Institutions on a Bubble

Bank failures in the Great Depression were caused by savings lost in the stock market bubble. Today our banks are prevented from investing in the stock market, instead restricted to a “safer�?asset class: real estate. To see the illiquid bubble that some of our financial institutions are now dependent on, see the chart below of U.S. home prices adjusted for inflation back to 1890.

Speculativebubble.com has created a rollercoaster video of this chart, which we recommend because it reflects the emotional aspect of markets. Financial institutions that are based on the real estate market will face serious problems as the boom unwinds. Mortgage lenders are already going bust. As home prices continue to fall, aided by regulatory and market restrictions on credit, baby boomers will put investment properties, in which they hold little equity, on the auction block. Alt-A mortgages which fueled these properties will fall in value. Current ‘thinking' is that financial institutions have passed on much of the mortgage risk to hedge funds. However when hedge funds fail, ‘prime brokers' historically have been forced to accept the hedge fund's losing positions. Illiquid arrangements (for instance credit derivatives) will then be the responsibility of the prime brokers. They will be forced to sell at any price as they try to prevent losses on their own books. As the editor of The Commercial and Financial Chronicle in November of 1929 reported on the Great Crash, ‘the crowd didn't sell, they got sold out.' The trading desks of the Wall Street Firms will cash out as the panic develops, the lady in Omaha will be stuck on the phone with a busy signal.

http://www.marketoracle.co.uk/Article806.html