On Friday, we noted our disagreement professor Paul Krugman as to the multi-variate causes of the crisis and collapse.

The point of contention was the impact of sub-prime loans on the entire US Housing market (and whether lending standards were enforceable). My argument was that then Fed Chairman Greenspan’s nonfeasance allowed all manner of Zero Lending Standard loans — primarily sub-prime 2/28 ARMs. Had he enforced lending standards, it would have prevented ~3-5 million unqualified buyers from entering the housing market. With significantly lowered demand, the credit bubble/housing boom would have looked very different.

That was Friday; The Sunday NYT brings an interesting phrase to our attention: That Lehman Brothers “precipitated the collapse.”

Frank Rich wrote:

“But in the 16 months since that other calamity in downtown New York — the crash precipitated by the 9/15 failure of Lehman Brothers — most of us are still ignorant about what Warren Buffett called the “financial weapons of mass destruction” that wrecked our economy.”

Rich uses an interesting — and I have to admit, correct term — when he states “precipitated.” It means to throw violently; to bring about especially abruptly. It reflects a factor that speeds or expedites an event. (Bill Safire would no doubt approve).

Too many writers seem to confuse causation with the subtler “precipitate.” Lehman Brothers no more caused the crisis than a trailer park that gets destroyed causes a tornado; The difference, as most will all acknowledge, was that Lehman was a factor in the overall build up of derivatives, securtitized mortgages, and leverage. But they were one of many firms doing these financial actions, and hardly a sole, “but for” cause of the collapse.

If I were to have any quibble with Rich, it is with how most people will misread the verb; Too many will read “precipitate” as “create;” rather than its meaning of an enzyme — one that rapidly accelerates a latent or existing chemical reaction. But that is not how most people will read that sentence — they will assume it means cause or create.

Perhaps its easier to conceptualize a feedback loop: There were many factors that contributed to the credit collapse, and each subsequent failure allowed the storm to pick up more force, enabling it to collapse a bigger and previously believed impervious firm:  As each firm went, the crisis was able to knock over a bigger domino, gaining power at every step.

Visually, I find the idea of a feedback loop gaining strength to be appropriate:First Bear Stearns fell, then Fannie Mae, then Lehman Bros, then AIG, Citi, Merrill Lynch and ultimately Bank of America.

>

Previously:
Bubbles & Banks & Zero Lending Standard Loans (January 8th, 2010)

http://www.ritholtz.com/blog/2010/01/bubbles-banks-zero-lending-standard-loans/

Source:
The Other Plot to Wreck America
FRANK RICH
NYT, January 9, 2010

http://www.nytimes.com/2010/01/10/opinion/10rich.html

Category: Bailouts, Credit

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

19 Responses to ““Precipitating” the Credit Crisis”

  1. DonF says:

    While I absolutely agree, I was more taken to the second part of that comment in that we are still very ignorant about the “financial weapons of mass destruction”. With that, I am glad to see Brooksley Born as a Commissioner on this Financial Crisis Inquiry Commission. Should be a very interesting week.

  2. Greg0658 says:

    “one that rapidly accelerates an latent or existing chemical reaction” .. yep .. saw what a latex reactor can do when it’s just not going as expected (wished) .. fyi it goes boom blow out the wall kill some nearby folks

  3. Greg0658 says:

    and ps .. 22-51 has cooked up an insurance policy for all that I hear

  4. Moss says:

    So true. Lehman’s demise illuminated, crystallized or otherwise defined the ‘fallout’ which was hidden so well that no one could preditd such a negative.

  5. max says:

    Too many writers seem to confuse causation with the subtler “precipitate.” Lehman Brothers no more caused the crisis than a trailer park that gets destroyed causes a tornado;

    Well, I didn’t! Heh. ‘Catalyzed’ might have been (and might be) a better word.

    First Bear Stearns fell, then Fannie Mae, then Lehman Bros, then AIG, Citi, Merrill Lynch and ultimately Bank of America.

    The basic problem with that framing is that people keep treating it as abnormal somehow. To me it seems like a perfectly normal 19th century banking crisis. Unregulated banks blow themselves up on a regular basis – and in a banking crisis of the 19th century, one bank going down almost invariably killed a lot of other banks.

