Monday, September 22, 2008
They keep saying it, and it's true: an era is ending on Wall Street. In fact, "Wall Street" as defined for the last 30 years, centered on independent investment banks seeking large returns by taking large risks, will be only a memory in a few months. Wall Street's two remaining large investment houses (Morgan Stanley and Goldman Sachs) are seeking to become much more like commercial banks. They will still do investing, but it won't be their sole business any longer. Diversified commercial banking is apparently the future of finance. Investment banking as an independent activity is about to disappear, at least as an institutional phenomenon.
The origins of this almost-gone era lie in the Great Inflation of the 70s and the reaction of investors desperately seeking higher returns to compensate. One asset bubble after another followed: commodities, such as gold; loans to developing countries, leading to an early 80s bust; the savings & loans (S&L) bubble and crack-up in the late 80s; the stock bubble of the mid- to late 90s; and lastly and most grandly, the 30-year-long housing boom that culminated in a bubble (2002-2007) and bust (2007-?). The housing boom lasted as long as it did because of the demographic bulge of the Baby Boomers, who entered their prime house-buying years in the mid-70s and exited just a few years ago.
The whole investment landscape is rapidly changing. Expect thinking and practice to become much more traditional, "square," and 9-to-5-ish. The era of the frantic, 14-hour investment banking workday is surely finished.
The new government intervention in financial markets is evolving in strange and not necessarily good directions. The danger is that the Treasury Department and Fed have developed a premature, pre-emptive, and open-ended intervention -- the risk and cost to taxpayers are vague and potentially large.
Unlike previous government bailouts, there's no clear criterion of which actors really are in distress and which are just having a bad day.
it's a total whitewash. money is fungible and will naturally move wherever regulation is friendliest.
this may be the negotiated death of new york as a financial capital, but don't imagine for a moment that finance is going to suddenly go tame.
A friend of mine was arguing that point, that high-flying investment banking will just move to London, as indeed, it already has, to an extent.
The problem with this theory is that the same forces are at work there. The UK and Ireland also had a large real estate bubble that starting collapsing a few years ago. The whole business of high-risk/high-return investment banking as an independent activity (not a side business of regular banking) was based on looking for bubble-ready asset markets and across-the-board outsized returns. Demographic trends are draining that away, at least in the developed world. The developing world might be a place for such a business, except it's politically too unstable and corrupt.
A somewhat insightful article by Binah, and I agree with much of it, though he leaves out the major party in assessing blame. The obvious one. The investment banks themselves. Sure, Congress and oversight agencies turned a blind eye as Wall Street built up this house of cards which anyone with an economics and history background could see had to come apart. But it was the investment houses that created, traded, bought, and promoted the risky housing based derivatives that brought down the US financial system.
Bankers like Lehman were insightful enough to protect their 2.5 billion dollars in bonuses (http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article4795072.ece). Does anyone think they didn't know what was happening?
I hope I don't sound like a lib here, but the silence of the conservative bloggers on this issue, other than Malkin, has been deafening. As we are on the verge of the largest full scale gang-rape of the American taxpayer in history, to prop up investment banks that have been playing and hugely profiting from this system. When Treasury Secretary Paulson is done raping the taxpayer, he'll just go back to his old employer, Goldman Sachs. And the taxpayer will be left holding the bag.
I don't really disagree with Steven's comment: the investment banks themselves rode the housing boom/bubble for all it was worth. They spent the last year watching the bubble collapse coming and obviously weren't fools. Everyone with their senses and minds turned on could see the bubble collapsing.
Some level of blindness and mistakes is inevitable in free economy, or a free society in general. At that point, we're looking at the behavior of individual and institutional market actors. Commentators like Michelle Malkin are right to condemn them.
But -- and this is a big but -- it's a whole other matter for government to encourage people (including investment bankers like Lehman -- big Dem donors BTW) to do such things, to enable them, and tell them, "No problem, no matter what you do, we have you covered," or, "Hey, want a loan? No problem! Don't worry about lending standards; they're so uncool." That's why the taxpayers might get gang-raped here -- we don't know enough to conclude that yet.
A girl's gotta protect herself, you know.
These guys were effectively short puts (by way of swaps) on a real estate market at record highs in the midst of an obvious bubble.
There's no way in any universe these were sound investment decisions. They simply didn't care.
Just so you know where I'm coming from - I don't blame any politician for this. I doubt there's 1 in 100 who even slightly understands it. Yes, the FM's dropped the ball in passing through bad debt with a much higher rating than it deserved and for sure none of this could have happened if they had not, but that was only one area where good faith broke down in all of this.
The investment banks were walking their shareholders off the plank with more than likely full knowledge of the likely outcome. Hedge funds and investment banks together were using weak debt instruments in shady and intentionally confusing deals to collateralize trading operations where the risk management was frankly all smoke and mirrors, and then pitching these deals at pension funds and foreign banks.
there might have been some degree of excusable and understandable error in all this, but not at Goldman or AIG or Citi. Those guys knew exactly what they were doing.
The essence of this scam is size. The real estate mortgage market is unimaginably huge. The fees and rake off of these deals made hundreds of millions for individuals and billions for institutions. Whether or not the trades made sense was never really the point. Obviously somebody was on the winning side of those swaps, but the loser came away rich too so long as he was willing to scuttle his country and the century+ old institution he ran/worked for.
If people had any idea how utterly criminal this behavior was, they'd be far more angry than they are. But people don't understand it. They can manage a bit of outrage and they have some vague sense that something bad has been done to them, but mostly they feel helpless and confused. It's very ugly.
Oh, but I think we have to blame politicians for a big chunk of it. At the federal level, most elected officials were involved in the Fannie Mae-Freddie Mac fiasco at some level -- some quite a bit, and a handful (like Barney Frank) played central roles in making it happen.
The housing boom went on for about thirty years, the time over which the Baby Boomers formed a large bulge of buyers. There would have been some bubble behavior during this period regardless.
But it was enormously amplified by the actions of the Fed in enabling cheap credit in 1995-1999 and 2002-2007. As for Fannie Mae and Freddie Mac, keep in mind that they're involved in close to a third of all mortgages. (The federal government is involved in about 40% of all mortgages.) Whatever they did and do, can't help but have a huge impact on the housing market. It's their sheer size.
The stock bubble of the late 90s, which lasted about four years, took two and a half additional years to hit bottom after the peak, and another two years to recover from, is a counterexample. It did have cheap credit feeding it, but no equivalent to Fannie Mae and Freddie Mac. The housing bubble lasted much longer and will take longer to unwind, in part, because of the sheer scale of government-sponsored "juicing" of the market.
Politics and economics are natural enemies of one another. Economics is about reality. Politics is mostly about selling fantasies. Put them together, and you get fantasy economics. It's not like a centrally planned economy, where prices are abolished and no one knows the cost of anything. Instead, it's the manipulation of prices, which look serious but are actually unreal. Everyone's carrying around a seriously distorted picture in his or her head.