Martin Luther King Day was a day of relaxation and rest for the student body. For the global financial markets however, it was a day of panic. The major global indexes were all down multiple percentage points. In a state of alarm, the Federal Reserve slashed key interests rates only to see the Dow plunge 300 points in the first hour of trading the next day. The Fed hadn’t cut interest rates outside of a scheduled meeting since 9/11, and had not cut them by as much since the 1991 recession. The news said in regular apocalyptic fashion that global markets had lost faith in the U.S. economy.
A few days later it was revealed that the market plunge was most likely due to a low level French trader’s actions at Societe Generale, the second largest bank in France. Jerome Kerviel had manipulated the trade monitoring system at the bank and single-handedly acquired $75 billion in bad trades. It was a simple scheme, one that only required him to enter into the computer system that he had hedged all of his bets, which he had not. When the upper management discovered his debacle they sold all of the assets at once, resulting in a $7.2 billion loss for the bank and an insinuation of global panic. Such a significant sell off in such nervous times prompted others to follow and soon the momentum and panic had spread from the offices of Societe Generale to those of Ben Bernake, the chairman of the Federal Reserve.
Cutting the federal funds interest rate shows just how nervous those at the top are about the condition of the economy. The subprime mortgage fallout has everyone uneasy.
But beyond the current market conditions, there is something unnerving about the fact that an insignificant Frenchman, who the New York Times called “Mr. Average,” could cause such turmoil in the markets and even scare the Federal Reserve into a drastic response. How can one unknown man at a desk on the sixth floor of a Paris bank manage to rock the world so?
It’s because financial markets have become vastly complicated. They act in many ways like a very intricate machine such as an airplane. Though complexities in design allow airplanes to fly and financial markets to stimulate economic growth, they also present enormous vulnerabilities. One small part breaks in an airplane engine and there is a crash. One deceiving Frenchman runs a little wild on his computer and there is, well, a crash.
The big difference however is engineers and mechanics have blueprints for airplanes. Wall-Street, economists, and politicians are far from having any sort of blueprint. Lessons are learned in hindsight. For the 90’s international bond crisis and the tech bubble the problem was figured out when it was too late. Potential disaster seems to always be one step ahead of stability.
Now we are far from seeing how the current credit crisis we are in will play out, but it may be a lot worse than people would like to think. If it only takes a “Mr. Average” to drive down global markets for a day, what does it take to drive them down for a year or a decade?
Weinberg freshman Cody Kittle can be reached at r-kittle@northwestern.edu.