    And it’s not like this sort of crisis hasn’t started recurring recently – I had a front row seat for the S&L housing bubble & bank meltdown and it preceded exactly the same way. A number of healthy banks started talking longer than normal risks, some fraudsters showed up to get in on the easy money, and the regular joe bankers saw the profit-opportunity, so everyone started getting it in on the action, and pretty soon ever bank has taken the kind of risks that sink banks in a crisis. Enjoying the returns, the usual suspects kept rolling the dice until an external shock kicked over the first domino.

    The problem is, is that a bunch of old people (like thee & me) recall a time after the banks had been properly regulated but before they had been idiotically deregulated, when banks seemed like real bastions of staid behaviour. It just turns out that that standard of staid behaviour wasn’t caused by bankers innately being smart, sensible guys, it came about because the law was written to enforce that kind of behaviour & regulators made the banks follow the rules.

    But living memory of the banking collapse of the Great Depression has faded away, and a bunch of con artists spied an opportunity to return us to the days of yore. It so turns out the bankers can run their cons and skip and get away with it (for now) so they have no reason to want to return to safe banking. But it is immediately apparent to everyone else that they need safe banking, but they can’t afford to buy the legislators the way the banks can.

    max
    ['But not to worry, since the bankers won't stop until they create a crisis so bad that they all wind up hanging from lamp posts. At which point it will suddenly dawn on them that there are probably better ways to make money besides the stealing.']

  6. [...] | Posted by Chill on 10 Jan 2010 at 11:57 am | A more realistic look at Lehman’s role in the financial crisis. [...]

  7. Steve Barry says:

    While Rich may not have totally mischaracterized Lehman, I have posted in the past that I am often infuriated by comments blaming the crisis on Lehman. It is so compelling to the MSM to do so, because it neatly pins blame on something that can’t fight back. Also for people who are scared or didn’t see this coming, blaming Lehman just about totally absolves themselves of their own faults. These are the same people who now believe the “crisis is over.” In fact we are in the early innings of the crisis. Consumers are just now finally reining in credit and they have a long way to go. Longer term rates will be rising…even the Fed says so…as we know massive issuance and debt rollover is coming this year, plus option-ARM resets. The stock market, which so far is ignoring the extreme bullishness of investors and massive insider selling, should start to discount this VERY soon.

  8. maynardGkeynes says:

    To me, precipitate carries the meaning from chemistry, that a latent component of a solution is suddenly expressed — ie, dissolved salt precipitates out as crystals. The subtle point, however, is that while the change of state may be rapid, the hidden material had been there all along. I thought that was the analogy Rich had in mind.

  9. Steve Barry:
    Did you make any predictions for 2010? Or did you quit after your 2008 ones(You know … quit while you are ahead … ;-) )?

  10. wally says:

    Lehman? Maybe. I still think the price of gas is what precipitated it. Credit was extended and extended and extended until the first shock of default would lead to more and more, like an avalanche. $4 gas is what triggered defaults on subprime, which triggered… etc., etc.

    The price of gas will do it again, too. If oil rises ahead of or faster than a recovery, there won’t be a recovery.

  11. elwood says:

    As a few commenters have pointed out, I think there is a bit of a mix up between “precipitate” and “catalyze.” Think of precipitation as adding a single tiny salt crystal to a super-saturated solution which rapidly results in all of those dissolved salts to crystalize and fall out of solution. It’s a rapid physical change from an unstable state and not a chemical reaction accelerated by a catalyst. To use an idiom, to precipitate something is akin to adding the straw that breaks the camel’s back.

  12. The Curmudgeon says:

    Precipitate is the perfect verb for what the Lehman Brothers failure represented for the crisis, round one. Now, what will be the precipitate for round two? Sovereign default? Abandonment of the Euro by France or Germany? Oil and commodity prices, again?

    A S.B. notes above, this ain’t over. The solution has again become “super-saturated” with fiat money. It’ll take less of a precipitate than another Lehman Brothers for all those leveraged dollars to fall out of the solution, again.

  13. km4 says:

    Observations from Frank Rich’s piece ‘The Other Plot to Wreck America’

    1) If Vampire Squid from Hell Citi, among the most egregious of Wall Street reprobates, feels it can get away with business as usual, it’s because it fears no retribution.

    2) The Vampire Squid from Hell is doing a far better job than terrorists could ever hope to do

    3) Without REAL financial reform – not more bullshit Hopium and Rose Colored Glasses outlook by assclown economists – Obama is gone in 2012 !

  14. Onlooker from Troy says:

    @max

    Good stuff. Indeed all the worry and anger that we haven’t done any real reform and that the banks are right back to their old games, while understandable and shared by me, are premature. They’ll keep pressing the game until it falls apart again. And much sooner than most think.

