse, he could probably show his shareholders that the factory is busy, the order book is full, the sales to retailers are healthy and a tour of some supermarkets shows the companies products being sold well. Once he does this, most people would be convinced and keep their investment in place. The CEO of a bank on the other hand would simply have to throw up his hands and say “trust me”. I don’t even think a bank could open a vault somewhere and show people a stack of cash, most of their deposits are probably given to someone to buy a loan on a house leased from someone else who bought it by taking a loan using his wife’s jewels as security or something. He could show his shareholders the number on the screen, but they would just say “yeah right” and ask for their money back. The more people withdraw their money, the stronger the rumour becomes, even more people turn up demanding their cash and down goes the back.

Its an interesting world and I look forward to following the developments. Just hope that my bank is safe…

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Written by clueso

September 16, 2008 at 12:11 pm

Posted in Uncategorized

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