The past week has brought massive headaches, hand wringing, hair-pulling and panic to Wall Street as two of the largest U.S. investment banking firms crumbled. The announcement that Lehman Brothers filed for bankruptcy was bad enough. Next, Merrill Lynch was swallowed by Bank of America. A day later, one of the largest insurance companies in the US, AIG, had to be rescued by the federal government. By Wednesday, Morgan Stanley and Goldman Sachs, the two largest investment companies still standing, lost over fifty percent of their stock values despite the announcement that their quarterly earnings exceeded analysts’ expectations.
What’s the cause? It all goes back to greed, running a market on borrowed credit and the failing housing market, of course. According to a September 18, 2008 article by Steven Pearlstein in the Washington Post, for the past ten years, America has been running mostly on borrowed credit from foreign countries. People purchased homes, cars, college educations, health care as well as consumer goods with the cheap and readily available credit, while saving less and less. In turn, the government was borrowing to pay for services and benefits Americans were no longer willing to pay for with taxes, a trend that began with Reagan and was taken to another level by the Bush Administration. Corporations and investment vehicles (hedge funds, private-equity funds and real estate investment trusts) used the cheap financing to buy real estate and other companies. According to Pearlstein, as a result of the availability of all this cheap credit, “the price of residential and commercial real estate, corporate takeover targets and the stock of technology companies began to rise. The faster they rose, the more that investors were interested in buying, driving the prices even higher and creating even stronger demand.”
The ripple effect of this was that industries expanded to supply increasing demands from consumers operating largely on borrowed credit. The auto industry built more cars, airlines added planes, developers built more homes and shopping centers, and retailers added shops. Of course, exponential consumption on borrowed credit usually hits a ceiling. According to Pearlstein, early in 2007, foreigners began to stop financing much of this activity, particularly “the non-government bonds used to finance subprime mortgages, auto loans, college loans and loans used to finance big corporate takeovers.”
If greed had not blinded all logic on Wall Street, foreigners’ unwillingness to lend more credit to the U.S. should have resulted in a slowdown. Interest rates on loans should have risen, demand for borrowing decreased, real estate and corporate stock prices should have leveled off, and companies should have begun to cut back on expansion. Instead, Wall Street took matters into their own hands in order to keep the underwriting fees rolling in. They decided to double their risk in a time when they should have been cutting back.
A year later we have a stock market crash with global ripple effects unseen before. While the market has been sent into chaos, analysts have been debating the extent to which the Federal Treasury should assist Wall Street. Should the federal government let Wall Street fall? Given that any rescue operation involves placing the burden of debt on taxpayers (who may or may not have investments in the stock market), this is a serious consideration. By refusing to rescue Lehman Brothers, Treasury Reserve Secretary Henry M. Paulson made clear last week that the government would step in only when it determined that the U.S. economy beyond Wall Street would be detrimentally affected. This was the case with its takeover of mortgage giants Fannie Mae and Freddie Mac as well as with insurance company AIG.
The whole thing is playing out like a family drama. Some argue that Daddy government should teach the kids a lesson about greed and let them fall on their behinds. Let Wall Street investors, shareholders and consumers living beyond their means on credit pay for their greed and imprudence! Others advocate more caution in Daddy’s disciplining approach. Not all the kids were bad, they say. Some good kids will be paying for the mistakes of the greedy ones inadvertently. There is also the possibility that the entire family will fall on their behinds due to the exorbitant greed of a few children.
It is fascinating that the average consumer is often being blamed for Wall Street’s economic woes as much as Wall Street itself. Consumers were supposed to understand all the complicated economic maneuverings behind the beautifully packaged loan products they were presented with at the bank through aggressive sales tactics? That seems equivalent to saying the average American should really have the will and smarts to stop eating fast food, even though every thirty seconds a commercial is enticing you to go to McDonalds or Burger King.
After thirty years of “free market” advocacy, which essentially means placing as few regulations as possible on the movement of finance capital owned by ten percent of the population, this is where we end up. What’s different about this era, however, is that Wall Street has done more to divest from the US internal economy and infrastructure than ever before. As Harold Meyerson of the Washington Post explained this week, “By its actions -- elevating shareholder value over the interests of other corporate stakeholders, focusing on short-term investments rather than patient capital, pressuring corporations to offshore jobs and cut wages and benefits -- Wall Street plainly preferred to fund production abroad and consumption at home.” This essentially means that Wall Street has not helped to create more jobs in the U.S., nor has it helped update the American crumbling infrastructure. In short, not much of the wealth amassed by Wall Street in the past decade has “trickled down” to the average American.
This wouldn’t be so bad if the government hadn’t also abandoned internal infrastructural projects (except for prison building) at the same time as investors were focusing on profit rate increases regardless the long-term costs to Americans. Governmental opposition to raising minimum wage levels has kept American incomes low while opposition to unionization, policies to modernize infrastructures, and affordable education has made the middle class increasingly vulnerable. Need we mention the health care debacle?
Donald Trump was on Larry King Live Wednesday night. After laughing over the billion-dollar loss one of his friends took as a result of investing in AIG, you know what the billionaire said? He said increased federal regulations that would limit greed on Wall Street is not the answer. (Imagine that…Trump’s mantra is “no punishment for greed!”) Everything will work itself out according to market logic, he argued. You know what else Trump said? It’s a great time to buy a house from a bank.
Sure. If only everyone wasn’t so far in debt that they can’t qualify for a loan; if only everyone wasn’t feeling like they might lose their job or small business at any moment; if only wages weren’t so low that people can barely survive; if only health care costs weren’t so exorbitant; if only the price of gas wasn’t reaching $5/gallon—it would be a great time to buy a house!
After this week on Wall Street, those who have stood against “big government” and for market deregulation are running home to government Daddy’s arms, crying “Save me!” Problem is, Daddy is pretty weak after thirty years of cuts to “big government spending” and slashed tax revenues. It remains to be seen if Daddy is strong enough to rescue the greedy children, not to mention the entire U.S. family.
Daddy and the Greedy Children
- Scris de Paula Ioanide PhD
- Categorie: Paula Ioanide