What a bizarre financial week

Wall Street
What a week. A French bank discovers $7bn in losses due to a rogue trader and starts to unwind the trades. This tanks the European markets. The Fed, not knowing what happened, panics and does an emergency three quarter point rate cut. The US markets open sharply down, then recover most of the loss.

The next day the NY insurance regulator mets with embattled bond insurers and says maybe a rescue could be possible. The Dow responds with a monster rally, one of the largest ever.

The next day the insurance regulator says, hmmm, maybe it’ll take longer than we thought. He was thinking $15bn would do it but other, more accurate estimates of the amount needed to prop up the bond insurers range from $120-200bn, making this only something a government could do.

The markets slid most of the rest of the week.

The Fed’s panic rate cut made them look really stupid. Plenty of financial blogs and websites questioned why the Fed was bailing out the stock market as that is not their mandate. Just who is in control, the Fed or the banks?

Maybe no one. That’s who. We have a vast, unregulated shadow banking system, trillions of dollars in opaque debt-backed securities, and a comatose, compliant regulatory environment. Huge sums of money flow across borders effortlessly. A financial butterfly flaps its wings, triggering a hurricane someplace else.

And I suspect we’ve only just begun. In great danger there can be great opportunity, true, but there will also be carnage. The bond insurers can not be allowed to fail, the repercussions would be too severe, spilling out into the economic world at large. Stay tuned.