Give me a big enough lever . . .

The front page of the Wall Street Journal today is chock a block with good stories, so you're getting posts on all of them.


Lehman reports a big loss, tries to raise money Just when you thought it was safe to go back in the markets.

Lehman's larger-than-expected loss was accompanied, as anticipated, by word that the firm will seek to raise $6 billion in fresh capital. On Wall Street, the loss underscored the challenges Lehman and its rivals must face as they dramatically reduce their reliance on borrowed money. The use of debt, which helped fuel record profits when markets were booming but also led to excessive risk-taking, has come back to haunt them.

As Lehman and other securities firms now curtail their use of borrowed cash, it will be much harder for them to generate the kind of profit growth investors had become accustomed to.

This inevitably puts me in mind of a wonderful passage from John Kenneth Galbraith's A Short History of Financial Euphoria, which I highly recommend, if for no other reason than the amusing stories. Galbraith notes:

Uniformly in all such events, there is the thought that there is something new in the world. It can be, as we shall see, one of many things. In 17th-century Europe it was the arrival of tulips in Western Europe . . . later, it was the seeming wonders of the joint stock company, now known as the corporation. More recently, in the United States, prior to the Great Crash of 1987 (often referred to more benignly as a meltdown) it was the accomodation of markets to the confident, free-market vision of Ronald Reagan with the companion release of the economy from the heavy hand of government and the associated taxes, antitrust enforcement, and regulation. Contributing was the rediscovery, as reliably as before, of leverage . . .

As to new financial innovation, however, experience establishes a firm rule, and on few economic matters is understanding more important, or frequently, more slight. The rule is that financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation on an established design, one that owes its distinctive character to the aforementioned brevity of financial memory. The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version. All financial innovation involves, in one form or another, the creation of debt, secured to a greater or lesser adequacy by real assets. This was true of one of the earliest seeming marvels: when banks discovered that they could print bank notes and issue them to borrowers in excess of the hard-money deposits in the banks' strong rooms. There was no seeming limit to the amount of the debt that could thus be leveraged on a given volume of hard cash. A wonderful thing. The limit became apparent, however, when some alarming news, perhaps the extent of the leverage itself, caused too many of the original depositors to want their money at the same time. All subsequent financial innovation has involved similar debt creation leveraged against more limited assets with only modifications in earlier design. All crises have involved debt that, in one fashion or another, has become dangerously out of scale in relation to the underlying means of payment.

This is, as is often true of Galbraith, slightly too pat. But there's a pretty deep truth in his assessment.