Sunday, September 21, 2008

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Financial: Trust and Confidence

by Reb Akiva at Mystical Paths

The whole financial system is based on trust, and your use of it is based on confidence. One institution trusts a piece of paper from another with a promise to pay (a "check"). You have confidence that when you hand over your money, whenever you go back to get it, it will be given to you.

Trust between financial institutions fails when they begin to perceive another institution as being in a risky situation, and think it may not be able to honor it's promises. Right now almost every institution is looking at it's neighbor suspiciously, given what happened to Bear Sterns, Lehman Brothers, and AIG. Since they no longer trust the other, they institute extra requirements to increase the likelihood of payment. Those cost extra, a lot extra, and strain the situation even further - where even institutions that were well balanced and in good shape may not be able to handle the strain of these extra costs.

Now for the confidence. Those in the know, the professional money managers who run the big pension funds, the hedge funds and large scale investors, saw this happening and lost their confidence. So they went to get their money NOW, before their institutions would go under. This put the institutions under massive pressure, which has now leaked out to even the average person reducing our confidence. Which makes us want to get our money out to "safety", which puts the institutions under MAXIMUM pressure.

Trust and Confidence are not the base cause of this problem, but they are what has brought it to a knife's edge of meltdown.

My children and I had a discussion of the Rothchild's over Shabbat. While the bracha and success of the father was an amazing blessing from heaven, the success of the next general as an international banking system spread across Europe could be attributed to the father sending them out, and the brothers having absolute trust in financial commitments made or received from their brothers.

The US Treasury's rescue plan is 100% focused on the trust problem. They will invest up to US $700 BILLION to "buy" troubled investments from the various institutions, so that no institution has to worry about whether another has the "bad mortgages" and can be trusted to cover it's commitments.

As I write this, it's late night Sunday in Israel. The US Congress has to approve, write the law, and fund this plan. At the moment they are balking because: it's an election year, no individuals get to claim enough credit, it may seem that they are bailing out the institutions and not really helping the people (there is some truth to this), and everyone wants to get their little thing in to say they took care of their people. They have till the open of markets Monday (9:00 AM Eastern) to get it done.

And even then, your guess is as good as mine as to whether it will be enough.

UPDATE: Lets Play Political Stock Market Chicken!

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