The Financial Meltdown - When Your Business Model is Questioned

I've refrained from commenting on the current state of the financial markets for some time. There has been a ton of commentary on the matter and in reading all of the news and opinions, it is clear that people in this country are really clueless as to why the banks and investment banks are in trouble. Everyone is pointing fingers at who to blame.

The truth of the matter is that anyone who invests in the financial markets should take the blame. The simple reason why banks and financials are in trouble is that all of a sudden the investors in the stock market decided that the rules of lending were not palatable and that the asset to loan ratio of companies were too high. The rules of lending are established by the government and essentially allow a bank to lend more money than it has.

For example, for every one dollar that is deposited into a bank, the government allows that bank to lend out a multiple of that amount. Now you can see why banks are so eager to have you put your money into their savings accounts. They can turn around and lend that money several times over at exorbitant interest rates. As investors in banks, we have loved that business model that was essentially sponsored by government regulations on banking.

The banks did nothing wrong. The investment banks did nothing wrong. They continued to loan money at higher and higher ratios, but these ratios were within the rules of lending. As investors, we continued to bid up the stocks of those banks.

All of a sudden when people started defaulting on loans or when the specter of unpaid loans arose, investors started to get nervous. Short sellers saw opportunity and the market punished companies with poor quality loans or high loan to asset ratios. But no one violated any rules. People who borrowed just began to be unable to pay loans.

Now we are at the point where some significant financial institutions have gotten crushed. People really should not be upset about it because like any other business, the business model of the bank or investment bank has gone out of favor. I can think of hundreds of companies who suffered a similar fate. What I will say is that most failures come early in a company's life, not decades or centuries later as is the case with many of these banks. But the same concept is true - that the business model of these companies have gone out of favor.

I could go on further on this issue but I will save it for my next post - how private equity companies would handle the fix versus the government's fix.

Comments

[kid mercury]

while everyone bears some blame, federal reserve deserves the primary portion of the blame. greenspan's fed created the dot com bubble by overexpanding the money supply. the money supply was again overexpanded to create the housing bubble. the money supply is AGAIN being overexpanded to pay for the bailouts of fannie/freddie, AIG, and apparently anyone on wall st who feels like getting the fed to print some money and give it to them. the end result will be massive inflation (the 14% we have seen thus far this year is just the beginning). the american people are being robbed via inflation, with the beneficiaries being those who received the excess money that was created: wall st firms and the military industrial complex.

time to get out of the US dollar. forex, gold, commodities are the way to protect yourself from inflation. over the next 3.5 years (i hope not sooner), we'll see the US dollar essentially die.