Last week, I wrote that we could be entering the end of an era of excess in which excessive financial risk, in particular, had been undertaken by big-time financial houses and leaders (masters of the universe) who completely set aside normal prudence — especially in the housing sector — in their own quests for wealth and power. What we have today is a full-blown financial crisis.
Federal and state regulators, Alan Greenspan's Federal Reserve, the Congress, major investors, and others facilitated all of it with lax oversight, complacency, and a disregard for a long history of burst bubbles in prior eras.
The failure over the weekend of talks to rescue or sell Lehman Brothers, in one or several pieces, has finally taken away the illusion that the down slide can be "managed" by U.S. and offshore masters through Fed, Treasury, and other governmental involvement. Lehman has declared bankruptcy. Any assets with value will be picked up at bargain prices by others. Other assets will be written down. Investors should expect no major market upticks for a long period.
If Lehman were an isolated matter, we could declare that a bankruptcy is exactly what the doctor ordered. The feds, already stretched with their commitments to the Bear Stearns, Fannie Mae, and Freddie Mac rescues, and their required commitments to 11 recently failed regional and local banks, refused to bring public dollars into a Lehman bailout.
Seeing the Lehman story unfold, and under some pressure itself, Merrill Lynch then sold itself yesterday to Bank of America. This will be stunning to many main-street investors. Merrill is without question the household name among retail brokerages, established in just about every major- and middle-sized city in the country. But its other operations put it at risk. It no doubt will continue to operate under the Merrill banner, though owned by BofA, but it would have been unthinkable only a few months ago that it would be sold or, for that matter, that Lehman would fail.
The feds and financial community have set aside a multibillion-dollar facility on which other financial institutions will be able to draw to sustain themselves. But it will not be enough to keep other big-name firms afloat if they are too burdened. As this was written, American International Group, another huge player, was trying to sell some of its assets, to attract new capital, and/or even to sell itself. Seattle-based Washington Mutual, big in its own right, also is on the watch list. If Lehman could not be sold in its entirety, or in pieces, and if the feds would not commit taxpayer money to its rescue, WaMu has even less chance. Rumors continue to circulate that JP Morgan Chase still might acquire WaMu and/or that WaMu's new management might sell some retail locations or operations to raise enough capital to stay alive. We shall see.
We all grew up in the simple knowledge that you can't have more money going out than coming in. You can't acquire things with money you don't have. Yet these simple dictums have been forgotten over at least a decade. There won't be anymore 125 percent mortgages written again soon, for instance, to enable purchase of homes by people who don't have enough income to service their debt. New risk management standards will begin to be applied to all pending and contemplated transactions. Planned major business and residential developments will remain parking lots for indefinite periods as available capital dries up. The housing recession, nationally, will last longer than anticipated.
How bad will this be? Perhaps, as I thought last week, it will be no more than a painful but necessary and overdue correction. But it could turn out to be more than that. We shall have to see what happens to AIG and WaMu and which other institutions, down the road, turn out to be in over their heads. At a minimum, a period of stagflation appears to lie ahead.
Voters, by the way, will be asking whether a President Obama or McCain would be more likely to see the country through a financial/economic crisis. Both have leadership qualities. But Obama is relatively inexperienced and McCain is a self-confessed financial/economic policy novice. Neither has had any depth of involvement in such issues — although cynics would argue that McCain's longtime association with, and advocacy of, S&L king Charles Keating might have given him a taste of them.
Democrats traditionally have been favored by voters as the party best able to deal with such problems. This dates back to President Franklin Roosevelt's 1930s efforts to stop the Depression. But the Depression, truth be told, was relieved by World War II. Buckle your seat belt.