    Folks think the storm has passed and the worst is behind us, etc. But as Steve Barry says, it’s only just begun. Don’t worry, we’ll get another shot at reform when the markets are once again roiling and losses spark the movement of the masses and grab the attention of Congress. What “precipitates” it? It doesn’t really matter. It’s coming and we’ll only “know” in hind sight what the ostensible trigger was.

  15. Steve Barry says:

    @Calvin:

    When I made that call in January 08, I really felt I was warning people about what I was about to occur. Now, I feel little ability or need to make such a prediction because 1) the market is being propped up and 2) anybody not understanding the risk by now will never get it.

    I do feel comfortable, without hard timelines to say the following:

    1) We are in a deflationary debt crash…there is nothing they can do to stop it or cause inflation. The next big problem will be the State deficits.

    2) Housing will not bottom out for at least 4 years

    3) The Dow will break its March low, probably by quite a bit, sometime in the next few years.

  16. flipspiceland says:

    Other venues offer up the NAMES of those responsible for the financial debacle. Why doesn’t “The Big Picture”, namely, Barry Ritholtz, do the same?

    Why is it that you consistently permit the people responsible for the gobal financial mess to hide behind corporate name costuming and meaninglessness? Where is the righteous naming of Dick Fuld and Joe Cassano, these larcenous characters who melt into the night after a few weeks of ignominy, and yet their firms’ names come up with unflinching regularity as if the firms have some kind of living, breathing existence?

    There are no ” Lehman Brothers” , not a single damned one. There is no ” Merrill Lynch”. Allowing these crooks to hide behind corporate names isn’t the finest of hours for this or any other blog. The names of the perps are not fictitious, as is a corporate name. These shysters are real, and as such truth demands that they live with their names being brought forward in each and every reference to their corporation.

    There ARE people who made the fateful decisions that Rich refers to. Even CNBC used the term “Geithner’s Fed….” the other day referring to another secret deal he made while The Big Picture did not.

    Why doesn’t BR?

  17. johngaltfla says:

    It’s amazing how the clowns in the MSM fail to study history, thus repeating errors of properly analyzing the flow and moments which marked the change in our society and of course, markets and economics. They key failure, if there was any to identify. would be the announcement by New Century Financial on February 7, 2007 which created a huge concern that the actual “subprime” mortgage problem was far worse than originally thought. By February 27, 2007 when the first serious day of major equity volatility was recognized with a 600 point drop closing with just over a 400 point drop, the implications of the failure of this company became apparent as Fremont and numerous other houses and the various swaps held on each others securities became apparent. The ensuing panic which culminated in an all but direct interference in the markets in August of 2007 where apparently some of the major houses were tipped off of the “special” discount rate cut the Fed initiated was the clue that Krugman and others should have been studying but instead they spend time looking for an obvious bogeyman to pin and assign political blame, results in more disinformation rather than the facts being promoted at this time. God help us as these clowns continue to ignore the cause and the impacts from the last 2006 through 2007 time period which set the table for Bear Stearns and the failures which cascaded afterward.

  18. Regul[at]ar Guy says:

    Gary Gorton of Yale has the most complete description of the crisis:

    Slapped in the Face by the Invisible Hand: Banking and the Panic of 2007
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1401882

    Abstract:
    The ‘shadow banking system’ at the heart of the current credit crisis is, in fact, a real banking system – and is vulnerable to a banking panic. Indeed, the events starting in August 2007 are a banking panic. A banking panic is a systemic event because the banking system cannot honor its obligations and is insolvent. Unlike the historical banking panics of the 19th and early 20th centuries, the current banking panic is a wholesale panic, not a retail panic. In the earlier episodes, depositors ran to their banks and demanded cash in exchange for their checking accounts. Unable to meet those demands, the banking system became insolvent. The current panic involved financial firms ‘running’ on other financial firms by not renewing sale and repurchase agreements (repo) or increasing the repo margin (‘haircut’), forcing massive deleveraging, and resulting in the banking system being insolvent. The earlier episodes have many features in common with the current crisis, and examination of history can help understand the current situation and guide thoughts about reform of bank regulation. New regulation can facilitate the functioning of the shadow banking system, making it less vulnerable to panic.

  19. DiggidyDan says:

    I agree with maynardgkeynes. It’s all semantics anyhow.