Credit teams are the real villians of the financial crisis

Image via WikipediaWas it short sellers that prompted panic about bank collapses or might the withdrawal/reduction of credit lines from commercial banks played a greater part? Merrill Lynch confirmed that Bank of America had cut its' credit lines to Merrill in the week preceding its' acquisition.

Credit lines are an essential part of the liquidity portfolio for brokers and if they are removed that does two things

• it immediately constrains the ability of the broker to trade and may force them to reduce positions at a time when forced sales will exacerbate their financial woes
• it sends a clear message that confidence has been lost and that news travels fast, causing further "panic" and prompting either asset withdrawals by investors or tightening of credit lines by other firms, all concerned about being left with nothing

A weakened share price by itself does not cause a company to fail. However, the indirect effects are usually

• it impedes the company's ability to raise further capital
  
• it generates a loss of confidence in the company - a share price reflects views on a company, which in turn triggers more direct effects e.g. withdrawal of deposits
• a re-examination of a company by a credit rating agency, which in turn may downgrade the company and prompt further problems

Had Lehman had an abundance of credit, it wouldn't have collapsed - it was its' liquidity [or lack thereof] that prompted the end of the firm.

In case you think I am picking on commercial banks, brokers have their own credit teams who do the very same thing and will readily cut the trading lines of a client if there is a hint of a problem.